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Discussing credit: phases of the cycle

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Elizabeth Murphy
Investment Director, Credit

Fixed income investors have experienced a period of very low interest rates over the past decade. Going forward, we are likely to see higher interest rates kept in place by central banks to control lingering inflation. In this new environment, corporate bonds can play a useful role in portfolios because different types of credit can be used at different stages of the economic cycle.

The four phases of the economic cycle


During the expansion phase, production is high, and the economy goes through rapid growth. Growth is good for business. Earnings tend to rise and balance sheets improve, so companies are less likely to default on their debt. Interest rates tend to be low. However, towards the end of the expansion cycle, the increase in the money supply causes inflation to pick up. As production is high, the demand for raw materials, manufacturing materials, and sources of energy also increases. Commodities, gold and cash tend to fare well, and short-duration credit usually plays a larger role in portfolios at the end of the expansion phase.

Slowdown / Stagflation

Once growth peaks, the economy will start to slow down. Inflation will also continue to grow, and businesses start to tighten their belts. The growth momentum turns negative, business conditions weaken, earnings fall, and more companies start defaulting on their debt. Government bonds and investment grade bonds fare well in this environment.

Recession / Disinflation

From here, the economy usually slides to disinflation. During this period, growth continues to slow down and eventually slopes into negative territory. Employment falls, prices stagnate, and default rates will bottom out. The measures taken by central banks to curb inflation have started to take effect and inflation will fall. Investment-grade companies usually survive well during downturns and towards the end of the phase, more opportunities within high yield will also start to emerge, as the positive momentum sees growth restarting again.


As inflation slows down and returns to target, central banks will start easing monetary policy, bringing interest rates down. High yield, which is sensitive to business conditions, usually continues to do well during this stabilisation phase.


All in all, there are winners and losers in all market environments, and this emphasises the importance of an active approach to investment. Not all markets are in the same phase of the economic cycle at the same time. An active approach allows investors the flexibility to invest across sectors and geographies throughout the cycle, whilst seeking the best opportunities.

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Elizabeth Murphy
Investment Director, Credit


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