Cautious optimism

Cautious optimism

Tuesday 18 April 2023 06:39 London/ 01.39 New York/ 14.39 Tokyo

Moody's Analytics Chief Economist Mark Zandi shares his views

SCI talked with Moody’s Analytics Chief Economist Mark Zandi ahead of his economic outlook keynote at Information Management Network’s 12th Annual Investors Conference on CLOs & Leveraged Loans in New York on April 17-18, 2023.

In general, the financial market mood is one of caution, but there is also room for some optimism, especially in the CLO and leveraged loan space. “There’s a lot of nervousness around the state of the economy, the global economy, the US economy, and what that might mean for corporate borrowers, which ultimately is critical to the CLO market, and the leveraged loan market,” Zandi explains.

Although the CLO market continues to do well, there is concern that this may not be the case in 6-12 months, according to Zandi. “However, I make the case that while the economy is struggling with high inflation and high interest rates as the Federal Reserve continues to push on the brakes, there's a reasonable probability the economy can make its way through the next 12-18 months without experiencing outright recession,” he says.

One reason for the relative optimism is because corporate balance sheets are in good shape, Zandi notes.

“Leverage is low, debt service is low. There clearly are businesses that have over levered and over extended, and there will be some problems, but broadly speaking, I think the corporate world is in pretty good financial shape and can face whatever economic storm is headed that way.”

“And this is really critical to avoiding recession because if businesses are able to manage their leverage, their debt, then its less likely that you need private investment which is the key to not going into recession,” Zandi adds.

Zandi also believes that as long as a recessionary risk is looming, it is difficult for the market to move into a higher gear. “The key here is getting to the other side of these macroeconomic issues that are weighing on and most significant those is inflation,” he says.

He continues: “Inflation has to come back down to something that everyone feels more comfortable with, including central banks and the Federal Reserve. Once it's clear that inflation is back in the bottle, and interest rates have peaked, I think that's when the market will find its footing again and can rebound.”

Despite the concerns, the market is doing pretty well, Zandi points out. He observes: “Leveraged loans outstanding of lease leveraged loans that go into CLOs, which is about three fourths of all leveraged loans outstanding, are still growing through early this year. The latest data shows it’s growing at almost double-digits year-over-year, which is meaningful growth. And even though credit conditions are starting to weaken, there's downgrades and you're starting to see some increased delinquency and default, it is quite modest in the grand scheme of things.”

Indeed, despite the macroeconomic conditions there is still huge value of investing in CLOs, according to Zandi. He says, “If you look historically through different stress periods such as the financial crisis and the pandemic, CLOs have navigated through them very well compared to other types of financial investments and other structured investments. So, I think there's a lot of evidence that CLO structures are durable, resilient against different economic environments and different conditions in the financial markets.”

As result, Zandi says: “I sense growing appreciation of CLOs among global institutional investors based on that historical experience of it being a safe investment. Especially in the context of these current concerns about the global macro economy, I think there's particularly a growing interest in the triple-A tranches, which should help support activity across the CLO market more broadly.”

Overall, Zandi believes that market regulators are unsurprisingly currently focused on the US banking system, following the collapse of Credit Suisse and Silicon Valley Bank.

“It’s unnerving to see several banks fail. That set off a bank run and significant deposit outflows and really highlighted some of the vulnerabilities in the banking system. So, I suspect the Federal Reserve and other major US regulators are going to be focused on the banking system at this point than what is currently happening in the CLO market,” he concludes.

Ramla Soni

About Mark Zandi
Dr. Zandi is on the board of directors of MGIC, the US’s largest private mortgage insurance company, and is the lead director of PolicyMap, a data visualisation and analytics company, used by policymakers and commercial businesses.

He is a trusted adviser to policymakers and an influential source of economic analysis for businesses, journalists and the public. Dr. Zandi frequently testifies before Congress and conducts regular briefings on the economy for corporate boards, trade associations, and policymakers at all levels.

Dr. Zandi is the author of two books: ‘Paying the Price: Ending the Great Recession and Beginning a New American Century’ and ‘Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis’. He is also host of the Inside Economics podcast.

Dr. Zandi earned his BS from the Wharton School at the University of Pennsylvania and his PhD at the University of Pennsylvania.