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Braking (and Not Breaking) the Economy

Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA

We believe:

  • There is a high level of uncertainty around economic outcomes.
  • The growing possibility of future Fed cuts supports the case for increasing portfolio durations across the Calamos fixed-income funds.
  • Credit spreads reflect an overly sanguine outlook and we are reducing exposure to credits vulnerable to a cyclical downturn.

Progress on inflation and surprisingly resilient economic growth allowed the Federal Reserve to pause its rate hiking campaign at its September 20 meeting. This pause affords the committee another six weeks to evaluate incoming data. It’s clear the Fed is looking for continued improvement in PCE Core Services (ex-housing). The message stayed the same and was two-fold. First, the Fed is confident a restrictive policy stance has been reached. Second, the central bank stands ready to do more if necessary. Despite this strong reassurance, long-maturity interest rates moved to a 15-year high.

We agree that monetary policy is restrictive at current levels, as evidenced by trailing 12-month inflation (core PCE) below the Fed funds effective rate and real yields on Treasury Inflation-Protected Securities well above 2% across the maturity spectrum. We expect future months and quarters to display some deterrence to consumer and business investment as a reduction in disposable income through higher borrowing costs roll into more areas of economic activity. We are squarely in the “impatiently waiting” phase, looking to ascertain how much economic momentum will be lost from past policy changes. We believe there is still a high level of uncertainty around potential economic outcomes and a recession cannot be dismissed.

We’ve seen fundamentals weaken modestly in levered credit. The traditional high yield market experienced year-over-year declines in both revenue and EBITDA through the end of the second quarter for the first time since 2020. Recall that prior quarter results looked healthier with 7.5% year-over-year growth in EBITDA, but the aggregate results relied heavily on significant strength within the leisure, energy and transportation industries. Although the direction of progress may have changed, aggregate levels of leverage and interest coverage continue to look healthy in our evaluation. We are monitoring the situation closely to determine whether a new trend towards weakness is emerging or whether results are simply becoming more volatile as the instability in input prices, labor costs, and consumer behavior show up in erratic results. Credit spreads in both the investment grade and high yield markets have widened slightly as strong balance sheets and technicals have offset the growing suspicion that results in coming quarters will be weaker.

On the topic of capital access, we believe developing private credit markets have ample capital available to fill the liquidity gap that occurs when banks and other traditional capital sources pull back. These new capital sources, along with low-cost, fixed-rate Covid-era debt, are likely to extend the transmission lag with which the Fed’s monetary policy affects economic activity. Nevertheless, a recession is still a possibility as liquidity conditions continue receding.

Positioning Implications

Recent increases in Treasury yields moved the market into closer harmony with the Fed’s own expectations for its forward rate path. Futures markets now indicate that at least two rate cuts will occur in 2024, down from the five cuts the market had priced in last quarter. Although this feels more measured, we believe rates could eventually reflect a scenario where no rate cuts are priced in for the next calendar year. We have been gradually increasing portfolio durations across strategies in expectation of peak-Fed policy rates and a greater likelihood that the next rate move is a cut. This leaves us with a modestly long benchmark duration in both Calamos Total Return Bond Fund and Calamos Short-Term Bond Fund. The duration of the Calamos High Income Opportunities Fund remains below its benchmark duration, but interest rate sensitivity in the high yield market is a smaller driver of risk and return. This has also led to selective reductions of our leveraged loan positions, although we maintain a significant loan allocation across mandates based on relative value and seniority considerations.

In our estimation, credit spreads reflect an outlook that is too sanguine. We are beginning to see a deterioration in fundamentals within the leveraged finance space. Although it is too early to determine whether this is a wobble or a new trend forming, we are actively reducing exposure to credits we evaluate to be more exposed to a downturn in cyclical activity, credits with weak contingent liquidity or credits with exposure to rapid deterioration of asset value. Based on our fundamentally driven investment philosophy, we believe there are select high yield issuers where investors are being well compensated for associated risks, and we are maintaining allocations in those areas. We are also increasing allocations to securitized structures that offer relative value in comparison to investment grade corporate debt.

Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-866-363-9219. Read it carefully before investing.

Diversification and asset allocation do not guarantee a profit or protect against a loss. Alternative strategies entail added risks and may not be appropriate for all investors. Indexes are unmanaged, not available for direct investment and do not include fees and expenses.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be appropriate for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

Duration is a measure of interest rate risk.

Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund’s prospectus.

The principal risks of investing the Calamos Total Return Bond Fund include: interest rate risk consisting of loss of value for income securities as interest rates rise, credit risk consisting of the risk of the borrower missing payments, high yield risk, liquidity risk, mortgage-related and other asset-backed securities risk, including extension risk and portfolio selection risk.

The principal risks of investing in the Calamos High Income Opportunities Fund include: high yield risk consisting of increased credit and liquidity risks, convertible securities risk consisting of the potential for a decline in value during periods of rising interest rates and the risk of the borrower to miss payments, synthetic convertible instruments risk, interest rate risk, credit risk, liquidity risk, portfolio selection risk and foreign securities risk. The Fund’s fixed income securities are subject to interest rate risk. If rates increase, the value of the Fund’s investments generally declines. Owning a bond fund is not the same as directly owning fixed income securities. If the market moves, losses will occur instantaneously, and there will be no ability to hold a bond to maturity.

The principal risks of investing in the Calamos Short-Term Bond Fund include: interest rate risk consisting of loss of value for income securities as interest rates rise, credit risk consisting of the risk of the borrower to miss payments, high yield risk, liquidity risk, mortgage-related and other asset-back securities risk, including extension risk and prepayment risk, US Government security risk, foreign securities risk, non-US Government obligation risk and portfolio selection risk.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization; it reflects a firm’s short-term operational efficiency and is used to determine operating profitability.

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