Global Credit Outlook
Sandra Chow, CFA - Co-Head of Asia-Pacific Research
October 2023
US Macroeconomic
Outlook & Credit Market
Forecasts
Macro Calls for ’24: Central Bank Policy
Fade the Dots
We remain skeptical the Fed can deliver another hike at
the end of 2023 and think rate cuts in 1Q24 are plausible
•
•
Fed funds futures price in the first full 25 bp cut in July
Our more dovish view is predicated on continued
disinflation over the next 12 months
•
•
The Fed is nearly as restrictive as it was in 1989 and 1995 and we doubt it
truly wants to passively increase the real policy rate by holding the
nominal policy rate steady in a disinflationary environment
Terminal Fed Funds Versus Rstar Estimates
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
-0.2%
-0.4%
-0.6%
Positive = Restrictive
Terminal less Rstar
1989
Negative = Accommodative
1995
2000
2006
2018
present
Fed SOMA Portfolio UST and MBS holdings ($tns)
We expect the Fed to continue QT at its current pace at
least through the first half of 2024
•
•
The Fed has reduced its Treasury and MBS holdings by more than $1
trillion combined from peak holdings in April 2022
$9
Treasuries
MBS
$8
$7
$6
$5
$4
QT seemed to negatively impact Treasury liquidity in
2022, but liquidity has since recovered despite the large
upswing in yields
•
2
Source: CreditSights, Federal Reserve Board, Bloomberg, L.P.
$3
$2
$1
$0
Jan-10
Jul-11
Jan-13
Jul-14
Jan-16
Jul-17
Jan-19
Jul-20
Jan-22
Jul-23
2
Macro Calls for ’24: Treasury Yields and Curve Shape
Treasury Yields Should Fall
We expect the 10y Treasury yield to fall to 3.75% at YE24
•
•
The implied rate by forwards is 4.6%
Short-Term Rate Expectations Have Skyrocketed
60 bp
1m Change in OIS Implied Rates at Future FOMC…
50 bp
40 bp
The market has swung too far in terms of pricing a very
restrictive Fed for the next 12-15 months
•
•
USD OIS markets have repriced 40-50 bp higher for late 2024/early 2025
30 bp
20 bp
10 bp
0 bp
-10 bp
Nov-23 Dec-23 Jan-24 Mar-24 May-24 Jun-24 Jul-24 Sep-24 Nov-24 Dec-24 Jan-25
Our Treasury 2s10s target is 25 bp at YE24
•
•
Recent Treasury curve bear steepening should give way to a more typical
bull steepening if the Fed signals it can begin cutting in H1
•
The implied curve shape by forwards is 9 bp at YE
10y Treasury Yield and 2s10s Curve + Forwards
100 bp
50 bp
Keep an eye on the Treasury 10s30s curve as an
indication of fiscal deterioration concerns
•
•
This part of the curve has consistently steepened in times of widening
budget deficits
Source: CreditSights, Bloomberg, L.P.
