KBRA Financial Intelligence

3 Things in Credit: Strong Technicals, Market Volatility, and Hot vs. Cold Data

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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.

This was a week with another so-called “hot” inflation print that sent markets into a tizzy, which probably says more about the richness of valuations rather than some inflection point in the narrative. After all, inflation is coming down, rates are normalizing, and a soft landing is unfolding. I loved David Kelly’s view of all of this, he’s the Chief Global Strategist of J.P. Morgan Asset Management, he implored the Fed to get rates back to a normal level, practice your golf game, and wait for the next financial crisis. Don’t micromanage the economy. But then, what would we all do???

This week, our 3 Things are:

1. Credit’s strong technicals. It will help you get comfortable with tight spreads.

2. Market volatility. It’s awakened in equities. Should credit keep pace?

3. “Hot” CPI vs “Cold” retail sales. Has the broader narrative changed?

Alright, let’s dig a bit deeper.

Credit’s strong technicals.

Having lived under central bank-engineered, ultra-low rates ever since the GFC, it was easy to forget about the annuities business. Low rates meant paltry returns in the product resulting in insufficient sizzle to attract future retiree attention. But with rates normalizing (if you consider normalizing to be pre-GFC sort of levels), the product has caught a bid. Last year saw record annuity sales of $385 billion, +23% year over year according to LIMRA, the life insurance trade association. LIMRA expects sales to remain elevated in 2024 and 2025.

Why this matters is the fact that money managers that sell annuities buy bonds. Lots of them. Corporates and asset backeds. With the baby boomer bulge continuing to move into retirement age, and with it, demand for lifetime retirement income and investment protection, annuities fit the bill.

So when we think about investment grade spreads hanging in at historically tight levels while facing an economic slowdown in 2024, it bears reminding that there are significant favorable technicals to this market, including:

• Low-ish M&A-related issuance,

• A healthy overseas bid for US exceptionalism, and, yes,

• A strong bid from retirement asset managers selling annuities.

And, of course, there is yield. Although we’re off the recent high set last October, yields are at the highest level since 2009. And with a record $6 trillion sitting in money market accounts facing reinvestment risk when the Fed gets around to cutting rates, high grade bonds should be sitting pretty.

Alright, on to our second Thing, Market volatility.

When thinking about the investing opportunity set, we all continue to be scarred by 2022, when everything went bad. Stocks, Treasuries, Investment Grade, High Yield all posted double digit negative returns. A chorus arose trashing the 60/40 portfolio.

Then, in 2023, all got well. Call it the everything bounce-back. Student body right, student body left. By the way, I’ve used that phrase in the past and some listeners have asked what that refers to. It’s American football-speak, where everyone on one team runs in one direction either right or left. Seems to fit whenever investors exhibit herd mentality. But I digress.

We got another taste of one way markets this week when the CPI report caused stocks and Treasuries to sell-off. But credit held tight. Why is that?

Because bonds in general are not supposed to be that sensitive to every data release. And this week is the perfect example. Let’s assume the CPI report does represent a narrative shift (more on that in a minute). That inflation is proving to be stickier than previously thought, that the Fed will dial back if not eliminate its newfound easing stance, that higher for longer will be needed to cool a hot economy.

In that scenario, even in that scenario, the vast majority of credit should be fine. Remember, bonds, generally, are not bought for the prospect of capital gains. They are bought for diversification and income. Remember that 60/40 portfolio?

A CPI report that missed its estimate by a bit, but where the clear longer-term trend remains in place should not be all that impactful to credit. It could very well be impactful to stocks, especially when the forward multiple on the S&P 500 crosses 20x for the first time in two years, and especially when a higher discount rate would lean on this market’s growth engine, tech stocks. But the CPI report really doesn’t change the backdrop all that much for credit. In fact, data indicating a strong economy is actually supportive of credit.

Now, too much of a good thing would be problematic because that does introduce continued monetary tightening that eventually drives up recession risk. That was 2022. But for now, the relative attractiveness of credit is little changed as a result of the CPI report.

Alright, on to our third Thing, "Hot" CPI vs. "Cold" Retail sales.

We talked last week about the data underpinning the post-pandemic recovery. Richmond Fed chief Tom Barkin warned of year-end, seasonally adjusted anomalies in the data, and the presence of confirmation bias, where market pundits selectively fit data to their narratives. All of that was helpful to prepare for this week’s key data. As discussed, the CPI data was read to be “hot,” even though most of the rise was due to the shelter component, which lags real-time data by upwards of one year, and where real-time data has come down dramatically.

Then we got retail sales, which was read to be “cold,” the biggest drop in 10 months. Cold weather, a hangover from a strong holiday season, you name it. Fit the data to your narrative.

From our perspective, the narrative remains the same:

• Inflation is coming down

  , and we expect continuing progress towards the Fed’s 2% target

• Growth is set to slow

  but remain positive, as consumer spending slows—modestly--as a result of stimulus savings drying up, higher borrowing costs, and confidence waning among some

• The Fed remains on the path to easing

  modestly (our view has long been 3 cuts in the second half), less because growth is slowing, but more because of mission is expected to be accomplished on the inflation front

• The US is expected to outperform

  other developed world economies due to a more dynamic growth engine

A noisy week for sure, but not one suggesting a different path forward.

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

1. Credit’s strong technicals. You can get comfortable with tight spreads.

2. Market volatility. Let the equity market agonize over what the future looks like. It’s good enough for credit

3. CPI vs retail sales. The narrative—soft landing with the Fed easing in the second half--has not changed

As always, thanks for joining. See you next week.