Bifurcation

Key takeaways

• After modest widening in mid-April, USD corporate credit spreads have largely retraced those moves over the past few sessions. We attribute the resilience of spreads to two factors: (1) ongoing strength in U.S. economic activity, and (2) the attractive all-in yield backdrop. While we see limited scope for material tightening at current levels, we expect spreads to remain supported and range-bound through 2Q2024.
• So long as U.S. growth remains resilient, we expect most pockets of USD corporate credit will be able to navigate a “high for longer” cost of capital. That said, the relative underperformance of CCCs is likely to persist, in our view. We also continue to see a case for tactical allocations to floating rate and front-end exposures in corporate credit, given the interest rate backdrop.
• While many market participants are focused on the start (timing) of the Federal Reserve rate cutting cycle, we are more concerned with the reason for it. Policy normalization in response to improved inflation is a more supportive backdrop for credit than policy easing in response to a sharp economic downturn. By the same token, an extended delay (beyond 2024) for rate cuts because of strength in U.S. economic activity would likely be more easily digested by credit, in our view, versus a postponement of rate cuts because of a sustained reacceleration of inflation.
• A sustained reacceleration of inflation is a key downside risk to corporate credit valuations. But not because we view a 25bp or 50bp rate cut as material for leveraged finance borrowers. Rather, such a scenario is negative, in our view, as it would likely interject significant uncertainty related to the path of U.S. monetary policy (as it may lend more credence to the potential for rate hikes).

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Exhibit 1: Leveraged loans have been outperforming, while longer duration credit has lagged
Cumulative monthly total returns (%) for the Morningstar/LSTA USD Leveraged Loan Index, the ICE-BAML USD HY Corporate Index, and the ICE-BAML USD IG Corporate Index

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Past commentaries

• Week of April 18th
• Week of April 11th
• Week of April 4th
• Week of March 21th
• Week of March 14th
• Week of March 7th
• Week of February 29th
• Week of February 22nd
• Week of February 15th