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BlackRock Commentary: Taking selective risk in credit

Wei Li – Global Chief Investment Strategist of BlackRock Investment Institute together with Amanda Lynam – Head of Macro Credit Research, Natalie Gill – Portfolio Strategist and Michel Dilmanian – Portfolio Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points

Risk-on: We get granular as the environment for risk-taking is supportive for now. That’s why we like euro area high yield credit, emerging market debt and U.S. stocks.

Market backdrop: U.S. stocks soared to record highs again last week. Ten-year U.S. Treasury yields were largely unchanged but slightly below their 2024 highs. 

Week ahead: We’re watching January U.S. payroll data out this week. A strong reading could confirm that still-high wage growth will stoke inflation, as we expec

Getting granular and being nimble to seize opportunities in the new regime are key lessons guiding us. We heed that lesson as inflation falls and the Federal Reserve readies interest rate cuts. This more supportive backdrop for risk-taking anchors why we’re overweight euro area high yield credit, dollar-denominated emerging market debt and U.S. stocks. We had preferred investment grade credit but now eye fixed income where spreads haven’t tightened as much. We still like private credit.

Even as sovereign bond yields were volatile over the past year, the spread between them and credit yields has tightened steadily. We cut global investment grade (IG) credit to underweight on a tactical, six- to 12-month horizon last September after preferring it over stocks and high yield since mid-2022. That change funds risk-taking in pockets of credit where the risks seem better compensated for. We favor high yield and stay neutral: Its yield is attractive and returns are less sensitive to interest-rate swings. Regional differences underpin why we prefer European credit overall. U.S. IG and high yield credit spreads are further below their 10-year average than European peers. See the chart. European spreads have underperformed since 2020 partly due to a different sector composition and weaker growth in Europe, in our view. Yet we think the excess yield in European credit compensates for the risks.

We see markets embracing a more supportive near-term macro outlook. In the U.S., we expect inflation to fall near the Fed’s 2% target this year before resurging beyond 2024. We went overweight U.S. stocks this year because we think the upbeat risk appetite can persist and broaden out beyond artificial intelligence, until resurgent inflation comes into view later this year. Robust U.S. growth, nearing Fed rate cuts and falling inflation have lessened the market’s recession worries. That’s good news for emerging market (EM) assets, in our view. We’re overweight EM hard currency debt – mostly denominated in U.S. dollars – as spreads look more fairly valued than U.S. high yield. We see broader credit spreads staying tight for now given the supportive risk-taking backdrop, and strong demand for new issuance of U.S. IG and U.S. high yield credit bonds.

Maturity costs

Yet we see a risk that could cause high yield spreads to widen as markets price in more credit risk. About 10% of the market value of euro area high yield debt is maturing in 2025, 6% of U.S. high yield debt – and even more the next year, BlackRock Aladdin data show. We find that’s not an exorbitant amount, and even the lowest-rated high yield issuers have been able to refinance debt this year. Still, refinancing at higher interest rates may challenge operating models that assumed rates would stay low, in our view. IG companies also have debt maturing, but we think their stronger balance sheets are more flexible.

A year after a few U.S. regional banks collapsed, we have seen the funding challenges higher interest rates create. We’re monitoring the impact of higher rates and maturing debt on commercial real estate. The sector will likely face more pain, but we think it will be manageable as the reset to lower valuations occurs over multiple years. We see a more supportive near-term macro backdrop. Firms that need to refinance may turn to private credit as banks cut back on lending. We prefer private market credit over public on a strategic horizon of five years and longer because we think demand will rise and higher yields better compensate for risk. Yet private markets are complex, with high risk and volatility, and aren’t suitable for all investors.

Our bottom line

We get granular as the near-term macro outlook improves the environment for risk-taking. We’re overweight U.S. stocks, euro area high yield and EM hard currency debt. We also see opportunities in private credit as public debt matures.

Market backdrop

The S&P 500 and Nasdaq keep marching higher, with both indexes hitting new all-time highs last week. U.S. Treasury yields retreated even as markets priced out more Fed rate cuts given resilient growth and sticky inflation – and now see just three quarter-point cuts this year. We still see inflation on a rollercoaster that the market could wake up to later in the year. The U.S. PCE inflation data confirmed that inflation will likely settle closer to 3% after falling toward the Fed’s 2% target this year. 

U.S. payroll data for January is in focus this week. A strong reading could confirm that elevated wage growth will push up on services inflation – and overall inflation once the drop in goods prices has run its course. Structurally slower labor force growth due to an aging population is a key long-term production constraint we think the U.S. will face. Elsewhere, we expect the European Central Bank (ECB) to hold rates tight at its policy meeting.

Week Ahead

March 5: Japan CPI; China Caixin services PMI

March 7: ECB policy decision; U.S., China trade data

March 8: U.S. payroll data

March 9: China CPI, PPI

BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 4th March, 2024 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.

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