Brian Moynihan, the chief executive of Bank of America Merrill Lynch. Photo / Getty Images
Brian Moynihan, the chief executive of Bank of America Merrill Lynch. Photo / Getty Images
COMMENT:
The chorus of doomsayers warning of turmoil stemming from corporate borrowing added a powerful voice this week.
Brian Moynihan, the chief executive of Bank of America Merrill Lynch, warned on Tuesday that the growth of the leveraged loan market — where lowly rated or heavily indebted companies borrow money— could accelerate an economic downturn. He should know: BofA has long been the largest arranger of such financing, and then selling the debt on to investors.
"It'll be ugly for those companies if the economy slows down and they can't carry the debt and then restructure it, and then the usual carnage goes on," he said, according to Bloomberg.
Jerome Powell, Federal Reserve chairman, has made similar claims to Moynihan, saying that even if high levels of corporate debt do not cause the next financial crisis, they could exacerbate it.
Pimco, the giant asset manager, has also said it is pulling back from lending to US companies.
Lawmakers in the US House of Representatives held a hearing this week on the topic, with academics also raising alarms.
It is curious, then, in a month that has seen concerns over slowing global growth amplified by the Trump administration's trade offensive, that credit markets appear unfazed.
Treasury yields have plummeted as angst over the slowdown has risen, but leveraged loan prices and corporate bond yields have seen much less of a reaction. For some analysts and investors, it is a sign of complacency.
The average price of US leveraged loans stands at about 97 cents on the dollar, according to an index run by the Loan Syndications & Trading Association. That is below the 98 cents level that the market spent much of 2017 and 2018 above, but nowhere near the low of 94 cents hit in December, when fears over lacklustre growth intensified.
The same is true in junk bond markets. The additional interest above Treasuries demanded by investors in the high-yield market stands at about 4.6 percentage points, higher than the year-to-date low of 3.7pp but still well below the 5.5pp reached in December. It means investors are demanding some extra compensation to hold the debt, but not much.
So why, amid so much doom and gloom, are investors so sure companies will pay back their debt?
Despite some weakness in economic data, most investors agree that the US is not yet about to slip into recession. Even Moynihan said that it is too early for that bell to toll.
Federal Reserve chairman Jerome Powell. Photo / AP
Some investors also push back on concerns over growth of the loan market, saying that corporate leverage is not actually that much higher than it was in the run-up to 2008. The ability of companies to repay the money they have borrowed remains strong, they add.
A further boost to the credit market came on Tuesday, when Powell left the door open to a cut in interest rates, in the face of escalating trade disputes and plunging Treasury yields.
Some investors hope that a rate cut, or cuts, will ease financial conditions, underpinning riskier assets such as stocks, corporate bonds and leveraged loans, extending the economic cycle for a little longer.
"There is definitely this idea that the Fed will come to the rescue of risky assets," says Subadra Rajappa, head of US rates strategy at Société Générale.
The potential for Fed rate cuts is seen as insurance against a downturn. In Powell's own words, the central bank will "act as appropriate to sustain the expansion".
The ideal situation is a so-called "soft landing", where a slowing economy gently touches down before taking flight again.
"I think we are going to drift along," says John Dixon, a high-yield bond trader at Dinosaur Securities. "I don't see us having a negative growth rate any time soon. I don't think the high yield market thinks so either."
Crisis averted? Not yet.
Some investors question whether the Fed cutting rates will do much to boost the economy. Interest rates are still not that high, and economic conditions are not that tight.
If a decade of record-low interest rates failed to stir significant inflation in the economy, despite low unemployment, what will a mild easing achieve now?
If this proves true then a more substantial slowdown could be on the horizon. The difference between three-month and 10-year Treasury yields has already turned negative, or "inverted", just as it has done before every US recession of the past 50 years.
If, however, the Fed is successful in supporting credit markets, the risk is that it exacerbates the problem that Moynihan raised this week.
A decade of low interest rates has encouraged companies to borrow cash while incentivising investors, starved of opportunities to generate higher returns, to lend it to them.
As Peter Boockvar, chief investment officer at Bleakley Advisory Group, puts it: "How will the Fed square an 'insurance cut' (as opposed to one legitimately used to deal with a pronounced economic slowdown) with the expressed worries about excessive corporate debt that the era of extraordinarily low rates encouraged?"
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