Navigating global credit markets

Khalid Ataullah, Senior Portfolio Manager - Credit Strategies Plenisfer Investments SGR

As is well known, the primary objective of U.S. monetary policy since 2022 has been to reduce inflation without causing a recession. U.S. Treasury Secretary Janet Yellen has more than once indicated that she’s reasonably confident of a soft-landing, recently reiterated this on 6th September in Austin, Texas: “a robust economy and strong labor market even as we’ve brought inflation down”[1].

But is this really the case? At Plenisfer, we believe that we are not quite there yet and we need more time to become convinced.

The Evolution of the Macro Scenario

While recent months have shown a gradual decline in prices*[2] across the economy, at Plenisfer, we have been focused on assessing how well the remainder  of the U.S. economy is holding up.

Some signs of consumer weakness had already emerged in April’s retail sales data, and more followed over the summer*. In the first week of September, as the market returned to normal after the summer break and U.S. Labor Day, we saw four consecutive days of key U.S. economic data releases: ISM[3] Manufacturing, JOLTS data, ISM Services, and Non-farm Payrolls. The big surprise of the week was the JOLTS[4] data, which showed a significant drop in job openings*.

The “mixed” macroeconomic data published so far* does not suggest a full-blown U.S. recession. At Plenisfer, we expect an economic slowdown driven by weakened consumption in a high-interest rate environment, coupled with a government less able to continue pumping liquidity into the economy, given the already high projected deficit and a debt-to-GDP ratio exceeding 100%*.

Looking at the last four months of 2024, beyond the evolution of macroeconomic data and monetary policy, the outcome of the U.S. presidential elections will also impact markets. A Trump victory would likely result in higher trade tariffs, lower taxes, less regulation, a stronger push to end the war in Ukraine, and more interference in central bank decisions. This could create a resurgence in inflation, and thus interest rates, increasing uncertainty in markets. The consequences of a Kamala Harris victory, whose candidacy has reshaped the electoral race, are becoming clearer. Her policies are reasonably aligned with Biden’s, meaning the Fed is likely to continue operating with an independent, data-driven approach.

In Europe, we don’t see significant signs of a slowdown, possibly because some economies, like Spain, are performing well, while others, like Germany, are acting as a drag*. The key for Europe, is that  inflation is coming under control, and we expect the ECB’s rate cuts to continue in an orderly manner.

Opportunities in Fixed Income

Even though the economic and, to some extent, political climate is filled with uncertainties, the current phase of the interest rate cycle, particularly in the U.S., offers a wide range of opportunities  in fixed income, especially in credit and rates, both in developed markets and locally in emerging markets.

Overall, in credit markets, both Investment Grade and High Yield, spreads are very tight, and credit risk is currently perceived by the market as reasonably low: we are likely now in the final phase of the spread rally that has lasted about two years and has seen double-digit returns.

Therefore, we believe that in fixed income, some of the clearer  opportunities will come from  portfolio duration management and the evolution of the U.S. rates curve, rather than relying on an unlikely further tightening of spreads.

Given our concerns about a possible economic slowdown, we think it’s preferable to look at Investment grade debt and some of that in longer bonds to build duration. We would expect spreads in High Yield to most likely widen from here, and if there’s a material economic slowdown/recession, this segment of the credit market may reprice significantly. If this is the case, it could offer  new opportunities, especially in the higher-quality area of High Yield, perhaps as early as mid- 2025.

We think that Emerging Market credit will be fundamentally influenced by the trajectory of U.S. interest rates and the strength or weakness of the U.S. dollar. Given the inflation landscape in most major economies, we are finally seeing a clear path towards global rate cuts. Meanwhile, local rates remain high in many emerging market economies, particularly in Latin America*. We believe there are potential opportunities in local assets, especially in stronger economies like Mexico and Brazil—countries withlimited exposure to short-term foreign debt and large foreign currency reserves. Also, there appear to be interesting situations in some much smaller economies  and in these cases, it will be  key to fully examine the fundamentals of the individual countries and assess the associated risks. Additionally, it’s important to note that if U.S. rates fall but this is accompanied by a significant recession, local market assets may not perform well.

[1] Remarks by Secretary of the Treasury Janet L. Yellen in Austin, Texas | U.S. Department of the Treasury

* Source: Bloomberg 

[3] The Institute for Supply Management develops indices based on questionnaires submitted to purchasing managers from various sectors

[4] Measure of the deficit or excess of labor supply at the national level

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