US corporate bond rate forecast: Rising rates create increasing opportunities in fixed income
The US corporate bond market has rallied this year as investors go into debt in place of risky assets as interest rates continue to rise.
But with inflation reading lower than expected in October, have bond markets begun to peak in the fixed income market?
What are US corporate bonds?
US corporate bonds represent debts issued on the open market by companies in order to fund their spending requirements. Corporate bonds are one of the pillars of US debt markets alongside Treasury bills (T-Bills) issued by the US government.
Corporate bonds have a higher risk profile than T-bills, because companies are less secure than the US state, which is highly likely to be able to repay all of its creditors, while companies are under more risks and obligations on their own debt.
These risks can be softened through investing in bundled debt packages based on credit ratings. They group high-quality corporate debts together according to a company’s balance sheet, repayment history and market risk.
They are also prone to the classic risks carried by bonds, namely interest rate risk and market risk.
When interest rates rise, the price of a bond goes down, as bonds at the previous price are less attractive than they were previously, pushing US corporate bond yields up for new investors. This is partly mitigated by maturities, with longer-term bonds carrying higher rates to offset the risk that US corporate bond rates will change over time.
Companies or groups with a lower credit rating are typically prone to higher interest rates, representing the increased market risk of the company and higher potential return for investors. These are split into investment-grade bonds and high-yield corporate bonds.
An example of the former is Moody's Seasoned Aaa Corporate Bond Yield. An example of the latter is the S&P high yield corporate bond index.
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Historical view on the US bonds rates
US corporate bonds tend to follow the path of US treasury bonds, as both respond to similar movements in the economy aligned to inflation and wider market risk. Both have notably appreciated this year amid a wider bear market in asset classes.
The 10-year T-bill, for example, began the year at 1.6% and has since risen to 3.8%, as of mid-November, buoyed by rising interest rates and investor pessimism over the level of transience in inflation.
Moody's seasoned bond meanwhile rested at 4.8% in November, having begun the year at 2.6%.
It is clear from the last month that there may be some optimism creeping back into the investor psyche despite wide anticipation of a recession in 2023. New inflation data showed CPI rising by 7.7% in October, a surprise to investors and analysts and increased rumblings that the US Federal Reserve (Fed) may be prepared to reign in its regimen of hawkish monetary policy that look set to push the US into recession.
There are still good US corporate bond yield opportunities. The S&P high yield corporate bond index has been tracking with inflation this year, sitting at 8.7% in November, a marked rise from levels of 4.8% in January.
What's driving US corporate bond rates right now?
Most major financial assets have seen their fate this year move alongside inflation, which has been sitting at four-decade highs in the US for most of the year in response to supply chain pressures following Covid-19, Russia’s invasion of Ukraine which instigated sanctions on energy, and a tight labour market.
That has put pressure on the Fed to hike interest rates in an attempt to quell price rises. The Federal Funds Rate (FFR) has jumped from a zero lower bound at the start of the year to a target range of 3.75 - 4% as of November.
Interest rates put pressure on businesses and consumers in terms of loan repayments, discouraging investment and spending. That takes money out of assets driven by economic demand, like stocks and commodities, and into safe havens like bonds and currency.
Earlier in 2022, Jim Caron, chief strategist of global fixed investment at Morgan Stanley, gave his reasoning for why US corporate bonds may be a safe bet in the current economic climate”
“Among corporate bonds with a relatively low risk of default, we see the most return potential in financials, which could benefit from interest-rate hikes. Financial companies also have the potential to adjust to higher inflation risks relative to other sectors in the market.
“Among non-financials, we like BBB-rated corporate bonds; we are cautious on those with ratings of A or above, which tend to have longer-duration maturities and are more interest-rate sensitive. Investors should also be wary of companies with mergers and acquisitions risks, as corporates making changes to their capital structures may dilute valuations for bondholders.”
Lower than expected inflation figures published for October might suggest the opposite forces will come into play as we approach 2023. Indeed, it would appear that rising interest rates are starting to feed into levels of demand and investment among businesses.
According to data from the Securities Industry and Financial Markets Association (SIFMA), US corporate bonds issuance fell -28.9% in the year to October 2022, suggesting less appetite among businesses to issue debt in a high interest rate environment with the expectation of a downturn on the horizon.
Breckinridge wrote that lower refinancings and mergers and acquisitions (M&A) debt offerings drove a 12% decline in investment-grade issuance through the third quarter of 2022.
But as prices come down, analysts at ING seemed confident that rates will too as the economy begins to shrink, potentially pushing bond prices back up, noting:
“The energy crisis in Europe adds to bond supply pressure as economies struggle to deal with recessions while at the same time buffering their economies from higher energy costs. This increase in supply is a driver for a widening in swap spreads, as government bonds at the same time unwind some of the quantitative easing-induced price premiums.
“Quantitative tightening is also humming in the background but is a much bigger deal in the US relative to the eurozone or the UK. Tighter conditions also contribute to vulnerabilities in the system, a system that is already being stressed by gaps in prices, wider bid/offer spreads and higher bank funding costs. In the US, repo should be pressured higher.”
Fidelity Viewpoints noted that some investors might be placing too much emphasis on rising interest rates in their attempts to sell bonds, noting the high value that can be placed on fixed-income returns from higher rates.
“Not only are yields up, prices are down, which is offering opportunities for those with cash to invest. Investor anxiety is creating opportunities to buy relatively low-risk assets at bargain prices even as they pay yields that are higher than they have been in decades,” Fidelity wrote.
US corporate bond rate forecast for 2023 and beyond
Analysts believed the events of the last year could have fundamentally changed the assessment among investors of bonds, with implications for US corporate bond rate forecasts.
“Even if inflation gets tamed in 2023, as we expect it will, we now know that an inflation vulnerability is back. That, plus more supply (especially in Europe) and balance sheet roll-off (especially in the US), should allow curves to steepen out, and actual US rate cuts will push in the same direction,” ING wrote, adding:
A US corporate bonds forecast by Goldman Sachs shared with Marketwatch predicted the instruments to return between 6.8% to 11.9% in 2023.
“Yields are much higher and the new issue market remains muted,” Anders Persson and John Miller of Nuveen wrote.
Final thoughts
Note that analysts’ US corporate bond rate forecasts may be wrong and shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before trading. And never trade money you cannot afford to lose.
FAQs
Who issues corporate bonds?
Corporate bonds are issued by companies to service debts and fund spending.
Are US corporate bonds going up or down?
US corporate bonds rose this year through to the end of October, but have fallen since amid lower than expected inflation figures.
Should I invest in US corporate bonds?
Investing in US corporate bonds can be a good strategy in times of economic gloom, but a potential recession could increase the chance of defaults. Whether bonds are an appropriate investment for you should depend on your risk tolerance and portfolio needs. Always conduct your own due diligence before investing.
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