Fallen angels to currencies: credit market dynamics
July 16, 2025
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3 min
Brian Kennedy
Portfolio Manager, Full Discretion Team
Loomis Sayles
What is your outlook for interest rates and inflation in the US?
We think rates are going to head marginally higher, even from today's levels in here. And I would caveat that by saying that the most recent developments in the Middle East could change that. Certainly, some of the geopolitical implications are very large right now. If we were to see a full-fledged war with troops on the ground in the Middle East, I think that all bets are off.
As far as the direction of interest rates, you would likely see more of a flight to quality at that point. Although is it going to be into the dollar, or will it be someplace else? Will it be into the Treasury market?
But I think, absent that, you would likely see a move higher in here. Again, tariffs and the unpredictable nature of where the tariffs are going to end up and what that means for inflation in here, the resiliency of global economies, including where we are in the US in here, and then also supply concerns-- again, the tax bill in the US is an unknown right now, but it does look like it would be significantly bad as far as the deficit is concerned. And so that would mean additional supply in the Treasury market.
So, we do think that means the Fed's on hold for a period of time. I think the Fed is really looking at inflation expectations at this point. They're still higher than they want out there.
I do think the immigration implications of what we're seeing in the US also means that the unemployment rate largely stays below 4.5% going forward for the rest of the year. And so, if I think about what the Fed's really trying to do here, you want a stable inflation over the medium term and full employment. And then neither side of that right now are we at the point where the Fed can really comfortably cut rates.
So, we think they're probably going to be on hold at least until the fall, but maybe even into the end of this year. So the markets have, time and again, priced in more rate cuts than the Fed has actually come through with. And I think we're starting to see that, and we have seen that, again through this cycle.
What are the trends & dynamics in credit markets?
You have to remember we're coming off a period of exceptionally pristine balance sheets in corporate America going back the last few years. So, what we're starting to see now is a little bit of, I would say, an off-the-top kind of a condition where profit margins are weakening a little bit, leverage is up, interest coverage is down. But we're now just getting back to a period of time where you consider it to be metrics that would equate to late cycle.
And so, I look at the balance sheets today in corporate America, and they're still in pretty good shape overall right now. So a little bit of degradation, but nothing significant. I would say one phenomenon that we're seeing that we think may present an opportunity for us is fallen angels. So, we haven't seen a lot of companies get downgraded in the last few years from investment grade down to high yield. But most recently, you've seen Nissan, Celanese, Whirlpool, and Warner Brothers Discovery all downgraded from investment-grade ratings down to high yield.
Fallen angels is one of our six pillars of investing. And so even when we are starting to see some corporate metrics break down in that market, we do think that there's opportunities there.
Which sectors do you believe have a favourable outlook for H2?
There's really three I would point to that I think look favorable at this point in time. Securitized credit, so we talk a lot about corporate credit, but I would also say that we can pivot to securitized credit in these portfolios, as well. And so, we generally don't invest in agency mortgages. But you do have a very large and increasingly growing market in corporate ABS as well as the CLO market.
And so, we look at that market and say it's an offshoot of corporate credit, where you still need to know your issuers, but they're largely shorter duration amortizing structures. And you can get into areas such as borrowing in data centers or fiber transactions, aircraft leasing. And so, you do get away from some of the consumer element that you've typically known in the asset-backed market.
Again, what I like about those is they're amortizing. So, as we talk about this higher-for-longer interest rate environment and reinvesting at higher rates, we're constantly getting cash thrown off on a lot of these shorter-duration products that we think are helpful. The CLO market is now $1 trillion market. We think that that's a good investment, as well, particularly in the AA and AAA ratings areas there.
I'd also point to bank loans. 5 and 6B-rated bank loans, we think, are an opportunity even above and beyond investment-grade credit as far as where returns can go right now. You don't have the type of convexity that we typically like in bank loans. And so, what we're really looking for are names that can add an additional 25 to 50 basis points of yield to make up for the lack of convexity in those structures.
And then the last one, I think, which may present us with one of the best opportunities for total return, would be in the non-dollar space. And so, as we continue to see the de-dollarization of trade take place in here, there's likely fewer dollars that are going to get recycled back into either the Treasury market or the US corporate markets over time. That presents opportunities for other currencies to appreciate against the dollar.
We also think that there's some currencies out there that may not appreciate against the dollar, but are also a very high and attractive yield, as well. So, I think it's a combination of yield in the non-dollar space, but also some currencies that can appreciate against the dollar.
