As we have said many times prior, it is credit – not love – that makes the world go ‘round.
The cost and availability of credit allows for investment in people and plants with the hope of economic growth. The lack of such – or deterioration of such – warrants watching very closely. I think there’s three big trends going on in credit that warrants attention:
- First, credit spreads (a measure of credit risk) remain abnormally low in both the investment grade (BBB- rated or higher) and high yield (BB+ rated or lower) public bond markets. The public bond market is pricing in a very low probability of financial stress and a low level of default risk. The public bond market is predicting a high probability of a “soft landing”. They could be right, and I hope they are right.
- Corporate CFOs are taking advantage of tight credit spreads and issuing new bonds at a fast and furious pace. Record new investment grade bond issuance this week. These CFOs may not love the risk-free rate at +4%, but they clearly think credit spreads are low/attractive and best to issue when spreads are tight. Rule #1 for any CFO: when debt financing is relatively cheap, take it…quickly.
- Something not great is going on in auto loans and credit cards that contradict tight credit spreads. As the chart below denotes, delinquency rates in both of these areas are on the rise and haven’t been this high since 2010. To me this data is linked to higher prices (“inflationary hangover”) and some underlying weakness in the labor market that just hasn’t made its way into the monthly payroll report yet. It’s not big enough to be a huge problem, but it is a problem and probably signals that outright recessionary risks are higher than the bond and stock market think.
The bad news is that consumer credit is soft. Not terrible, but soft. The good news is that the Fed will likely cut rates earlier/quicker, especially in an election year. Everything is politics, including the Federal Reserve.
Source: NY Federal Reserve, Jones Trading as of February 27, 2024
Richard Barrett
Chief Investment Officer
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