31 | 2023 Investment Outlook | December 12, 2022 INVESTMENT GRADE CREDIT Capturing Elevated Yields Without Longer Duration or Lower Quality KEY POINTS Richard Ford We expect credit spreads to remain range-bound in 2023, limited by macro Global Head of 1 uncertainty, while the anticipated lack of economic destruction means spreads are Investment Grade unlikely to make new wides. Credit, Portfolio Manager We believe investment grade credit yields are at levels that meet investor goals, 2 without the need to extend duration or move down in credit quality. Uncertainty is expected to decrease as central banks pivot to a more balanced policy 3 mix focused on growth and inflation, and cost increases become less challenging for corporate planning. What We Are Seeing ƒ Four themes are dominating the credit debate: y Geopolitical challenges—Ukraine conflict, deglobalization, sustainability—have triggered supply-side disruptions and higher inflation. y Zero-COVID policies in China have led to lower global growth expectations. y As central bank policies have shifted to fighting inflation with tightening financial conditions, markets are focused on a potential policy error. y Corporate profitability is under pressure from cost increases, and aggregate demand is expected to fall, resulting in increased defaults. ƒ Many recent trends look positive for credit, including signs of moderating U.S. inflation, supply- side relief in Europe and a potential reopening in China, with lower energy prices. As a result, valuations have moved to the tight end of our expected range—just above the long-run average—for investment grade credit. ƒ Overall, we see companies entering 2023 with defensive business models, strong liquidity and optimized costs of production thanks to efficiencies implemented during the COVID era. We also see lower leverage that considers the risks to corporate profitability in 2023. ƒ Markets are expecting a recession in 2023, as signaled by the inverted, risk-free yield curves. However, with employment remaining strong, nominal growth is expected to be positive. Moreover, with generally strong consumer balance sheets supported by the fiscal stimulus under COVID, we expect a “different” recession, where default rates do not spike. What We Are Doing ƒ We look to capture elevated investment grade credit yields, which we believe are at levels that can meet investor goals without the need to extend duration or move down in credit quality.