US Economy: Strengths with Cracks

The US economy continued to demonstrate resilience despite tariff and inflation-related risks. Q2 GDP was revised upward from 3.3% to 3.8% due to an increase in consumer spending, which was revised from 1.7% to 2.5%. Consumer spending is the largest driver of US GDP. Several leading and lagging indicators, such as control group retail spending, are also pointing to a strong Q3 GDP print. S&P 500 companies reported solid Q2 results, with aggregate revenues increasing by high single digits and earnings rising by low teens. That said, several consumer discretionary companies in sectors such as housing and restaurants have signaled a more cautious consumer environment.

Cracks are also appearing in the labor market. Non-farm payroll numbers have declined sharply in recent months. Payrolls were as high as 323k in December 2024 but dropped to 159k in April 2025, followed by 19k, -13k, 79k, and 22k between May and August 2025. This weakness is consistent with tariff and immigration-related uncertainties in the US. However, unemployment claims have remained in a tight range, with the most recent weekly reading declining from 231k to 218k, suggesting that employers are not resorting to mass layoffs.

Chart I: US Non-Farm Payroll

Source: Bloomberg

Wage growth has remained stable, with average hourly earnings increasing by 3.7% in the latest reading. Along with the wealth effect from strong equity markets (which disproportionately benefits higher-income households), this has contributed to persistently high inflation. According to Bloomberg, the top 10% of earners account for 49% of consumer spending. Core PCE rose 2.9% in August, well above the Fed’s 2% target. Several publicly traded issuers have signaled that price increases are coming to offset tariff costs. Overall, inflation is expected to remain elevated.

Chart II: Core PCE

Source: Bloomberg

Leveraged Credit Market:

High-yield issuance has remained strong, with yields tightening across the rating spectrum. HY bonds continue to rally, with overall yields below 6.75%, BBs below 6%, and CCCs around 10%. Demand is being fueled by heightened rate-cut expectations amid softer jobs data. Issuers are capitalizing on these conditions, with YTD issuance reaching $265 billion compared to $279 billion for all of 2024.

In the leveraged loan market, traders continue to report healthy and balanced volumes, with prices holding steady to slightly higher. Issuers are extending maturities and lowering pricing amid strong demand. The market is benefitting from robust CLO formation—the dominant buyer base in leveraged loans. YTD, there have been more than 290 new CLOs issued, totaling over $142 billion, excluding over $230 billion in refinancings and resets.

Loan bids have held around the 97 level this year. Beneath the surface, however, strength is concentrated in BB and single-B credits, while CCCs are currently trading in the high 70s, down from a peak in the low 80s earlier this year. This reflects policy-related uncertainties, elevated interest rates that disproportionately impact weaker “loan-only” borrowers, CLO concentration limits on CCCs and secular headwinds (e.g., AI disruption) in large sectors such as TMT. Within the CCC cohort, TMT and Capital Goods have been the weakest performers, with the deepest price declines, highest yields, and widest discounted margins.

Chart III: Leveraged Loan Bids by Ratings

Source:  LSTA and Bloomberg

Summary:

Despite policy uncertainty, a slowing job market, persistent inflation, and the ongoing government shutdown, valuations in both equity and leveraged credit markets remain rich. We continue to see price and yield dislocations in lower-rated leveraged loans. While this weakness is justified by macroeconomic headwinds, disciplined, bottom-up investors will likely find value in select opportunities.

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