Credit quality in aggregate has mostly held up due to the impact of high nominal growth and COVID-era consumer savings on corporate revenues, with default rates yet to show a meaningful rise this side of the debt maturity wall. Nonetheless, traditional indicators of a deteriorating credit cycle – an inverted yield curve, tighter lending standards, and elevated debt levels – remain in evidence. Notable in the third quarter was the sharp rise in real rates, which alongside a fresh tightening in financial conditions is likely to weigh on credit.
- Sharp rise in real yields as market dialogue shifts to supply-demand imbalances
Rates rose sharply in the third quarter as investors focused on G7 budget deficits and supply-demand imbalances creeping into fixed income markets, driving term premia higher.
- Access to capital – a mixed picture
Large companies still appear able to borrow with ease. Small and medium enterprises – those relying on the banking system – are more exposed to higher costs, particularly as more leveraged borrowers have been turning to floating rate loans.
- Issuer fundamentals – generally okay but areas of credit stress evident
We expect default rates to climb but remain relatively low for the next 12 months. Issuers came into the slowdown with strong fundamentals and many companies have termed out their debt.
- An unusual cycle – and why we remain cautious
Leading indicators pointing to a recession (the Conference Board Leading Index, for example, indicates a recession should have already started) have been somewhat blindsided by consumer strength, the disconnect between nominal and real growth, and easy fiscal policy.
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