Fixed Income Quarterly Strategy — April 2024

With US inflation having outstripped expectations over the past three months, monetary easing postponed to the second half of the year, and risk premiums well below historical averages, investors’ patience has been put to the test.

“We are data-dependent and not Fed-dependent” – Christine Lagarde

The first quarter 2024 featured many adjustments on the fixedincome markets. Early in the year, the consensus was pricing in six or seven US key rate cuts in 2024, reinforced in its belief, among other things, by rather accommodating language from the Fed chair (1). This view soon collided with above-expectation inflation, as monthly CPI (2) figures surpassed 0.4 % in February and March (3). After bottoming out early in the year, bond yields accordingly rose back throughout the quarter.

In Europe, key rate cuts had been priced in for as early as March, but it’s now looking more like June, despite job market-driven services inflation at 4% (4). The ECB president’s insistence that it was “data-dependent” and not “Fed-dependent” is even causing some investors to ponder the possibility of an uncoupling in monetary policies between the two central banks. Under this scenario, the ECB could take action before the Fed, which would be surprising but not unprecedented.

Everything is a matter of timing

On the credit market, take note of the resilience of risky assets, driven mainly by positive surprises on growth. Generally speaking, all of the market has fared rather well, driven by momentum on the real-estate market. Some cracks have nonetheless emerged in the shakiest corner of the market, with the return of idiosyncratic risk, illustrated by such recent events as SFR/Altice, Ardagh Glass, Atos and Intrum. In just one week, the CCC (5) segment’s year-to-date gains were wiped out. Such cracks generally point to deeper fault lines, as idiosyncratic risks tend to spread (6) throughout the market.

Meanwhile, risk premiums are currently below their historical averages of the past 10 years, particularly in the BB and B (7) segments. While good news for borrowers, one wonders how sustainable this configuration is, and what its potential impact would be in the event of a market turnaround. We have also seen a compression of spreads between the BB and BBB segments, as well as between B and BB. The latter has heightened the market’s vulnerability, particularly in light of increased volatility and idiosyncratic risks.

Regarding High Yield (8), managing the 2026 debt wall remains a major concern. So far this year, issuance has totalled almost 35 billion euros on the European market (9). Moreover, the market has been propped up by negative net supply (-16 billion euros in the first quarter) and the good performance of real-estate hybrids, a segment that had underperformed drastically in 2023. The refinancing window is therefore open, but for how long?

How we are positioned on the credit markets

Against this backdrop, we are raising credit quality in the portfolios and keeping a close watch on refinancing risks. For example, we are reducing our exposure to High Yield and corporate hybrids. Regarding Investment Grade (10), we are seeking out opportunities in A ratings or in non-cyclical, upper-BBB debt.

Barring a downturn in the growth outlook, the credit markets should hold up, as they have so far this year, to rising interest rates. However, the combination of narrow spreads and a less favourable political context in the US gives us pause. Inflation looks unlikely to return to the target without a greater negative impact on the economy. And yet the consensus is betting on a positive scenario.

We don’t think taking this risk makes sense. The compression of risk premiums between the various rating categories helps enhance credit quality without undermining the portfolios’ actuarial yield. For example, there is almost no spread any more between cyclical and non-cyclical companies. Opportunity cost is therefore almost non-existent. However, if the best-case scenario does not come to pass, we will have leeway for investing.