Summary
• Given the volatility in equity markets, many observers are surprised at the muted response in corporate credit markets.
• Our read is that credit investors expect the recovery will continue even as the Fed moves to combat inflation. They see little risk of a recession that would precipitate rising default rates.
• If credit investors change that view, high-yield credit spreads could easily gap out 200bp from current levels.
• That could leave the Fed with the uncomfortable choice of continuing to fight inflation and risking recession or turning on the liquidity taps and sacrificing its credibility.
Market Implications
• Our base case is that the recovery will continue. In this scenario, credit spreads will likely continue to leak wider until equity markets settle down.
• Investors should be watching the corporate credit markets for any indications that this view might be changing.
Summary
• Given the volatility in equity markets, many observers are surprised at the muted response in corporate credit markets.
• Our read is that credit investors expect the recovery will continue even as the Fed moves to combat inflation. They see little risk of a recession that would precipitate rising default rates.
• If credit investors change that view, high-yield credit spreads could easily gap out 200bp from current levels.
• That could leave the Fed with the uncomfortable choice of continuing to fight inflation and risking recession or turning on the liquidity taps and sacrificing its credibility.
Market Implications
• Our base case is that the recovery will continue. In this scenario, credit spreads will likely continue to leak wider until equity markets settle down.
• Investors should be watching the corporate credit markets for any indications that this view might be changing.
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