Meaningful rate relief is unlikely

Key takeaways

• We are not expecting significant, near-term interest rate relief in the form of Federal Reserve rate cuts. Rather, we believe a “shallow” rate cutting cycle (once it eventually begins) is more likely. Federal Reserve officials have publicly referenced uncertainty related to the “degree of restrictiveness” of the current monetary policy stance, due in part to resilient U.S. growth. Absent a sharp and unexpected deterioration in the U.S. labor market (which is not our base case), we struggle to identify a sense of urgency for the Federal Reserve to cut rates significantly.
• This “high for longer” interest rate environment – at least relative to the post-financial crisis era – has two implications for USD corporate credit investors. First and foremost, capital allocated to USD corporate credit should primarily be based on income and yield, not total return. The second implication is that dispersion will remain elevated – a theme we have emphasized over the past few quarters.
• Separately, two weeks ago, we highlighted the ongoing decline in covenant defaults rates in the private credit market, despite a persistently high cost of capital environment. Indeed, after declining (improving) for four consecutive quarters (through 1Q2024), the covenant default rate for the Lincoln International Proprietary Private Market Index now stands at 2.7% (a level below the average 4.3% rate of the past four years).
• Recently released 1Q2024 data for a separate universe – the 15,600 directly originated U.S. middle market loans included in the Cliffwater Direct Lending Index (CDLI) – illustrates a similarly encouraging trend. Realized losses for the CDLI were 23bp in 1Q2024, bringing the trailing 12-month realized loss rate to 85bp. This realized loss rate is modest in the context of the interest income generation of the asset class and remains below the long-term average.

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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 May 23rd
• Week of May 16th
• Week of May 9th
• Week of May 2nd
• Week of April 25th
• 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