As the global economy wrestles with rising rates and elevated inflation, credit spreads between corporate and government bonds moved wider this year.
However, the long-term outlook for high-quality corporate bonds has improved, said Adam Ditkofsky, portfolio manager and vice-president at CIBC Asset Management.
To date, investment-grade corporate bonds have modestly underperformed government bonds, Ditkofsky said. This has been especially true for short-term financial issuers, such as banks and insurance companies, which were responsible for more than 80% of new corporate bonds this year, he said.
Until recently, these bonds were being priced with “substantially larger” corporate spreads than than they had been a year earlier, Ditkofsky said, but that started to change this summer. The market started to price in an end to the U.S. Federal Reserve’s rate-hiking cycle, Ditkofsky said, and investors saw “a light at the end of the tunnel.”
In Canada, corporate bonds performed well earlier this summer, with midterm corporate bonds returning more than 4% in July, Ditkofsky said. This supported non-financial issuers coming to market again, with solid demand from investors seeking yields higher than what government bonds offer.
Longer term, Ditkofsky said the bond market will continue to wrestle with two key themes: whether rates have risen high enough to cool inflation, and whether this monetary tightening will cause a recession.
Ditkofsky said that even if inflation has peaked, it will likely remain close to 5% over the next year.
“Over the near term, we could see corporate bond spreads widen further, especially if we go into a deep recession,” he said. “But over a longer horizon, return opportunities in high-quality, short-date corporate bonds look attractive. And these bonds are less sensitive to movements in yields and credit spreads than their longer-dated counterparts.”
Overall, Ditkofsky said he’s “a lot more optimistic” about the bond market now than at the beginning of the year.
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