Timothy Crawmer is a director and global credit strategist at Payden & Rygel, a global asset management firm. He recently spoke to financial journalist Chuck Jaffe about the global fixed income markets for Chuck’s MoneyLife podcast. Below is an expert from that interview.
Chuck Jaffe: These are interesting times to be talking about credit because we expect the Federal Reserve will cut interest rates in September. What is your expectation?
Tim Crawmer: As far as the expectations for the Fed, we are in the camp that the Fed is going to start the rate cutting efforts in September with a 25 basis points at that meeting. Followed by another two 25 basis point cuts in November and December. That's predicated on what we've been seeing from inflation data and the unemployment picture, which are the two target metrics of the Fed’s dual mandate.
I know there's been some fears in the market, or some heightened expectations, that the Fed might need to do a 50 basis points cut in September. But we think recent data has led more towards 25 and they'll look to start out that rate cutting cycle with just a 25 basis point cut in September.
Chuck Jaffe: We watched the market get shaken hard a couple of weeks ago, and as you pointed out, it changed the fears of recession and what kind of landing we're going to get.
Tim Crawmer: In our view, we are still very much in the soft-landing camp. You need to be cognizant that there is a possibility of a hard landing, but right now the numbers are not pointing to that. We're seeing a pretty robust employment picture. The reason why I say robust is because the rise in the unemployment rate has not been driven by layoffs. It's been driven by more people looking for jobs, which is a positive thing in our view for the economy. And also, the consumer is still spending. So, that's resulted in robust GDP numbers and expectations going forward.
From an individual investor perspective, I'd be positioning a portfolio with the expectation that you'll see a soft landing. With that being said, I wouldn't be getting too far over your skis with risk exposure, because valuations have come a long way over the course of the year. You're just not going to see the same type of upside that we have seen in the past. You do want to be cautiously optimistic.
Chuck Jaffe: Let's talk a bit about the yield curve because as you said, you want to be long on the front end of Treasuries as you're looking at this, but this yield curve has been inverted for a very long time. What do you expect to happened when this scenario changes?
Tim Crawmer: We expect the yield curve to steepen from here. The Fed is going to start cutting rates, so that's going to result in some steepening at the front end of the curve. Our expectation is that when you see those Fed cuts come in, you'll see a bull steepening where the entire yield curve is moving lower, but the front end is moving lower than the long end. The entire yield curve will move lower because the front end reflects lower Fed Funds rate expectations and the longer end reflects lower long term inflation expectations.
Chuck Jaffe: We have gotten this far into the credit cycle and rates being higher for longer, inflation being higher for longer, and one thing we really haven't seen is a significant wave of defaults. Is there any thought in your mind that there's still going to be a significant rise in defaults going forward?
Tim Crawmer: I don't think there's going to be a significant rise in the default rate, but there will be an increase in the default rate as we move forward. What has happened in the leveraged loan and the high-yield market, which is obviously the lower credit rating part of the spectrum, is these companies did a pretty good job before the 2022 rate increase to lock in low coupons. This year, they're going to have to refinance into these higher rates. As that happens, it's going to increase their interest cost and decrease the margin for these companies.
The high-yield market on the whole has upgraded itself significantly over the years, so there's a lot more higher quality BB companies that will be able to survive this increase in the cost of debt. But there still is a significant portion of the CCC, specifically in the leveraged loan market, where they do have higher leverage and they are going to be impacted more negatively by this rise in the cost of debt. And in that part of the universe, we will see a rise in defaults and that will result in just an overall increase in the default rate within high yield, even though the vast majority of the universe is going to be fine in high yield. You just have to remember that we're starting from an extremely low default rate right now, so any increase in that CCC bucket is going to result in an increase for the overall high-yield default rate.
Chuck Jaffe: So, you're saying it's going to look worse than it really is?
Tim Crawmer: Exactly. It's going to be very idiosyncratic and a lot of these companies that most likely will default and cause that rise in the default rate are already trading with the expectation that they're going to default. So, it's not going to have a big impact on the valuation of high yield because it's already reflected in prices.
Chuck Jaffe: One of the areas that people have been turning to in order get greater yield has been private credit. As you have seen significant growth and attention paid to the private credit side of things, do you worry that until people really understand it, we're just waiting for there to be some very public blow up?
Tim Crawmer: I think there's going to be some issues in the private credit market. I think it's going to be rather limited and it's going to be manager specific. And the reason why I think that is there are a lot of proven managers out there who are good at picking private credit investments, and they are going to be fine. But with any hot market, there's always a lot of money chasing after it, and all of that money results in new managers starting up businesses that might not be as experienced, might not have as deep of a track record, and they might not have access to the best deals in the market to put their money to work in.
I think that there will be some trouble, and it will be focused in less experienced, newer managers. When you think about, they're getting the worst deals because the good deals are going to the proven managers out there that have the relationships with the originators, whereas the new managers are kind of picking up the scraps that aren't as good from a credit quality perspective.
Chuck Jaffe: We've been talking about the market for credit and what's happening with rates in the US. But we've had foreign central banks that have cut rates before the U.S. has done it. Does that in any way, shape or form influence where in the world you want to invest? For the longest time, the U.S. stock market has been the best market in the world. Diversification hasn't paid. Is that what we're also seeing in the bond market?
Tim Crawmer: In the bond market, we have seen a lot of convergence between different markets. So, the European market from a corporate bond perspective has outperformed the U.S. this year, especially when we saw the equity market sell off earlier this month. European bonds performed really well in that timeframe.
Also, emerging markets have compressed significantly this year. That's all in expectation that central banks across the globe are going to be easing. Some, as you mentioned, have already started. Some still are looking to start. But given that convergence, we prefer to be in the U.S., especially versus Europe, because there are some risks coming ahead. Specifically if we get a Trump administration, they have historically put up tariffs against Europe and other emerging market areas like China, and that would cause some pressure on those bond markets versus the U.S.
About Payden & Rygel
With $156.8 billion under management, Payden & Rygel is one of the largest privately-owned global investment advisers. Founded in 1983, the firm manages fixed income and equity portfolios through domestic and international solutions. Advising the world's leading institutions and individual investors, Payden & Rygel provides customized strategies across global capital markets. Payden & Rygel is headquartered in Los Angeles and has offices in Boston, London, and Milan.
This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results.
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