When I published my 2023 credit market outlook back in October 2022, I advocated for a defensive portfolio risk posture amid growing recession risks, while still preserving sufficient cash/liquidity to take advantage of anticipated market dislocations. Following a rally in many market segments, I’ve observed a shift in credit risk and sector rotation opportunities.
While I still favor defensive positioning from a tactical perspective, in the wake of last year’s sharp rise in yields, I believe higher-yielding credit sectors overall appear attractive over a three-year investment horizon and are trading close to their median spread levels as of this writing.
Don’t count on a soft landing
Since my last outlook, many areas of the credit market have rallied on optimism that moderating inflation would soon enable central banks to pause their rate-tightening campaigns. Following a decline in government bond yields and a compression of credit spreads, certain fixed income sectors look less attractive today than they did a few months ago.
Is the optimism warranted? I fear not. In my view, economic risks have not dissipated, and many developed market central banks appear more steadfast in their resolve to tame persistent inflation. Some of the credit market indicators I monitor have indeed improved at the margins, including rosier corporate management outlooks and declining commodities prices. But the monetary policy regime remains a headwind, and I suspect it will be very challenging for central banks to engineer a soft landing. Still, I see several potential opportunities in select higher-yielding credit sectors (Figure 1).