What’s going on here?
Global financing conditions have stayed stable despite a rough patch in financial markets this month, with signs of recovery in equity and corporate debt markets.
What does this mean?
Fears of a US recession and the unwinding of the yen carry trade initially rocked financial markets. The S&P 500 tumbled nearly 10% but has clawed back some losses, now sitting 5% below July’s peak. European stocks also took a hit but are bouncing back. Both higher-rated and lower-rated corporate bonds have regained much of their risk premium over government bonds. According to Legal & General Investment Management, there haven’t been big enough shifts to significantly change financing conditions for companies or households. Goldman Sachs’ gauge shows US financial conditions are still historically loose and easier than last year, even with the recent market turbulence.
Why should I care?
For markets: Market resilience amid upheaval.
Despite the initial shake-up, markets are showing some grit. Goldman Sachs estimates that another 10% drop in equities would only cut US economic growth by just under half a percentage point over the next year. With the Federal Reserve likely to start trimming rates soon, borrowing costs should go down. US 10-year Treasury yields have dropped over 50 basis points since early July, and similar patterns are seen in the UK and Germany. This climate has allowed top-rated companies to raise substantial funds, like last week’s $45 billion in US bond sales.
The bigger picture: Caution for weaker borrowers.
While investment-grade bonds are seeing inflows, signaling confidence in stable entities, junk bonds and US leveraged loans are facing outflows, showing caution towards weaker borrowers. JPMorgan noted the largest outflows from leveraged loans since March 2020, hinting at possibly tighter liquidity conditions. This guarded stance, even with the Federal Reserve’s likely rate cuts and falling Treasury yields, suggests that while credit markets might open up more, the outlook for riskier borrowers remains wary. The VIX index dropping below 20 points this week indicates lower volatility, but the real impact on equity fundraising is still up in the air, especially considering August’s historically slow IPO activity.