Given recent headlines discussing the Fed’s holding of interest rates coupled with Moody’s downgrade of U.S. Treasury ratings, we have reexamined a previous premise: Why does private credit always seem to perform well?
While last time we looked at the federal funds effective rate, today we use the 10-Year Minus 2-Year Treasury rate to better examine the perceived cost of public vs. private funds with a longer-term premium.
With the wide difference in scale of the two data sets, we can look at the year over year changes to find insights. The Treasury data is characterized by strong swings (2000, 2003, 2007, 2020, 2021) and one long trend (2009 – 2019). An overall relationship is clear from the chart: Reductions in Treasury rates tend to coincide with reductions in the credit fund return rate.
Curiously, the inverse is less true, as the increased return to Treasuries in the early 2000s only translated to a demonstrable increase in private credit return about two years after the initial move. Similarly in 2007, the increase in Treasury rates is followed by an increase in private credit (PC) returns, but only after significant volatility.
Looking at these points we conclude that private credit returns exhibit minor correlation with medium-term treasury yields during decreases, but during recessions (periods when Treasury yields tend to rise), there is significant volatility to returns. The PC return a few years out of a recession tends to be significantly higher than average (speaking to the ROI of deep value investments made during these periods, which we have seen before).
In the 2010s, without recessions we see the Treasury return exhibit a slow slide down as the easy money of the period gave little illiquidity premium offerings. In line with that, we saw a similar decline in PC returns, though after a volatility spike in 2017 there was a recovery, and overall PC shows a tighter return band than the public illiquidity premium, likely due to how PC targets higher risk and return opportunities to offset lower returns on illiquidity.
Much as we saw in our previous chart, private credit displays remarkable stability over the time period. Given the private data cutoff for the above chart is Q2 2024, it is relevant to note that the Treasury rate recovered later that year. In 2025 we are likely to see volatility in the private credit space in the short term. That could subside when the markets stabilize, and credit is able to profit from its deeper investments.
Of course, with the credit downgrade we will likely see higher risk premiums on Treasuries, which may induce private credit shocks earlier than otherwise anticipated by the data.
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