By Simon Thorp, CIO Credit at Aperture Investors
The key market narrative will now begin to change from inflation to growth. Inflation will decline but disappointingly slowly, leading to interest rates being kept higher for longer. The key is the 2-year/10-year US Treasury curve inversion – which at the time of writing on November 20, is down -70bps. In our assessment, this indicates that a deep recession is on its way.
The world has never experienced such a backdrop when it has been:
1) Awash with debt.
2) In a post-Covid recovery state.
3) Emerging out of ten years of zero interest rate policy and QE.
4) Struggling with the geopolitical fallout from Russia and China.
Looking ahead to 2023, therefore, we have the following views:
- Investment grade credit will outperform high yield as government bonds steady and concerns turn to growth, leading to spread decompression
- European credit will outperform the US (it’s cheaper, better quality, and would benefit from any Ukrainian conflict cessation)
- Default rates will end higher (over 2023/2024) than the market expects due to severity of the downturn, 2024 maturity walls, and the low quality of credit fundamentals in the leveraged loan market
- Volatility will remain elevated and much greater dispersion will occur in BB and B credit spreads as the market starts to bifurcate between the winners and losers in a recessionary environment.