Late-Cycle Drama Is Unfolding

Here are the key takeaways from our latest Fixed-Income Outlook report:

  • In this environment where we believe credit spreads are not enough to compensate for risks, it is prudent to stay up in quality and maintain adequate liquidity to pick up undervalued credits during more opportune times.
  • We believe that the Fed will pause rate increases in the first half of 2019, with the risk that this pause could last longer. Additionally, the possibility of a rate cut cannot be ruled out.
  • The Fed pause is supportive of a rally across risk assets in the near term, but it will also allow excesses to continue to build in the system.
  • Many of the concerning trends previously discussed by our sector teams, including the potential for high downgrade volume in the investment-grade market and defaults in certain credit sectors, remain at the forefront of our long-term thinking.
  • Our baseline forecast now envisions one more hike later in the year, with balance sheet runoff ending before year-end. Further rate hikes may be required in 2020 should inflation expectations begin to rise meaningfully.
  • Our recession forecasting tools continue to point to a downturn starting by mid-2020.

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Important Notices and Disclosures

Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

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