2s10s forwards
10y forwards (rhs, inverted)
2.0%
2.5%
3.0%
0 bp
3.5%
-50 bp
4.0%
-100 bp
-150 bp
Mar-22
3
Treas 2s10s
10y Treas (rhs, inverted)
4.5%
Oct-22
May-23
Nov-23
Jun-24
5.0%
Dec-24
3
Macro calls for ’24: Net Treasury Issuance Elevated Amid Large Deficits
Treasury Terming out Debt Pushes 10y Yield Higher
-$4,500
Net Treasury Issuance Above $2 Trillion in FY24
6%
Historical and Projected Estimates of Treasury Privately-Held Net Marketable Borrowing ($bns)
Fiscal Year
Budget Balance (12m rolling
sum, inverted, $tn, lhs)
2022
2023
2024
2025
1,375
1,704
1,650
1,446
Change in Cash Balance
421
153
0
0
Other Means of Financing
-125
-125
-125
-125
Total Net Marketable Borrowing
1,671
1,732
1,525
1,321
150
720
720
180
1,821
2,452
2,245
1,501
-$4,000
10y Treas (rhs)
5%
-$3,500
-$3,000
4%
Deficit
SOMA Redemption
Privately-Held Net Marketable Borrowing
Source: CreditSights, U.S. Department of the Treasury
-$2,500
3%
Nominal Coupon Treasury Auction Sizes ($B)
-$2,000
-$1,500
2%
$70
$60
$50
-$1,000
1%
-$500
2-Year
7-Year
30-Year
3-Year
10-Year
5-Year
20-Year
2-Year FRN
$40
$30
$20
$10
$0
4
0%
Source: CreditSights, Bloomberg, L.P, U.S. Department of the Treasury
$0
4
Macro Calls for ’24: Election Season Noise Likely
Key US Election Dates/Timeline:
Nov. 8 ‘23: 3rd Republican Primary Debate
Policies to Watch:
•
Jan. 15: Iowa Republican Caucus
Feb. 8: Nevada Republican Caucus
Feb. 24: South Carolina Republican Primary
March 5: Super Tuesday
July 15-18: Republican National Convention
August 19-22: Democratic National Convention
Nov. 5: Election Day
•
•
•
•
Dec. 16: Electors Meet to Cast Votes
Current Presidential Expectations
•
•
•
•
Biden (D, Incumbent): 43%
Trump (R): 37%
Newsome (D): 15%
DeSantis (R): 6%
5
Source: CreditSights, FactSet, ICE Data Indices, LLC, PredictIt
SAVE Plan (Student Loan Relief)  Executive action that could be unwound if a
Republican becomes president
Inflation Reduction Act  Enacted, bipartisan legislation with some opposition
from Republicans
Heightened Regulatory Scrutiny  Recent focus on antitrust could shift with
nomination of a new FTC Chair
TCJA Provisions to Expire in 2025  High income individual and corporate tax
breaks likely to be policy focus, especially amid large deficits
Geopolitics  While there is bipartisan support of continued pressure on Mainland
China, a Trump/Republican victory could see a return to ‘America First’ policy
Credit Market Performance Mixed Pre- and Post Elections
IG Spreads
Year
Election Outcome
Leading Into Election
Post-Election
2020
Wider
Tighter
Democratic Sweep
2016
Tighter
Tighter
Republican Sweep
2012
Tighter
Wider
Democratic President; D Held Senate; R Held House
2008
Wider
Tighter
Democratic Sweep
2004
Tighter
Tighter
Republican Sweep
2000
Wider
Wider
Republican President; Narrow Republican Congressional Majority
5
US IG & HY: Final Forecasts for ’23 & Preliminary Full Year ‘24
•
•
•
•
With spreads trading around our YE ’23
targets in both IG and HY, we are tactically
cautious on potential near-term spread
widening.
For ‘24, we are constructive on valuations
as we see compelling yields for total return
investors, and some upside in IG excess
returns. We assign a 35% probability to
our CreditSights View for ’24.
However, we acknowledge that the risks
of a hard landing/recession and stagflation
are elevated (40% combined probability);
each of these scenarios would result in
moderate to meaningful spread widening
across IG & HY.
We attempt to ‘follow the Fed’ in a
scenario with a 25% probability; spreads
would likely widen modestly from current
levels as cash remains anchored at the
front-end in money markets and t-bills.
