Risk and reward in stressed and distressed debt

WHAT is the current outlook for credit markets? Interest rates had been in secular decline since the 1980s. In the aftermath of the global financial crisis, rates hovered near zero as central banks embraced quantitative easing and flooded markets with liquidity. Among other effects, these monetary policies elevated the valuations of most assets, including private and public debt.

This trend came to an end in 2022 when central banks began to raise rates and tighten credit conditions to tame inflation. Today, investors must navigate this transition. In terms of economic expression – and to take a page from Thomas Piketty – we have shifted from an r > g to an i > g world. That is, from one where the real rate of return (r) exceeds the rate of economic growth (g) to one where nominal interest rates (i) outpace the rate of economic growth.

This has significant implications for debtors whose earnings are likely to grow slower than the interest accumulated on borrowed funds. As our parents might say, this is likely to “end in tears”.