The desk interprets recent developments in the credit markets as an indicator of underlying volatility likely to influence FX pair movements. Per the full note from UBS Asset Management, the performance of broadly syndicated loans and high-yield bonds has been impacted by concerns over AI technologies and geopolitical tensions in the Middle East. This suggests a potential shift in investor sentiment and risk appetite, creating headwinds for currencies sensitive to credit market fluctuations. While volatility has been a dominant theme, the 'coupon-clipping' expectation has not fully materialized, as evidenced by continued coupon payments despite fluctuating prices.
What the desk is arguing
The desk sees current volatility in the credit markets as a harbinger of subsequent risk discord in FX trading. UBS's commentary highlights how the integration of AI into the market introduces both enthusiasm, particularly for data centers, and trepidation linked to conflicts in the Middle East.
As the credit landscape shifts due to external concerns, it raises questions about currency stability. The dynamic is underscored by the market's response to developments in technology and geopolitics, with broader impacts on risk-sensitive currencies expected.
Where it sits in our coverage
The consensus target for the EUR/USD remains at 1.075, with a range of 1.04 to 1.12 across firms. Specific Dec-26 targets include: - jpmorgan: 1.10 - bofa: 1.04
This view appears to sit at the upper bound of the consensus spread, suggesting a moderately bullish outlook for the EUR against the USD amidst credit market volatility.
How other firms see it
Firms aligned with this perspective include jpmorgan, indicating a bullish stance, while bofa presents a contrary view with a more cautious approach. This divergence suggests the market may be vulnerable to unexpected shifts in sentiment owing to external pressures.
The trajectory of the EUR/USD appears particularly impacted by the ongoing conversation around AI technologies and central bank responses, particularly relating to Fed policy decisions in the face of evolving credit conditions.
01Credit market volatility signals potential risk in FX.
02AI and geopolitical tensions play a critical role in market performance.
03Current consensus on EUR/USD leans towards a moderate bullish outlook.
04Divergence among firms suggests heightened market sensitivity.
Market implications
Traders should watch for levels around 1.075 for EUR/USD as a pivotal point amid ongoing volatility from credit conditions. Positioning signals will be key in assessing market reactions to geopolitical tensions and AI developments, influencing overall risk appetite.
Risks to this view
Should there be a significant downturn in credit quality or a sudden escalation in geopolitical conflicts, this could reverse current market positions and prompt a flight to safety, adversely affecting currencies tied to risk. A sharp decline in performance of high-yield bonds or a change in the macro outlook could signal a shift in trader sentiment.
ubs
We are back now with the Credit Snapshot with our colleagues from UBS Asset Management. Joining us today for the segment, glad to welcome members of the Credit Investments Group. We have on the line with us today John Popp, a global head and CIO, David Mechlin, head of Liquid Credit, along with Eileen Liu, head of U.S.
Client Portfolio Management. Eileen will guide today's conversation with John and David. So with that, Eileen, thank you for dropping by.
I know you'll be focusing on recent market developments within broadly syndicated loans, high-yield bonds, as well as CLOs. So a lot to cover with our listeners. Eileen, let me turn it over to you.
Great. Thank you so much, Dan. We're excited to be here today.
Yes, as you mentioned, we're going to discuss what we're seeing in credit markets. Perhaps we'll just start the conversation with some more timely topics. So first, actually, David, I'll start with you.
So when we spoke at the end of last year, we and really the rest of the market, we were anticipating a bit of a coupon-clipping type of year for both broadly syndicated loans and high-yield bonds, but that's certainly not what we've experienced in Q1 and into April. We've seen quite a bit of market volatility driven by AI concerns, as well as the conflict in the Middle East. So to start us off, can you give us a quick recap on how AI has affected both the loan and bond markets?
Well, the little secret no one tells you about coupon-clipping is you still clip the coupon, which the market is still doing. But yes, as you said, we are seeing some movement in prices in the market for a couple reasons. The biggest of which is what you just alluded to in terms of artificial intelligence.
It's sort of grip markets, both positively and negatively. I think you've seen significant enthusiasm in parts of the market, largely around data center build-outs, the mega large-cap equities that can capitalize on this trend. You've seen pockets of fear in the market, and it is interesting to us.
