The tariff tantrum unleashed on April 2nd hit credit markets that were already correcting, driving spreads significantly wider. From the tights of mid-February to March month-end, spreads widened to 6-month highs as credit volatility rose, reacting to economic and policy crosscurrents and the knock-on effects from degrossing of extended “risk on” positions, especially in momentum driven equities. CDX IG had widened from 46.5 basis points to 61.4 and CDX HY from 291 to 376 basis points. April to date, pricing in tariff uncertainty, spreads widened further to 73 and 436 basis points respectively.
Cash bond markets have widened significantly from late February tights as well. The Bloomberg US Aggregate Corporate Index has moved from an option adjusted spread of 77 basis points to 116 and the JP Morgan High Yield Index widened 178 basis points to 474. For context, their 5-year averages are 113 and 382 basis points respectively.
New issue markets functioned reasonably well through March, despite the volatility. In the US, $184B investment grade bonds priced, contributing to a record Q1 tally of $531B. The “window” was open for high yield as well where $26.6B priced in the month, topping totals for the two preceding months. Despite syndicated loan activity quieting some in March, totaling $57B, Q1 ’25 was still the 3rd most active quarter at $336.8B. Activity in all three asset classes continued to skew heavily towards refinancing and repricing, although net loan issuance in March was the highest since 2022. Activity screeched to a halt once hit with last week’s tariff news. As of this morning, investment grade syndicate desks are making the first attempts at pricing deals that have been stuck in the pipeline waiting for some market stability.
Even before the tariff news, banks and other market participants were adjusting forecasts towards slower growth and higher inflation. While most lagging and coincident economic indicators have remained solid, consumer and business sentiment has deteriorated. The recent University of Michigan Index of Consumer Sentiment fell to 57 in March from 64.7 in February, and the Conference Board Consumer Confidence Index plunged from 98.3 to 92.9; both readings were the lowest since mid-2022.
The sudden shift in Washington towards efficiency and expense cutting driven by DOGE has also contributed to the risk off sentiment as investors logically assume reversing previously stimulative spending, even on the margin, could detract from growth.
Adding the tariff news to this brew has triggered another round of forecast adjustments. JP Morgan now expects 2025 real GDP growth of -0.3% and a full 5 Fed easings reaching a Funds rate of 3%. Our concern is that core inflation, which was already stubborn before the tariff news, will rise, handcuffing the Fed’s ability to cut rates that much.
Higher interest rates for leveraged credits and downshifting growth continue to contribute to default and distressed exchange activity through March. Issuer-weighted default rates including distressed exchanges are 3.51% and 4.72% on a trailing 12-month (TTM) basis for high yield and leveraged loans respectively. KBRA (formerly Kroll) estimates that in private credit, defaults and non-accruals total 5% on a TTM basis. Moody’s, even before the tariff news, forecast 5% defaults in their “moderately pessimistic” scenario and over 8% in their most pessimistic. Access to capital for refinancings from the relatively “open” new issue market for leveraged credits had been an offsetting positive through March. Chronic disruption should contribute to more stress on certain issuers leading to liability management attempts and perhaps additional defaults.
We believe this environment favors credit managers who can deploy an ensemble of strategies incorporating both long and short exposures providing varied sources of alpha. More specifically, skilled managers who can carefully underwrite mispriced and stressed credits, express views through a wide array of cash and derivative instruments and profit not only from spread compression but also decompression and dispersion. We believe the opportunity set in credit has expanded greatly over the last few weeks and that elevated credit volatility will persist.