Macro Markets Episode 65: Macro and Micro Views on Credit Opportunities in a Shifting Economy
Maria Giraldo and Rebecca Elkins join Macro Markets to provide top down and bottom up perspectives on opportunity in the high yield and bank loan market.
This transcript is computer-generated and may contain inaccuracies.
Jay Diamond: Hi everybody and welcome to Macro Markets with Guggenheim Investments, where we invite leaders from our investment teams to offer their analysis of the investment landscape and the economic outlook. I'm Jay Diamond, head of thought leadership for Guggenheim Investments, and I'll be hosting today. So, let's dive right in. Now there's a saying in fixed income: there is no such thing as a bad bond, only a bad price. Now, what that means is that every bond that isn't a treasury or agency security comes with credit risk. But fixed income investors need to evaluate whether yields available in the market are compensating you for taking that risk. Now, as an asset management firm with foundational experience in fixed income, this is where we spend a lot of our time. Now, given where spreads are today, this is a very timely topic for us. And here to talk to us about this are two leaders from our investment team: Maria Giraldo from our Macro Research and Market Strategy group, and Rebecca Elkins from our corporate credit portfolio management team. Maria and Rebecca are also principal contributors to our High Yield and Bank Loan Outlook publication, which can be found on our website at GuggenheimInvestments.com/perspectives. So with that, Maria, Rebecca, thanks so much for taking the time to chat with us today.
Maria Giraldo: Happy to be here.
Rebecca Elkins: Thanks for having us.
Jay Diamond: All right. Let's get started with Maria. Can you kick off the conversation with a high-level view of our macro outlook? And where does Guggenheim see the economy in 2025?
Maria Giraldo: We see the economy is on solid footing. The consumer is still pretty strong. We're coming into 2025 with strong momentum. And we're just expecting that the economy is going to gradually slow. In 2024, growth came in around a little over 2.5 percent. We're probably going to get to a bit under 2 percent in 2025, and that's not an outlier view. Consensus is right on top of 2 percent so we're kind of in line with the broader market there. I think what's really worrying investors right now is the progress on inflation. And this is where there's a lot of uncertainty. We're coming off of a strong inflation wave, one of the worst we've been in since the 1980s. The Fed had to hike interest rates and really tighten conditions. So we were making very steady progress moving their inflation target core PCE down toward 2 percent. And now that looks like that progress is going to be very bumpy. We see it just plateauing from here. Core PCE is going to get stuck around 2.7 or 2.8 percent this year. And a lot of it is coming from impact of tariffs. So what does this mean? You know, it means that the Fed is going to have to be really cautious now. They were trying to cut interest rates, but now they're going to really have to look at the data month by month to see if they should continue cutting rates. Our view has shifted now. Last year we had expected that the Fed would cut a decent amount this year. Now we think that they are only going to cut once and there's a lot of uncertainty embedded in that projection. There's a lot of uncertainty embedded in investor and corporate behavior that could still hurt growth. So a lot of uncertainty is what you're going to hear in this podcast today.
Jay Diamond: Great. Well, let me stick with you for one more question, Maria. So with this economic backdrop, how does this relate to credit?
Maria Giraldo: Yeah, I mentioned that we're coming into 2025 with strong momentum. And that's definitely very visible in corporate earnings. Corporate profitability is solid. Q4 corporate earnings season, which we're kind of at the end of now, is showing very strong results. I think for the S&P 500, Q4 EPS is going to come in 17 percent year over year. That's going to be the strongest quarter since 2021. And when they take a step back and look at the aggregate Fed's financial account data. So now this includes investment grade companies, high yield companies, large and small. What we see is that profits as a share of GDP is very high. So that means that companies in aggregate are operating with great margins. That also translates to, from a credit perspective, decent leverage. We're not seeing outsized leverage taking or aggressive borrowing behavior at the high level. And we're seeing solid interest coverage, probably actually the best interest coverage ratio for the economy that we've seen since pre 1970s. So why this matters from a macro perspective is that we don't see broad imbalances in the system. This underpins our view of economic stability for the rest of the year. The corporate sector is going to stay solid, we think as long as the labor market is solid, as long as the consumer’s solid. But one challenge that I would say with all of this is that all of this data is backwards looking. So we need to really think about how the policy environment could affect our interpretation of the momentum that we're coming into and the strength in corporate fundamentals, but I'll save that for later.
