First Quarter 2023

Speed and scale have been unique aspects of this pandemic cycle.  The shutdown of economic activity, fiscal/monetary responses, and market recovery all occurred at record size and pace.  There are positive aspects.  Decisive stimulus made the economy more resilient and restored capital market functioning.  There are also decidedly negative aspects.  When distortions to the real economy and financial system unexpectedly unwind, there can be unintended consequences and reactions can occur at warp speed, causing accidental and possibly, permanent damage.  Speed can transform what simply could have been a series of unfortunate events into a full-blown crisis.

From the macro perspective, the demise of some banks has been a negative shock that dialed up the risk of a more pronounced economic slowdown.  Banks had already begun to lower credit exposure.  It is unclear how much of what they are doing is to address the challenges of tightening monetary policy, or just risk management given where we are in the cycle.  If expected new rules and regulations are implemented and require higher capital buffers, it will also further slow lending.  The banking stress highlights the fragility of our system.

Against a backdrop showing cracks of financial stress, judging the path of interest rates requires more than assessing the Fed’s success in dampening inflation.  We are factoring in the risk more hikes could add to what has been an extremely volatile rate regime.  A pivot to rate cuts seemed remote at the beginning of 2023, but now has a higher chance depending on how well backstops for bank liquidity shore up market confidence.  Also, while our base case is that a debt ceiling agreement is achieved, fits and starts in talks will be another source of volatility in the rates markets.  Our trading range for the 10-year Treasury is 2.75%- 4.25%.  It is wider than normal reflecting the range of probable scenarios.

Investment grade Corporate spreads have widened moderately reflecting the modest deterioration in Credit metrics forecast for 2023 and the heightened uncertainty surrounding issuers in the Financials sector.  Repricing is happening more quickly but not always more accurately.  We expect Credit spreads to continue to exhibit two-way volatility driven by heightened risk environment.

Market gyrations are producing more opportunities to buy securities with attractive spreads issued by companies that we believe to be strong, stable, and resilient through the cycle.  Technicals remain supportive with higher yields continuing to attract interest in fixed income.  A severe recession would result in a period of materially wider spreads.  We would view that as a strong buy signal versus current modestly attractive levels.


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Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.

This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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Source: Pugh Capital, Bloomberg, and Bloomberg Indices.

As of March 31, 2023.