Recent data confirms the base case

Key takeaways

• One focus this week was the release of U.S. labor market data for October and November, which had been delayed due to the government shutdown. The data were mixed and noisy, but the underlying trend was consistent with our base case: the U.S. labor market weakened further in recent months but did not sharply deteriorate. Nonetheless, the ‘feedback loop’ between corporate margins, the labor market, consumer spending and overall economic activity is a key risk to monitor in 2026, in our view.
• We continue to view this rate cutting cycle as a normalization of monetary policy, rather than a deep easing into accommodative territory. With 175bp of cuts delivered by the Federal Reserve since September 2024, the Fed Funds rate (3.5-3.75%) is already approaching some estimates of neutral. We see only modest room for additional cuts in 2026, absent a sharp downturn in the labor market (which is not our base case and would likely be accompanied by higher risk premia and wider credit spreads).
• For USD corporate credit markets, we see two primary implications. First, the compelling all-in yield backdrop for investors should remain firmly in place, despite spread levels which are hovering at the tight end of the historical range.
• Second, for floating rate borrowers in the broadly syndicated leveraged loan and private credit markets, the bulk of the fundamental tailwind from lower debt service costs has likely been delivered. That said, the residual benefit of previous rate cuts should provide incremental support to coverage ratios and default rates (which we believe have peaked for this cycle).
• The recent steepening in U.S. interest rate curves also leaves us comfortable with another key view which we have held for the past few quarters: fixed rate credit should be owned for it is all-in yield and income characteristics, and not for a potential total return ‘boost’ from tighter spreads or materially lower interest rates.