The Big Idea

Safety in consumer credit and real estate, but no safe harbor

Steven Abrahams | May 2, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Debt portfolios look like they will have a tough time diversifying away their tariff exposure, at least based on market performance through April. Portfolios should be able to reduce exposure by shifting away from corporate credit and toward consumer credit or real estate. But avoiding tariff risk altogether looks tough. There is no safe harbor.

A volatile April

Excess returns—returns after stripping out the impact of shifting interest rates— show the broad impact of potential tariffs this year (Exhibit 1). Excess on most sectors moved sideways or rose steadily until mid-February when the US announced plans to put new tariffs on all imported steel and aluminum. This came along with a rapid back-and-forth over country tariffs on Canada, China and Mexico that played out through February and March. The tariff news pushed spreads wider and volatility higher, and excess returns across all sectors sank. When Liberation Day came on April 2, explosively wider spreads and higher volatility pushed excess return down sharply everywhere. The 90-day pause on tariffs announced April 9 has helped excess recover.

Exhibit 1: Excess returns on US fixed income show the impact of tariff risk

Source: Bloomberg, Santander US Capital Markets

Consumer credit and real estate top direct corporate exposures

Agency CMBS, ABS, private CMBS and agency MBS have delivered much better performance than sectors with direct corporate exposure. Consumer credit and real estate have come through the chaos a little dented but in much better shape than investment grade corporate debt, leveraged loans or high yield corporate debt. The differences between sectors—and between the first quarter and April—shows up a little more clearly in a few pictures:

From January through March, Treasury debt, which delivers no excess return by definition, along with agency CMBS, ABS, private CMBS and agency MBS show much better returns and generally lower volatility than loans, investment grade debt and high yield (Exhibit 2).

Exhibit 2: Assets without direct corporate exposure outperformed through March

Source: Bloomberg, Santander US Capital Markets

In April, the same pattern generally held with agency CMBS, ABS, private CMBS and agency MBS topping sectors with direct corporate exposure; it is worth noting that MBS nevertheless took a big hit from rising rate volatility in April, that annualized returns across all assets fell more sharply in April and annualized volatility rose by roughly three to six times (Exhibit 3).

Exhibit 3: Assets without direct corporate exposure outperformed in April

Source: Bloomberg, Santander US Capital Markets

Asset returns become more correlated in April

The other thing easy to miss in the strings of excess returns alone is that as the market moved from January through March into April, asset returns became much more highly correlated. That comes out in the correlation of day-to-day returns across sectors. With seven separate sectors creating 21 different pair-wise correlations, showing the changes in those correlations between the first quarter and April gets complicated. But it is straightforward to show the changing distribution of those correlations, and show that the average correlation more than doubled from 0.19 during January through March to 0.52 in April (Exhibit 4). In April, all assets became more correlated either from the direct impact of tariffs or their indirect impact through expected inflation, growth and possible Fed response.

Exhibit 4: Asset returns became much more correlated in April

Note: Distribution of pairwise correlations of daily returns between asset sectors.
Source: Bloomberg, Santander US Capital Markets

Markets clearly want to treat consumer balance sheets and real estate as insulated from the direct impact of tariffs, and that stands to reason. Consumers working for companies directly affected by tariffs can still look for jobs elsewhere and keep paying their debts while the companies potentially struggle to stay in business. And owners of real estate rented to companies directly affected can look for new tenants. Most consumer and real estate balance sheets have flexibility that most importers and exporters do not.

It is worth noting that not all consumers are equal these days. Consumers at the lower end of the income distribution show clear signs of stress, especially judging by the magnitude of serious delinquencies in mortgages taken out by the financially weakest households. As my colleague Brian Landy has pointed out, some vintages of loans guaranteed by the Federal Housing Administration show serious delinquencies approaching 10%. Outside of delinquency rates in the first years following Covid, these are highest levels since the Global Financial Crisis. Proposed cuts in US federal spending, which flows disproportionately to households at the low end of the income distribution, could add to the credit pressure there.

Although markets have rebounded since the US paused tariffs on April 9, we have not yet seen the economic effects of the uncertainty around tariffs and the risk of re-escalation of tariff threats is not gone. Trade deals take a long time work out—the average US deal before 2016, according to the Peterson Institute, taking 18 months from launch to signing. The markets are likely to come to the end of the US 90-day pause with few deals finalized and the rest somewhere between ongoing or not going at all, raising the risk of continuing uncertainty or even re-escalation. Given the opaqueness of negotiations and the idiosyncrasies of US policy, risk-reward along with the record of the last few months argue strongly for allocating away from corporate credit and toward consumer and real estate exposures.

* * *

The view in rates

The market closed on Friday pricing fed funds at 3.53% to end the year, 34 bp below the Fed’s March dots. The market has a first 25 bp cut priced for June or July, a second cut by September and a final cut in December. That will likely require the Fed to look through the inflationary impact of the administration’s remaining tariffs, assuming that they hold, and focus on the risks to growth.

Other key market levels:

Fed RRP balances closed at $148 billion as of Friday, elevated at the end of April as limits on bank balance sheets likely pushed repo cash to the RRP
Setting on 3-month term SOFR closed Friday at 426 bp, down 2 bp in the last week
Further out the curve, the 2-year note traded Friday at 3.93%, up 17 bp in the last week. The 10-year note traded at 4.31%, up 4 bp in the last week.
The Treasury yield curve traded Friday with 2s10s at 48 bp, flatter by 3 bp in the last week. The 5s30s traded Friday at 87 bp, steeper by 2 bp over the same period
Breakeven 10-year inflation traded Friday at 227 bp, unchanged in the last week. The 10-year real rate finished the week at 204 bp, up 4 bp in the last week.

The view in spreads

Bearish on credit spreads with US trade policy in flux. The Bloomberg US investment grade corporate bond index OAS traded on Friday at 106 bp, wider by 4 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 158 bp, wider by 3 bp in the last week. Par 30-year MBS TOAS closed Friday at 38 bp, wider by 1 bp in the last week.

The view in credit

Tariffs should weaken most credits assuming slower growth, and hit specific credits hard based on exposure to cross-border trade flows. Excess returns from the first week of tariff war point to the specific sectors more or less exposed to tariff. We have been watching cracks in credit quality at the weaker end of the credit distribution for months. Fundamentals for the average of the distribution continue to look stable. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. Consumer debt service coverage is roughly at 2019 levels. However, serious delinquencies in FHA mortgages and in credit cards held by consumers with the lowest credit scores have been accelerating. Consumers in the lowest tier of income look vulnerable. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks. If the Fed only eases slowly this year, fewer leveraged companies will be able to outrun interest rates, and signs of stress should increase. LMEs are very opaque transactions, so a material increase could make important parts of the leveraged loan market hard to evaluate.

Steven Abrahams
steven.abrahams@santander.us
1 (646) 776-7864

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