Credit markets – Mind the spread
The end of last week saw some increased volatility after months of protracted calm. Strong US PPI data triggered inflation fears and a wobble in rates and credit. We would not underestimate signals coming from market action last week. US macro keeps sending out robust signs, on growth and labor markets but recent on inflation too. The three cuts currently in the price for 2024 are reasonable, but further strength can lead to a re-pricing of terminal rates and subsequent curve steepening. Credit spreads are back to late 2021 levels, and high-yield prices in default rates below the ones reached in an average year, despite the recent modest uptick. Volatilities remain at two-year lows cross-market. Overall, this environment has been conducive to an accumulation of positioning in carry trades, and we see credit as vulnerable to both an improvement in US data and a deterioration in sentiment. We continue to see limited value in rates and beta credit, and recommend investors focus on selected areas of credit or use current levels to reduce market beta.
Fed Preview – Doves may fly away
The FOMC will hold rates unchanged on Wednesday night, but new projections will likely see stronger growth and inflation in 2024. The risks for the dot plot are tilted to the upside, both for the 2024 dot which previously had indicated 3 cuts, and the long-run neutral dot at 2.5%. Either change may be taken negatively by risk assets. February data was mixed but not clearly dovish, whereby monthly inflation fell from the seasonally high January levels but remained elevated. The labour market loosened and consumer spending cooled, albeit at healthy levels. The base case remains for the Fed to start lowering rates in June, currently priced at 50%, but risks are tilted for cuts to start later this year.
Algebris Investments’ Global Credit Team
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