Neuberger Berman: Recession isn't imminent despite the catastrophe in Ukraine

Fears of a global recession have waxed and waned since the pandemic hit more than two years ago. As government policies have propped up economies around the world, accompanied by record levels of bond-buying, rising inflation saw concern peak again, even as markets during the height of COVID responded far better than many expected.

Then war broke out in Ukraine. And in the middle of last month, Russia was in danger of defaulting on its coupon payment obligations. The Kremlin ultimately made its US$117 million payment on time, but it has highlighted very real concerns that leave European markets particularly exposed.

This was one of the topics discussed with Adam Grotzinger, senior portfolio manager of New York-based multi-asset fund manager Neuberger Berman during his recent visit to Australia.

Grotzinger also discussed the outlook for corporate credit, especially given the concerns about defaults that have also dogged this sector in the last couple of years. During the interview, he outlines which parts of the credit space are most appealing, and explains whether he thinks the Russia-Ukraine conflict could tip us into a recession.

Edited transcript

What is your outlook for government bonds?

Adam Grotzinger: There are a couple of crosscurrents in markets because of inflation, but also geopolitical conflict being high and the implications of higher commodity prices. The conundrum the market's facing is inflation versus growth. Central banks have been focusing on inflation, with hawkish rhetoric to cool inflation expectations on a go-forward basis. And the result of that in bond markets, particularly government bond markets this year, has been starkly higher yields, and lower bond prices in government bond markets as those markets recalibrate to an expectation of a very hawkish Fed.

Simply put, government bonds have had a tough start to the year, with negative performance because of central bank activity, with the Fed talking hawkishly on inflation and bringing government bond yields up to price for that hawkish directionality.

We've been hearing a lot about corporate defaults for a long while, but they've never eventuated. Are debt markets living on borrowed time, or is this environment really very different?

Grotzinger: I think this environment is still conducive to corporate debt. And if you look at credit fundamentals in some of the markets, they're healthy. Look at areas like the high yield market, where you could say all these non-investment grade companies are arguably the most vulnerable to weaker growth, what do their leverage metrics look like? What does their debt serviceability look like? And all of that's been stable to improving over the last couple of years.

You've also seen improvement in the borrower types in some of these markets. So, I'll take the high yield market in the US as another example. Over the last decade-plus since the GFC, you've seen that market migrate to more and more BB issuers. So, the highest quality ends of the high yield market versus its historic past, where there was more CCC issuance in frothy periods of the market or more leverage buyout type of issuance in debt proceeds. Today, it's solid BB names, household names like Netflix that are in that space. And what are they using debt for? To refinance and use in their operations. So, I'd describe the overall metrics as healthy.

The last point I'd make around what we expect for defaults on a forward-looking basis is that I still expect that to be benign. In the US high yield market this year, there are 75 basis points of default expectations forward-looking, next year, maybe it goes up a bit to mid 1%. But that’s still well below the long-term average trends for defaults in high yield credit. That's a manifestation of the US economy slowing. But our base case is not one of a recessionary risk on the foreseeable horizon.

Could we see a recession in Europe spurred by the effects of the war in Ukraine, especially if the conflict drags on for months?

Grotzinger: Compared to the US, Europe is more vulnerable to the impact of commodity pressure, commodity prices and the implications for growth. The slowdown in Europe is starker than in the US. What are the mitigants to the slowing growth? There's a lot of fiscal spending taking place in Europe right now. Take Germany, for example, with its additional military spending coming. These are multitudes of what the countries like Germany have spent in the past on fiscal. Not only are we talking about big numbers, but good tails that will support growth in the out years out of Europe. So, it's going to be "stop and go" for Europe. But I think fiscal policy can mitigate some of that slowdown.

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