The Fed Is Losing Control of Credit | Henry Peabody

Peabody argues that monetary policy is transmitting unevenly because private credit and fixed-rate bonds insulate some borrowers, while consumers, housing demand, triple-C borrowers, and other marginal borrowers remain highly rate-sensitive. Mortgages near 6% and used-car loans above 7% are adding to affordability pressure, particularly for lower-income households.

AI investment and onshoring are supporting demand and contributing roughly 6% annualized in nominal GDP terms, but Peabody says they also require mammoth amounts of capital and push costs higher. In his view, reducing demand and inflation in this environment could require more aggressive Fed action than in recent cycles, even as policy may remain higher for longer.

Peabody links the post-2020 higher-inflation, higher-capital-cost regime to fiscal and monetary cooperation during COVID and says historically high real rates could attract capital if investors can earn roughly 2% to 3% real returns over 10 or 30 years. He also views nominal growth as an anchor for long-term rates, while noting that inflation breakevens have not moved materially wider.

Credit risks are building beneath a less transparent market structure: lending has shifted from banks into vehicles that provide less information about non-performing loans, reserves, asset values, and forced selling. Floating-rate leveraged loans and triple-C credit are particularly exposed, with coupons above 10% or even 12% and six-times-or-more leverage weakening interest coverage.

Peabody expects defaults to be higher in a year but explicitly does not forecast a spike, with software credit a particular concern because recoveries depend on intellectual property and projected cash flows rather than hard assets. He says the risk is amplified if businesses become obsolete or margins compress.