TCW's Whalen Sees 2023 Credit 'Reckoning', Warns on Debt Risks

Key Takeaway

• TCW's Bryan Whalen predicts a credit market correction in 2023, citing overpriced corporate debt and economic overoptimism.
• Despite recent demand, investment-grade and high-yield bond returns are down, signaling potential future losses amid economic slowdown.
• Whalen suggests the Fed's eventual rate cuts could indicate a declining economy, potentially leading to more aggressive monetary policy.

Credit Market Correction Looms

Bryan Whalen from TCW Group, overseeing more than $170 billion, predicts a significant correction in the credit markets within this calendar year. He argues that current pricing does not reflect the underlying risks, suggesting an overvaluation that could lead to a "reckoning" in the credit market. This perspective comes amid slowing US job growth and an unexpected rise in the unemployment rate, which has led to a rally in bonds and a decrease in yields on two-year Treasuries to approximately 4.8%.

Fed Rate Cuts and Corporate Debt

The anticipation of Federal Reserve rate cuts as early as September has spurred a rush into corporate debt, driving spreads on investment-grade bonds to their lowest levels in years and a surge in high-yield debt issuance. Despite this demand, returns for US investment-grade bonds have dropped by about 2.2% this year, with junk bond returns barely reaching 0.95%. Whalen emphasizes the importance of considering the broader economic context, including inflation and growth rates, when analyzing the potential for rate cuts.

Consumer Spending and Market Sentiment

A stock-market rally is keeping consumer confidence and spending high, according to Whalen. However, he warns that this spending is increasingly being charged to credit cards and depleting savings, a situation that could quickly reverse. The potential for a weaker economy raises the risk of losses in both investment-grade and high-yield bonds, should companies face downgrades or defaults. Whalen suggests that the Fed may need to cut rates more aggressively once the economic downturn gains momentum.

Altice's Debt Crisis and Market Implications

Altice's distress, with its $60 billion debt stack, is causing ripples through leveraged debt markets in the US and Europe. The company's financial struggles have led to a cautious approach from loan underwriters, impacting refinancing efforts for other borrowers, unsettling collateralized loan obligation markets, and prompting demands for stronger covenants from credit investors. Altice's situation exemplifies the risks associated with weak covenants and the power imbalance favoring large borrowers in distress, serving as a cautionary tale for investors in high-risk, high-yield debt.

Street Views

• Bryan Whalen, TCW Group (Bearish on the credit market):

  "We think the pricing is totally inconsistent with the potential risks out there, and we think at some point probably this calendar year you’re going to get a reckoning in the credit market... Not everything in the economy is as rosy as they’d like to believe." "Picking the right month when the Fed actually goes isn’t the right part of the analysis. It’s: What’s going to be the state of the world, what’s going to be going on with inflation, what’s going to be going on with growth when they actually do start to cut... We’re seeing slowing all over the economy." "History would suggest that by the time the Fed actually starts cutting, the economy’s on downward trend, it's got downward momentum... More likely than not, in our estimation,  the Fed's gonna have to go more aggressively once they finally do start to go."