Your weekly economic update from the team at FXD Capital
The yield premium between corporate bonds and US Treasuries is at its lowest level in more than a decade. Seemingly every weekly update has some form of a sentence ending with “lowest/highest for a decade”.
Yield spread compression is a sign of increased confidence in corporate balance sheets and the broader economy. Or, the flip side is a more reluctant scenario, where faced with piles of cash, investors are digging around under the sofa desperately looking for keys.
Spreads between USTs and investment-grade corporate bonds currently stand at around 0.87%, the lowest range since 2007. The equivalent spread for high yield bonds sits at 3.12%, which again is testing all-time lows. Issuers are evidently trying to make hay while the sun shines: 373 junk-rated companies have already raised $277bn this year, at a pace 60% higher than in 2020, indeed only four other years in total eclipse the amount accumulated over five months in 2021.
As food for thought: Even if corporate earnings rise 25% this year, Debt to EBITDA levels will still be around 14x (Bank of America, May 2021). Such ratios were last seen in 2009 when the world was amid the Financial Crisis.
The initial feeling when looking at spread compression is one of the improved risk conditions, which naturally leads to the conclusion that corporates are more prudently run and thus, can borrow money cheaper. While that is indeed happening, this is not down to excellent stewardship by business owners. Instead, their boats have been lifted by rising tides: continuous money printing, accommodating asset purchasing programs and corporate bailout programs eliminating jeopardy.
Corporate and sovereign debt will always be different beasts, no matter how close yields become. The lower the credit rating, the more correlated the bond behaves versus general equities during market downturns. For investors in new junk bond issuances, who are being compensated at historic low levels of risk spread, they presumably are giving an affirmative answer to the question: “will risk conditions be better when this matures?”. It’s bewildering to imagine them being any better than now, but who knows?
Retail sales unexpectedly fell in May as the population diverted attention away from aisles to the tables of recently reopened restaurants and pubs. Sale volumes fell 1.4% on the month, leaving forecasters out at sea with their 1.6% predicted increase. Food stores bore the brunt of the fall, with household goods and garden centres faring strongly, with the ongoing rarity of BBQs and outdoor furniture continuing its story.
What’s most pertinent when reviewing retail data is the persistence of online sales, which are remaining steady (currently 28.5%) despite shops and normalcy returning. While online shopping for some is a way of life, for others not so. The pandemic almost doubled online shopping penetration overnight, and the persistence of this shows that paradigms have changed for good, and the high street will invariably contract permanently when the dust settles.
The Federal Reserve’s monthly policy meeting concluded on Wednesday, with the base rate held at its 0 – 0.25% range, as expected. As a sign of a gradual acknowledgement of recent inflation effects, minutes show that rate increase expectations have moved ahead by one year to 2023, from March’s prior estimates.
In light of recent changes and optimism surrounding the US economy, GDP forecasts have revised up to 7% (from 6.5% in March) and unemployment down to 4.5%. Core inflation is anticipated to reach 3% (versus 2.2% predicted in March) before subsiding to 2.1% in 2022
There were also indications of an impending repeal of 2020’s crisis policy measures. While asset purchases remain steady at $120bn per month, talks have begun about how to turn off the spigot. All eyes are on when this “tapering” will start, and the Fed has previously commented that the economy would need to make “substantial further progress.”
ECB top brass meets in Frankfurt today to discuss a range of issues on the bloc’s horizon, ranging from inflation to climate change. Regarding inflation, the question of the ECB’s flat 2% target is open for debate, with some hoping for a shift towards an average mark, which allows for the kind of fluxes we are seeing in the States right now. Or they could move towards one used by the BOE, which uses tolerance bands around a target and an explanatory letter to the chancellor whenever breached.
The broader topics for discussion about affordable housing and climate change are noble and exciting topics to discuss at such meetings. But also ask a question about how far remits can potentially stray for bodies like the ECB?
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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