Building confidence

Key takeaways

• This week’s May U.S. inflation data was cooler than expected – a welcome development for Federal Reserve officials, considering the string of upside inflation surprises in 1Q2024. But even with this favorable inflation reading, the June FOMC meeting skewed slightly hawkish in our view, as illustrated by the revised “dot plot” in the June 2024 Summary of Economic Projections (SEP), as well as some of Chair Powell’s commentary during the press conference (detailed within).
• Nonetheless, after an in-line inflation reading for April, and this better-than-expected print for May, we believe the groundwork is forming for at least one 25bp rate cut in 2024 (either in September, or in 4Q2024). The onus will be on the next few months of inflation data to continue this recent (favorable) pattern, such that the FOMC receives the “greater confidence” it desires before starting to normalize monetary policy.
• For corporate credit investors (in liquid and private markets), the interaction with growth remains paramount for two reasons. The first relates to the “depth” of the eventual rate cutting cycle. So long as U.S. growth remains at or above trend (note: 2Q2024 real GDP is tracking well above trend, at 3.1% per the Atlanta Fed GDPNow), we continue to expect a “shallow” rate cutting cycle. This makes the prospect of significant, near-term interest rate relief (on borrowers’ debt service costs) unlikely. But it will also leave “all-in” yields elevated for a range of investors seeking to deploy capital into the credit markets. This will likely keep IG and HY credit spreads range-bound in aggregate (and may even support tightening, as issuance slows through the summer).
• The second reason relates to credit’s fundamentals. Solid economic growth should allow most of the corporate credit market to continue to navigate the “high for even longer” interest rate environment with relative resilience – extending the trend of the past few quarters. The exception, in our view, will be capital structures with unsustainably high leverage and an inability to grow in a capital efficient way. This underscores the importance of credit and sector selection, in our view, and supports the case for elevated dispersion across asset classes, sectors and issuers.

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Exhibit 1: April and May inflation data have been encouraging
Contributions to month-over-month headline U.S. CPI (seasonally adjusted)

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Past commentaries

• Week of June 6th
• Week of May 30th
• Week of May 23rd
• Week of May 16th
• Week of May 9th
• Week of May 2nd
• Week of April 25th
• Week of April 18th
• Week of April 11th
• Week of April 4th
• Week of March 21st
• Week of March 14th
• Week of March 7th
• Week of February 29th
• Week of February 22nd
• Week of February 15th