High Yield & Loan Strategy: Higher rates, more AI-capex, lower fragility

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High Yield & Loan Strategy: Higher rates, more AI-capex, lower fragility

2022 redux?

With economic data coming in hotter than expected, and markets now pricing in a hike

for the year, should Fixed Income investors be worried? While rate hikes are

disadvantageous for duration, we do not expect a repeat of 2022’s violent market

reaction in the credit space should hikes become a certainty. Reasons below:

1) Rates have limited room to increase from a high base, even if deficits and

inflation point to structurally higher levels. Further, we think corporate yields

don’t have the same propensity to increase as sovereign yields do. Corporate

spreads could further compress into rising rates if rate volatility remains benign

and fundamentals hold.

2) Duration has continued to decline post ’22, and today stands at 3.0x in HY and

6.5x in IG, ~1x lower than levels of the last hiking cycle. Price sensitivity to

rates has decreased for corporate credit.

3) In 2022, on the heels of massive fiscal easing, the obvious choice was to shun

duration and extend down the ratings curve. But today that trade-off is less

pragmatic and some would prefer taking rate risk over quality risk in the face of

AI-disintermediation concerns.

4) Investor positioning is comparatively heavy on cash vs LevFin credit today

(Exhibit 1, Exhibit 2), while the opposite was true in ’22. IG is the only part of

the credit market where cumulative flows since 2021 are meaningfully positive,

however that market is buoyed by its appeal as a “safe-yield” asset. This means

credit is unlikely to witness 2022’s broad derisking, but rather a rotation or

redeployment.

5) Moving on to macro, base case for Iran war is to “muddle through” without

causing a permanent hit to demand. This could keep inflation more transient