Jay Diamond: Now, Rebecca, how does this outlook feed into general themes that you're seeing, particularly in the bank loan market? Are you seeing these things show up in issuer fundamentals in aggregate?
Rebecca Elkins: What Maria is saying from a more macro level is very applicable and generally is reflected in the bank loan market specifically. If you're looking at bank loan issuer fundamentals based on the public data that we have, as well as for private issuers, leverage and interest coverage looks fine, which again, largely echoes what Maria had said. Earnings for bank loan issuers are continuing to grow in the low or mid-single digits, which is helping to offset higher borrowing costs. And you're also not seeing aggressive borrowing, also echoing what Maria said. You’ve also seen a supportive technical backdrop where demand for loans is outpacing supply. You've also seen a wave of refinancing and repricing activity in the loan market, so performing issuers are able to also lower their nominal spreads, lowering their overall borrowing cost. Based on this macro outlook, where we have stable growth, that should continue to support earnings growth for bank loan issuers as well, which could also potentially translate into opportunities for our portfolios. I would say though, and this is a concern, particularly with the bank loan market, given bank loans are floating rate, so they fully bake in the higher interest base rates. There definitely is still tail risk in the market. And this is issuers that coming into this cycle either had margin profiles that were already tight and/or just had too much debt on their balance sheets, and they just can't withstand the high rates, particularly for this extended period of time. And you have seen that play out a little bit in some sectors more than others. For 2023, you saw the media telecom sector and the health care services spaces, both, due to some industry specific factors, but also as well as combined with the higher borrowing costs, underperform. In 2024, you actually saw this most with food and beverage manufacturers. They were impacted the most. But I would say at the end of the day, it really comes down to the individual businesses and those trends that I mentioned, where they either just didn't have the cash flow profile to withstand the higher borrowing costs and/or they just had too much debt on their balance sheet. So when the cost of that debt increased by multiples they couldn't handle.
Jay Diamond: So it’s really issuer specific.
Rebecca Elkins: Yes, exactly.
Jay Diamond: You mentioned rate sensitivity. How do you think the impact of slower Fed rate cuts that Maria was mentioning, will affect the bank loan asset class from your perspective as an investor, but also from the perspective of the borrowers that you're lending to?
Rebecca Elkins: It's a double-edged sword because as a loan investor, obviously the higher rates goes immediately to your coupon and your interest income. From a carry standpoint, having a higher for longer rate environment is great. And you've seen over the past two years, post GFC, record or close to record returns for loans. On the other hand, we do have healthy fundamentals. Issuer interest coverage is still close to the historical average, but it's that tail that we're still cautious on. You're going to continue to see that higher for longer rate environment impact these issuers. For those issuers, a 25 basis point cut here and there isn't going to make or break. It's really just this higher elevated, longer term rate environment where they're just likely going to run into trouble. And you have seen this in the bank loan default rate. This is a backward looking statistic. But if you're looking at the default rate over the last 12 months, this has ticked higher for the loan market. We're now slightly above the historical average. So a little over 3 percent versus the longer term historical average is a little under 3 percent on a par weighted basis. And we think that that's going to continue in the year ahead.
Jay Diamond: So what do you make of the default environment ahead given where we are today?
Rebecca Elkins: The past year or two years, really late 2022 heading into 2023, the market was freaking out. The distress ratio or the share of the market trading below 80 spiked and credit spreads widened. But you really didn't see this spike that the market was pricing in. The default rate has trended up slightly, but you aren't seeing a spike to the levels that we saw in Covid or in the GFC. And we think that that trend is, obviously barring any major macroeconomic shocks, we largely think that trend is going to continue, where you're not going to see a massive spike in defaults, but you are going to be in that slightly elevated call at 3 to 4 percent range for a longer period of time.
Jay Diamond: Okay, great. Now, so for those listening, GFC is the great financial crisis of 2008 and on. Maria, you left us dangling when you talked about policy. Let's go back to that. What's top of mind for the macro team when it comes to thinking about policy and the outlook?
