A KBRA rating agency report on credit risks suggests that the Federal Reserve’s “near singular focus over the near term on taming inflation runs the risk of overshooting its goal of curtailing demand, thereby increasing the risk of a hard landing.”

The report: Credit Finds Itself in a Riskier Place says: “In our view, it does not seem the Fed is weighing all the countervailing inflation data – such as the slide in commodities prices, housing activity downtown, and improved supply-side friction – against the decidedly lagging indicator of the consumer price index, which the central bank is aggressively reacting to.

“We hold out hope that the Fed will aspire to being truly data dependent as it moves forward and temper its tightening. But we’re not optimistic.”

KBRA’s research contends the US economy is weakening as a result of mounting inflation-related headwinds, including those arising from the central bank’s aggressive catch-up in tightening financial conditions.

The report says for credit spreads, which have held in close to long-term averages, the gravitational pull is wider into 2023. Important offsets to the effects of the slowdown are the strong balance sheets of consumers and businesses as well as the sound condition of the financial system.

The agency said that it is uneasy about Fed policy for a number of reasons, including the realisation that “we quite possibly are moving to a new paradigm, one where (interest) rates will (be) higher for longer. In this new paradigm, higher-for-longer rates are expected to contribute to a material slowdown in US economic growth.”

The report continued: “At this juncture, we do not see the Fed as balancing its dual mandate, with inflation reduction seemingly trumping employment maximisation – and the concomitant economic growth.”

And to back their contention that we are moving to a riskier place, the report offers:

▪ The Fed basically declared that an unemployment-driven recession is needed to tame inflation.

▪ Financial conditions indexes have deteriorated to levels not seen since April 2020.

▪ The Bank of England unexpectedly intervened to prevent an imminent crash of the gilt market.

▪ Russian President Vladimir Putin has dramatically escalated the war against Ukraine.

▪ A number of multinationals warned on earnings.

▪ Material negative wealth effects figure to lean on consumer confidence.

▪ 30-year mortgage rates are approaching seven per cent.

The report concludes the gravitational pull for spreads is wider, judging that the mix of aggressively tightening financial conditions into an economy headed towards recession is not something investors will endure at long-term average spread levels.

It said: “September and October are always tough months in story years, so perhaps investors are holding on to risk at current levels in hopes of a late-in-the year rally (and acknowledging that with liquidity drying up, it is tough to move positions). The problem is, it seems this story will not improve for some time. Accordingly, our bias for up-in-quality credit has gotten a bit stronger.”