Bob Michele on Bond Market Calm, Recession Risks, and Private Credit

Bond Market Stability and Recession Outlook

• 💡 The bond market has calmed due to the deleveraging passing through the system, forcing out levered investors and proving false narratives about foreign selling of treasuries.
• ⚠️ The bond market is signaling a potential recession for the U.S. economy, especially if current tariffs proceed with only moderate compromise.
• 📉 Break-even inflation rates on TIPS are below 2%, indicating the market anticipates that a one-time price reset will kill demand and lead to recession.

Credit Risk and Investment Grade Opportunities

• 🎯 Investors are advised to stick to the Treasury market and clip coupons, but good quality credit risk can still be taken.
• ✅ Investment grade companies are expected to fare well through potential periods of increased input costs and demand destruction.
• 📊 The majority of the high yield market is also anticipated to be fine, with default rates projected to remain manageable even in a recession.

Private Credit and Shadow Systems

• 🏦 A significant concern is the growth of private credit, estimated at $2 trillion, which may not be as transparently marked to market as public markets.
• 🔍 There's a potential for a shakeout in the private credit space as institutions with expenses to pay, like pension funds and endowments, look at their portfolios.
• 📈 While public high yield markets appear clean, the pain is expected to be felt more acutely in private credit.

Market Flows and Investor Sentiment

• 🌍 Despite talk of the end of dollar exceptionalism, significant flows from the APAC region and the Middle East have entered the U.S. bond market.
• 💰 There's steady flow into the bond market, particularly the municipal bond market, which is considered too cheap.
• 📊 Official institutions and governments are not seen selling U.S. treasuries, and their buying in the one, two, and five-year parts of the curve has been strong.

Near-Term Market Outlook

• 📈 For the next couple of months, the outlook appears to be smooth sailing, with potential to retrace sell-offs from March and April.
• 🗣️ Positive signals include the 90-day delay on tariffs, ongoing negotiations, and the Federal Reserve monitoring the labor market.
• 🏛️ Corporate America is entering this period in good shape with compelling profit margins and healthy consumer balance sheets, making investment grade companies less worried.