Market Update
U.S. equity markets ended the week lower again as the war in Iran carries on and geopolitical concerns continue to weigh on markets. Oil prices remained elevated throughout the week, as traffic through the Strait of Hormuz came to a halt and several major producers in the region announced oil production shutdowns. The oil futures curve suggests that prices will normalize from current levels but a meaningful risk premium is here to stay until there is more clarity regarding the conflict. The sudden spike in oil and energy prices caused treasury yields to increase due to the rise in inflation expectations which has made investors push out the first rate cut to September or October. In terms of economic data, CPI data for February came in line with estimates, although the report is a little irrelevant as it was before the increase in energy prices. The GDP number for Q4 was revised down notably to 0.7% quarter-over-quarter (compared to 1.4% previous estimate), with the downward revision coming from all areas. This week on Wednesday we have the FOMC meeting where the attention will be on the commentary regarding the economy and their forecasts for the remainder of the year.
February CPI Inflation
The CPI numbers for February showed signs of inflation moderating, with core CPI rising 0.2% month-over-month or 2.5% year-over-year, slightly lower than the prior month, while headline CPI increased 0.3% for the month or 2.4% year-over-year. A key driver of the improvement was housing registering its lowest pace of growth since 2021, where rent and owners’ equivalent rent (OER) slowed to 0.20% (from 0.23% in January) as official CPI housing data continues to catch down to the pace of new lease rents. Core services excluding rent and airfares also cooled to 0.31%, down from 0.39% in January and well below its average pace earlier in the year. These trends suggest easing inflation in services as labor market conditions soften and strong productivity growth helps contain wage pressures.
Despite the encouraging CPI data, recent geopolitical developments involving Iran have complicated the inflation outlook. Rising energy prices represent a potential supply shock, increasing production costs across industries and raising the risk of further pass through to consumer goods prices, particularly in energy sensitive sectors such as plastics and manufacturing. Reflecting this risk, market-based inflation expectations have moved higher, with the 5-year breakeven rising to 2.61% by the end of the week.
Private Credit Faces Headwinds Amid Software Concerns
The private credit market has been under immense pressure recently, as a flurry of investors have raced toward exits amid concerns about underwriting standards and anxieties over additional loan markdowns coming down the pipeline. The catalyst for the panic wasn’t necessarily a single event but rather a growing series of warning signs across the industry, with early worries being focused on distressed subprime auto lenders, but attention has since shifted toward the software sector. Concerns about software were heightened after prominent banks, including JPMorgan, began marking down the value of loans tied to software companies and reassessing their exposure to the sector. This has put pressure on large private credit managers such as Blackstone, Blue Owl, and KKR, which depend on management and performance fees from these funds, but also have to somewhat acquiesce to investors' demands when they want to exit. The outflows from these funds have a direct earnings impact on these companies, as when AUM decreases, total fees collected from these funds shrink alongside it, and it also forces private credit managers to potentially have to sell high-quality assets to fulfill redemption requests. The concern going forward is whether the turmoil surrounding the private credit market will have spillover effects on the broader financial system; thus far, it appears to be premature to make the claim that it will, but if we continue to see pressure on the sector and broader credit crunches, it could cause direct losses to banks that have lent to these institutions.
Sources:
https://markets.jpmorgan.com/jpmm/research.article_page?action=open&doc=GPS-5233638-0
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
