Deal activity is picking up in the private equity and private credit markets, in anticipation of central bank rate cuts and stabilisation in economic growth, according to Principal Asset Management.

Tim Warrick, head of alternative credit at the asset manager, said that this presents an opportunity for private debt.

“Provided Fed rate cuts are sufficient to ward off systemic events and prevent a shift back to tighter credit conditions, M&A and leveraged buyout activity are likely to continue picking up for the remainder of the year and into 2025,” he said.

“The private direct lending middle market will most likely continue to finance a greater portion of the activity as commercial banks and the public loan market remain less compelling for private equity sponsors and borrowers seeking to grow their businesses.”

Read more: BlackRock: Fed cuts signal market “recalibration”

Warrick highlighted a growing disparity between the upper mid-market, which faces increasing competition from the public market, and the lower and core direct lending mid-market.

Credit spreads have tightened significantly in the upper middle market, he said, compared to the lower and core mid-market.

“The spread movement across markets has improved the relative value of lower and core middle market private credit compared to public and larger private credit opportunities,” he added.

“When also considering other important aspects of relative value, such as lower leverage levels and virtually no payment-in-kind, meaningful maintenance covenants, relatively attractive original issue discount, and more favourable call protection, the attractive value of lower and select core middle market opportunities is even more noticeable for investors.”

Read more: Moody’s: Private credit to hit $3tn by 2028

The Federal Reserve has been loosening monetary policy this year amid falling inflation, whilst trying to manage an economic ‘soft landing’.

The central bank recently cut its base rate by 50 basis points to 4.83 per cent.

“The first lien senior secured nature of the direct lending middle market, coupled with the attractive risk premiums and orientation to more resilient industries, should contribute to attractive relative value during the coming quarters,” Warrick said.

“If the public markets remain ‘risk-on,’ the Fed rate path is likely measured and in conjunction with an economy working into and through a soft landing. If the economic path becomes bumpy, the Fed’s rate path will likely accelerate in reaction to public markets experiencing significant volatility and drawdown.

“In either case, middle market direct lending should provide the diversification and resiliency it has provided in many other uncertain market environments.”

Read more: Principal predicts “manageable” default rates for direct lending market