Post-Tariff Thoughts
Liberation Day brought with it an abrupt shift in sentiment and a wave of selling as investors digested a tariff announcement that was far more punitive than expected. The severity and magnitude of the levies will have far reaching implications on supply chain countries, particularly in Asia. The tariff landscape today is much more complex than it was years ago and for this reason, we believe the potential disruption to US corporate issuers could be more significant.
While we recognize the degree of the impact will vary across industries, as some are more insulated to tariffs than others, profit margins will likely compress as companies are forced to absorb some of the near-term tariff headwinds. It’s not realistic to expect them to completely pass on any price increases to consumers, nor extract meaningful concessions from suppliers to cover higher costs. Ultimately, we believe these new tariffs could stunt consumer spending and slow growth. Credit fundamentals are healthy now and most companies have termed out their debt1, but in our view a deterioration in credit quality should be expected, particularly if tariffs remain in effect for an extended period of time.
Spreads across sectors, ratings, collateral types, and structures have all widened since the announcement, but selling is relatively orderly. The hit to sentiment has been noticeable and it’s keeping buyers on the sidelines. Recession odds are also moving higher with JPMorgan now forecasting a 60% probability of a recession this year.
Within the securitization market, commercial real estate is certainly vulnerable due to supply chain disruptions and reduced consumption. In the consumer ABS market, fundamentals are starting to soften, given a rise in delinquency rates2. Meanwhile, we believe Agency mortgages should be more of a safe haven given their good liquidity and government support.
While we have not engaged in any material portfolio repositioning, we have reduced marginal risk in sectors that have performed very well over the last couple of years. Over the coming weeks, we believe spreads will continue to widen near-term (absent a market-friendly resolution on tariffs), and this will eventually present compelling value for re-entry. Although we are not ready to add risk at these levels, we are evaluating securities that have been “thrown out with the bath water” while we continue to sell names most directly impacted by the new tariffs (e.g. consumer cyclicals). We maintain that relatively high absolute yields in fixed income combined with lower Treasury rates should assist with managing the risk against near-term spread widening.
1 MacKay Shieldsr
2 Federal Reserve Economic Data (FRED) – St. Louis.
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