Alternative Credit Letter

Yields on leveraged loans are currently reaching 10% and remain materially higher than yields on equities. Since 2022 the loan investors have been benefiting from rising rates, which translated into increasing income via quarterly benchmark rate resets. With any new loan refinancings, investors are now also benefiting from increased credit spreads, as lenders incorporate higher

Credit yields are now significantly higher than earnings yields on equities. HY bonds are currently yielding 8.5% and loans 10.4%. Meanwhile, earnings yield on equities ranges from 5.1% current to 7.5% when adjusted for the long term inflation expectations published by the FED. Most of the increase in credit yields is attributable to rising rates.

One of the fastest rate increase paths in modern history has led to a true paradigm shift in US Treasury rates. Compared to one year ago, the rate levels are now higher and have negative term premia causing inversion anywhere beyond the 6-months tenor. Such inversion indicates recession risk, which remains a topic of debate

Central banks moved away from easy money policies and changed course. Not only the interest rate hikes but also the liquidity withdrawals have affected the markets and will continue to do so. After years of quantitative easing with ballooning balance sheets, the regime shift means that central banks will no longer backstop markets – unless

Slowing global economy, combined with tightening financing conditions and input costs inflation will lead to higher expected credit default rates in 2023 and beyond. In our observations, market participants expect that defaults would peak at around 6 to 6.5% in 2023 for high yield bonds and just below 5% for leveraged loans. As the chart

Since the start of the year, credit spreads of European loans have increased from around 400 bps to above 700 bps. At the same time, short-term interest rates have just been lifted to around 2% by the ECB on October 27th. As a consequence, European loans earn now on average an attractive yield of 9%

The Fed’s rate hike path in 2022 is driving up bond yields in all markets. For example, the yields of the short-term high yield and investment grade bond indices bottomed out in 2021 and climbed to a high of 10.2% and 5.3%, respectively, by the end of September 2022. The latter is a remarkable rise

In March 2022, the USD swap curve became inverted and by the end of August the difference between the 2-year vs 10-year tenors fell to -0.6% (see also Alternative Credit Letter in April), a signal of economic weakness ahead. In June this year, the Fed funds futures curve also inverted, pointing to a more dovish

The peak Fed funds rate is currently priced in at a level of 3.4% (down from >4% in mid-June) for February 2023. However, the shape of the curve is of even greater importance. The inverse shape of the current Fed futures curve indicates that the market expects the Fed to succeed with its measures to

Fixed income markets suffered in June another painful month. For example, high yield bonds are down -7.3% and -16.7% YTD, the worst half-year performance since the global financial crisis in 2008. The sell-off this year has been deep, but the pattern has not matched that of previous ones as it was primarily driven by higher