The quality of the corporate credit issues it is weaker than what the market is pricing in. The metrics for the second quarter of the year show a general deterioration, which suggests that defaults could accelerate in the second half of the year, although its pace is slower than in previous cycles.
A seasonal pause in primary issuance could support markets in the short term, but at Janus Henderson we believe that tightening lending standards, rising refinancing costs and a slowing economy will gradually affect credit quality.
Recent data delivers conclusions for all tastes. Bears could mark weakness in leading economic indicators, persistent core inflation and deteriorating credit metrics; Bulls could counter with strong labor markets, declining headline inflation, and a robust consumer.
As recession fears eased, markets priced in a more moderate credit default cycle. Our view is more cautious, as we expect more “problem credits” to emerge as the lagged effects of tighter policy take effect. That said, the schedule could get longer, as many companies won’t refinance their debts for one to four years, on average.
Credit quality is weaker than the market believes
The combination of high inflation and strong nominal growth largely protected corporate credit quality as nominal profits held up. That’s why, Heavily indebted companies were largely left out of trouble that would normally be associated with this phase of the credit cycle. However, they may be affected by the combination of higher financing costs and a slower growth environment.
The new environment of falling demand, declining inflation, slower growth but high real rates will tighten lending standards, and the availability of capital for the most indebted companies will tighten. A further tightening of liquidity under quantitative tightening will also affect access to capital.
During the previous quarter, the tightening of financial conditions together with the weakness of the manufacturing PMIs contributed to lower the profits of some industrial companies. It is also likely that the recent bankruptcy filings of some small companies will spread more widely to the capital markets.
Details about the credits for gastronomy of the City of Buenos Aires with a rate of 23%
The widespread slowdown in consumer demand as a result of the rate hike seeping into the economy will hurt earnings and expose the 10-15% of heavily indebted companies that have so far managed to stay afloat. There could be an exogenous shock to the cash flow of these companies.
Flexibility and careful selection of credit remain the key. Total returns look attractive across the credit spectrum as key interest rates have risen. However, investors should keep in mind how far higher-yielding issues can go, given considerations around default risk and liquidity issues.
Spreads have narrowed further, especially in the higher performance segments. Unless a soft landing materializes, yields on some sub-investment grade bonds may not provide sufficient cushion for the slowly rising default risk and declining liquidity.
Seasonal technicals may support near-term credit markets, but at Janus Henderson we expect credit quality dispersion to become more material later in the year as companies face the hurdle of credit maturities. 2025. A selective and agile investment approach is paramount.
*Global Head of Fixed Income at Janus Henderson
2023-08-14 03:03:50
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