US economy

Corporate debt dangers still lurk even if Fed eases


Trade wars? Nothing to fret about. Slowing growth? Not a problem. 

At least, that appears to be the message from corporate debt markets, which are showing few signs of worry. Investors are betting that the Federal Reserve will swoop in, cut interest rates and prop up debt-laden companies before the year is out.

The latest piece of evidence to support that view came from weak US inflation data on Wednesday, solidifying expectations among many strategists that an easing of monetary policy is not far away. Deutsche Bank joined a growing chorus this week, saying that subdued price rises, along with deteriorating trade relations with China, pointed the way to three cuts in the Fed funds rate by the end of 2019.

That assumption of further help from the Fed could explain why the return demanded by investors in corporate debt has fallen this month from a peak of 4.84 percentage points above US Treasuries to 4.32 percentage points on Wednesday. That is in line with levels seen at the end of 2016, when economic conditions were robust enough for the Fed to embark on its most aggressive trajectory of policy tightening since before the financial crisis.

But if the Fed takes a different path this time, judging that the US economy really needs a boost from lower rates, there are still good reasons for investors to be cautious on the credit market.

Some big investors are already warning about the dangers of being too heavily invested, arguing there is too little return on offer for too much risk. Pimco has said it is shifting away from lower-quality companies that have binged on cheap financing over the past decade. AllianceBernstein this week noted a “marked deterioration in the quality of corporate debt” in recent years and warned that bond prices were likely to fall, pushing borrowing costs higher.

Besides, if the Fed were to make another supportive move, it is not clear what effect it would have. Interest rates are still low by historical standards. Several years of ultra-loose financial conditions have encouraged companies to lever up but have failed to generate substantial, consistent growth or inflation.

Jan Hatzius, chief economist at Goldman Sachs, is not even convinced that the Fed will lower rates. It is a “close call”, he says, but Fed chair Jay Powell’s recent assertion that the central bank will act to sustain the economic expansion was more an acknowledgment of the risks posed by the various trade skirmishes than a nod to potential rate cuts.

Certainly, now is not the time for pandemonium. There is no need to run for the hills for fear that corporate debt markets are about to collapse. But such unbridled optimism in the path ahead, as implied by these thin spreads, looks equally unwarranted.

joe.rennison@ft.com



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