(Bloomberg) - Credit markets face a dramatic repricing in 2024 as higher capital costs slam lower-rated borrowers, according to JPMorgan Asset Management’s Oksana Aronov.
“The interest rate reckoning took its time to arrive — I think the credit reckoning will as well,” the chief investment strategist for alternative fixed income said in an interview on Wednesday. “There is going to be a big one, just as there was a big one in interest-rate risk.”
The shakeout will be focused on companies with fundamentally weak balance sheets, according to Aronov, whose firm managed $2.9 trillion as of September. It will reverberate more broadly through corporate debt, providing opportunities for investors, she added.
Credit markets surged this week as traders moved to price in aggressive rate cuts starting early next year. But Aronov does not expect Federal Reserve easing until the end of 2024 — if at all — given stubbornly high inflation, particularly in services. Her view stands in contrast to JPMorgan’s economists, as well as other banks’ revised forecasts for rate cuts starting early next year.
“I know this is a crazy notion right now but we think that on balance, there is more of a risk of a hike next year than these aggressive cuts that people are pricing in,” said Aronov.
Aronov told Bloomberg Television in an earlier interview that she expects a “really dramatic repricing” in credit. She has long argued that credit spreads are too tight to compensate investors for fundamental risks, with US junk risk premia at about 360 basis points. She’s shorting the high-yield bond market via “extremely cheap” default swap indexes and isn’t looking to buy until spreads exceed 500 basis points.
As funding costs stay elevated and a wall of debt comes due, Aronov predicts the US high-yield default rate — bonds and loans combined — will exceed 10% in 2024. That’s well above consensus estimates of about 5%, and more than double where it’s expected to end this year.
“The default drumbeat will continue,” said Aronov. “It’s plausible that we could cross that 10% threshold.”
Aronov expects situations like the March banking crisis, which slammed financial sector bonds — particularly additional tier 1 debt — to occur more frequently.
“We’re going to see more and more of these kinds of surprises throughout 2024 as the higher cost of capital continues to bite,” said Aronov. “When you have a liquidity underpinning that is so precarious, you are going to have dramatic moves in the market that are not necessarily always going to be fundamentally driven.”
JPMorgan took advantage of the bank rout to buy AT1s and Aronov continues to like contingent convertible financial debt. She also favors high-grade floating-rate bonds, which make up more than 30% of her portfolio, as well as select non-agency mortgage credit.
She’s also keeping ample cash on hand, ready to take advantage of any market dislocation or forced selling.
“We have a lot of dry powder in the portfolio, which is basically ultra-short and money market type investments which are paying us at 5.5% plus,” said Aronov. “When you have a BB credit that has a 6% handle on the yield, should you really be buying this when you can earn nearly as much in cash?”
By James Crombie
