US Credit: Navigating through an ambiguous policy backdrop
Policy Near Neutral: Markets have priced out a sustained easing cycle after the Fed’s hawkish cut, leaving policy near neutral. Firm break evens and elevated real yields suggest sticky inflation and a structurally higher neutral rate.
Liquidity Tightening at the Margin: Conditions remain loose, but liquidity and stress indicators show emerging tightening. The QT suspension stabilises reserves, yet high term premia and weak long-end demand limit duration upside.
Credit Market Reaction to AI-Driven Cap Ex: U.S. corporates continue scaling AI-related capex, often via bond issuance. Most AI-linked issuers show muted CDS moves, though leverage-heavy names still face spread-widening risk. Credit Steady, Income-Driven: Credit returns rely more on carry than valuation. Higher-grade bonds act as duration proxies, while lower-rated credit gains from stronger income. High-yield and loans reflect rotation toward neutral-rate backdrop.
Fed Policy Near Neutral After Hawkish Cut Implications for Inflation and Neutral Rate
Insights
Across structural, curve, and policy models, the nominal neutral rate now sits above its historical median, reflecting economic resilience and elevated inflation expectations.
The October 2025 25bps cut likely placed policy near or slightly above neutral—tight enough to contain inflation but close to levels that could curb growth.
This gives the Fed room for one more cut but argues against a sustained easing cycle, as excess accommodation could reignite inflation still above the 2%target.
Breakevens and Real Yields Signal Sticky Inflation and Higher Neutral Rate
Insights
Breakeven and real yields remain firm, signaling a persistent disinflation plateau and adjustment to a higher structural regime.
The 5-year breakeven stays slightly above the Fed’s target, reflecting sticky prices tied to resilient services inflation and a still-tight labour market supporting wage growth.
Similarly, elevated 10-year TIPS yields and steady 5y5y break evens show real rates above pre-pandemic norms and anchored—but not easing—long-term expectations.
Together, these trends support a cautious policy stance until clearer disinflation evidence emerges.
Liquidity Indicators Tighten While Labor Market Softens What It Means for Rates
Insights
Most financial-condition indicators remain broadly accommodative—supported by firm credit sentiment and elevated risk tolerance—making a sustained rate-cut cycle unlikely.
Still, a tightening trend has emerged, particularly across liquidity measures, signalling early signs of policy transmission.
With the policy rate sitting slightly above most neutral estimates, this shift is becoming increasingly relevant for the labour market, where alternative indicators already point to some softening—see Macrobond charts related to alternative labour market data.
If liquidity tightens further, maintaining policy above neutral could amplify labour-demand pressures.
Market Pricing Shifts Toward Policy Pause After Hawkish Fed Cut
Insights
Following the October 2025 “hawkish cut”, in which the Fed Chair stressed that a December move “is not a foregone conclusion”, markets have largely priced out expectations of a sustained easing cycle.
While investors still assign some probability to a December reduction, the hawkish delivery and subsequent Fed communication have introduced meaningful uncertainty. A December cut is now virtually a coin-toss, with some pricing pointing to a possible shift into January 2026 instead—allowing the Fed to evaluate the impact of the prior consecutive cuts. After a December-or-January adjustment, markets foresee policy remaining on hold until at least mid-2026.
Again, this shift reinforces the view that policy is nearing neutral.
Fed QT Suspension Stabilizes Reserves and Its Impact on Yields and Credit Spreads
Insights
With the October 2025 decision, the Fed suspended quantitative tightening (QT),holding the balance sheet steady rather than resuming easing. This implies renewed Treasury and MBS demand, even as overall financial conditions stay loose.
The pause reflects lessons from 2019, when QT-driven reserve scarcity stressed funding markets. With liquidity tightening at the margin, the Fed aims to preserve market functioning and avoid similar strains.
Historically, QT pauses align with lower yields and tighter risk premia, though high-yield spreads can widen as credit risk is repriced. The current setup signals cautious rebalancing, not a new easing phase.
Treasury Yield Curve Flattens as Issuance Offsets QT Support
Insights
Building on our earlier Macro Trends discussion, the hawkish tone accompanying the October 2025 cut pushed the curve higher in a near-parallel move, flattening it and reinforcing expectations that policy is nearing neutral.
Despite the QT suspension, long yields also rose—likely due to the Treasury’s bill-heavy issuance offsetting the usual support from a QT pause.
Investors’ reallocation of duration toward high-grade credit may be another factor, as many issuers now offer spreads comparable to Treasuries.
Similar dynamics appear in other major markets, where fiscal uncertainty continues to constrain sovereign-bond demand.
Long End Treasury Rally Limited by Firm Real Yields and Weak Auction Demand
Insights
The QT suspension could support longer-dated Treasuries, though Treasury secondary-market operations have already eased pressure in the 10–30-yearsector.
Still, elevated real yields—driven by sticky inflation and firmer term premia—limit room for a long-end rally. Demand also remains uneven, with several 20- and30-year auctions earlier this year showing weak appetite and prompting deeper Treasury intervention.
Using Macrobond’s PCA function, the yield-curve term structure can seamlessly be derived across its key components—level, slope, and curvature.
Overall, the curve has eased slightly but remains balanced, consistent with policy stability and a neutral stance.
Credit Returns Led by Carry Across Quality and Maturity
Insights
With the term structure easing only marginally and liquidity still tight, performance is increasingly driven by income rather than valuation shifts as investors prioritise stability.
Higher-grade bonds act as duration proxies—moving broadly with Treasuries and offering limited pickup—while lower-rated credit benefits from stronger income profiles and moderate spread compression.
Across maturities, shorter and intermediate tenors provide the most balanced mix of yield and rate sensitivity, whereas the long end remains constrained by persistent term-premium pressures.
Overall, credit continues to reward measured exposure across both quality and maturity.
AI Driven Capex Fuels Bond Issuance and Diverging Credit Spreads
Insights
U.S. firms have announced major AI-related capex plans in data centers, networking ,and custom chips.
Amazon, for instance, projects over USD 100 billion in 2025, while others like Alphabet have issued multi-tranche USD and EUR bonds to fund similar projects.
Despite these commitments, credit-market reactions remain muted, with CDS spreads for most AI-linked issuers stable—reflecting confidence in earnings strength and capacity to absorb higher spending.
The picture is not uniform, however. Oracle’s USD35 billion multi-year capex plan has driven spread widening amid rising leverage, weaker free cash flow, and uncertainty over long-term returns.
High Yield and Loans Converge Toward Neutral Rate Dynamics
Insights
Credit conditions have shifted toward a more neutral stance, with sub-investment-grade performance now driven more by rate sensitivity and funding costs than broad repricing. High-yield (HY) bonds—being fixed-rate and duration-exposed—have outperformed as policy expectations eased and cuts materialised.
Credit-risk premia have continued to tighten, hinting that markets still favor additional accommodation. This has boosted leveraged loans (LL), which have regained momentum as the HY–LL spread narrowed, signaling a move toward neutral-rate dynamics.
However, another cut could briefly restore support for HY, though its durability would hinge on further liquidity improvement.
