As investors prepare for interest rate cuts and economic growth to slow, J.P. Morgan Chase and Morgan Stanley expect the return on US investment-grade bonds in 2024 to surpass speculation-grade bonds for the first time in four years. Meanwhile, Bank of America suggests that investors allocate higher-rated bonds rather than junk bonds because the bank believes that this year's interest rates, corporate profits, and bond issuance will all challenge credit.

According to our understanding, fixed-rate bonds — bonds usually issued by investment-grade companies — are more sensitive to rising interest rates, and investors holding such bonds should benefit from the Federal Reserve's reduction in borrowing costs this year. Meanwhile, the economic slowdown may affect the performance of low-rated bonds, and Morgan Stanley expects this to happen this year.

“It depends on the macro environment,” Morgan Stanley strategist Vishwas Patkar said in an interview on Tuesday. “We think the economy will eventually have a soft landing, but there will be bumps in the process.”

The strategist believes that the return on short-term bonds such as five-year bonds has better upside than long-term bonds. Longer-term bonds have already benefited from the rebound in December last year, and there is currently limited room for upside.

Globally, investment-grade debt struggled to rise in the first half of 2023, until the rebound that began in November drove returns to nearly 10%, the biggest two-month increase on record. Until then, the “higher for longer” outlook dampened market performance, and better-than-expected economic growth pushed returns on high-yield bonds and leveraged loans to 13%. Entering 2024, the situation may be different, as investors have absorbed expectations of interest rate cuts due to the slowdown in economic growth.

Bloomberg Intelligence credit strategist Noel Hebert wrote in a report in December last year: “US Treasury yields continue to decline due to weak macroeconomic conditions, which may promote strong returns associated with the longevity of bonds.” He anticipates that investment-grade bonds will bring investors medium to high single-digit returns.

However, not all institutions are optimistic about high-rated bonds. BlackRock reduced its holdings of global investment-grade credit on the grounds that narrowing interest spreads “cannot make up for the expected impact of interest rate hikes on corporate balance sheets.”

Mitsubishi UFJ Financial Group is less optimistic about credit overall. Its strategist warned that in the case of a “bumpy landing,” the potential downside could be huge, and advised fund managers to wait a while before investing in US fixed income products.

Strategists, including George Goncalves, wrote in a report last month: “Even with interest rates falling as drastically as we expected, the pricing of credit spreads and risk assets is perfect. Judging from the current level, judging from the current level, we think there is limited room for the total return of a single credit product to increase.”

But for institutional asset management firm Robeco, the uncertainty surrounding the possibility of a recession later this year reinforces the reasons why investment-grade credit is superior to high-yield bonds.

Robeco's Sander Bus and Reinout Schapers wrote in a report: “As the overall yield of investment-grade credit remains at an attractive level and the return prospects are good, this asset class can compete with many other riskier classes.”