As we enter the fourth quarter, markets appear to be at a crossroads. GDP growth was negative in both the first and second quarters, and estimates for Q3 GDP are roughly zero. Data throughout the summer showed some signs of softening inflation and stabilizing growth before September’s hot CPI print poured cold water on the positive sentiment and strong rally. The reaction was swift and severe as markets were forced to rapidly recalibrate their expectations for the trajectory of this tightening cycle. Expectations for the terminal Fed funds rate have increased by nearly 50 basis points and expectations for rate cuts were pushed to the second half of 2023. Equities have fallen roughly -8.5% in the wake of the data release, while the 10-year U.S. Treasury yield has risen to 3.56%, driven almost entirely by rising real yields. Further weighing on sentiment, this has occurred against a backdrop of macroeconomic data that points to a less robust growth picture in Q3. As of mid-September, there is a decidedly pessimistic sentiment pervasive throughout risk assets. Will credit markets continue to follow in the path of equities, where short bursts of optimism are quickly squashed by stubborn inflation and hawkish rhetoric? Or will inflation show signs of cooling, boosting sentiment in an otherwise dark year? Time will tell, but buckle up, for Q4 is likely to be anything but boring.
Key takeaways
- It’s been a volatile year so far, with oscillations between fears over rising inflation and interest rates versus concerns over economic growth causing sharp reversals in market leadership. As of September 14, high yield bonds and senior secured loans are down -10.99% and -1.50%, respectively, year to date.
- While credit will likely continue to trade alongside equity sentiment in the near term, the ultra strong fundamentals underpinning the asset class are relatively more favorable than those in the equity market. Should markets begin to stabilize, we could see the asset classes begin to decouple.
- Perhaps now more than ever, we recommend an active approach in credit, as markets continue to navigate a muddled cocktail of higher inflation, tightening monetary policy and slowing economic growth.