6
1 Represents
US Credit Strategy IG/HY: Final Forecast for ’23 & Preliminary Full Year ‘24
Forecasts
YE 2023
YE 2022
Probability Weighting
US Treasury Yields
Fed Funds Target (Upper)
2-Yr UST
5-Yr UST
10-Yr UST
2-Yr/10-Yr UST Curve
US Investment Grade
OAS
CreditSights
View
Fedspeak
View
Bear 1:
Stagflation
Bear 2: Hard
Landing
35%
25%
20%
20%
4.4%
4.4%
4.0%
3.9%
-55bp
5.5%
5.2%
4.8%
4.8%
-36bp
5.5%
4.4%
4.0%
4.0%
-35bp
4.5%
3.5%
3.5%
3.8%
25bp
5.3%
4.5%
4.7%
4.8%
25bp
7.0%
6.8%
6.5%
6.0%
-75bp
1.8%
2.0%
2.3%
2.5%
50bp
138bp
128bp
120bp
100bp
130bp
150bp
200bp
-1.4%
5.5%
2.5%
6.3%
3.4%
5.4%
2.4%
5.0%
0.6%
6.3%
-0.6%
7.7%
-3.5%
4.7%
Total Return1
Gross Supply ($bn)
Net Supply ($bn)
US High Yield
OAS
YTW
-15.4%
1,241
434
-1.1%
981
343
6.1%
1,100
374
8.3%
1,200
420
0.0%
1,000
340
-9.3%
900
180
9.9%
1,100
275
479bp
9.0%
426bp
9.3%
400bp
8.2%
350bp
7.2%
450bp
9.4%
500bp
11.7%
750bp
10.0%
Total Return1
Gross Supply ($bn)
Net Supply ($bn)
-11.2%
113
62
4.6%
130
42
11.0%
175
79
11.1%
250
113
4.9%
200
90
-1.9%
150
30
3.2%
125
31
1.6%
2.6%
3.0%
3.0%
4.0%
5.0%
7.5%
1
Excess Return
YTW
HY Defaults (TTM % Issuers)
2
Excess and Total Return for the period beginning 12/31/2023 and ending 12/31/2024 for YE 2024 Scenarios.
estimated cycle peak.
Source: CreditSights, FactSet, ICE Data Indices, LLC, Dealogic, Bloomberg, L.P.
2 Default forecast represents
YTD 2023 as CreditSights
of 10/03
Base Case
YE 2024 Scenarios
6
Strategies for ’24: Other Scenarios
Fed View
• Expect one more Fed hike in
’23; on hold until June ’24 with
two 25 bp cuts before the
November election.
• Front-end UST yields begin to
fall heading into 2H; 10Y to
4.75% by year-end.
• Despite wider spreads,
modestly positive total return
prospects in both IG and HY;
weaker, but positive IG excess
returns.
• Duration: Favor the front-end.
• Ratings: Prefer As (Financials)
and BBBs in IG; Prefer BBs in
HY.
7
Source: CreditSights
Stagflation
• Expect continued 25 bp hikes
at each meeting through June
’24, reaching 7% terminal.
• Front-end UST yields continue
higher.
• Spreads likely to widen, but
capped as higher yields drive
dollar prices lower.
Total/excess returns negative
across IG/HY.
• Duration: Front-end offers
most insulation against rising
yields; sticky long-end spreads
as prices fall.
• Ratings: Higher quality
preference amid elevated
borrowing costs.
Hard Landing
• Expect rate cuts early in 1H24,
taking Fed Funds to 1.5%.
• Bull steepener drives UST
yields lower across the curve.
• Spreads widen materially on
downgrades and defaults, but
not to March 2020 or GFC
wides.
• Duration: Long-end spreads
generally fare better in hard
landings and falling long-end
yields boosts total return
prospects.
• Ratings: Up in quality bias in
both IG and HY.
7
Key Recs for ’24: CreditSights View
Fed & Rates
Spreads & Returns
• Expect cuts to begin in 1Q24 with 25 bp at every
other meeting, bringing Fed Funds to 4.5% by
year-end (with more cuts anticipated in ’25).
• As market prices in easing, front- and intermediate
(2Y-5Y) yields fall at the fastest pace, while the
10Y declines to 3.75%.
• 2s/10s bull steepens to +25 bp by YE 2024.
• As Fed begins to ease, cash comes out of Money
Markets and into spread products, driving IG and
HY spreads to 100 bp and 325 bp, respectively.
• Double-digit total return prospects in HY and high
single-digit for IG.
• Low single-digit excess returns for IG.
Curve Positioning
Ratings
• In IG, continue to extend duration with a focus on
7-10s and 10+, where total and excess return
potential is stronger than in the front-end.
