Correlations Between Credit and Equities Are Breaking Down
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Credit markets are relieved after inflation data showed cooling price pressures, but a weakening economy poses risks to corporate debt. Risk in the high-yield credit market eased to the lowest since March following cooler-than-expected inflation in June. However, if the Federal Reserve doesn't manage a soft landing and the economy cools too much, credit downgrade and default rates could rise. Weakness in hiring, wage growth, and services activity, along with a 30% chance of recession in the next 12 months, point to emerging economic weakness. Credit investors are currently ignoring the risks and piling into debt sales for high yields. Correlations between equities and credit are breaking down due to higher interest rates, which negatively impact equities but support credit. Morgan Stanley remains constructive on credit, but other investors are rotating out of the US and favoring Europe. Leveraged finance bankers are waiting for a potential revival in mergers and acquisitions in the second half of the year. US company pensions are expected to shift billions of dollars into corporate credit. The global artificial intelligence frenzy is driving demand for energy-intensive data centers, potentially boosting sales of green debt. Loose bond documentation has left investors vulnerable to asset stripping in recent debt deals. Jefferies Financial Group is winding down trading positions at its hedge fund 352 Capital after suing its former portfolio manager over an alleged fraud. Various banks and investment firms have made personnel changes and strategic moves in the credit market.

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https://www.bloomberg.com/news/articles/2024-07-13/credit-traders-worry-about-an-economic-slowdown/