High-grade corporate bonds bested mortgages by a wide margin in 2019 and are likely to outperform them again this year, according to JPMorgan Chase & Co.
Prominent among the reasons why is the substantial carry and rolldown advantage of high-grade corporates compared to mortgages, JPMorgan’s head of fixed income research Matthew Jozoff said in an interview.
Carry is the difference between the interest earned on and the cost to fund a position. Rolldown is a type of return earned on a bond as it gets closer to maturity, when its interest payment is relatively high for a shorter-term security, allowing the price to rise. Should both corporate and mortgage spreads remain steady for the entire year this would help corporates outperform by around 0.90%, Jozoff said.
That would lead to a continuance of what was seen in 2019. Corporate sector return of 14.54% bested the 6.35% seen by mortgages last year, according to Bloomberg Barclays indexes. For the year corporates saw excess returns of 6.76% and mortgages earned 0.61%. Corporates have benefited from central bank policies across the globe that have driven down borrowing costs, spurring investors to seek higher-yielding bonds.
“One reason risky assets are doing well is the desperation for yield around the world, especially with all the negative yielding debt outstanding globally,” Jozoff said. JPMorgan expects the Fed to lower rates just once in 2020 compared to the three interest rate cuts seen in 2019.
The quality of mortgages delivered to settle trades was under stress due to a number of factors that encouraged borrower refinancings, though Jozoff expects this issue may improve a little this year. Also, with the JPMorgan forecasting a year-end 10-year Treasury yield of about 2.05%, the refinancing risk for mortgages may remain muted.
The risks seen to corporates are macro in nature, such as a tariff war, geopolitical events and economic growth. With a higher beta than mortgages, corporate spreads would widen out more in a risk-off environment.
The 2020 supply outlook also favors corporates. Mortgage net supply is forecast at about $250 billion plus another $220 billion in Fed roll off, which would be little changed compared to 2019. Corporate supply, ex-emerging markets, is expected to drop to $359 billion, down almost 54% from a recent peak of $776 billion in 2015.
“In terms of a relative change in supply,” Jozoff said, “corporates are more favorable than MBS.”
