The word that best describes economic conditions right now has to be ‘uncertainty’. We hear it frequently on earnings calls from investors and across the capital markets, from all participants.
By way of evidence, we searched the word uncertainty in the Fed’s ‘Beige Book’. The ‘Beige Book’ is a summary of economic conditions by region across the US, and what we found was that for the past 18 months, the word shows up between 10 and 15 times. But in January 2025, we see that the trend begins to go up. So, for example, in January, the number appears about between 10 and 15 times. Then it goes up to about 45 and then as high as 80.
We think the reason for that is that going from ‘the worst tariffs of all time’ to ‘the worst tariffs of all time’, is still the worst tariffs of all time. We don’t know yet what the medium and long-term effects are, and that’s partially because we haven’t settled yet on what the tariff regime is going to look like.
How does this affect economic data? Well, what we are seeing is that consumer sentiment and management sentiment is in decline, and so consumers and the corporate sector are holding off on spending. Capex budgets are being reigned in, and the consumer looks like they’re going to keep their hands in their pocket for the moment.
That leads to a decline in economic expectations for GDP growth, consumer spending, private investment. These all are shaped like a cliff dive from 2025, and in the opposite direction are inflation expectations and recession expectations, which are all in the rise.
All of that being said, going into this period of uncertainty corporate fundamentals are in pretty good shape. Balance sheets are in decent shape. Liquidity is in decent shape.
We don’t see a lot of leverage in the system, at least in the corporate sector and that’s quite good because there’s a bit of runway for companies to embrace this period of uncertainty and defend the balance sheets to get through it. That being said, where we do see a risk of leverage in the system is actually in the Treasury market.
So, putting all these factors together, how we are positioned is right now going into this period of uncertainty, is that we prefer higher quality credit for Europe over the US. We like banks and insurance companies and other services that are out of scope for the tariff regime. We also think high-quality managers in CLOs still make sense, and the ABS market has been very robust.
In the meantime, where we can deploy them, our options book is still quite active to protect against downside risks in a spread-widening environment. In this period of uncertainty, we’re still comfortable with credit on a total return basis and an all-in-yield basis; credit market are still very attractive. But, clearly we need to be positioned for this period of uncertainty and it implies being positioned in higher-quality credit and in sectors that are less vulnerable to an extreme tariff regime.
