Analyses
Credit Markets Brace for Inflation: Winners vs. Losers
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Insight Article
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novembre 15, 2021
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novembre 15, 2021
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Credit Markets Brace for Inflation: Winners vs. Losers |
With U.S. inflation accelerating to its highest rate in a decade, near-term uncertainties related to the pace of interest rate hikes and the impact on earnings are top of mind for many credit investors.
Based on underlying sector trends, we see this current period of accelerating inflation as part of an economic expansionary phase that could lead to a more sustained global recovery and GDP growth over time. When we look at the effects of inflation on credit profiles by sector, we can examine the impact of wage inflation as well as higher commodity and input costs on the earnings and cash flow trajectory.
Undoubtedly, the supply shock created by the pandemic has led to higher prices. Across industries, supply-chain disruptions and longer-term strategic shifts to bring manufacturing onshore have strained resources, causing input prices to rise. We believe these are durable factors that can exert upward pricing pressure and drive so-called cost-push inflation.
But this is more than just a supply shock. We also observe a substantial recovery in demand across sectors. Importantly, we expect that to grow for a variety of reasons, consistent with an economic expansion. That can also exert upward price pressures, so-called demand-pull inflation.
Source: Morgan Stanley, as of September 30, 2021.
First the good news: Sectors with a chance to win
Not all the news is positive: Sectors under pressure
Challenges and Opportunities Remain
As always, changes in the macroeconomic environment present both challenges and opportunities. Today, the big change is inflation and how companies adjust to this risk.
The elements of cost-push inflation that exist today may cause stress in some corporate sectors. Companies whose earnings, cash flows and profits are tied to factors that are fixed — and where both rising input costs and the inability to pass through high prices can squeeze margins — will face challenges.
On the other hand, there are companies that can address rising demand more efficiently, adjust prices more quickly, pass through higher costs and increase productivity. They may observe benefits to their earnings, cash flow and profit margins.
The opportunities lie in selecting sectors, and more specifically companies, that are best able to adjust, adapt and innovate during a changing environment.
Risk Considerations
Diversification neither assures a profit nor guarantees against loss in a declining market.
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in a portfolio. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Certain U.S. government securities purchased by the strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. High-yield securities (junk bonds) are lower-rated securities that may have a higher degree of credit and liquidity risk. Sovereign debt securities are subject to default risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. The currency market is highly volatile. Prices in these markets are influenced by, among other things, changing supply and demand for a particular currency; trade; fiscal, money and domestic or foreign exchange control programs and policies; and changes in domestic and foreign interest rates. Investments in foreign markets entail special risks such as currency, political, economic and market risks. The risks of investing in emerging market countries are greater than the risks generally associated with foreign investments. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, and correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Due to the possibility that prepayments will alter the cash flows on collateralized mortgage obligations (CMOs), it is not possible to determine in advance their final maturity date or average life. In addition, if the collateral securing the CMOs or any third-party guarantees are insufficient to make payments, the portfolio could sustain a loss.
INVESTMENT GRADE CREDIT RESEARCH TEAM |