Maria Giraldo: Yeah, there's probably no shortage of topics we're keeping an eye on. I'll start with tariffs because I think that's for us right now, really coming to the forefront in terms of how it's introducing a lot of policy uncertainty. And in the macro world there's these indexes that we track about policy uncertainty. It sort of measures how many times uncertainty comes up in newspapers and things like that. And we're now at the highest levels since, depending on the index you look at, since 2008. So clearly this is starting to have a real effect on business’ ability to decide what they're going to invest in. What does the next 12 months look like? Should they continue to hire? And we're now starting to get early read of that impact on sentiment. The administration, I would say, has been more aggressive out of the gate in terms of their tariff policy than we had expected them to be. You know, we knew that it would be used as a negotiating tool to some extent. We knew that there would be attempts to put tariffs on China in particular. I think Mexico and Canada and the extent to which we wanted to put tariffs on them, has been a little bit of a surprise, especially so early on. But then also the delays have then introduced even more uncertainty for markets in terms of not knowing what's going to happen after a month or two of them reviewing and negotiating where these tariffs could go. I think now from our standpoint, what we're really thinking about is that there is an element still of negotiating, using tariffs to negotiate, but there's also this element of just leveling the playing field globally, because our effective tariff rates really are lower than so many of our foreign counterparts. So we have to assume that tariff rates are going to go up at this stage. We think the effective tariff rate is probably going to be close to about 8 to 9 percent. The effective tariff rate is essentially an average rate that importers pay on the products that we import. Since the mid-nineties, it's been less than 3 percent, right. So we're tripling the effective tariff rate. And that's probably going to be where we're at by the end of 2026. And so businesses are going to have to start thinking about that. So that's one element. Tariffs is something we're thinking about. Tax cuts is another. There's major provisions from the Tax Cuts and Jobs Act from 2017 that are expiring after 2025. So that's likely to expire if Congress doesn't do anything about it and tax rates will go up for all consumers. So we're expecting that they're going to extend the Tax Cuts and Jobs Act. House Republicans right now are trying to tie that in with the congressional budgeting process. I will not bore the audience with the details of that. We're in for several weeks of back and forth negotiations on that. We do think at this stage that they'll get it done. Other things we're monitoring, I won't get into, I'll just kind of name them in order is executive orders on a variety of other White House priorities, border control and immigration, DOGE’s federal cost cutting efforts and the impact on labor market. Just so many policy changes that investors are having to really navigate in this environment. And we can't forget about the debt limit.
Maria Giraldo: Yeah, the debt limit is sort of being included in the budget reconciliation process at this stage. So, it's all coming in one big beautiful bill as they're terming it.
Jay Diamond: Yes. So as a strategist, Maria, how are you incorporating all of these moving parts into your outlook on credit?
Maria Giraldo: Yeah, as I said at the top of the podcast, it's just introducing a lot of uncertainty because it impacts behavior, impacts sentiment, it impacts investment. And for my models, my models are largely based on backwards looking data. Right. So I feed in, for example, in a default rate model, what corporate fundamentals look like. What does bank lending look like over the past several quarters. But now I have to think about really, how is it going to look like in an environment where policy is shifting a lot and the economic backdrop could be shifting? So, for example, previously I had expected that lending was just going to continue to improve. Banks were going to make it easier for businesses to borrow from them. Declining interest rates was going to make it more affordable for business to borrow. I think I have to rethink that input into my model, because now banks are probably going to have to be a lot more selective on which businesses they lend to. Another one is directly on corporate fundamentals. If we don't extend the Tax Cuts and Jobs Act, that could have an impact on interest coverage, for example. Increases in the effective tariff rate could have impact on corporate profitability. So all of these are things that I really have to qualitatively adjust to really think about what the range of outcomes could be from a high level. I also want to balance. I don't want to make this all negative. We need to balance upside risks. So on that front we want to think about AI. We're seeing quicker advances than we had expected in generative AI with DeepSeek that could potentially make it much more affordable for businesses to adopt AI. And in general, AI is just generating a lot of animal spirits of what the US can see in terms of investment and productivity. So there's upsides and there's downsides. All of that I have to sort of qualitatively incorporate in my credit outlook.
