KBRA Financial Intelligence

3 Things in Credit: Strength Into Transition, April 2, and Fed Tea Leaves

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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.

We were fascinated this week to watch the market’s reaction to earnings out of Williams- Sonoma, the home furnishings chain. The company had a healthy beat on both top and bottom lines as well as margins and increased the dividend 16%. The market’s reaction? The stock sells off 13%. Turns out investors are skeptical of management’s guidance. But wait, there’s more. Over the course of the day, the stock rallies (must’ve been a good earnings call) to close down just 3.5%. In the past month, the company’s forward multiple has gone from a premium to the broader market back to the market multiple. Such is the life of a consumer discretionary name that imports in a time of tariffs.

This week, our 3 Things are:

1. Strength into transition. New national accounts data is out, giving insight into how prepared the consumer and commercial sectors are as we head into “transition.”

2. April 2. The day-trading partners receive their “number.” What will we learn?

3. Fed tea leaves. The much-anticipated March meeting. We’ll tell you what it means for credit.

Alright, let’s dig a bit deeper.

Strength into transition.

So, we apparently are heading into a period of “transition.” Sounds like the new “transitory.” Something you hear that makes you dial back your risk and move away.

But when thinking through the possible transition, i.e., slowdown, the starting point of the economy is important. Regular listeners are well aware by now of our “Two Economies” theme, where wealthier households and larger businesses have flourished in the post-COVID period, while less wealthy households and smaller businesses—those particularly vulnerable to inflation and limited access to favorable credit—have struggled. The aggregate economic data, however, finds us reasonably well positioned to power through the slowdown phase.

So says the latest Flow of Funds data compiled by the Fed. Starting with the all-powerful U.S. consumer, household net worth reached a record $169 trillion in Q4, up 8% from the prior year-end, and a whopping 44% from the pre-pandemic level. Debt-to-net worth has reduced to 11.9% from 13.7% pre-pandemic. Total household debt to GDP has fallen to 69%, a 24-year low. The household debt service ratio has ticked up to 11.3% but remains below the longer-term average of 12.6%. The U.S. consumer, in the aggregate, is well positioned to withstand whatever the transition throws at it.

Over on the commercial side of things, the balance sheet is in solid shape. Debt-to-equity of 41.6% is a couple of percentage points below its long-term average, and significantly below the pandemic period high of 52%. The liquid assets-to-short-term liabilities ratio stands at a record high of 104%. Profitability remains solid with return on equity at 11.3% in 2024, nearly a point above the 10.4% longer-term average.

So, again, in the aggregate, the U.S. is well positioned to face mounting headwinds related to policy uncertainty. The equal weighted S&P 500, down just 1% on the year in this “correction” and where its forward multiple of 17x is bang on the long-term average, says as much. But smaller firms? That’s where the market is sensing vulnerability, with the Russell 2000 down 7% on the year (and down 15% from its post-election high). Useful attributes to test firms on as we head into transition include pricing power, strategic discipline, and the appropriateness of capital structure. In other words, it’s time to move up in quality.

Alright, on to our second Thing—April 2.

The new administration has targeted April 2 as the day it plans to release its findings on trading partners, part of a framework for resetting the global economic order. According to the Treasury Secretary, each country will receive a number—a reciprocal tariff—reflecting what the administration believes is the cost of that country’s trade barriers.

In the meantime, there’s been a steady stream of product- and country-specific tariff deployments—on China, on Canada, and Mexico, on steel and aluminum. Copper, lumber, autos, pharmaceuticals, microchips have all been publicly targeted but not yet implemented. The uncertainty around what ultimately gets done and for how long has made planning difficult, something that is clearly weighing on the price of risk.

So, will visibility improve April 2? Only a bit. Apparently, “the number” is the starting point for negotiations that press reports say could take six months or more to finalize. And we wouldn’t expect that whatever is decided April 2—or even in any particular final decision—will be definitive. What makes tariffs appealing in the toolkit is that it can be deployed simply, quickly, and materially.

So, what does April 2 represent? It just might be “peak tariff.” As in peak uncertainty, as least as it relates to tariffs. Sure, things change, and tariffs can be adjusted quickly. But April 2 should give some much-needed dimension to the worst case. It would be a stretch to imagine a negotiation resulting in a more onerous tariff outcome. Instead, “numbers” are likely to come down as country’s make concessions. The analysis then shifts to scenarios laying out how much of “the number” will end up being the final cost.

Alright, on to our third Thing—Fed tea leaves.

I’ll start off by saying, I’ve given more interviews over the past week on the topic of stagflation than I have over the rest of my entire career. And the Fed delivered a view of that this week—slower, below-potential growth and higher-than-target inflation. A central banker’s most vexing scenario. So, how did market observers react? Indignantly. How could the Fed NOT take a view? We actually heard one talking head opine that “this Fed is lost.” Really? And you would …

Coming into the meeting our view was that “we expected the Fed to hold rates at current levels reflecting risks on each piece of its dual mandate remaining roughly in balance.” We were quick to add that, “but by no means does this imply that forces impacting growth and inflation are stable.”

We saw the new administration’s ideological policy shift to America First putting the economy and the global world order in transition with downside risks to U.S. growth and upside risks to inflation over the near term. Throw in heightened uncertainty around the timing and magnitude of effects related to policy sequencing and we concluded that this period will surely prove to be a challenging one for Chair Powell’s data-driven Committee. Check. Check. Check.

What we learned Wednesday is that the Fed acknowledges that policy uncertainty—related to trade, immigration, fiscal, and regulatory—is, in Chair Powell’s word, “significant.” Separating the “signal from the noise” will be critical. Accordingly, the Committee is predisposed to waiting for greater clarity before acting. That implies almost by definition that the Fed is going to be behind the curve, something that is, well, normal and reinforced by the Committee’s downgrading the importance of survey data.

Chair Powell believes (and the Summary of Economic Projections reflects) that expected inflation from tariffs is likely to be, yes, transitory. Love that Powell went back there. Consistent with that view, the Chair mentioned inflation surprises would likely be met with leaving rates higher for longer (as opposed to hiking), but he did justify the Committee’s projection to leave two cuts in the forecast on the belief that current policy is “clearly restrictive.”

So, what does all of this mean for credit? We do not see any material impact as a result of what we learned this week. By the Chair’s own admission, Fed policy “is not on a preset course.” We do believe the “Fed put” remains, although the trigger point to cutting rates is when the risk of falling growth—higher unemployment—convincingly exceeds the threat of higher inflation. Today, we are just not that close to that being the case. Other factors outside of the Fed’s control—mostly centered on reduced economic activity stemming from the administration’s policy uncertainty—are rebuilding risk premia across credit from historically low levels. Normalization coupled with policy uncertainty leaves us biased to modestly wider spreads.

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

1. Strength into transition. The consumer and commercial sectors in the aggregate are well positioned to withstand slowdown.

2. April 2. It’s a starting point for negotiation, but it just might represent “peak tariff.”

3. Fed tea leaves. The “Powell put” is alive and well.

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