Chance of U.S. recession climbing with current headwinds

There is a heightened probability of a U.S. recession, primarily due to labour market weakness and inflation risks, says Jeffrey Mayberry, fixed-income asset allocation strategist and portfolio manager at DoubleLine Capital in California.

“The jobless claims number is continuing to go up every single week — not to levels that you’re worried about yet, but the trend is something where we’re probably at a yellow light,” he said in a July 14 interview.

Listen to the full conversation on the Advisor To Go podcast, powered by CIBC Asset Management.

Mayberry said there’s also a risk of higher inflation. “It’s kind of being priced into bonds, but maybe not to the same extent that we are expecting,” he said.

In the current economic environment, Mayberry said he likes inflation swaps, which don’t have the supply/demand dynamics of Treasury inflation-protected securities. Zero coupon inflation swaps are pricing in higher inflation over the next two years. “But over the medium to longer term, inflation is coming back down towards a more normal level.”

However, it’s not all doom and gloom in the U.S., he said. Corporate credit earnings are “very strong,” with low probability of defaults over the medium term, despite ongoing volatility around tariffs.

“(While) there are some worrying signs, nothing where we are advocating for selling credit,” he said. “(It is) something just to keep an eye on, something to have your hand close to the ‘ready’ button, and ready to make potential moves, depending on whether the data worsens or strengthens from here.”

Through year-end, fixed-income investors should consider structured credit, like residential mortgages, commercial mortgages, asset-backed securities, Mayberry said.

“While those spreads have come in and tightened, we think the probability of default is relatively low, and those spreads still give you some advantages over your investment-grade corporate bonds or higher up the credit stack in your high yield, your double-B high yield. You get some more yield, similar amounts of risk, similar amounts of volatility.”

He added that riskier credit continues to do well, with high yield up 2.5% in Q2, almost doubling the return of the Bloomberg U.S. Aggregate Bond Index.

There is also opportunity in non-dollar names, like emerging markets, he said. “Look at Canadian fixed income being a potential buying opportunity to move into those types of non-dollar trades, whether it’s in Canada or anywhere else around the world.”

Mayberry said the Fed is likely to cut rates in September and October, so investors should have more exposure to the lower end of the Treasury curve, and less on the longer end. This includes shorter-duration assets.

“The volatility that we saw in the second quarter could continue here over the rest of the year, and provide some opportunities to pick up some relatively cheap bonds, and try to take advantage of some dislocations in the markets to provide good yielding, good spreading assets with (much) lower amounts of risk,” he said.

This article is part of the Advisor To Go program, sponsored by CIBC Asset Management. The article was written without input from the sponsor.

Suzanne Yar Khan

Suzanne has worked with the Advisor.ca team since 2012. She was a staff editor until 2017 and has since worked as a freelance financial editor and reporter.