The Markit iBoxx USD Liquid Investment Grade Index, a widely followed gauge of investment-grade corporate debt, is higher by 1.70% over the past month. That could be a sign corporate bonds offer some benefits as inflation-fighting instruments.
While the Markit iBoxx USD Liquid Investment Grade Index is trading lower on a year-to-date basis, its recent bullishness comes against the backdrop of the Consumer Price Index (CPI) rising in April and May. For income investors, it’s worth noting corporate bonds have some favorable history on their side when it comes to performances in inflationary environments.
“Inflation itself is not so much a problem for corporate bond markets nor are higher rates. Historically, these markets have reacted more to the volatility associated with rate rises rather than the actual rate rises themselves, causing credit spreads to widen,” notes Victoria Whitehead of BNP Paribas.
Rather, accelerating economic growth, which can stoke inflation, is historically supportive of corporate bonds. That’s a point to consider over the near-term because the U.S., the world’s largest economy, is heating up on the growth front.
“Accordingly, as the macroeconomic situation improves on the back of lockdowns being wound down, economies improving and company earnings showing rising momentum, we have seen credit markets outperform other fixed income segments such as government bond markets substantially this year. We have had low credit spread volatility recently,” according to Whitehead.
Corporate bonds are also proving resilient as global economies shake off the effects of the coronavirus pandemic. At the height of the pandemic last year, credit spreads – the added yield investors get for accepting risk above Treasuries – blew out.
Helped in large part by the Federal Reserve’s bond buying program, those spreads narrowed. Additionally, low interest rates stoked a spate of new issuance, helping some companies refinance at lower rates or shore up their balance sheets with fresh capital. Fast-forward to 2021, and between the firming economy and companies flush with cash, corporate bonds could help investors guard against inflation even if the Fed tapers its asset purchases.
“Corporate cash holdings remain at high levels with both liquidity ratios and coverage ratios close to all-time highs and notably stronger than at previous QE tapering points,” concludes Whitehead. “This renders corporate defaults not only remote, but means supply pressures are low.”
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