Constructive on corporate credit
As we enter the second half of 2022, we have a moderately constructive outlook for corporate credit and the high-yield market. Corporate fundamentals remain solid overall, with a return for market participants in general to pre-Covid levels of profitability. However, we believe that these healthy financial metrics will likely weaken in the face of slower growth and margin pressure. We believe valuation is more attractive for both investment-grade and high-yield credit. However, technical aspects of the markets, including fund flows and transaction costs, have become more challenging.
Our favorable fundamental stance is tempered by concerns about global economic growth and tightening monetary policy, as well as the ongoing conflict in Ukraine and potentially negative effects on energy supplies from sanctions on Russia. Within this context, we continue to closely monitor issuers' balance sheets and their ability to generate free cash flow, particularly in a period of slower economic growth.
The sell-off in risk assets continued in Q2
Excess returns* relative to Treasuries, Q2 2022
Source: Bloomberg, as of 6/30/22. Indexes are unmanaged and do not incur expenses. You cannot invest directly in an index. Past performance is not indicative of future results. See page 6 for index definitions.
*Excess returns are calculated relative to comparable maturity U.S. Treasuries for each index. Excess return does not always mean "outperformance."
Mortgage market more attractive
Consistent with risk markets generally, commercial mortgage-backed securities (CMBS) spreads have widened during 2022. In our view, the increased liquidity premium has enhanced the appeal of select market segments. We believe the fundamental environment will continue to improve in the CMBS market as workers return to offices, consumer traffic increases at retailers, and hotels welcome back business and leisure travelers. Moreover, with real assets serving as collateral, along with the potential for rent adjustments, CMBS have historically performed well during periods of rising inflation. At the same time, we think the sector will face headwinds as borrowing costs rise and property values are pressured.
Within residential mortgage credit, wider spreads have created better value among mid-tier and lower-rated securities. As of quarter-end, we were finding attractive investment opportunities in those areas of the market, as well as among seasoned collateral that has benefited from higher home prices.
New potential for prepayment risk
With the Fed beginning the process of reducing the mortgage assets in its portfolio, we believe many prepayment-sensitive securities may offer attractive risk-adjusted returns at current price levels and prepayment speeds. Many of these securities may also offer meaningful upside potential if mortgage prepayment speeds continue to slow. An uptick in demand for alternate loan products that allow homeowners to access equity in their homes, such as home equity lines of credit, could be a catalyst for prepayment speeds to slow further.
Floating-rate securities remain attractive
We have a moderately positive outlook for the loan market. In our view, the majority of loan issuers have sufficient capital to absorb the pressure that higher interest rates place on free cash flow. Loan issuers are emphasizing that major supply chain glitches and inflationary costs are leading to higher working-capital investments. Companies are also grappling with when to pass these increased costs along to customers. Following record loan issuance in 2021, we believe companies generally have sufficient liquidity to fund these working-capital investments.
Next: Currency views
More from Fixed Income Outlook
Although central bank efforts to fight inflation could end in recession, we are constructive on some areas of fixed income.