Very clear article. Thanks. However, David, I am increasingly puzzled: if the economy is so strong, why would the Fed consider cutting interest rates? Also, if you were to give a percentage, how likely do you think it is that there will be a rate cut in the first half of the year? Thank you.
Hi. The Fed would need to cut bc they target inflation and the labor mkt, not growth per se. And if inflation below expectations that existing rates represent and artificial tightening. Which eventually hits the labor mkt.
Thank you. I get your point. I understand that the two mandates of the Fed are inflation and employment. My previous question was not clearly articulated, and what I actually meant to say was: If the economy is doing so well that the labor mkt remains strong, coupled with inflation risks arising from geopolitical factors (such as the Houthi forces in the Red Sea), this might lead to a situation where the Fed has no reason to cut interest rates.
Good stuff David. Glad I’m here! And sorry for all the Twitter hassle for you. Is the private feed intact or do we need another? Thanks for all the great info!
Thinking out loud here with regard to the tight credit spreads...
(1) It looks to me like credit spreads tightened largely as a result of a fall in rates (I.e. the market pricing in imminent cuts, making it less likely that companies will run into refinancing issues).
(2) If the current growth stabilization pushes those cuts out, then spreads should increase, right?
I’m not saying there’s going to be some horrible credit event, but spreads seem really low here, especially with the large step up in maturing high yield debt this year. Maybe the cycle goes something like:
(1) Ongoing growth/strong labor pushes cuts out;
(2) Spreads start to widen as more debt matures with persistently high rates, and some companies default;
(3) Which causes growth to weaken, and disinflation to continue;
(4) Which causes the Fed to actually cut and avoid a real credit event.
Maybe I’m off base here, but thoughts on how pushing out cuts will affects spreads near term?
I think credit spreads have dropped because revenue has grown faster than base rate impacts and refi is actually a 26-28 issue not a 24 issue. This suggests that debt investors beat equity investors as CF goes to pay interest charges without a problem but doesn’t leave much for growth. This is my tortured explanation of why RTY is underperforming. But also my explanation for why it may start to work here.
There is a large increase in maturing high-yield debt in '24 (relative to '23), but you're correct that the larger maturity walls are not until 2026 and beyond. I'm surprised that spreads are this tight with (1) SOFR where it is; and (2) the aforementioned step up in maturing debt. I don't think there's going to be some crisis (especially b/c the Fed can cut--and has plenty of room to work with--given inflation being where it is), but I also think spreads being below avg 2019 levels is suspect.
- you probably know, but Atlanta fed GDP now has increased quite a bit to 2.4 as of January 19 for Q4 2023, which seems to support your argument.
- I agree that disinflation will go on and if sectors like construction will delay rate cuts it suggests that certain goods will get hit quite hard. It may be worth to look into this for some shorts. Maybe there is even some connection to the recent drop in Chinese stocks? I know they have been going down forever but certain producers seem to be locked in a price war that will not end soon.
Very clear article. Thanks. However, David, I am increasingly puzzled: if the economy is so strong, why would the Fed consider cutting interest rates? Also, if you were to give a percentage, how likely do you think it is that there will be a rate cut in the first half of the year? Thank you.
Hi. The Fed would need to cut bc they target inflation and the labor mkt, not growth per se. And if inflation below expectations that existing rates represent and artificial tightening. Which eventually hits the labor mkt.
Thank you. I get your point. I understand that the two mandates of the Fed are inflation and employment. My previous question was not clearly articulated, and what I actually meant to say was: If the economy is doing so well that the labor mkt remains strong, coupled with inflation risks arising from geopolitical factors (such as the Houthi forces in the Red Sea), this might lead to a situation where the Fed has no reason to cut interest rates.
Good stuff David. Glad I’m here! And sorry for all the Twitter hassle for you. Is the private feed intact or do we need another? Thanks for all the great info!
Private feed is @MacrostratPB
Thinking out loud here with regard to the tight credit spreads...
(1) It looks to me like credit spreads tightened largely as a result of a fall in rates (I.e. the market pricing in imminent cuts, making it less likely that companies will run into refinancing issues).
(2) If the current growth stabilization pushes those cuts out, then spreads should increase, right?
I’m not saying there’s going to be some horrible credit event, but spreads seem really low here, especially with the large step up in maturing high yield debt this year. Maybe the cycle goes something like:
(1) Ongoing growth/strong labor pushes cuts out;
(2) Spreads start to widen as more debt matures with persistently high rates, and some companies default;
(3) Which causes growth to weaken, and disinflation to continue;
(4) Which causes the Fed to actually cut and avoid a real credit event.
Maybe I’m off base here, but thoughts on how pushing out cuts will affects spreads near term?
I think any potential rate kick will be measured in 6 week increments (FOMC meetings). Marginal impact there.
I think credit spreads have dropped because revenue has grown faster than base rate impacts and refi is actually a 26-28 issue not a 24 issue. This suggests that debt investors beat equity investors as CF goes to pay interest charges without a problem but doesn’t leave much for growth. This is my tortured explanation of why RTY is underperforming. But also my explanation for why it may start to work here.
There is a large increase in maturing high-yield debt in '24 (relative to '23), but you're correct that the larger maturity walls are not until 2026 and beyond. I'm surprised that spreads are this tight with (1) SOFR where it is; and (2) the aforementioned step up in maturing debt. I don't think there's going to be some crisis (especially b/c the Fed can cut--and has plenty of room to work with--given inflation being where it is), but I also think spreads being below avg 2019 levels is suspect.
Hi David,
two quick comments:
- you probably know, but Atlanta fed GDP now has increased quite a bit to 2.4 as of January 19 for Q4 2023, which seems to support your argument.
- I agree that disinflation will go on and if sectors like construction will delay rate cuts it suggests that certain goods will get hit quite hard. It may be worth to look into this for some shorts. Maybe there is even some connection to the recent drop in Chinese stocks? I know they have been going down forever but certain producers seem to be locked in a price war that will not end soon.