Bank Loans in the Time of Higher for Longer

Markets welcomed 2024 with expectations of six rate cuts in 2024 from the US and eurozone, five cuts from the UK, and a belief that most major economies would see a period of slow growth. Now, markets are looking for just one or two cuts in the US, UK, and Eurozone, yet these economies appear to be undergoing a cyclical recovery. With prospects of a soft landing in sight, investors are assessing opportunities in risky assets in an environment of already-lofty valuations.

In fixed income, rates have taken a significant leg higher since their post-GFC days, the US yield curve has been inverted since mid-2022, and yet credit spreads on high yield bonds remain at their tightest levels in years. In this environment of elevated rates and tepid but resilient growth, we favor risk assets but with selective risk exposure. In particular, we see an attractive return profile in bank loans with zero duration risk, meaningful credit protections, and attractive valuations. Issuer fundamentals also remain solid (and have even improved in the latest Q1 2024 data), though some deterioration is likely as the lagged effects of restrictive monetary policy take hold.

Despite our view that disinflation should continue, we anticipate central banks are likely to keep rates “higher for longer”, well above recent history. The fundamental outlook calls for an extension of the current cycle, in our view, but credit spreads on most bonds are unlikely to rally further from here. We believe bank loans offer diversification and a bright spot for credit investors, as the floating rate nature of these assets adjusts according to market interest rate changes, offering protection from inflation and an attractive source of income. In this piece, we review bank loans in the time of higher for longer policy and interest rates.

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Data as at 28 June 2024 unless otherwise specified. Sources: Bloomberg and Invesco.