KBRA Financial Intelligence

3 Things in Credit: Cooling Growth, Jobs’ Sentiment Shift, Technical Strength

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

So, this was the week of Warren Buffett’s annual letter to Berkshire Hathaway shareholders, and the headline picked up by most outlets was the fact that Berkshire has accumulated $321 billion, some 27% of its assets—both records for the business. Mr. Buffett was not apologetic, explaining that, “often, nothing looks compelling.” We found it interesting that in 2024, 53% of the 189 companies Berkshire invested in had a year-over-year decline in earnings. Outperforming can be challenging, even for those that can make their own good luck.

This week, our 3 Things are:

1. Cooling growth. Correction is just another word for normalization.

2. Jobs’ sentiment shift. This is worth keeping an eye on.

3. Technical strength. Helping you get comfortable with tight spreads.

Alright, let’s dig a bit deeper.

Cooling growth.

So, there was a lot of market chatter, and action, this week around the theme of slowdown. How concern among market participants has shifted from inflation to growth prospects. As if it represents a newly found paradigm shift. To which we would say, “really?”

The U.S. economy has been set to slow for some time now. Sure, the election served as a positive catalyst to growth in its immediate aftermath—animal spirits! Tax cuts! Deregulation! No landing!

Yet the broader, growth-slowing forces of inflation, restrictive rates, and the running down of excess savings had been reducing heat in the economy. This was all in plain sight. At the end of September 2024, the Bloomberg consensus 2025 growth forecast for the U.S. was 1.7%, down some 40% from what would become 2.8% recorded in full-year 2024. The Trump bump took the 2025 estimate up to where it is today (2.3%), still slower than where 2024 ended up. The forces of slowdown have been evident now for more than a year. Much of it is just normalization.

Now jump ahead to today, and layer on top Trump uncertainty—from anti-growth tariffs to, well, disruption. The kind of uncertainty that is causing businesses to hit pause. Pause on acquisitions—we’ve seen it in depressed M&A volume. Pause on capex—we’ve seen it in lower investments in equipment. Pause on growth—we see it in the latest PMI survey.

And we see it among some consumers holding back on spending. We saw it in retail sales. We heard about it from Walmart management.

We see it in markets. The 10-year has fallen for six consecutive weeks, and not for the reason Scott Bessent would like to see. It’s fallen as global investors seek a haven against a rising tide of geopolitical uncertainty. And slowdown. Post the election, and in the face of debatably hot inflation prints, “no cuts!” became fashionable (ignoring the consensus growth view). No more. Markets are back to two cuts in 2025. Oh, and by the way, that’s where we’ve been. On expectations of a second-half slowdown.

Stocks? They’ve hit a wall, especially cyclicals. Transports are down 12.9% from the recent high, the Russell 2000 down 11.5%. Homebuilders are down 18%. Banks are down 10.6%. What about credit? A much more muted reaction. What does that tell us?

1. We are normalizing into a still constructive growth environment (just not one that is unsustainably frothy). That suggests equity valuations are more at risk of correction than credit’s.

2. Recession probabilities are still low, and that’s still good for credit. Bloomberg consensus has ticked up from 20% to 22.5%, but that’s still low. We’re at 10%. That suggests credit valuations can be historically tight.

3. Credit yields are in reasonable proximity to 20-year averages (a big change from most of the post-GFC period), suggesting spreads can remain tight as growth normalizes.

The most influential factor in risk—the labor market—has yet to crack materially through the slowdown. Oh, sure, we did breach the Sahm Rule last summer, but that was simply the labor market correcting. A more material cracking is the thing credit investors should pay closest attention to.

Alright, on to our second Thing—Jobs’ sentiment shift.

Speaking of the labor market, it’s strong, right? The unemployment rate of 4.0% is nicely below the 50-year average of 6.1%. We haven’t hit that level, excluding COVID, in 10 years. Continuing jobless claims have risen but remain well short of alarming levels. Labor participation has recovered, and is historically strong among key 25-54 year-olds. It’s all good, right?

Well, there are a few cracks out there which we’ve talked about recently—the hiring rate, for example, which has shrunk to a decade low 3.4%. Monthly hirings were down 325,000 (5.6%) year-over-year. And job openings fell 14.5% over the course of the year. Chalk a lot of this up to uncertainty and the sobering realization that stimulus-fueled excesses were eroding.

The latest relevant survey data is reflecting that uncertainty (and conservatism). In the New York Fed’s Empire State Manufacturing Survey, net hiring intentions over the next six months hit a six-month low, as did the services sector survey. The Philly Fed’s six months from now hiring expectations in manufacturing hit a five-month low.

From the consumer’s standpoint, 51% of those surveyed in the University of Michigan’s Surveys of Consumers believe unemployment will rise over the next year; that’s up from 32% a year ago. For context, over the prior 20 years, reaching a level above 50% has only been breached twice: in COVID and the GFC. And over at the Conference Board, where its latest Consumer Confidence Survey (as of February 19) carried a subtitle “Pessimism about the future returned,” its “jobs plentiful” less “jobs hard to get” differential fell to 17 from 30 a year ago. Some 16% of those surveyed found jobs hard to get; that’s up from 13% a year ago.

So, we’re seeing cracks in the sentiment on the part of both hiring firms and employees. That’s different from cracks in employment. Pessimistic sentiment reflects a cautiousness about the future, something that curtails growth. Cracks in employment can turn growth into recession. That distinction has obvious consequences for defaults, both consumer and commercial. For now, it’s a sentiment sag. Keep an eye on it.

Alright, on to our third Thing—Technical strength.

Fundamentals, technicals, valuations—the three pillars of the credit markets. We talked last week about the historically tight level of public market spreads. Some of that of course reflects strong fundamentals in the aggregate, reflecting to some degree the massive fiscal and monetary response to COVID (and the long tail effects of that response). But it also reflects strong technical factors underpinning the asset class.

One such factor, of course, is the absolute level of yields: public IG at 5.3%, private IG 7%+, public high yield 7.2%, private high yield 10%+. Those levels, boosted of course on the back of the Fed’s restoration of a more normal rates framework, fit nicely into the old 60/40 portfolio. We’re seeing strong demand for fixed income’s core attributes of diversification and income, which complement (or provide comfort to) equity valuations trading at historically high multiples and cash yields that are sliding lower. Yield buyers are clearly supporting this market.

A second technical factor is new issue supply. It’s reducing into that strengthening demand. Some of that has to do with reduced expectations for M&A-driven volumes, which have been slow to materialize due to policy (and maybe a little macroeconomic) uncertainty. We’re also seeing private markets continue to siphon off supply that in the past would’ve hit the public markets. That’s especially true, of course, in leveraged finance. And, finally, the absolute level of rates is no doubt reducing supply from the go-go days of zero interest rate policy that welcomed just about any issuer in size. The higher cost of capital, and the higher hurdle rates that come with it, are squeezing out (or limiting access of) flawed issuers.

The technical unknown hanging over the asset class in 2025 is the risk-free rate, the Treasury, which makes up a whopping 84% of your public investment-grade yield and a not insignificant 61% of public high-yield (yield). Supply, demand, and volatility on that front are much harder to dimension. Good luck.

So, there you have it, 3 Things in Credit:

1. Cooling growth. Don’t mistake correction for over the cliff.

2. Jobs’ sentiment shift. It’s weakening. Keep an eye on it.

3. Technical strength. Positive forces keeping spreads tight.

As always, thanks for joining. We’ll see you next week.