Something for everyone
Data in the second quarter offered something for everyone. Bears could point to weakness in lead economic indicators, stubborn core inflation and credit metrics deteriorating. Bulls could counter with strong labour markets, declining headline inflation and a robust consumer. The resolution of the US debt ceiling impasse removed a key market risk. With recession fears scaled back, markets have been pricing in a more muted credit default cycle. Our view is more circumspect. We expect more “trouble credits” to emerge as the lagged impact of tighter policy takes effect.
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- Credit cycle continues to move down - Quarter-on-most-recent-quarter metrics show a broad, albeit shallow deterioration.
- Not a typical credit cycle - A unique feature of this cycle is the high disparity between nominal growth and real growth, with high inflation allowing nominal earnings at companies to stay robust.
- Attractive yields - but is it enough? All-in yields look attractive relative to recent years because policy rates have moved up, yet spreads are tight and for some high yield bonds may not offer sufficient cushion for rising default risk.
- Dispersion pronounced – Nimbleness and careful credit selection remains key. Deterioration in credit quality will affect some sectors and economies more than others. It is often in the tails – the weakest 10-15% of companies – that a credit cycle unravels.