Experience the latest updates in Capital markets with our free daily emails. Our myFT Daily Digest email will keep you informed on the latest news every morning. Investors and various measures indicate that rising stock prices and falling bond yields have made it easier for US companies to raise funds, neutralizing the impact of the Federal Reserve’s interest rate hikes.
This improvement is evident in the National Financial Conditions Index compiled by the Chicago Fed, which has reached its lowest point in 16 months. While looser financial conditions counter the Fed’s goal of slowing the economy and controlling inflation, it also suggests that the Fed might need to maintain higher interest rates for a longer period.
Sonal Desai, chief investment officer for Franklin Templeton Fixed Income, highlights the significant loosening of financial conditions, unwinding about 450 basis points of rate hikes and taking us back to March of last year. This indicates a strong demand with no need for interest rate cuts as the market believes a recession will not occur.
As the Fed continues to increase interest rates, the Goldman Sachs US Financial Conditions Index has dropped, approaching the low it hit in mid-July. This reflects the market’s belief that the Fed has finished raising interest rates and is now focused on bringing down inflation, which has fallen sharply in recent months.
Furthermore, the stock and corporate bond markets have contributed to these looser conditions. The enthusiasm for artificial intelligence has driven US stocks into a bull-market phase while a lack of new deals in the junk-bond market has led investors to focus on the few available options. This has resulted in lower borrowing costs for low-rated companies, with the premium they pay narrowing to its lowest since April 2022.
Investors note that this year’s tightening of spreads can be attributed to the shrinking junk bond market, low new issuance, and upgrades to investment-grade territory. Overall credit quality has improved, and fears of an imminent recession have subsided, buoying valuations.
While private credit has come to the rescue, allowing access to funds, higher interest rates and tightening lending standards by banks still pose challenges for weaker issuers. Although it may be slightly more expensive, money is available for those who need it.
Mike Chang, a high-yield portfolio manager at Vanguard, points out that financial conditions have not eased uniformly. Stronger issuers have better access to capital markets, but weaker ones still struggle to secure funding. It will take time for higher interest rates to have an impact on the economy and corporate balance sheets due to the high levels of refinancing activity in recent years.
Overall, the equity markets have experienced a surge due to the growth of artificial intelligence and the success of big tech stocks. This has made it easier for companies to raise cash through share sales, with fundraising through US initial public offerings up 104% year on year.
As the encouraging environment for businesses continues, market observers eagerly await the Senior Loan Officer Opinion Survey on Bank Lending Practices for further insights into lending standards. The Fed has acknowledged the potential risks of looser financial conditions and stands ready to take further action if necessary.
Ultimately, financial conditions may fluctuate, but the Fed remains confident that interest rates will have a positive impact on economic activity and inflation over time.
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