We think about this relative to historical periods, and how does this rhyme or differ with those periods? And you think of the internet bubble and the enthusiasm that came out of that. I think the AI wave, we'll call it, really since Estropic releasing a new update in Claude and I guess now it's three months ago, back in January, a lot of fear.
A lot of fear of the unknown. And the unknown creates concerns, creates volatility in credit if credit investors naturally think about downside protection. So the AI investment thesis, et cetera, we've seen areas of significant issuance.
The high-yield market, we've seen a number of new deals come to market, AI investment opportunities, and I think we will see that very shortly in the loan side, too. And that is something we'll watch over the next six to nine months. But when we think about the first quarter in particular, and you think about the return profile and volatility, we definitely saw that play itself out a bit, particularly around software names.
Heightened competition, the ease to create new software, fundamentals in the software space continue to be very strong. But it is a large piece of the market, and it's creating a lot of focus. And we've definitely seen some price movement in the face of that.
And so when you think about just sizing the markets, and I'll use some generalities here, but private credit is probably something like 25% exposed to software, probably syndicated loans less so, around just shy of 15%, maybe 13%, 13% plus or minus in software. So it's a meaningful sector, not as large. And then high yield, actually around 5%.
So varying degrees around below IT credit exposure to software. But that's really where, Eileen, more acutely you're seeing some of those artificial intelligence impacts play themselves out in terms of the concerns that you're seeing out there in the market and being reflected in prices at this point. That's really helpful, David.
Thank you. Maybe another topic that's been causing what you mentioned, fear or fear of the unknown. Can we get your thoughts on how the Middle East conflict has also affected our market?
You know, it's interesting because, you know, war with Iran you would think would be more front and center. But as I mentioned, the AI narrative has probably been more impactful. That's not to say that the market isn't concerned or looking at the events in the Middle East right now with an eye towards, you know, caution or what that might mean in various sectors.
But you're actually seeing some positives. You're seeing some concerns in parts of the market. You're actually seeing some positives, though, at the same time.
You know, what comes front and center to me is the chemical sector. The chemical sector was probably the most pressured sector in the market. And it's maybe a little reverse Isaac Newton here.
What goes down must come up. And a reminder of cyclical sectors can sometimes see recoveries. One of the best performing sectors we've seen this year is chemicals.
And really that's because, you know, U.S., to a lesser degree Europe, but U.S. chemical companies are significantly advantaged when there's energy concerns out there. And obviously energy in the sector has done very well, but that's, I think, got more obvious. I think, you know, it's a little more intuitive for folks.
But the chemical sector actually, U.S. producers are significantly advantaged at this point relative to Asian companies. And so you're actually seeing significant improvement in the credit profile of chemicals companies. And so that's something where the Middle East conflict can have an impact, but in this case it's actually having a significant positive fundamental impact.
And we are seeing that. There will be pockets, something like packaging, et cetera, those sectors that have inputs, you know, input costs that might go higher, something that we're keeping an eye on. But, you know, as opposed to, if you contrast this with the AI narrative, it's more fundamental.
AI is more technical. We aren't seeing any weakness in those software companies fundamentally. It's more of a technical impact.
This is more fundamental, and it's also more disparate. You're seeing pockets of market actually see some benefits from some of the conflict that we've seen. That's really helpful to hear.
Maybe, John, maybe you'll take the next one. So private credit and then all these various vehicles that actually invest in the asset class have also been a topic of interest for our clients and covered in the news these days. Can you comment on the evolution of private credit markets and how that affects the liquid loan market?
Trying to think about private credit, you know, what comes to mind is everything old is new again. There is nothing really going on here that hasn't been done before. I think you have to look at the market for financing non-investment grade companies.
And if you look over the arc of history in these capital markets, when I started in the business, the only real capital market for non-investment grade financing was Iobox. The loan market was still Manny Hanny, Nations Bank. It was First Chicago, Continental Illinois.
You can go down the list. And then when Clinton struck down Glass-Steagall, you started to see an increase in consolidation. And with that, the development of capital markets for loans, where banks would really be the originator of the loan and then distribute it to institutional investors.
