The Bloomberg U.S. Investment-Grade Corporate Index yield remains historically attractive: we haven’t seen yields consistently above 5 percent since the Global Financial Crisis. That said, demand for investment-grade corporate bonds is likely to wane if yields drop below the 5 percent level. While we continue to believe higher quality corporates outperform on a relative basis, tightening financial conditions, deteriorating credit fundamentals, and recession risk mean that this cohort is unlikely to replicate first quarter performance. Although financials underperformed in the wake of the banking crisis and look relatively attractive, near-term caution is the prudent path given continued uncertainty. First quarter earnings have eased some concerns over deposit outflows, however commercial real estate exposure, decreases in net interest margins and short selling in equity markets continue to add to investor angst. Consumer and technology issuers should see slower growth, lower revenues, and stubbornly high input costs that continue to shrink their margins as well.
Technicals remain a positive tailwind as the lack of primary issuance will likely continue throughout the second quarter. Supply was already below 2021 levels prior to SVB’s default but further declined into the end of the quarter, lower on both a gross (-15 percent) and net (-24 percent) basis vs. the first quarter of 2022. The dearth of long duration supply, down 24 percent, also helped buoy 30-year spreads despite the rally in U.S. Treasury yields. Fund flows provided further support for investment-grade spreads, with around $62 billion of inflows in the first quarter, according to J.P. Morgan data.
The spread relative to the risk-free rate for the Bloomberg U.S. Investment-Grade Corporate Index widened by just 7 basis points in the first quarter to 138 basis points, while the all-in yield dropped by 22 basis point to 5.17 percent. However, dispersion increased materially, with financials underperforming by 25 basis points while the industrial sector remained unchanged. We do not expect to see spread compression in regional banks relative to money center banks, as regional spreads remain around 100 basis points wider than pre-SVB levels, while money center banks have held steady and industrials have tightened on the year. Year to date, though, investment-grade spread levels look attractive compared to both investment-grade derivatives and equities.
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