"We believe the Fed (Federal Reserve) will blink and then begin easing policy in late 2023," he said in an email. "The economy is starting to show signs of slowing, but overall, the consumer and labor markets remain relatively healthy, which is another reason why we believe the recession will be brief."
Mr. Dunlap expects real gross domestic product to continue to fall off the "blistering average pace" of 5.9% in 2021 and 2% in 2022, reaching -0.5% in 2023. "Growth the rest of this year will be under pressure due to lower consumption, lower non-residential and residential investments, slower inventory build, and lower trade activity because of slower global growth," he added.
Meanwhile, institutional investors remain most concerned about continued high inflation "coupled with a higher-than-expected terminal rate for an extended period," he noted.
However, Mr. Dunlap also said he thinks policy rates and inflation are at or near their peaks. "After going parabolic in 2022, both headline inflation and core inflation will continue to descend, reaching 2% to 3% by the end of 2023," he said. "Near-term headline and core inflation pressures have peaked due to declining food and energy prices, falling used-car prices benefiting core goods, and declining shelter and medical services benefiting core services."
Moreover, as the growth picture dims in 2023, Mr. Dunlap expects the labor market to begin "showing signs of weakening" and the unemployment to rise to about 5%, from 3.7% in 2022. "We believe the upcoming recession will not have as much job loss as previous cycles did, given the still-dramatic labor shortage," he said, noting there are about 1.9 current job openings per unemployed person.
Within the fixed-income universe, he currently favors non-agency residential mortgage-backed securities due to "deeply discounted dollar prices with prepayment and call upside potential, as the market is currently priced for maximum extension." In fact, he added "loss-adjusted yields range from 6% to 15% in high-quality cash flows with robust structural credit protection and backed by U.S. homes."
One macro factor that is not getting much attention is the fact that a continued decline in interest rate volatility will be "very supportive" for mortgage and securitized product spreads in 2023, he said.
"The great bond bear market of 2022 and the volatility storm that ensued sent structured credit spreads in government-guaranteed assets to crisis levels and spreads in some areas of AAA-rated securitized credit wider than even those of BBB-rated corporates," he said.
Angel Oak has about $19.2 billion in assets under management.