Fed – Eyeing a pivot.
On Wednesday, the Federal Reserve came across more open to support growth than it has been at any point over the past three months. The central bank hiked Fed fund rates 75bp to 2.25-2.50% range, and the tone remains focused on inflation. Forward guidance will continue to be scarce and inflation data will determine decisions in the next few meetings. However, the message was weaker than in June. The Fed pointed policy rates are now in the middle of neutral and called the cycle frontloaded. Chairman Powell acknowledged the slowdown in activity that was required to tame inflation is already under way. He stressed the US economy is not in a recession, and that this is an undesirable outcome. The message reinforces the idea that any further sign of weakness from here, especially in core inflation and labour markets, will trigger a less hard-liner approach. Since we have two inflation prints between now and the next meeting, and since the easing of supply bottlenecks should be apparent in those, we may be set for some pivot in September. Markets reacted aggressively, with 10y heading down to 2.6%, and 2y rates pricing out hikes. Markets now price the terminal rate to be reached in January at 3.20%, just 80bp above current policy rates and 60bp below Fed own forecasts. Cuts are priced in 2023. We think any pivot in September may help credit and risk, but it’s now largely priced in rates markets, where some inflation persistent may actually trigger some repricing higher.
Markets – Fight your fears.
We see current spread levels as an attractive entry point. In July, credit valuations reached level in line with deep recessions, across credit segments and geographies. Over the past 20 years, entering credit markets at current level delivered 12 months returns between 7% and 15%, depending on the credit segment. Bond outflows have now reverted most of the inflows since the beginning of 2021. This week rally points to positioning being extremely short, so any small easing of inflation or just some headline stability can help credit tighter. Valuations continue to be attractive after the recent move too. Overall, Autumn can continue to be volatile but we believe credit markets have entered capitulation territory post June selloff. We thus see current levels as good entry point for long term investors.
Algebris Investments’ Global Credit Team
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