Despite Treasury Headwinds, Corporate Credit Beckons

Three months of discouraging inflation data coupled with some hot economic data points are considered headwinds for U.S. Treasurys because both scenarios indicate rate cuts by the Federal Reserve aren’t as imminent as previously expected.

On the other hand, some market observers argue the case for corporate credit, particularly investment-grade fare, remains sturdy. That could signal opportunity with exchange traded funds such as the WisdomTree U.S. Corporate Bond Fund (WFIG). Year-to-date, WFIG is beating the widely followed Markit iBoxx USD Liquid Investment Grade Index by about 150 basis points. This confirms there’s validity in embracing the highest-rated corporates. WFIG delivers on that front as more than 43% of its holdings are rated AAA, AA, or A.

WFIG’s effective duration is 6.45 years, which puts the ETF in the intermediate-term category, and that is a positive for investors looking for true diversification with fixed income because historical data points indicate intermediate-term bonds are less correlated to stocks than are longer duration fare.

Economic Data Could Support Case for WFIG

As noted above while solid economic data points are arguably providing headwinds to Treasurys, the opposite should be true of the impact on corporate bonds.

“Good economic data should be good for credit; historically, low-but-rising PMIs, as we’ve been seeing recently, is the most credit-friendly regime,” observed Andrew Sheets, global head of corporate credit research at Morgan Stanley. “Corporate bond supply hasn’t risen nearly as much as the supply for government bonds. The carry for credit is positive, thanks to still-steep credit curves. And the time of year looks very different: over that same period since 1990, April has been the best month of the year for corporate credit — as well as broader stock markets.”

While the current outlook regarding when and to what extent the Fed will cut rates is murky, WFIG compensates investors for those risks with a 30-day SEC yield of 5.26%. Plus, the ETF’s stout credit quality implies default risk among its holdings is somewhat benign.

Those positive traits aside, some market participants assessing WFIG are apt to want clarity on when rates will decline. There is optimism that will happen at some point this year.

“The good news? Well, Morgan Stanley’s interest rate strategists expect these headwinds to be temporary, and still forecast lower yields by year-end. But for other asset classes, including credit, it’s also important to note that that same data, supply, carry and seasonality debate – fundamentally look very different in other asset classes,” concluded Sheets.

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