Fixed income outlook: The case for high-quality ABS

Quick takes on capital markets

July 21, 2023 | 2 min read

As a likely economic slowdown approaches, the investment outlook for short, high-quality consumer asset backed securities looks attractive. Although further prime credit normalization is expected given consumer headwinds, delinquencies and defaults remain below pre-pandemic levels. The combination of attractive pricing and solid starting fundamentals could result in enticing risk-adjusted yields even as economic conditions deteriorate in the second half of the year.

ABS delinquencies
January 2017–June 2023

Line graph of asset backed securities delinquencies from January 2017-June 2023, comparing prime and non-prime consumer ABS

Source: Intex, Principal Asset Management. Data as of June 30, 2023.

The landscape for fixed income investors is shifting as we enter the third quarter of 2023. Notably, several historically reliable economic indicators are signaling that a recession is on the horizon—setting the stage for segments of fixed income to perform well as the economy slows.

In this environment, short, high-quality consumer ABS looks particularly attractive. The inverted yield curve and market technical factors have led to high benchmark yields and wide spreads, while prime consumer credit remains solid despite recent normalization. This combination of attractive pricing and solid starting fundamentals could result in enticing risk-adjusted yields even if economic conditions deteriorate in the second half of 2023.

Although further prime credit normalization is expected given consumer headwinds, delinquencies and defaults remain below pre-pandemic levels, and tight post-Global Financial Crisis credit underwriting should keep performance in check. Conversely, subprime credit has weakened more noticeably. Inflation has weighed on lower income households, and delinquencies and defaults among riskier borrowers are now above pre-pandemic levels.

As the U.S. economy faces headwinds, the investment outlook for short, high-quality consumer ABS looks favorable—particularly, prime credit with well-structured deals and strong sponsors. Wider spreads have the potential to enhance returns and the resilient structure of the asset class, with a historical track record of performing well through economic cycles, offers a level of downside risk mitigation amidst heightened market volatility.

Read the full quarterly outlook from Principal Fixed Income for more themes, opportunities, and investment implications across global fixed income markets.

Disclosure

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision. Fixed-income investment options that invest in asset backed securities are affected by the quality of the credit extended in the underlying loans. Defaults or losses on the loans will negatively impact the value of asset backed securities.

The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice.

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