Following interest rate hikes and considering growing evidence that inflation expectations had peaked, the short-term real rates have been recovering from their record lows. At the same time, the 5-year breakeven inflation data suggest stabilization towards 2% range. The recovery of real rates is benefiting fixed income investors. When considering the longer term 5-year breakeven inflation levels, US investment grade aggregate implies positive real yields of 2.4%, while high yield (HY) credit reaches 6.6%.
US HY and private credit, yielding over 8 and 10% respectively in nominal terms, exceed also the current 5% YoY Consumer Price Inflation (CPI) levels. Significant portion of their yield premia reflects expectations of higher losses due to defaults. In order to keep beating inflation throughout the economic cycle, it is important to select managers, who had been disciplined and had not compromised their credit underwriting standards during the earlier low-rates environment and who have a track record of selecting quality borrowers. Such managers are best positioned to benefit from current market environment of high rates and wider credit spreads.