And that evolution is pretty well ensconced now. I mean, the loan market really is an institutional market owned by funds, owned by CLOs largely, and then separate account mandates. On the private side, that didn't evolve as quickly as the loan market.
After the GFC, however, you started to see banks pull away from mainstream lending, small and medium enterprise businesses in particular. And you saw the rise of firms like Golub and Monroe and Pennant Park, quite a few smaller businesses that were designed to take care of that whole. What we've seen more recently is a continued move in terms of the appeal of private assets among investors that's led to what we've called a convergence between the broadly syndicated market and the private market.
So much of the private market is formally resident within the broadly syndicated market, and the broadly syndicated market is providing takeouts for a lot of the private stuff. I think the other thing that's a little bit more recent is, even though functionally there's nothing really all that new going on, the rapidity of capital raise here has led to some of the angst in the market. I'm reminded of an old saying from an English class in college, the road to access leads to the palace of wisdom, for you can never know what is enough until you've had more than enough.
And I think to some degree the rate at which that money was raised got to the more than enough category. So it's not to say that the private debt market is broken, but I do think that money was raised so quickly and the eagerness to put it out was such that there are certainly examples of underwriting standards probably taking second seat to just the notion of originating and booking a fee on the part of many of these institutions that have raised these funds. Now, the locked up funds, kind of no problem.
There's a lot of institutional capital. We've actually seen money going out of our market into the private space, people redeeming broadly syndicated, moving into private at the institutional level. I think where all the headlines are really focused is the retail behavior around this and trying to get money out of the interval fund constructs or any construct that allows some level of liquidity.
So I think that's calming down, but I don't think that it's a harbinger of a massive issue with respect to incredible default rates and major losses. I think it's just a little bit overblown and I think people are linking the liquidity or inability to get their money out that there must inherently be something wrong in those portfolios. Many of them, yes, but not to the degree that we think it's a systemic issue.
Lloyd Blank finds out talking up his memoir and saying, oh, this reminds me of 08. This is nothing like 08, which was really driven by synthetic subprime lending that just multiplied the same risk again and again and again. Here, again, you might have a risky loan and it might go bad, but it's just that one loan.
So I think the impact directly on the broadly syndicated market can be seen a bit in that people that want liquidity and they can't get it out of their private fund if they have money in the broadly syndicated market are going to turn to that. And then the broadly syndicated market has also been a market that has been owned quite extensively by many of the large private funds, like a B cred. So, again, that can put downward pressure on the broadly syndicated market as those holders of broadly syndicated paper are going that way to get the liquidity to meet some of the redemption requests.
From a credit standpoint, probably at the end of the day, a positive impact from this dislocation usually brings opportunity. There's certainly more money being raised on the private side, but I'm hopeful that we'll start to see maybe a little bit of spread widening in here as risk is reassessed. And I think for the people on the broadly syndicated side, that's going to be a plus.
Thanks, Eileen. Thanks, John. Okay.
So then what about maybe our next topic? Given what we're seeing in the markets today with the new Fed chair to come, what are our thoughts on Fed policy and rates, and how do you think that might affect credit from both a technical and fundamental perspective then? I think that from a fundamental perspective, I don't really see much of an impact.
Clearly from an administration standpoint, there's going to be pressure on Warsh to push things down. On the other hand, with the war and the continued growth in the economy, I think there's a little bit of upward pressure. So I don't see them raising rates, but the swiftness with which they might push things down I think is going to be delayed a bit.
So the technical there would be bonds could rally. High-yield bonds are underperforming loans here today. But if we saw a sense that rates are going to rise, that would be more acute because high-yield bonds are like all-time tights.
But I think that what's going to happen, I think the bias is going to be to tighten, but I think the broader market is going to push back against that. And in terms of how it fundamentally affects underlying credits, I don't really see much of an impact here because I don't see much of a move up to put pressure on these companies, and I don't see that big of a move down to provide them material relief where there are companies that are facing a little bit of cash flow problem. Okay.
That makes sense. David, how about back to you? Specific to CLOs, we've seen record years of issuance in 2024 and 2025.
It felt like the market just couldn't get enough paper in those years. What are we seeing in 2026 so far? Well, there is a general.
