Dec Mullarkey
Managing Director, Investment Strategy
and Asset Allocation

LinkedIn

There were few surprises this week as Jerome Powell took the podium and updated markets about the U.S. Federal Reserve’s rate decision. As expected, rates remained unchanged. Chairman Powell highlighted that he was not overly concerned about the recent spate of firmer inflation. And the Fed’s summary of economic projections (SEP) is still signaling three rate cuts this year – with markets expecting the June meeting to be the kickoff.

But the Fed significantly raised its GDP growth outlook for the year. Powell elaborated that a key contributor was brisk growth in labor supply, with immigration a notable contributor. The Fed expects labor market rebalancing to continue and, in turn, ease wage pressure.

One less noticeable, but important, change in the SEP was the Fed increasing its view of the long run Fed Funds rate. This terminal rate is a combination of the inflation and real rate that is expected to keep the economy humming at a stable pace. Past research and Fed targets suggested 2.5% was about right. But persistent U.S. fiscal deficits and financial conditions that seem less sensitive to Fed rates have led to a rethink. Varying research suggests something in the 3%–3.5% range may be a better target.

For now, the Fed upped its terminal rate to 2.6%. While not a big shift, this is generally the central bank’s approach, to first signal some change and follow it up with incremental revisions. Powell has already weighed in, stating that he thinks “rates will not go back down to the very low levels that we saw” over the last cycle.

Source: U.S. Federal Reserve, 2024.

Melissa Boulrice
Senior Director, Asset Management,
Public Fixed Income

LinkedIn

Canadian interest rates rallied 8–15 basis points lower on the soft February Consumer Price Index report showing a surprise drop in inflation to 2.8%. Economists had expected inflation to go the other way and rise to 3.1% from 2.9% in January. We’ve now seen both January and February inflation surprises to the downside and both months come in at sub-3% levels. However, it’s important to keep in mind that the Bank of Canada (BoC) has been anticipating some volatility, and earlier this month repeated its projection of inflation to remain close to 3% through the middle of the year before easing in the second half. So, while we view this latest reading as encouraging and bolstering the case to begin relaxing monetary policy soon, two back-to-back lower prints aren’t a sure sign of the BoC’s desire for “sustained” progress to lower inflation.

Source: Bank of Canada, 2024. 

Linda Kong Ting
Senior Director and Credit Analyst,
Asset Management

LinkedIn

While economic data continue to come in strong, we are beginning to observe signs of progression in the credit cycle. Bloomberg recently reported on an analysis from the Kroll Bond Rating Agency (KBRA) of its Direct Lending Deals data from March 21 that show that private credit deals were worth an average of 48 cents on the dollar in default over the past 12 months, somewhat less than syndicated loan deals in which values were 55 cents post-default. While this is not an especially large difference, KBRA noted that currently defaulted loans in the private credit space were marked much higher than syndicated loans a year before default, despite lower values when the credit event actually occurred. Although we would caution extrapolating too much based on KBRA’s small sample size, these recoveries are far below prior cycles, when secured lenders typically recovered 70%–80% of their principal.

In the public space, we are increasingly seeing hedge fund short theses based on accusations of what have been characterized as mismarked books and improper accounting classifications. While the supposed inconsistencies appear to be aimed at flattering equity-linked compensation, this implies similar incentives for the corollary of too-rosy marks in areas like private credit and commercial real estate (CRE). While this risk is ever-present for those who deal in illiquid asset classes, we wonder whether the big blows are yet to come for many players in these areas. With relatively few pacesetting transactions and a big bid–ask spread, particularly in CRE, we think the reckoning may not be evident until the Fed rate cuts actually arrive – an event that seems to be pushed further and further out.

Sources: Bloomberg, Kroll Bond Rating Agency, 2024.

The information may include statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. All opinions and commentary are subject to change without notice. SLC Management is not affiliated with, nor endorsing, any third parties mentioned within this article.

Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.

 

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