- When monetary conditions were loose and the prospects good, the spread between high yield debt and that of rock-solid companies were generally quite tight.
- While the Fed has raised rates, yields are also being pushed higher as investors raise their forecast for how high inflation will run, rocked by the rising cost of energy and food.
An oft heard adage is that the stock market, isn’t the economy.
And while that may be true, the debt market could well be.
When monetary conditions were loose and the prospects good, the spread between high yield debt and that of rock-solid companies were generally quite tight.
Given the abundance of liquidity, investors looking to make their money work harder for them, were willing to lend to some of the riskiest borrowers in a search for yield.
But the U.S. Federal Reserve’s hawkish pivot has changed the calculation, with borrowing costs for companies and individuals rising since last December and the recent rate hikes by 0.25% sending Treasury yields soaring to their highest level in almost three years (yields rise when bond prices fall).
Treasuries are the risk-free benchmark from which virtually all financial markets take dressing, including everything from what we pay on our mortgage to our cars and while yields had been rising for some time, they hadn’t yet bled into corporate debt markets, that is until now.
To be sure, the rising cost of borrowing isn’t down solely to the Fed.
While the Fed has raised rates, yields are also being pushed higher as investors raise their forecast for how high inflation will run, rocked by the rising cost of energy and food.
Financial conditions for borrowers did ease slightly, thanks to a stock market rebound early this week, but even that respite proved temporary as U.S. Federal Reserve Chairman Jerome Powell reiterated that the central bank would soon need to run off its US$8.9 trillion balance sheet, which will send yields rising and tighten conditions further.
Fortunately, most companies managed to make hay while the sun shined last year, borrowing while the going was good, with airlines and cruise companies loading up on debt.
This year, riskier companies with junk-rated bonds have only reached out for US$38.8 billion, down over 70% from a year prior, and conditions are getting tougher for those looking to borrow.
That the debt markets have been regearing themselves since last December suggests that the Fed didn’t even need to actually raise rates to achieve what it set out to do – temper activity through tone.
Since last December, the Fed’s tough talk on inflation has seen markets respond without needing central bank intervention and could ultimately mean that policymakers have the needed flexibility to hold back on rate rises in the event that economic conditions should worsen.