We found this really across different asset classes below IG credit, whether it's CLOs, loans, high-yield. Supply has been just simply limited and constrained relative to the demand. And as you said, CLOs are no different when you think about that.
There's been significant amount of demand for the asset class. John mentioned the maturity of the asset class where CLOs comprise a very significant amount and tend to be a very stabilizing force in the loan market. Year-to-date, issuance of CLOs is lower than it was last year.
It's still robust when you look at just nominal amounts of issuance, still pretty strong and pretty busy, fairly busy for the market, probably less so as we kind of have a period of volatility in here in the first quarter as we saw price volatility. I will say that the market structure that we've set up for that to come back pretty strongly, and I think we've seen that in various periods of time, even last year during the period of tariffs. Of course, you might see a slowdown, even more of a longer impact.
Perhaps in 2022, you saw somewhat of a slowdown, but that came back quickly. I think we'll come back pretty quickly from here on the issuance side. There's just that reset that happened.
The spreads go wider, and I think what typically happens, though, is that market participants see that, and they see that actually as an opportunity because one of the biggest complaints folks would have said a few months ago, end of last year, was, oh, boy, the arbitrage, it feels tight. The average loan spread is maybe a bit light. Maybe it's a bit tight for what I would like to see relative to my cost of financing on the CLO side, and actually, I think John alluded to this, as you kind of see some of the dynamics and the shifts that are occurring within private credit, here's a good shot we actually see some opportunity for wider spreads on the asset side, and I think that will.
It is already, and that will draw investors. Software, obviously, has become more of an opportunity than it was a few months ago, given where spreads are. Software historically priced among the tightest loans in the market, and now they're certainly wider, and for investors that are willing to take on some of that software exposure, you're actually seeing significant yield opportunities.
But beyond that, I think there's generally, you know, if private credit capital raising does slow relative to levels, it doesn't necessarily mean to see outflows, but if you see a slowing of investment trends on the private credit side, you could see opportunities for both high yield and for the loan market to see the asset spreads get to a place where that quote-unquote arbitrage, right, the ability to earn a higher return on the assets becomes more and more compelling, and you see more and more issuance, and just from a market structure basis, I think we're set up well for that. A lot of the investors in the market at this point have raised what are called captive equity funds, and so that means that individual managers of loans have raised capital that can be deployed over many years, and so that is sort of waiting on the sidelines for regular deployment, and I think we'll continue to see that. So the capital's been raised.
On the debt side, we've seen a growth in CLOETS, and that's been a significant, I'd say, boon for demand on the debt side, on the AAA side, and down. And so the capital is there. The capital is there for the formation of more CLOs.
We might have seen a slowdown here in this period of volatility. Historically speaking, that typically means that when the doors open to more issuance, I don't want to say the floodgates open, but certainly the doors open, and there's significant demand that should come on the back of that. So I would expect over the next few months we start to see a bit more activity, and that actually probably will be a nice driver of demand for the asset class over the next few months, among some other pockets that I think can come in.
Okay. Thank you, David. So, John, I'd like to take a step back now.
While the topics du jour have really been AI, Middle East conflict, even private credit and volatility from these elements, I want to go back to a question that we used to hear a lot. What inning are we in? So basically, where are we in the credit cycle today, and how should long-term investors think about non-investment grade credit?
I think with respect to the loan asset class, if you look at it going back to 92, it's had three down years. You know, 08, no surprise, but the others, the drawdowns were, you know, 100 basis points or less. It is a, David used the term coupon clipping, it is a very resilient asset class that I think has increasingly become a core part of people's portfolios just as a source of income with a low volatility profile.
You know, high yield is inherently more volatile, but that has less to do with credit than it does to do with rates. I mean, most of, you know, high yield is really a rate-driven strategy, I think, first and foremost. So there's, I think, more risk in that.
But that question, which was, you know, really on the tip of every one's tongue in panel discussions after the GFC, you know, seventh inning with the rain delay, fourth inning, when you pick an inning, it doesn't, it got to be a little bit silly. So I think in terms of where we are in the credit cycle, I think this asset class, you know, absent some, something like a GFC, where you had a pretty aberrant global recession, is going to be pretty stable. Idiosyncratic risk, no question.