Jay Diamond: So Rebecca to investor all that matters is the future. Even with backward looking models. Maria just noted some downside risks, some upside risks. Tariffs, AI, let's take those one at a time. So how exposed is the bank loan market to tariffs?
Rebecca Elkins: Great question and it's definitely something that's been topical for our market specifically. And I would say in general the loan market is more insulated than the investment grade or high yield markets, just given they tend to be slightly smaller issuers—particularly investment grade versus bank loans—and tend to be a little bit more domestically facing. But that's painting a pretty broad brush to something that's pretty nuanced and specific. And I would say, generally speaking, tariffs introduce another element of bifurcation in the market. It's issuers that have non-U.S. exposures in their supply chains, non-U.S. production or revenues from foreign entities versus the issuers that are really more domestically focused that are going to be more insulated. And it feels like every day you get a new headline and something is changing, but we have done a deep dive on our portfolios, working with the different sector analyst teams to see where they have identified particular risks or themes across their industry, across their borrowers, and then also identifying potentially some specific issuers they think have a more material potential exposure to tariffs. And I would say that after going through that comprehensive review, we determined that the list of more potentially impacted borrowers was pretty small in the single digits as a percent of our total platform. One point that Maria brought up with DOGE, our aerospace and defense industry team, just recently did a comprehensive review on the potential DOGE impact, particularly on the government services businesses in our portfolios. We also had the health care team in the other day doing a broader Medicaid review across our exposure, and if there was potential regulatory changes how that would flow through the portfolio. So, we're continuing to refine and add on the analysis.
Jay Diamond: And what about AI? We mentioned that before as maybe a potential upside. How are you thinking about that as it relates to the bank loan market?
Rebecca Elkins: It's another interesting one and another topic that's really difficult to box in. And there are some interesting opportunities, but it's still pretty credit specific. And we're still in very early stages in terms of seeing this play out. AI specifically, I think the most immediate and visible positive impacts of AI are more so in the larger investment grade space. The hyperscalers, the chip manufacturers of the world. For this generally smaller bank loan issuer space, three sectors really come to mind as potentially being more impacted, whether to the positive or the negative. Another sector I would call out is the energy and power sectors. General consensus is that U.S. electricity demand is going to increase significantly over the next 5 to 10 years, growing at about 3 percent a year, which is three times the growth rate of the last 20 years, and driven by a handful of factors, but one of the most notably is this data center build out to support the growth of AI. Data centers are expected to be about a third of overall U.S. electricity demand growth through 2030. So this is likely going to benefit both power and energy sectors. On the power side, there are bank loan issuers that have more single plant generators, but those single plant operators are likely going to benefit from the increased power demand. There's also utility services businesses that help build and maintain the grid of infrastructure that are likely going to benefit. And then in terms of energy, the increase in electricity demand, it's naturally going to drive up natural gas prices, which flows through and drives value across the natural gas value chain. On the other hand, if energy prices go up, there are some losers. Consumers of natural gas like housing, or building heating, chemicals, etc. Then the last sector I would call out is technology. And for the most part, we've seen AI more as a supplement or an add on feature to existing software platforms rather than a full replacement. But it's a double-edged sword. There are slower moving incumbents that maybe haven't adopted AI capabilities and/or they're heavily debt burdened, and so they're more likely to lose market share to players that are more nimble and adding these AI capabilities. So at the end of the day, software adoption is driven by a customer's return on that investment. And so if AI is improving that return on investment, that's going to drive demand. So you might see a little bifurcation on the impact there as well. And then otherwise I would say you started to see some adoption across sectors. But we're very early innings and it's going to take a while to play out.
Jay Diamond: Now you were focusing on the loan part of the capital structure for companies in these sectors. But I imagine what you're talking about would apply, whether you were an equity holder in one of these companies or a bondholder in one of these companies. These same dynamics are at work.
Maria Giraldo: Yeah, what I thought was interesting actually in listening to Rebecca, I love to hear when from the bottom up, there's these themes that really resonate with what we see from the top down, because we have to think a lot about how AI investment is going to lead to productivity gains, for example. That's a big conversation in the macro world. But when you look at like census data, for example, that actually tracks and asks businesses, have you adopted AI? It's still such a small share. It's like 6 or 8 percent of businesses that are actually seeing that they're using AI to generate revenue. So, we're seeing certain areas that are beneficiaries. As Rebecca perfectly laid out, we're in the early stages, and if we think about the AI value capture, we're kind of in that stage where a lot of it is related to infrastructure, and eventually it's going to be related to end users. And we're just not there yet. But it's something that we're tracking very closely.
