Inflation remains sticky, with US core PCE still holding above 3.5%. The disinflation on goods has faded with ongoing uncertainty around the potential impact of tariff-driven cost-push pressures. Services inflation and lagging shelter CPI continue to delay a clear deflation path, keeping the Fed firmly on hold. The US economy grew by 2.0% year-on-year in the first quarter of 2025, down from 2.5% in the previous quarter and marking the slowest pace since Q4 2022, with further downside risks rising. Consumer demand continues to soften, with credit growth stalling, and private investment remaining constrained by high real rates and policy uncertainty. Fiscal deficits and elevated insurance remain a structural long-end overhang.

The US labour market continues to cool with unemployment now nearing 4.3%, participation rates have remained steady while hiring and wage growth is weakening. While this supports the Fed’s  cautious stance, it does not warrant imminent rate cuts amid persistent inflation. Treasuries offer elevated real yields of ~1.75-2.0%, with breakevens underpricing forward inflation risks. Treasuries remain modestly cheap, but rising term premium reflects supply saturation, fading foreign demand and an absence of QE support.

Volatility remains structurally elevated, driven by inflation uncertainty, fiscal issuance and the post election policy environment, with the Fed unlikely to validate rate cut expectations without material deterioration in growth or inflation data.

Moving to investment grade credit, corporate fundamentals remain solid, with EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margins reaching three-year highs of 31.5% in Q4 2024. Leverage and interest coverage seem to have plateaued at historically resilient levels, particularly for A- and BBB- rated issuers (coverage: 9.2x and 6.4x respectively). Near term refinancing risk remains relatively low, with less than 7% of index maturities falling in 2025 and most issuers have extended tenors into 2027-2029.

Spreads remain priced for near perfection, with investment grade at ~84bps, tighter than 94% of post 2000 observations. Spread per unit of leverage has compressed to ~27bps, offering limited compensation for incremental credit or macro risk. Relative value is concentrated in select defensive sectors (e.g. utilities and health care), while cross-rating dispersion remains historically low.

ETF inflows have slowed, net issuance is still light, and dealer inventories remain thin. ETF flow data and high yield skew suggest investors are holding, not accumulating, signaling late-cycle positioning caution within credit. Relative performance vs treasuries has stalled for benchmark duration corporates, but absolute return potential is increasingly constrained by rate sensitivity and compressed spreads.

Earnings resilience remains broadly intact across high yield credit issuers. Q4 2024 revenue grew 2.6% YoY and EBITDA rose 3.8% ex-energy, led by gaming, leisure and services. BB-rated credits maintain strong metrics (leverage ~3.8x, coverage >5x), while B and CCC issuers face margin and refinancing pressure. Defaults remain low, but are expected to rise toward 2.8% in 2025, concentrated in CCCs.

Spreads have compressed to ~318bps over treasuries, tighter than 92% of post 2000 observations. Spread per turn of leverage is ~82bps, reflecting reduced compensation for risk. High yield investment grade differential (~221bps) signals underpriced quality risk. Carry continues to look attractive in BBs and short-dated Bs, but CCC valuations are stretched with downside asymmetry building. The investment technicals for high yield credit remain supportive, but are moderating. Issuances are down 11.5% YoY, helping spreads, but liquidity is increasingly concentrated in large, benchmark-eligible names. Relative momentum favours high yield over investment grade. Absolute price action remains robust across all timeframes.