BlackRock: Fed cuts signal market “recalibration”
The recent rate cut by the US Federal Reserve represents a “recalibration” of monetary policy, which slightly increases the risk of some private credit defaults.
According to a new analysis by Amanda Lynam, head of macro credit research at BlackRock, and Dominique Bly, macro credit research strategist at BlackRock, the Fed’s decision to cut rates by 0.5 per cent means that the US growth backdrop is still relatively resilient.
Lynam and Bly noted that this growth backdrop will remain a key driver of corporate credit sentiment – especially for high yield, private and leveraged loans. However, they added that they do not expect default risks to change substantially in the private credit market as a direct result of the rate cut.
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“A constructive fundamental macro backdrop, combined with supportive technical factors (i.e., persistent yield-based demand, reinvestment of higher coupon bonds, and limited net supply in certain markets), should keep most subsets of USD and EUR credit spreads within their recent narrow – and tight – ranges,” they said.
“While the Federal Reserve has now officially embarked on a rate-cutting cycle, the policy rate will nonetheless remain in restrictive territory for at least the next few months (and possibly longer, in our view).
“As such, market participants are still watchful for signs of fundamental deterioration – especially from borrowers exposed to floating rate debt.”
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Lynam and Bly added that private debt defaults will be generally contained in aggregate, with higher risks associated with smaller borrowers.
“Smaller borrowers have generally experienced higher covenant default rates than larger ones…partly due to more restrictive covenants in the lower middle market (as smaller EBITDA deals are typically underwritten with tighter covenants),” the BlackRock executives said.
“It also reflects, in our view, the tendency of small firms to have less diversification (product, geography, customer, etc.), thinner financial cushions, and fewer economies of scale than their larger peers – all of which can make smaller businesses more vulnerable in certain macroeconomic environments.”
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