Jay Diamond: Now at the top of the show, I mentioned the High Yield and Bank Loan Outlook, which is our quarterly publication, and looking at the leverage credit market. Maria, give us a quick overview and key takeaways from our most recent issue, which came out last week.
Maria Giraldo: Despite having a view that the economic environment is stable and conditions are good, corporate fundamentals are strong, we do get a lot of investor inquiries, client inquiries on whether we're concerned about where tight spreads are, spreads are being very tight relative to history. And we do. We developed now, I think, a decade ago, a dashboard that tracks these across multiple sectors and just tries to look at them all in a similar fashion. And we see that across the board investment grade, high yield, they’re trading a very tight percentiles. They're back to levels from the 1990s. They're in the kind of fifth percentile of historical valuations. And so, we wanted to dig into that a little bit more. What are the reasons? Is it really all technical? A lot of people will say that has to do with the supply demand imbalance. There's very limited issuance, very strong demand in the yield environment. And that's definitely true. That's a big driver. But we were also encouraged to see that the fundamentals can explain why spreads are so tight. And this is thanks to S&P Global Ratings gave us historical data on leverage ratios, interest coverage margins, just a lot of fundamental data going back to the 1980s. And then when we compared spreads relative to where those fundamentals are now, compared again to history, we found that actually spreads still have some more room to narrow. On their own, they're in a fifth percentile of historical valuations. When you do something more like a spread to leverage ratio, they're kind of more in the 15th percentile if you're looking at high yield corporates. If you go even deeper, like Triple C's, you're probably more in the 30th percentile. So for us, what does that mean? Maybe there's a little bit of scope for spreads to tighten a little bit more, or at least stay kind of where they are right now. Stay rangebound for a while. We were there in 2004 to 2006. Spreads were just in a tight range for two years, so we could be here for a while. The other one is that if we see a little bit of a deterioration in fundamentals, maybe leverage starts to creep higher or interest coverage deteriorates a little bit, the market can absorb it. Because again, when you look at valuations relative to fundamentals, we're not seeing something that's very stretched at this stage. That's really the crux of the piece.
Jay Diamond: So Rebecca, as a portfolio manager, what do you think about pricing? Are we getting compensated at these levels for the risks that we're taking?
Rebecca Elkins: The million dollar question. In general, I would echo exactly what Maria has said. We've seen spreads tighten pretty materially really over the past year or two in the bank loan market, just as Maria mentioned, for broader credit markets. And this has been driven by at the technical dynamic, just for our listeners benefit, about two thirds of the bank loan market is held in collateralized loan obligations or CLOs. And then the balanced third is held by retail funds, mutual funds, ETFs and then individual investors. And so you had a year, last year of record CLO demand. And on the demand side record levels. And then on the supply side most of the issuance coming to market is issuers refinancing loans that already exist. So the loan market isn't really growing and you have record demand chasing those loans. And so that's what's really driven very, very tight technical environment and driven spreads tighter. And then on the back of that you also have, as we've also discussed, the generally solid fundamental backdrop as well. So investors aren't super concerned about the underlying fundamentals. So put those two things together and you get much tighter spreads. But would say that compared to other credit markets, loan spreads still do look slightly better versus the historical data. Using the percentiles, like what Maria discussed, loan spreads are within their 50th percentile versus the sub10 percentile in the high yield corporate market. And all in yields are still very attractive. And as I mentioned all in coupon driving the majority of return for a loan. So looking at all in yields, we actually are still slightly above the historical average for the bank loan market. So you still are being well compensated to be a loan investor despite the fact that you've seen the tightening of spreads over the past 1 to 2 years. But in terms of kind of how we're looking at things from a portfolio management standpoint, we definitely are cautious. Just given the trends we've highlighted. You've seen spreads tighten and there is still tail risk in the market. At the moment we are a little bit risk off, and we're being very selective on new names that we add to the platform, more than we have been historically. We're constantly reevaluating our portfolio holdings to make sure, do we think this still makes sense? Is there more downside than upside risk? Does it make sense to maybe trim or sell these positions just given where they're trading? But would say overall, just given the spread tightening environment, we still think there are opportunities in bank loans. But we remain very, very cautious.
