ab4 January 2024Global Research and Evidence LabPowered byUBS Evidence LabYESGlobal StrategyRevisiting our 2024 US credit outlookThe contours of the outlook have changed since we published Goldilocks on the horizon in mid-November. In this short note we mark to market the US credit outlook, highlighting the most important themes, key developments, and revised forecasts:1.The shallow recession and credit downturn in 2024 appears less certain and/or further out on the horizon: Our credit-based recession probability now stands at 30% through Q324, above prior mid-cycle slowdowns but below the ~40% recession threshold as corporate profit growth stabilizes, and our consumer health gauge improved moderately to a z-score of -0.1 (vs. +0.4 before recession onsets) on strength in building permits (Figs 1-2). 2.The weakest links in credit markets are sending mixed signals on the outlook First, UBS Evidence Lab’s Corporate Bankruptcy monitor shows less stress in filings by count, particularly for private firms from the highs (> Access Dataset). Second, however, US leveraged loan ratings migration deteriorated again in December, led by downgrades to CCC. And third, US consumer delinquencies keep rising, in part as excess savings fell further through Q3 with all income cohorts 1-1.5stdev below average (ex- the top quintile, Figs 3-5).3.Spread performance before rate cuts has been quite different from past cyclesWith the market eyeing a March rate cut credit spreads ripped tighter in Q4 (US IG -22, HY -71bp q/q), quite at odds with history leading up to a cut albeit the starting point for spreads was wider this time. Historically, we see two better parallels: one, Fed rate cuts start and persist (in-line with our baseline view), in which median Baa spreads are -1, +13 and +27bp in the 6mo prior, 6mo after, and 12mo after, respectively, the first cut. Two, Fed rate cuts start, stop, and hikes resume in 4-5 quarters, in which spreads are +64bp, -21bp and -11bp, respectively (Figs 6-7).4.The probability of spread widening remains high, even in a softer landingConditional on the macro backdrop HY spreads at 333bp are almost ~100bp inside our fair value spread, reflecting below trend economic growth despite lower equity and rate vol. But the outright comparison is also hard to dismiss: the last time HY spreads traded this tight at year-end was 2021 (283bp) and then 2006 (275bp), both preceding years of substantial widening. On average, when HY spreads have traded below 400bp they have widened 40bp and 120bp, respectively, over 6 and 12mos (Figs 8-9).5.Credit technicals will likely weaken as yield buyers ease and supply ramps up With US IG yields roughly 1% lower at 5.2% the demand from all-in yield buyers is likely to ease a bit, at least from a very robust pace heading into Q4 from investors particularly those overseas. We think stronger ...
