September 2022 Credit Market Update:
Peak Inflation and Market Bottom? Maybe…Maybe Not.
The Fed Plays Catch-Up; the Data Does Not
The Fed enacted a third consecutive 75 basis point increase at the September mid-month FOMC meeting. Powell’s remarks at the press conference were a reiteration of the intention to prioritize getting inflation under control, over the potential economic impact of below-trend growth. The goal is to get the Fed funds rate to a restrictive level, quickly. He defined restrictive as a level that puts meaningful downward pressure on inflation.
The median of the FOMC’s projections for the Fed Funds rate by end 2022 increased to 4.4%, and it projected unemployment to increase to 4.4% by late 2023. Quantitative tightening, which refers to the reduction of balance sheet holdings, was also increased to $100 billion a month in September. This was interpreted by the markets as putting a soft landing potentially out of reach.
Some key data points each month, in the order each is released, are 1) the employment number, 2) CPI, and
3) consumer spending. Fed watchers attempting to predict the next rate increase, and the impact to the economy, are fixated on these numbers. The problem is that they either aren’t moving in the right direction, or they aren’t moving quickly enough to have the desired impact.
- The September non-farm payroll number was 263,000, versus the Dow Jones estimate of 275,000.
- September CPI was a disappointing 8.2% year-over-year, slightly above expectations for 8.1%, and a hair lower than August’s 8.3%. For the month, CPI increased 0.4% as core goods were flat but services costs increased, reflecting the still-booming labor market.
- Retail sales for September, released by the Commerce Department, were flat against an August number that was revised up by 0.4%.
The combination of an aggressive Fed, continued high inflation, a strong labor market, and consumers that are not decreasing spending has generated speculation of an impending recession. The 3-month vs 10-year Treasury yield curve, which is often cited as a historically accurate recession indicator, has recently been very close to inverting. Both Fitch and S&P Global are predicting shallow recessions in late 2022 or 2023.
How Did the Credit Markets React?
The 10-year Treasury yield hit 3.95% on September 27th, which was a new closing high, and then fell to 3.84% by the end of the month. The two-year yield saw the biggest increase, of 132 basis points over the month. Investment grade corporate spreads widened 159 basis points at month end, reflecting investors fears of a recession and perceived risk in this asset class.
A Closer Look: Volatility Is Increasing
The equity market “fear index,” the VIX, is familiar to many investors. The bond markets have their own version, the MOVE index. This index measures volatility using the cost to insure against larger-than-normal interest rate moves. It calculates the future volatility in U.S. Treasury yields implied by current prices of options on Treasuries of various maturities.
The index has recently come close to the levels seen during the beginning of the COVID crisis in 2020, before the Fed began stimulus measures designed to increase liquidity. However, despite the Fed’s recent efforts to unwind its balance sheet, there is still considerable liquidity in markets.
Chart Spotlight: Bond Market Volatility
While higher, the MOVE index is still well below the levels seen during the GFC.
Top Picks for Future Private Credit Investment (%)
ICE BofA U.S. Bond Market Option Volatility Estimate Index (MOVE). Source: Axios
Performance Among Credit Indices
Source: Bloomberg as of 10/3/2022
Credit Asset Classes – Data as of September 30, 2022
Other Related Asset Classes – Data as of September 30, 2022
