Investment grade outlook: What would a rate cut mean?

As usual, the next move by the Federal Reserve (Fed) is on investors’ minds. What could a rate cut mean for investment grade bonds and the economy? Also, investors are asking where they should consider investing on the yield curve. We tackle these questions and more in our Q&A on how we’re navigating the bond market in September.

Fed rate focus

Craig: Markets had priced in earlier and potentially deeper Fed rate cuts than policymakers have indicated. How are you positioning investment grade credit against that backdrop, and what risks do you see if the Fed cuts for “bad” versus “good” reasons?

Matt: The Fed’s post–Jackson Hole tone has been a bit more balanced, with softer labor market readings giving them more flexibility to ease. From our perspective, the bond market could benefit in either scenario. If the Fed cuts because inflation has sustainably cooled, spreads could remain tight or even compress further. If cuts come in response to weaker growth, investment grade credit could still hold up — high-quality bonds could become more valuable, and income could remain durable. That’s why we like the intermediate part of the curve, which captures yield and price appreciation potential without taking on excess duration risk.

Craig: Assuming the Fed cuts rates in the near future, how might it impact the economy?

Todd: Cuts will still matter, but perhaps not as powerfully as in past cutting cycles. The Fed’s more balanced tone after Jackson Hole and softer labor market data give them scope to ease, but the transmission of those cuts into the economy is likely to be slower than they’ve historically been. Corporations largely termed out (transferred their debt internally) at very low rates, so they aren’t rushing to refinance. Most households still have mortgages well below prevailing levels. That means rate cuts may not unlock the same wave of new spending seen in the past. We’d expect some support for things like small business loans, credit cards, etc., but not the kind of broad, rapid acceleration in earlier easing cycles.

Craig: Some investors are worried about the Fed’s independence. What are your thoughts about any political influence over monetary policy?

Matt: It’s certainly a concern whenever politics enters the conversation around central banks. Historically, politicized central banks often deliver higher inflation, weaker currencies, and more volatile growth. The structure of the Federal Open Market Committee (FOMC) helps insulate policy decisions. Regional Fed presidents hold votes alongside board governors, and the committee’s stance isn’t dictated by one appointment. In our view, the Fed remains committed to its dual mandate, and while the headlines can cause noise, they don’t change the fundamental trajectory for interest rates or our constructive outlook for investment grade bonds.

Where to invest on the yield curve?

Craig: Investors are asking where to invest on the yield curve.

Matt: If we think about a rate-cutting environment, that usually means a steeper curve because the Fed has more control over the front end. So it seems like a logical place would be in shorter duration, where you could benefit from rates coming down. But we think the intermediate part of the curve continues to offer the best balance of income and flexibility. The front end has already priced in a lot of Fed easing, plus reinvestment risk comes into focus sooner in the shorter end. On the very long end, you don’t get much extra yield for taking on a lot more duration and potential volatility. Intermediate maturities — where our core and core-plus strategies are focused — can give you attractive yields, some potential price gains if rates fall, and most importantly, a long runway for durable income. That said, short-term bonds aren’t a bad place to be, either — especially for investors looking to move out of cash. It has a lot less volatility than longer duration and some potential benefits if more Fed cuts do get priced in.

Investment grade outlook

Craig: Treasuries have been somewhat range-bound but have still been volatile. How has the volatility affected corporate bond spreads and liquidity conditions in the investment grade market? Are you seeing opportunities in relative value between Treasuries and corporates?

Todd: Rates have continued to react to economic data releases and headlines, but spreads have been resilient this summer. That reflects the structural demand for investment grade credit. For us, Treasuries are driving a lot of attractive all-in yields, while corporates are adding a modest spread on top of that. Taking on some high-quality credit risk can provide yields that are competitive with the longer-duration Treasury yields but with much more stability and less sensitivity to rate swings.

Craig: Do you think leverage trends and refinancing activity in investment grade companies will remain benign if rates stay higher for longer, or are we at an inflection point?

Matt: Fundamentals remain sound. Many issuers termed out their debt when financing costs were at historic lows, which gives them breathing room even if rates stay somewhat higher. We’ve just had the highest earnings beat rate (the percentage of companies that beat earnings expectations) since 2021, and if you exclude the COVID-19 years, the highest earnings beat since 2013.¹ So with earnings and cash flows still solid, we don’t see this as an inflection point. For bondholders, the takeaway is that investment grade credit continues to offer income with limited credit risk, which underpins the case for staying invested in our view.

Craig: There’s been a steady demand for investment grade credit from liability-driven investors and global buyers. Has that support shifted, and how important is it to the market outlook as we enter Q4?

Todd: That demand story remains intact. In August, we had the third-highest two-week inflow period into investment grade funds in history.² On the institutional side, pensions and insurers have continued to buy higher-yield credit, particularly in the intermediate- to long-term portion of the curve, providing a steady source of demand. This has helped keep spreads anchored despite the volatility in rates, and we expect them to remain a meaningful tailwind into year-end. There’s a heavy new-issue calendar, and we’ve seen an uptick in merger and acquisition (M&A) deals. Those are both potential headwinds. So we’ve gotten slightly less enthusiastic on valuations in the near term, but we don’t see those as fundamentally changing the story for the asset class.