Expectations are that the Federal Reserve could lower interest rates multiple times this year, including the possibility of a first-quarter cut. So some advisors and investors are feeling optimistic about what 2024 has in store for fixed income assets.
Reasons for that positivity are credible, but the bond climate isn’t 100% sanguine across the board. Take the case of corporate bonds. Recent data from S&P Global Ratings indicates default rates surged a staggering 80% last year. That may mean investors seeking corporate debt exposure in 2024 may do well to focus on investment-grade fare and ETFs such as the Vanguard Interim-Term Corporate Bond ETF (VCIT).
VCIT follows the the Bloomberg U.S. 5-10 Year Corporate Bond Index, It sported a 30-day SEC yield of 5.05%, as of January 12. That confirms that it doesn’t skimp on outcome simply because it holds higher-quality corporate issues.
Venerable VCIT Pertinent Today
With corporate bonds, there’s no such thing as “risk free.” But VCIT does an admirable job of limiting investors’ exposure to potential adverse credit events. Nearly 48% of the ETF’s 2,105 holdings are rated AA or A, the second- and third-highest ratings used on bonds.
VCIT’s stout credit quality is relevant at a time when some market observers believe default rates among lower-rated issuers could trend higher again this year.
“In 2024, we expect further credit deterioration globally, predominantly at the lower end of the rating scale (rated ‘B-’ or below), where close to 40% of issuers are at risk of downgrades,” noted S&P Global Ratings. “We expect financing costs to remain elevated despite the prospect of rate cuts. And while borrowers have reduced their 2024 maturities, a large share of speculative-grade debt is expected to mature in 2025 and 2026.”
The Federal Reserve estimates U.S corporations currently carry $13.7 trillion in debt. That’s high, particularly at a time when financing costs are elevated. That indicates some junk issuers don’t have avenues to refinance outstanding obligations at lower rates. Conversely, many of the issuers found in VCIT have refinancing capabilities. More importantly, they have the cash flow necessary to service debt obligations.
VCIT’s quality roster is important for another reason. If the Federal Reserve is slow to cut rates, doesn’t cut by the expected 150 basis points over the course of 2024, or doesn’t cut at all, it could be the lowest-rated corporates that incur the most punishment as fixed income risk appetite declines. That’s not an issue for VCIT.
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