INSIGHTS

On October 15, 2024

Entering a New Phase: How the Fed’s Pivot is Changing the Business Cycle

John Fekete, Crescent Capital’s Head of Tradeable Credit, updates his recent Market Commentary with additional insights following the Fed’s September rate cut

In the “late” phase of a business cycle, we expect a tight labor market and rising inflation will lead to higher interest rates; economic activity often reaches its peak, while growth remains positive but slows — as we have seen over the past two years. Now it appears we are about to enter a new phase, ushered in by the Fed’s policy pivot and 50bps (basis point) rate cut in September. This new phase is expected to be characterized by further declining interest rates, looser financial conditions and strong credit growth.

Cracks have appeared on the employment front, prompting fears that high rates pose a new threat to the economy. Risks have shifted away from surging inflation to the potential downside posed by a cooling labor market. While the unemployment rate has risen to 4.2%, it remains low by historical measures. The increase in the unemployment rate has occurred alongside an expansion in labor supply on the back of the 2022–2023 immigration surge rather than a sudden drop in labor demand. This influx has been key to the rise in the U.S. labor force and suggests labor market indicators may not follow historical patterns.

The combination of higher unemployment and lower inflation strengthened the case for rate cuts. Fed Chair Powell’s remarks, after announcing a 50bps cut on September 18, were closely aligned with our views on a soft landing. The Fed sees the economy growing at about 2% per year, disinflation is on track, and unemployment is likely to stabilize at about 4.4%. Powell’s remark, “The U.S. economy is in a good place, and our decision today is designed to keep it there,” is encouraging indeed. In our view, September’s 50bps move was an “insurance cut” made while the economy is solid to help limit the chance of a downturn. The Fed’s “put” is in play, which should be a good setup for credit markets.

The threat of an earnings recession for leveraged issuers has shadowed the Fed’s higher-for-longer rate path, but earnings were healthy enough in the first half of 2024 to blunt the damage to credit measures as higher debt service costs were largely offset by robust earnings growth. Leveraged loan borrowers showed revenue and EBITDA (earnings before interest, taxes, depreciation, and amortization) growth — 2% and 4%, respectively — for the 15th straight quarter from April to June, according to LCD Pitchbook.

What does the Fed policy pivot mean for credit? Rate cuts should result in lower interest expense and higher free cash flow going forward, as nearly two-thirds of the public and private leveraged finance market has floating rate coupons. These factors are likely to be a tailwind for credit, resulting in higher interest coverage ratios and potentially fewer credit rating downgrades or defaults. We believe investors can take advantage of a carry-friendly environment with modest signs of corporate or consumer stress. The technical backdrop appears positive for credit spreads as considerable cash sits on the sidelines waiting to rotate into the market, in our view.

CRN: 2024-1004-12032 R

Opinions in this piece are those of Crescent Capital and are not necessarily that of AAM.  Any forecasts or opinions expressed herein are Crescent Capital’s own as of September 30, 2024 and are subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.

This commentary is made available for informational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Nor is the information intended to be nor should it be construed to be investment advice. Certain information contained herein concerning economic trends and performance may be based on or derived from information provided by independent third-party sources. Crescent Capital believes that the sources from which such information has been obtained are reliable; however, neither can guarantee the accuracy of such information nor have independently verified the accuracy or completeness of such information or the assumptions on which such information is based.