Conference Presentation, Panel, Fireside Chat
Credit Trends: Back From the Brink?
- Credit markets were previously in a precarious, frothy state due to mismatched capital structures, where even minor disruptions like rate hikes could trigger a rapid unwind of stretched positions.
- The global coronavirus acted as a significant shock that pushed markets over a cliff, with emerging markets like India facing severe setbacks from lockdowns that may delay their economic engines by multiple years compared to developed nations.
- Retail flows into emerging market credit funds have remained negative weekly since mid-March, signaling a deteriorating credit environment outside the US and developed markets.
- Default rates are expected to eventually exceed 10%, with a typical lag between the economic downturn and the realization of restructurings and non-performing loan trades.
- The Fed's unprecedented liquidity measures are viewed as masking underlying recession consequences, as liquidity does not equate to solvency and balance sheet restructuring will inevitably be required.
- Concerns regarding a "second leg" of the recession center on demand destruction occurring when the CARES Act sunsets at the end of July, involving a drop in disposable income rather than just a supply shock.
- Economic recovery is projected to follow a "U" shape over a period of perhaps two years, complicated by difficulties in reopening the economy, a vaccine rollout taking time, and potential future waves of infection.
- Long-term fiscal impacts may include financial repression, increased taxes, or another US fiscal response in an election year, alongside anticipated higher regulation and continued opposition to globalization.
- Future Fed support is not expected to bail out the credit markets, particularly lower-end segments, during a subsequent recession, though market functioning may still be assisted.
- Credit managers are expected to see a divergence between the top quartile and the rest of the pack over the coming 18 months as portfolio consequences diverge.
- Interest rates are anticipated to remain anchored permanently at very low levels, with potential pressure toward negative rates, while loan documentation is expected to tighten.
- A future reckoning involving global defaults and restructurings is expected to eliminate market euphoria, potentially requiring some capital loss to restore discipline.
- The market may lose functionality due to liquidity constraints as banks are constrained by Basel rules and Volcker regulations, reducing their ability to cushion shocks.
- Credit solutions are shifting toward structured capital, rescue capital, and extensions rather than traditional bankruptcies, with a specific focus on real estate underwriting for disrupted office markets.
- Investors are actively exploring greenfield opportunities in India and maintaining long-term positions in logistics, warehousing, and distribution spaces as beneficiaries of the e-commerce trend.
- Greater Fed transparency is desired to improve price discovery and mitigate negative consequences from expectations of a "Fed put."