Policy has a lagged effect
As we have said before, the US Federal Reserve will continue to tighten until something breaks. The lagged effect of policy means that it may take a long time for it to take effect – like pulling a brick with elastic – but when it does it moves quickly. This ‘brick on elastic’ gave way in banking. Nevertheless, corporate credit excess returns were positive over the quarter despite the end of quarter volatility. Overall spreads tightened in high yield and traded sideways in investment grade.
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- Recession more likely – Banking turmoil has exacerbated tight credit conditions and could push GDP down by around 0.3-0.4%, bringing forward the likely recession.
- The credit cycle has moved lower – Access to capital is tightening, while cashflow and earnings face further threat from recession.
- An inflection point is nigh – Policy has done a lot of work already and so investors should keep an eye on policy function.
- Dispersion to continue – Regional differences will emerge in central bank policy paths, while we expect to see increased dispersion across ratings and sectors, as interest rate sensitive sectors feel the pain.