Peak rates and patience

Key takeaways

• Heading into the May 1st FOMC press conference, we were focused on two topics: (1) whether we had reached “peak” monetary policy rates in the U.S., and (2) how patient the Federal Reserve would be in achieving its 2% inflation target. On net, the commentary skewed dovish as Chair Powell said a rate hike was “unlikely”. The FOMC’s patience also appears to remain intact, despite stalled progress on the inflation front.
• For corporate credit investors, this minimization of “rate hike risk” (at least for now) is positive for sentiment. The relative clarity on the path of U.S. monetary policy – coupled with solid U.S. growth and historically elevated all-in yields – should combine to keep USD credit spreads range-bound. We continue to favor shorter-duration and floating rate exposures – although the relative value vs. fundamental trade-off (and credit selection) is critical for the latter, as many of those firms are navigating sharp increases in debt service costs (via their floating rate debt).
• While not our base case, a sustained reacceleration of inflation remains the key downside risk to corporate credit valuations, as it would likely interject significant uncertainty related to the forward path of U.S. monetary policy (and may lend more credence to the potential for rate hikes). Additionally, we see a high probability for a shallow rate cutting cycle, once it ultimately materializes (we still expect 2H2024) – a view that is already reflected in market pricing (Exhibit 1). This means investors should be bracing for a “high for longer” cost of capital environment.
• Given this backdrop, market participants are understandably watching for vulnerable pockets of corporate credit. As we outlined in our 2Q2024 Global Credit Outlook, we see tentative signs of plateauing in default rates, given the (1) receptive capital markets (especially to lower rated borrowers), (2) proactive liquidity raising completed in recent years, and (3) supportive economic activity. Nonetheless, we expect some of the specific drivers of 2023’s default activity will remain dominant in 2024, absent material interest rate relief. These include distressed exchanges, “repeat defaulters,” and “loan only” capital structures.

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Exhibit 1: The market’s repricing of rate cut expectations reflects “high for longer”
The U.S. policy rate implied by Fed Funds Futures at various points in time, through early 2025

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Past commentaries

• 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