Viewpoint  |  September 22, 2023

Staying in Short-Dated Credit as the Rate Curve Dis-Inverts

How will the dis-inversion of the yield curve impact credit investors?

The past 18 months have witnessed a rapid rise in interest rates as central banks tackle intensifying inflationary pressures globally. These policy measures have put upward pressure on the front end of the rates curve, while rising recessionary concerns and the anticipation of rate cuts have resulted in an inverted rate curve. This is a rare phenomenon and has historically been considered a precursor to recession. 

However, with central banks near or at peak policy rates, macroeconomic data continues to surprise on the upside – particularly in the US. Recessionary fears appear to be receding, and a ‘higher for longer’ rate and inflation outlook suggests the current curve inversion is no longer justified.

Rate Curve Inversion

Within a ‘normal’ market environment, the rate curve is upward sloping. This reflects the need for additional compensation for extra inflation and duration risk. This traditional curve shape can change – as we are currently seeing - on the back of shifts in monetary policy or economic expectations.

The 2022 yield curve inverted due to central bank monetary policy rate hikes, with the short end moving up to reflect higher policy rates. Subsequently, the long end fell to reflect the market’s belief that policy rates would return to lower levels in response to recessionary pressures, and as inflation returned to central bank targets. These combined factors resulted in the highest level of curve inversion since the early 1980s in the US, and early 1990s in Europe. 

However, macroeconomic data continues to be relatively solid, and the economic ‘soft-landing’ narrative curated by the Federal Reserve has resulted in the slow dis-inversion of the rate curve. Investors who dogmatically followed the rate curve inversion playbook may now be reconsidering this position as that recession risk – and the related return to a low-rate environment - is being questioned.

A Return to a ‘Normal’ Environment

During a ‘regular’ rates curve cycle, following an inversion, the curve typically flattens as policy rates fall and the front end of the curve moves lower. As this easing of monetary policy stimulates economic activity, the rate curve can steepen back to an upwardly sloping ‘normal’ shape. However, we believe that the steepening in this cycle could instead come from the long end rising to reflect higher longer-term inflation, a higher-for-longer rate environment and an economic soft landing in the US.

Impact on Credit Portfolios

With this in mind, we believe investors should not disregard the embedded value in short-dated credit. This could again provide investors with protection should we see interest rates driving negative returns in longer-dated credit.

Short-dated bonds continue to offer a yield premium over longer-dated credit as well as some shelter from interest rate and spread volatility. Absent a significant recession, or a U-turn in central bank policy, we believe they are likely to outperform longer-duration assets over the medium term.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of September 2023 and may change without notice. All data sourced from Bloomberg, as of 21 September 2023.

-------------------------------------------------------------------------------------------------------------------------------------------

Important Information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of a fund’s future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2023-09-21-11935