But in the aggregate, you know, leverage is down to levels that are comparable to the early 2010s. Coverages in terms of cash flow are kind of right in there in terms of, you know, being fairly healthy. Even the software sector has shown good cash flow generative capacity.
And I think a lot of people are thinking about some of the issues in software more, some enterprise value back-end issue more than they are about a credit issue in most cases. So I think the credit profile of the asset class continues to be robust. You know, to some degree it's always the first inning as these companies come in.
David was talking about available capital. There is a ton of money that needs to be deployed. We really still haven't seen for the last several years, you know, the standard activity that we had gotten used to by the private equity community in terms of funding new issue transactions, which is hard given the elevated stock market.
But there is capital there. And I think we will continue to see it deployed. We will continue to see new opportunities.
And I think the area that David was talking about, CLOs, I think the area that we'll probably start to see a bit more in is in the middle market where up to now most of the middle market CLO issuance really was a financing mechanism for direct lenders. But as mark-to-market has become more of a topic, as people are looking through these portfolios and trying to create more transparency, I could see growth there again in this convergence thing as things that are getting done in the direct lending market start to behave more like broadly syndicated loans, the tradeability of them. And what you wind up with is really something that's maybe a not-rated market versus a rated market in terms of having the credit metrics associated with them.
So, great question, very common question that we've had to encounter for almost 20 years now. But I think we're in a good spot. Thanks, John.
That's good to hear. So, David, as we look across everything we've discussed, and really to wrap up our market overview discussion today, where are you seeing the most interesting opportunities right now? You know, if you take everything we just sort of talked about, kind of pockets of volatility, but lots of capital has been deployed, and in some ways there's just an incongruous kind of thought there, right?
It's when you think about the volatility that's out there, but at the same time you hear what we're saying about the technicals are strong, and the fundamentals really outside of some pockets of volatility are actually looking fairly benign. It feels like there should be an opportunity. I think there is.
And I think this is a unique opportunity to be a capital provider to markets, right? You know, when everything's going well in markets and everything's kind of, quote, unquote, clean and easy, you're really competing to deploy capital, right? And so if you think of the last couple of years, the loan market has wanted more loans, right?
But now there's been competition with private credit, where private credit's been saying, you know, I'm willing to do this quicker, tighter, more leverage, more nuances in the structure, et cetera, and trying to kind of grab opportunities that way. And the high yield market, you know, it's somewhat different as a fixed rate asset class, and it's certainly become more of a higher quality, more double B, we'll call it, asset class, versus, say, single B or single B and below for private credit. But high yield's sort of been in there, and there's been this competition to deploy capital.
I do think that over the next 12 months, given these pockets of volatility that we've been talking about and we're seeing, there will really be an opportunity to compete for capital coming in, i.e., if you're a capital provider, it's actually probably a pretty interesting time. I do think there will be lots of puts and takes, though. When you look across loans, you look across bonds or illiquids, private credit CLOs as well, and sort of pick your spot as an investor, right?
Where do I want to be? You know, I see this disconnect maybe in opportunity sets, and I can provide a new solution as a high yield investor, right? This is the example I would use, is to go back to the comments earlier around software.
Software, we still think, is a pretty interesting place to invest, right? And maybe private credit will reset and not have 25% software exposure going forward, but high yield at single-digit exposure is, I think, incredibly well set up in some ways to sit there and say, you know, hey, we're a mature market. We have less software exposure today.
We can actually take advantage. If you're a software company and you need financing, come into the high yield market, right? And so I think being able to be a capital provider in this market, it adds significant value.
And so when you think of that construct, a multi-asset investor, kind of if you have your multi-asset hat on and you say, look, I don't need to be a loan investor or a bond investor or an illiquids manager or a CLO investor, I just want to be a credit investor, I think that's probably the greatest opportunity because you can kind of unlabel the product and you can just say, look, if there's an opportunity set to deploy credit into kind of developed markets, U.S., Western European as well, it's a pretty interesting place to be in some ways, maybe even more interesting because you, I don't want to say less competition for asset deployment, but it's a very different competitive set today than you were looking at maybe a year or two ago. And I think that's probably where we see some pretty incredible opportunity. Great.
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