In our last Multi-Asset Credit (MAC) update, we highlighted the dual nature of market risks. Just a few weeks ago, there was a glimmer of hope that Trump’s tariff proposals might be manageable for both the US and the global economy, potentially supporting spread sectors. However, we also stressed the importance of diversification given the possibility that trade tensions could escalate, increasing uncertainty and pressuring spread sectors. Fast forward to today, global financial market uncertainty has skyrocketed. Trump’s tariffs have become more aggressive and credible than anticipated, clouding economic forecasts and thickening the left-hand tail of macro distribution.
Over the past weeks, we’ve tactically managed our duration positioning and view duration as an effective risk-off ballast against spread risk in MAC portfolios. With the sharp turn in global financial market sentiment, we’re now closely monitoring potential shifts in US Treasury and equity correlations, especially with rising inflation expectations on the horizon. Given the increased likelihood of this risk, along with growing fears of recession and stagflation, we favor US steepener trades, focusing more on the belly of the yield curve rather than the long end.
In terms of sector positioning, we’ve cautiously added exposure to higher-quality, high-yield corporate bonds and various investment-grade corporate bonds, while holding back on structured credit and emerging markets (EM). Like the Federal Reserve (Fed), we remain vigilant due to the unpredictable domestic and foreign policy decisions coming from the White House.
Sector Views
Trump’s latest tariffs are shaking up the global credit market, posing a significant threat to corporate profitability rather than solvency, and likely creating headwinds for growth-dependent asset classes like equities. However, we believe the credit market can still thrive in a low- or slowing-growth environment, as long as management teams stay laser-focused on generating free cash flow and reducing debt. Here’s our take on how these new tariff developments are impacting each asset class in MAC portfolios.
High-Yield
Spreads have widened since mid-February, but we remain confident that strong credit fundamentals will prevent significant declines in valuations. We don’t foresee a substantial increase in default rates in the near term, given the current leverage profiles, the absence of imminent maturities. Unless a recession occurs, we view current spreads as an attractive entry point to increase exposure to select higher-quality, high-yield issuers. However, sectors that warrant caution include consumer products, retail and home construction.
Bank Loans
In the bank-loan space, we’ve reduced exposure to cyclical sectors like autos, chemicals and building products due to tight spreads and moderating growth. Additionally, we’ve avoided auto companies with supply chains in Mexico due to aggressive Trump tariffs. Beyond autos, we’ve ensured our portfolio holdings lack significant manufacturing exposure in Mexico, particularly to industrials, building products or consumer products. Despite these adjustments, we expect bank loans should perform well, supported by attractive yields and a favorable collateralized loan obligation (CLO) issuance environment driving demand.
Collateralized Loan Obligations
CLOs are likely to follow macro sentiment, especially in lower-rated segments. However, most CLOs are backed by diversified loan baskets, insulating the investment-grade portions. Tail risks for BB rated CLOs and equity tranches can increase, particularly in deals with significant exposure to sectors impacted by tariffs. We’re selective, avoiding below-investment-grade CLOs that are less diversified or heavily exposed to autos, chemicals and building products. We prefer shorter spread durations within each rating category and aim to add or rotate positions on any widening, given the already attractive yields in the CLO space.
Investment-Grade
Investment-grade corporate fundamentals started the year strong, with demand for bonds matching robust supply—a trend we expect to continue due to attractive yields in the rates market. While spreads in cyclical industries reacted negatively to the latest Trump tariffs, the overall sector spread widening was moderate, especially considering the magnitude of the equity market downturn. Our investment team is currently inclined to add positions during periods of weakness and focus on industries and issuers more insulated from tariffs, as well as on high-quality issuers experiencing sympathetic spread widening.
Non-Agency Residential Mortgage-Backed Securities
Residential housing fundamentals remain strong, with low supply of both existing and new homes expected to persist. We prefer new-issue deals at the top of the credit stack and seasoned credit bonds with upgrade potential as deals de-lever. We believe the impact of tariffs will be minimal, potentially reducing new home construction and thereby supporting higher home prices.
Commercial Mortgage-Backed Securities
The commercial mortgage-backed securities (CMBS) market’s trajectory will likely be influenced by credit and equity market performance. Higher goods costs may challenge rents in consumer-oriented sectors like lodging, retail and multifamily housing. Industrial sectors might see reduced demand for space due to decreased foreign trade. If tariffs delay rate cuts, it could negatively impact commercial real estate credits and values, pressuring refinancing success rates and further constraining lending. Despite these concerns, we believe that the CMBS market has many mispriced credits, but we will approach near-term volatility cautiously.
Emerging Markets
In the EM space, fundamental performance has been relatively stable, as reflected in current spreads. With the Fed in an easing cycle, we expect EM central banks to follow suit, leading to a decline in local sovereign yields over the medium term. While we anticipate some near-term volatility, we believe tariff uncertainty will create attractive opportunities in EM. In frontier markets, we continue to hold select exposures and find value in select new issues. EM corporates remain a core holding, benefiting from conservative financial policies and strong duration-adjusted carry. However, we’ve adopted a more cautious approach in EM local markets due to the uncertainty surrounding Trump tariffs.