KBRA Financial Intelligence

3 Things in Credit: Falling Oil, Tariff Impact, and Credit Appeal

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

This was the week that we got some downbeat commentary from the Fed—“the risks of higher unemployment and higher inflation have risen”—and a trade “deal” of sorts between the U.S. and UK. The latter still has to be finalized, but the agreement in principle was delivered with great fanfare and was met with a healthy pop in the equity market. Or maybe the pop was attributable to the white smoke at the Vatican. Tough to say.

A comment by a portfolio manager did catch my attention this week. When asked to sum up the environment, he described it this way: There is a 50% chance the Fed will not cut this year and a 50% chance it cuts 200-300 bps. Kind of sums it up pretty well.

This week, our 3 Things are:

1. Falling oil. Is it good or bad for credit?

2. Tariff impact. We’ll highlight some useful commentary.

3. Credit appeal. How does credit stack up in this environment?

Alright, let’s dig a bit deeper.

Falling oil.

One of the things we’ve learned over the decades is it’s really hard, or treacherous, to predict oil prices. The commodity is largely produced by state-owned or affiliated enterprises that are, by their very nature, political. Decision-making is driven by forces that are not entirely economic. About 40% of global production today comes from the Middle East and Russia.

But when the price of oil falls 26% from a year ago, you have to think through the implications of the move. The price of a gallon of gasoline, $3.15, is 50 cents, or 14% below the year-ago level. That adds up to a proverbial tax cut, albeit a modest one, to the American consumer—call it $20 a month or so back into disposable income. Yes, it provides some relief to lower-income households and provides some offset to inflation elsewhere, but its overall effect is rather modest.

To oil producers, it’s painful. The current West Texas price of $58 a barrel sits below the break-even levels reported across all major U.S. drilling regions, which range from $61 to $70 a barrel, according to the Dallas Fed. Earnings expectations for the energy sector have come down hard as a result of the price pressure. With some 72% of companies in the S&P 500 reporting Q1 earnings, energy firms on average reported EPS 14% lower than the year-ago quarter. According to FactSet, at the sub-industry level four of the five subindustries in the sector are reporting a year-over-year decline in earnings: Oil & Gas Refining & Marketing (-109%), Integrated Oil & Gas (-14%), Oil & Gas Equipment & Services (-8%), and Oil & Gas Storage & Transportation (-2%). Oil & Gas Exploration & Production (17%) is the only sub-industry reporting year-over-year growth in earnings. For Q2 and full-year 2025, equity analysts have cut their forecasts by 15%.

In credit, investment-grade energy is now 35 bps wide to the industrial index, up from 15 bps a year ago. And with WTI forward prices only modestly higher ($66 by Q4) and growth slowing, things are not likely to materially improve any time soon. That’s not good for the oil & gas industry, which accounts for around 11 million jobs, or 5% of total U.S. employment, and $1.8 trillion in GDP, just under 7% of the U.S. total. So, a bit of a mixed bag in terms of overall impact to the economy. But the direct hit to a meaningful industry—and the signal sent that the global economy is slowing—leave us on the net negative side of things in terms of the impact to credit.

Alright, on to our second Thing—Tariff hits.

We’ve seen some interesting disclosure around the potential impact of tariffs. One thing that is commonly ignored in these calculations, in our opinion, is details around the forward look. Fed Chair Powell alluded to this lack of detail in his press conference this week, saying, there is “so much we don’t know” about the tariff regime, including “scale, scope, timing, and persistence.” What forecast assumptions are being made? How severe is the hit to economic growth? For how long? How broad? We just don’t know. That’s the problem economic actors are facing. And that, of course, frustrates many market observers and participants that want proactive monetary policy response, rather than something data driven. But that’s another story.

In terms of disclosure, let’s start with HSBC, the “world’s best trade finance bank,” at least according to one trade publication. The bank disclosed the impact of what it calls a “plausible downside tariff scenario,” which assumes significant increases in tariffs that would result in a “notable slowdown” in global trade and a “slowdown” in GDP growth. Alright, we’ve at least got some detail.

Under that scenario, the hit to revenues is expected to be—only—“low single digit.” Modeling for loan losses shows an increase of $0.5 billion above the base case. Those hits don’t amount to much for a bank forecast to earn $32 billion pretax in 2025. Now, as we said, this guidance does factor in economic slowdown, so this really says more about the fact that HSBC doesn’t take a lot of risk in its core business lines.

Then there are companies such as United Airlines that have guided under two scenarios, Stable and Recessionary in United’s case. This also takes into account the macro environment. Despite the fact that the company says its outlook is “dependent on a macro environment,” which it believes is “impossible to predict with any degree of confidence,” it does predict earnings anyway, where the midpoints of its 2025 EPS estimates range from +18% to -25%, depending on the scenario. That’s quite a gap.

Bloomberg Intelligence has come out with sectoral views that factor in estimated tariff rates based on reviews of 275 companies. Consumer staples are facing on average a 51% hit to operating income absent any mitigating effects. Consumer discretionary (at 42%), materials (39%), and technology (37%) would also be materially hit. Health care and communications are the winners, with less than 2% impact. To offset tariff cost increases, firms producing materials would need to raise prices by 19%, technology by 17%, consumer discretionary by 12%, and staples by mid-single digits. The combination there, of higher costs and higher prices, fit neatly into a stagflationary outcome. And that’s not good for credit.

Alright, on to our third Thing—Appeal of credit.

In preparation for a presentation this week, we compiled total returns on a variety of asset classes since the election and compared those to the S&P 500. The results are telling. In an environment where stock valuations are clearly frothy and growth is set to slow (but not fall off a cliff), the appeal of credit’s diversification and income grows.

Since the election, U.S. public high yield has outperformed the S&P by 4.6%, while U.S. public investment grade has outperformed by 4.4%. A 60/40 portfolio modeled by BlackRock has outperformed the S&P by 2.6%. European public IG has outperformed by 3.6%, and European public high yield by 3.9%.

The risks to credit are inflation and/or recession. We saw the ravages of the Fed’s rate hikes in 2022 and are wary of sharp economic downturns when stock/credit correlations turn positive. But in an environment where growth is slowing but not expected to fall off a cliff and where inflation is relatively well behaved (the two should go hand in hand), credit figures to remain in demand.

Investors that can absorb illiquidity and complexity can do even better, with 200-300 bps premia available via private credit and esoteric asset-backed securities.

So, there you have it, 3 Things in Credit:

1. Falling oil. A modest benefit to the consumer, but the hit to energy producers and signal it is sending on global growth are not a plus.

2. Tariff impact. It’s fluid, but at the end of the day, it’s a tax, and the near-term effect is inflationary.

3. Credit appeal. Relative value, taking into account the benefits of income and diversification, remains strong in this environment.

As always, thanks for joining. We’ll see you next week.