What's Next for the Credit Cycle?
The Loomis Sayles Macro Strategies Team
As of November 20, 2020
The global credit cycle appears to be rolling into recovery after swift progress through the downturn and credit repair phases. Here, we share our analysis of the credit cycle and key factors we’re watching.
WHAT IS THE CYCLE TELLING US?
We use the table below to track important indicators of the credit cycle. The majority of signals are now consistent with the recovery phase of the credit cycle, especially when incorporating our forward-looking views.
WHAT ARE WE WATCHING?
The table above tracks the most significant indicators of the credit cycle. However, we’re also watching factors specific to current circumstances that might influence progress through the cycle. In our view, no individual variable is likely to single-handedly shift the cycle, but it may ignite a chain of developments that ultimately rotates the cycle. Here’s a snapshot of these special factors:
WHAT CAN WE EXPECT FROM THE RECOVERY PHASE OF THE CYCLE?
Here are common themes typical of recovery:
Importantly, we do not expect a smooth path through recovery. Surging COVID-19 cases worldwide and dwindling fiscal support will likely moderate the pace of growth in the months ahead. However, with a vaccine on the horizon and a US fiscal package anticipated in early 2021, we believe markets will look through short-term disruptions.
Several economic indicators support our positive view of the recovery:
Together, we believe these factors could create a powerful engine for the recovery when we exit pandemic conditions. If social distancing begins to lift in late spring 2021, we believe global GDP could reach its 4Q 2019 peak sometime in late 2021 or early 2022.
READ ON FOR A SNAPSHOT OF OUR VIEWS ON KEY TOPICS RELATED TO RECOVERY
OUR VIEW: Positive vaccine news should keep us on track to begin easing social distancing by summer 2021.
THE DETAILS: COVID-19 cases in Europe and the US are on the rise, which could slow the recovery. However, we think testing, tracing, and containment measures will help prevent severe lockdowns. We expect large-scale vaccine distribution to begin in early 2021, and social distancing measures could begin to ease by summer 2021.
OUR VIEW: We believe global growth will moderate in Q4 2020 as COVID-19 cases surge in major countries. However, we expect the pace of growth to accelerate in 2021.
THE DETAILS: The recovery in global growth may be tempered in the near term as major economies try to contain the spread of COVID-19. However, an additional US fiscal package, monetary policy support and pent-up demand could feed a strong recovery once vaccine distribution begins.
OUR VIEW: Effective fiscal delivery is critical for the recovery. Despite delays, we believe the US will ultimately deliver what’s needed by Q1 2021.
THE DETAILS: Extreme partisanship in the US government may limit, or prevent, any fiscal action in Q4 2020. We think a fiscal package is more likely to pass in Q1 2021. If Republicans keep control of the Senate, it could be in the range of $1.5 trillion.
OUR VIEW: We expect companies to pursue genuine deleveraging, where profit growth exceeds debt growth and the debt-to-profits ratio declines.
THE DETAILS: We are not yet seeing companies actively deleverage. Profits are just starting to bounce back, but it is early days. Once profits and incomes sustain a rebound, we expect to see more deleveraging efforts. Companies will typically shift their focus from financial engineering to fixing their balance sheets. Of course, the defaults we’ve seen are another form of deleveraging, but it is much healthier to lower the debt-to-profits ratio.
OUR VIEW: Credit spreads have retraced much of the March selloff, but we see room for additional tightening over the next six months.
THE DETAILS: Credit spreads appear well supported as profits continue to bounce back and monetary policy remains easy. Markets appear to be looking forward to a successful vaccine and an end to social distancing by mid-2021. Any significant delay in a vaccine would be a major headwind for the markets.
OUR VIEW: In October, inflation in most major economies was below 1.5% on a year-over-year basis.
THE DETAILS: Global inflation remains very low. In October, inflation in most major economies was below 1.5% on a year-over-year basis. We see limited inflation pressure in the near term and we expect central banks to remain accommodative.
OUR VIEW: The US dollar appears more likely to depreciate as long as risk appetite stays well supported.
THE DETAILS: The dollar has been trading in a range for a few months now. We believe the dollar will eventually break out of that range and grind weaker as investors feel more comfortable taking risk and shifting their portfolios abroad.
1Source: Bureau of Economic Analysis NIPA Tables, Q3 2020.2Source: National Federation of Independent Business.
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