Investment-Grade Corporate Bonds: Tax Changes Enhance Technicals

Clarity on tax policy helps drive spreads to 10-year tights, but headwinds remain.

February 23, 2018


This Investment-Grade Corporate Bonds sector report is excerpted from the First Quarter 2018 Fixed-Income Outlook.

The passage of the new tax plan was a significant driver for investment-grade corporate credit spreads, which tightened to levels not seen in over a decade. We anticipate corporate credit spreads to remain at similar levels or tighten over the first quarter of 2018 despite multiple headwinds, such as quantitative tapering, geopolitical risks, and what many believe is the tail end of a virtuous credit cycle. The firm tone will remain intact as the technical picture, driven by domestic and foreign demand, should persist in the near term. Net issuance for 2017 fell by 6 percent from 2016, and early estimates suggest net issuance will fall an additional 12 percent this year. If Treasury yields stay rangebound or back up in an orderly manner, we expect foreign and domestic demand to limit any spread widening in corporate credit. The net effect of tax policy implementation on investment-grade credit at the industry level remains somewhat unclear, but is expected to be mostly positive and could lead to significant cash repatriation. All else equal, this could result in decreased supply from perennial issuers as it would create a steady wave of cash earmarked for reinvestment within the sector, further enhancing the technical picture.

Investment-Grade Corporate Bond Spreads Should Remain Stable in Q1

We anticipate corporate credit spreads to remain at similar levels or tighten over the first quarter of 2018 despite multiple headwinds, such as quantitative tapering, geopolitical risks, and what many believe is the tail end of a virtuous credit cycle.

Investment-Grade Corporate Bond Spreads Should Remain Stable in Q1

Source: Bank of America Merrill Lynch Research, Guggenheim Investments. Data as of 9.30.2017.

The Bloomberg Barclays Investment-Grade Bond index returned 1.2 percent during the fourth quarter. Spreads tightened by 8 basis points quarter over quarter and 30 basis points since the beginning of the year, ending December at 93 basis points. Returns were mixed by rating, with AAA-rated bonds returning 8 percent in 2017, compared to returns of 4.6 percent for AA-rated bonds, 6 percent for A-rated bonds, and 7.1 percent for BBB-rated bonds. It is important to note that AAA-rated corporates represent only 2 percent of the index.

Investment-Grade Corporate Bond Spreads Cushioned the Treasury Selloff

Investment-grade corporate bond spreads have tightened since September despite a selloff in U.S. Treasurys that caused the yield on the 10-year Treasury note to rise 70 basis points. The passage of the new tax plan was a significant driver, helping spreads to tighten to levels not seen in over a decade.

Investment-Grade Corporate Bond Spreads Cushioned the Treasury Selloff

Source: Bloomberg Barclays, Guggenheim. Data as of 1.23.2018.

Tail risks in the market continue to creep higher, which should result in more cautious investor behavior later in the year. With that in mind, we still favor the up-in-quality trade as we move closer to the end of the credit cycle. We will look to add risk opportunistically if selling in long-dated high-quality corporates materializes, perhaps on the back of foreign selling. We remain constructive on bank preferred securities with higher floating-rate back ends, but we believe better entry levels will present themselves later in the year.

—Jeffrey Carefoot, CFA, Senior Managing Director; Justin Takata, Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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