Industry Voice: The impressive recovery in sterling investment grade credit

Aegon AM Investment Grade portfolio manager, Euan McNeil, reflects on how sterling credit markets have fared since the end of the disastrous and short-lived Truss Premiership.

clock • 4 min read
Industry Voice: The impressive recovery in sterling investment grade credit

As we head towards the completion of Rishi Sunak's first 100 days as UK Prime Minister, it is worth reflecting on how sterling credit markets have fared since the end of the disastrous and short-lived Truss Premiership.

The answer is that markets have performed extremely well. Since Liz Truss resigned on 20 October, sterling investment grade bonds have returned 8.8%*, aided by a material recovery in the gilt market (10-year gilt yields are lower by around 60 bps over this period) and an even more impressive compression in investment-grade spreads.

This happened for a combination of reasons - falling inflation; renewed domestic fiscal credibility; lower expectations of gilt supply; an easing of concerns about how much central banks will tighten; and an acknowledgment that sterling investment grade valuations had reached extremes.

We have to say, we weren't surprised by the recovery, as we set-out in our 17 October article titled ‘Why investment grade credit is looking attractive'. What happens now is much tricker.

So, what might investors expect from investment grade credit over the remainder of the year?

Let's start with the Bank of England and the likely path of rates this year. Current market expectations are for base rates to peak at close to 4.5% at some point in Q3 (the current rate is 3.5%). While retail figures for the festive period beat the dire expectations, it would be a stretch to describe the UK consumer as being in rude health.

We expect inflation to continue to moderate, particularly aided by lower energy prices. We also believe the Bank of England will ultimately fall short of market expectations around rate rises. We would not be surprised to see the Bank's prevailing rhetoric err on the hawkish side in the interim, as it wrestles with a desire to regain credibility. Ultimately though, delivering four further hikes before the end of Q3 of 2023 will be a challenge.

Sterling credit spreads reached a wide point of 250 bps in mid-October and have since retraced around 80 bps, reaching an aggregate level not seen since June 2022. While the ‘easy' money has undoubtedly been made, aggregate (index) spread levels are still at reasonably elevated levels compared to where they have been over the past 10 years. The all-in-yield figures are just as compelling, with a current yield-to-maturity of more than 5%. By way of context, this figure was closer to 2% at the start of 2022 and 1.4% at the end of 2020, albeit we are clearly operating under a different monetary policy regime now.

The global economic backdrop has deteriorated in recent months. The consequence seems to be greater confidence that central banks are now willing to countenance the notion that the worst of inflation may be behind us. This should allow some further - perhaps modest - tightening of credit spreads.

If our assumptions around the likely path of interest rates and credit are broadly correct, then a mid-single-digit total return for the remainder of 2023 would not be a surprise.

Graphical user interface, applicationDescription automatically generated

*Source: Bloomberg. Markit iBoxx £ Collateralised and Corporates Index. Total return from 20 October 2022 to 17 January 2023 (GBP).

 This post is funded by Aegon Asset Management

For Professional Clients only and not to be distributed to or relied upon by retail clients.

The principal risk of this service is the loss of capital. Please note that other risks will be present.

Opinions and/or example trades/securities represent our understanding of markets both current and historical and are used to promote Aegon Asset Management's investment management capabilities: they are not investment recommendations, research or advice. Sources used are deemed reliable by Aegon Asset Management at the time of writing. Please note that this marketing is not prepared in accordance with legal requirements designed to promote the independence of investment research, and is not subject to any prohibition on dealing by Aegon Asset Management or its employees ahead of its publication.

All data is sourced to Aegon Asset Management UK plc unless otherwise stated. The document is accurate at the time of writing but is subject to change without notice.

Data attributed to a third party ("3rd Party Data") is proprietary to that third party and/or other suppliers (the "Data Owner") and is used by Aegon Asset Management under licence.  3rd Party Data: (i) may not be copied or distributed; and (ii) is not warranted to be accurate, complete or timely.  None of the Data Owner, Aegon Asset Management or any other person connected to, or from whom Aegon Asset Management sources, 3rd Party Data is liable for any losses or liabilities arising from use of 3rd Party Data.

Aegon Asset Management UK plc is authorised and regulated by the Financial Conduct Authority.

AdTrax: 5065187.3. Exp Date: 31 January 2024.

Advertisement

More on Investment

Investment Company of the Year Awards Winners Interview - JPMorgan Global Growth & Income Investment Trust

Investment Company of the Year Awards Winners Interview - JPMorgan Global Growth & Income Investment Trust

clock 22 February 2024 • 3 min read
Investment Company of the Year Awards Winners Interview - JPMorgan European Growth & Income plc

Investment Company of the Year Awards Winners Interview - JPMorgan European Growth & Income plc

clock 22 February 2024 • 4 min read
Partner Insight: Global social bonds can offer more impact

Partner Insight: Global social bonds can offer more impact

Impact investing offers investors the opportunity to pursue financial returns and social and environmental outcomes.

Sarka Halas
clock 21 February 2024 • 2 min read
Trustpilot