One of the biggest moves we have seen in rates/credit space in the last 2 years as Global Central Banks have been on a rate hiking spree to tame inflation has been in ‘long-end bonds’. Some of these 10-25+ years to maturity bonds have corrected more than 20-25% in price terms from their last 2 years' highs.
The yield/price of a bond is a function of both credit spreads and corresponding treasury yields. While we agree that spreads are currently trading rich and there can be correction if the most awaited recession hits the economy in the next 1-2 years, there is a decent probability that these bonds can still clock a total return of anywhere between 10-20% (given long duration and hence higher sensitivity to rates).
This is after taking into account the carry from coupon income along with a view that long-end treasury yields will also come down in the next couple of years. We have already started seeing this as the US 10-year treasury yield chart hit a textbook double top above 4% earlier this month and is currently trading at 3.7%.
Moreover, historically we have seen that in times of credit stress usually the credit curve also flattens as the market believes the event will not go on for a long time with long-end credit spreads not blowing up (when adjusted for the duration) as much as the short-end spreads.
Below we present a simplified scenario analysis for Total Returns for I31831US Index (10-25 years Investment Grade corporate bond Index which can be a good proxy for long-dated IG papers).
Currently, the spreads are trading at 150+ handles with a Yield of around 5.49% and an average coupon/carry of 4.76%. The average rating for this Index is A3.
We, at Kristal, have also started seeing rising interest for long-end good credit corporate bonds, and below are a few bonds that can be considered.
Note: These provide coupons of 4.5% - 7% p.a. thus, providing decent carry as well in case the price appreciation view takes longer to play out.
The same is also available on our platform for ‘Click and Trade’ with a few of these available for as small as 10k notional size!
Please note that these statements are indicative in nature, and do not substitute professional financial advise. Kindly consult your financial advisor before taking an investment decision regarding the same.
July 19, 2023
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