• In HY, the belly of the curve (5-7s) and long-end
(10+ years) are likely to post the strongest total
returns amid tighter spreads/falling UST yields.
8
Source: CreditSights
• Remain comfortable with reaching down for credit
risk in As and BBBs in IG.
• Expect CCC spread compression to slow, though
total return prospects are best for lower-rated HY
market segments.
8
Oil Prices: Limited Upside Risk from Israeli Conflict
Brent Crude Price
Israel: Natural Gas Fields
140
130
120
Brent Crude ($/barrel)
110
100
90
80
70
60
50
40
9
Source: Bloomberg, BMI
9
US Dollar: Range Trading
Base case: range trading between 100-108
115
110
US Dollar Index
105
100
95
90
85
Jan-21
10
Apr-21
Source: Bloomberg, BMI
Jul-21
Oct-21
Jan-22
Apr-22
Jul-22
Oct-22
Jan-23
Apr-23
Jul-23
Oct-23
10
China Macroeconomic
Outlook
China Macro: “Around 5%” Growth - Slowing But Not Crashing
Industrial production growth accelerated in August.
Retail sales growth accelerated as offline sales
improved.
20
40
30
15
20
YoY %
YoY %
10
5
10
0
-10
0
-20
-5
Total
12
Source: NBS, Wind, CreditSights
SOEs
POEs
Retail Sales
Online Sales
Aug-23
Feb-23
Aug-22
Aug-23
Feb-22
Apr-23
Aug-21
Dec-22
Feb-21
Aug-22
Aug-20
Apr-22
Feb-20
Dec-21
Aug-19
-10
Aug-21
Feb-19
-30
Offline Sales
12
China Property: Continued Downturn Despite Support Measures
Fire-sale properties on display outside a property
agency shop in Jin’An district, Shanghai.
13
Source: CreditSights
Few visitors at a new project sales office by Yanlord in
Longgang district, Shenzhen
13
October Golden Week: An Uneven Recovery
Strong
• Domestic tourism
• E-commerce
• Delivery services
• Food & beverage
Weak
• Home sales
14
Source: CreditSights
14
Manageable Impact from China Slowdown in SE Asia
Selected Emerging Markets: Exports to China as % of GDP
35.0%
Exports to China as % of GDP
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
15
Source: IMF, CreditSights
15
Asia Credit Market
Outlook
Asia vs. US Investment Grade
Asia ex-Japan $ Investment Grade Index (ex-sovereign) vs. US Corporate Index
420
Asia IG (USD)
370
US Corp Master (USD)
320
OAS (bp)
COVID-19
China clamps down
on shadow financing
270
220
US-China trade war
170
120
S&P downgrades
US to AA+
Greek debt crisis
Russia-Ukraine conflict
70
17
Source: BAML, FactSet, CreditSights
17
Asia Supply Drought Protects Secondary Spreads
Asia ex-Japan New $ Issuance
300
250
$ bn
200
150
100
50
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
1Q
Source: Dealogic, CreditSights. Note: 2023 to 30 Sep 2023
2Q
3Q
4Q
18
18
Asia IG Credit Sector Strategy
Outperform
Market perform
Underperform
Financial services exbanks
Local authority (LGFV)
Banks
Insurance
Basic Industries
Capital Goods
Retail
Energy
Media
Real Estate
Technology &
Electronics
Telecom
Utility
19
Source: CreditSights
19
Investment Views
How to Invest?
• US IG and HY: Market Weight with short-term tactical caution
• Currently tight spreads and headwinds from high energy prices, strong USD
and negative effects on consumer/corporate earnings
• Expect rate cuts to begin in Jan 2024. Begin to extend duration (7-10 yr and
10 yr+ in IG and in the belly), reach for credit risk in As and BBBs.
• Asia IG: Market Weight
• Financials: prefer Tier 2 and NBFIs to senior paper; seek suitable AT1 entry
points
• Corporates: favour defensive credits with strong balance sheets e.g. selected
China tech, Korean utilities
21
Source: CreditSights
21
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