Jay Diamond: What accounts for the strong demand we've seen in bank loans on the one hand? And do you think that issuance is going to stay relatively light going forward? So in other words, are these favorable technical dynamics going to be persisting going down the road?
Rebecca Elkins: So far this year, we've seen largely a continuation of those themes. One metric we look at in terms of issuers being able to tap the market to reprice or refinance, is the share of the market that's trading above par. And we came into the year with still 60 plus percent of the market trading above par. That has come down slightly, but you’ve still seen, for the most part, issuance in 2025 dominated by refinancing, repricing type transactions, which are not net new loan issuance transactions. What really drives growth in the loan market is leveraged buyout or merger and acquisition. So LBO or M&A volume. And why we've seen the pullback in volume driven by those transactions is the math doesn't work. For a leveraged buyout to work where rates are right now, either rates need to come down or valuations need to come down. And you haven't really seen a big give in either of those variables. And then you add in the uncertainty with the new administration and potential tariff impacts. And so you would kind of been hearing chatter that maybe we would start to see LBO M&A volume improve this year, but then you had all of the additional macro related noise. And it continues to kind of get pushed out in terms of the estimates. And that's really what would drive net new supply to the market. And then on the demand side, you're continuing to see strong CLO issuance driven by investor demand for the liabilities. And there's dynamics with captive equity holders and fund managers raising captive equity funds. And while spreads are very tight on the CLO liability side, they still look pretty attractive compared to other investment grade asset classes. So you're continuing to see that engine keep pumping. So I think really, again, barring any major macroeconomic shock, you're likely to see that trend continue. And then all else things equal, it probably will continue to drive modest tightening of credit spreads this year.
Jay Diamond: We have covered a lot of territory. I want to thank you both for the time you've given us. But before I let you go, I just have to ask, what would be a takeaway that you would like for our listeners to leave with? Maria, why don’t we start with you.
Maria Giraldo: We're coming in with strong momentum, as I mentioned. So that is creating a supportive fundamental backdrop. But I do think that investors need to be prepared that over the next 12 or 24 months, we're going to be in this sort of daily uncertain policy environment. We as a macro team do not see that changing anytime soon. It seems to be part of the strategy. So, this is a good environment for an active manager. Hearing Rebecca talk about what portfolio management is doing, what the credit analysts are doing, it's clear that they're really rolling up their sleeves and reacting to the news and even being proactive, in many cases, to potential changes coming down the pike. That's something that you need the resources, you need the resources to be looking at it on a daily basis. So this is a good environment for active management. Rebecca, anything you would add there?
Rebecca Elkins: I totally agree. Last year the bank loan market exhibited the least volatility in returns since the great financial crisis. You had all positive returns. In environments like that, obviously you're getting solid all-in return, but in terms of being able to really drive value for clients as an asset manager, the differentiation really comes when there's market dislocation. Particularly for a platform like us, we're very bottom-up focus, very selective. That's really where we drive our long-term outperformance across the cycle. And so as nice as it's been having this coupon clipping environment, a rising tide lifts all boats environment, I think if there was a little bit more market dislocation driven by this uncertainty, that's really where we would be able to find attractive opportunities and demonstrate our ability to outperform.
Jay Diamond: Fantastic. Well, again, thank you both. Thank you, Rebecca. Thank you, Maria, for your time and for your insight. Please come back and visit with us soon. And thanks to all of you who have joined us for our podcast. If you like what you are hearing, please rate us five stars. Now, if any of you have questions for Maria or Rebecca or any of our other podcast guests, please send them to Macromarkets@GuggenheimInvestments.com, and we will do our best to answer them on a future episode or offline. I'm Jay Diamond and we look forward to gathering again for the next episode of Macro Markets with Guggenheim Investments. In the meantime, for more of our thought leadership, including our latest High Yield and Bank Loan Outlook, please visit GuggenheimInvestments.com/perspectives. So long.
Important Notices and Disclosures
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