Meghan Robson, head of US Credit Strategy for BNP Paribas, speaks to Global Finance about directional forecasts and what to expect post-election.
Global Finance: What surprised you in 2024?
Meghan Robson: The economic landscape has been positive and driven credit spreads to multiyear tights. In investment grade bonds, we’re now at spreads of 80 basis points. That’s a level we haven’t seen since 2005. In high yields, we’re now trading below 300 basis points. That’s the tightest since 2022. We were expecting US growth to slow more than it has. Data has been better than we expected, not only in the labor market but also consumer spending remains very resilient. The retail sales reading is strong. This raises the chances of a soft landing.
On monetary policy, the Federal Reserve has been a bit more dovish than we expected. Chairman Jerome Powell used his Jackson Hole speech in August to declare victory on inflation and ended up delivering that 50 basis point cut. Our base case was a 25 basis point cut—a bit more than expected. That really supported a bullish view. The market still expects that the Fed will be able to continue rate cuts at a regular cadence into next year. All that bodes well for credit and lowers the chances of a recession.
GF: Do you foresee a soft landing?
Robson: We are expecting a soft landing. We’re starting to see signs that corporate fundamentals are improving. In the second quarter, growth in Ebitda [earnings before interest, taxes, depreciation and amortization] outpaced interest expense growth for high-yield corporates. We’ve seen this downtrend in interest coverage. That is finally starting to stabilize as we’ve lapped higher rates and have easier comps there. As rates start to come down, that should potentially look better. There’s also the benefit of easier credit conditions going forward, which we think will continue into next year and allow corporates to refinance.
Another point is maturity walls. We’ve seen dramatic improvements with companies addressing maturities due in 2025, but also a lot of progress on maturities due out to 2026. We’re less concerned about that kind of imminent threat we were worried about at the beginning of the year? The risk looks a lot better, and all those reasons support the soft-landing thesis.
GF: Were the recession fears a false alarm?
Robson: Everything you learn as a credit analyst indicates there would be more problems after a rise in rates. So, I think there was some justification in looking at history and the impacts to interest coverage, and predicting that corporate fundamentals would have been more challenged. It seems like markets tend to overreact both positively and negatively to the news. So, the risks were overstated in terms of the market reaction, but I think there were solid reasons to believe we could have seen a bigger downside scenario than we have.
The year-over-year change in corporate margins is still positive, and as a result, profits are broadly expanding. Companies, for the most part, have not had to lay people off. Until you really see that margin compression, I think we won’t see a pickup in layoffs. If we do see margin compression, then companies will be forced to cut costs, and that’s where the recession probability could rise.
GF: How does US credit compare to the rest of the globe?
Robson: We have a modest preference for Europe over the US, given where valuations are. Also, political risk is a bit lower in the European region than the US. We’re also very focused on China’s growth. Beijing’s stimulus, in our view, is not enough yet to be a game changer for some of the sectors with exposure to China that we’re worried about. Chemicals and basics, for example, are going to struggle. We’re also closely watching the Middle East conflict. There’s clearly a feed-through to energy prices, and it could be a headwind to some of our issuers of things like transportation that rely on energy costs.
GF: After LVMH’s earnings, what’s your take on the luxury sector?
Robson: We’re more cautious. In aggregate, we’ve seen a strong labor market, and retail sales are robust. But in the second quarter, this new theme emerged of a slowdown in discretionary spending categories across all income groups, and one subsector is aspirational luxury. Think about a purchase that you might make once per year, like a purse. Consumers are much more discerning around big-ticket items, large leisure goods such as pools and boats. Liquor brands, for example, take these premiumization strategies, and we’re beginning to see spending fall off from those areas. We group all of those into highly discretionary spending categories and are underweight for those types of sectors. But we still think the consumer remains solid.
GF: How might the US presidential election outcome affect the dollar?
Robson: One of the key tail risks with reference to the dollar is sweeping trade policy from Donald Trump. We could have a 10% global tariff across the board and 60% on China. That could boost inflation of up to 5% relative to the baseline and a spike in rates. We would see high yields in the leveraged finance markets much more vulnerable in that situation. Some folks argue that high yield would do better under trade restrictions, just because companies have been more domestically focused in terms of their revenue. Our view is that ultimately, the macro backdrop of inflation and higher rates would be more challenging.
In terms of defensiveness, we like investment grade over high yields. There are certain sectors that we think are offering better risk/reward. So, credit spreads have gotten so tight and so compressed that there’s not much of a cyclical risk premium. You’re not being rewarded as an investor for taking on that extra risk given how tight spreads have become. So, we do like noncyclical sectors like utilities and healthcare, which we think could perform better should we see a pickup in volatility.
GF: Is the election delaying M&A activity?
Robson: There has been a delay of not only M&A, but also capex as it relates to the US election. We think that Kamala Harris would be more dampening to M&A volumes, whereas Trump would be more supportive of M&A just given his track record of supporting less regulation. For debt issuances, there’s typically a six-month runway between announcing the M&A and then seeing the deal price. If we were to see announcements after the election, it wouldn’t be until probably the end of first quarter 2025 or second quarter 2025 that we would see the corresponding debt for that deal.
GF: How does it look for private equity firms?
Robson: The borrowing channel looks better. Interest rates, expected to move lower, signifies that the cost of funding is good. We’ve also seen equity or purchase price multiples of leveraged buyouts, even though there haven’t been many, move lower than the peaks. That’s in specific sectors like software, where the multiples have been lower. That, combined with lower rates, makes it much more economical for private equity sponsorship. We’ve also seen a willingness of sponsors to contribute an elevated percentage of equity to deals, which should facilitate more activity.
GF: For corporates, what should their strategy be?
Robson: Be nimble and flexible in terms of your issuance plan. When market conditions are strong, you’ll be in a place where you can take advantage. Recently, we had some issuers on the sidelines, monitoring the situation for potentially coming to market. We saw rates fall off 10 basis points. They ended up putting those on hold. But should we see an improvement in conditions, they will be able to take advantage of those. I think for investment grade, the demand continues to be strong from yield buyers. Investors domiciled in Japan have seen their hedging costs come down, so that continues to support issuance in investment grade. And then in high yield, given lower recession risks, investors have a lot of appetite for supply. They’ve been starved of issuance. There is potential for those deals to be received well also, but we would recommend waiting until after the election. I think there’s still potential for volatility.
GF: What risks concern you?
Robson: The best catalyst is the one you don’t know. I think for credit, the unknown risk could be a technical one where volatility potentially causes something similar to the European pension-driven selloff. As it relates to Japan, given that the buyer base has grown so much, there could be a forced-selling surprise type of scenario. The selloff in August demonstrates how quickly markets can react negatively and have something turn technical. That is something we’re always trying to unpack. There’s also the underpricing of the election risk: Investors seem very complacent, especially around Trump scenarios where they say he won’t end up actually doing anything he said because he’s “market positive and wouldn’t enact anything.” I think that understates the policy risk.
GF: How will AI shape the future of corporate credit analysis?
Robson: Advancements in AI are extremely exciting for corporate bond researchers. Natural language processing can help with analyzing things like earnings statements. In terms of the creativity in the work product you can generate. Long term, it remains an open question. There will be a lot of investments in companies that can fail. For now, there’s a positive outlook.
