US economy is strong, rates elevated, consumer cash at record highs. AI adoption uncertainty is the real wild card.
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Hello & welcome back to the Weekly Fix. My name is Tim Leary & I’m a Senior Portfolio Manager on RBC’s BlueBay Leveraged Finance Team in Stamford, Connecticut.
It’s mid-June, kids are just about done with school and it would appear that the conflict with Iran is trending towards a resolution. As oil sells off, inflationary concerns should subside and the focus shifts to our new Fed Chair Kevin Warsh. To level set a bit, we saw the ECB hike rates 25bps to 2.25% on deposits last week and the bank of Japan hiked its policy rate by 25bps to 1%, while the RBA left rates unchanged at 4.35% this week. The market isn’t expecting a move out of the FED this week, but the market will hang on every word in the statement and Warsh’s first presser.
Let’s zoom out a bit. The US economy is growing, unemployment is low, rates are well off the recent lows and corporate earnings are strong. There is an AI capex funded shot in the arm to US GDP that is unparalleled across the globe. Consumer checking and savings account balances at the largest banks in the US are higher than they were pre-covid – in fact they are higher even if you take into account the last 6 years of inflation. On an apples to apples basis, Americans have more cash today, across each income band, than they did before the covid blip. So, with that backdrop, you can see why rates may remain elevated.
The key known unknown remains how AI will impact the job market. The Fed’s dual mandate of full employment and stable pricing will inevitably be impacted by the growth in AI usage and the costs associated with that usage. That uncertainty around the pace of adoption and what that adoption looks like in practice will lead to uncertainty in the direction of travel in the economy and rates.
The nice part about high yield corporate bonds is that while credit spreads reflect the health of the economy and credit rating profile, the all in yields and short duration nature of the asset class is getting more & more investor attention.
We continue to see value in the certainty of high yield carry & the income it distributes each month. Sometimes it’s as simple as realizing that a bird in the hand is better than two in the bush.
As always, thanks for your time & good luck trading.
Key takeaways
The macro backdrop supports higher rates: US GDP is growing with strong AI capex, unemployment is low, and corporate earnings are solid. Consumer cash balances are actually higher than pre-COVID on an inflation-adjusted basis across all income bands.
AI's impact on employment is the key unknown: The Fed's dual mandate (full employment + price stability) will inevitably be tested by AI adoption. Uncertainty around the pace and nature of job displacement creates unpredictability in economic direction and rate trajectory.
HY carry offers meaningful income relative to duration: With elevated rates and short duration, high yield bonds provide monthly income and spread compensation tied to credit fundamentals, creating potential for total return in the current environment.