The recent tumultuous sell-off in financial markets this month has caused some concern among investors, but global financing conditions have remained relatively stable. Despite this, the risk of further volatility looms, keeping borrowers on edge.
Equity and corporate debt markets have experienced some recovery after the initial plunge sparked by U.S. recession fears and the unwinding of a popular yen carry trade earlier in August. However, they still remain weaker than they were a month ago, with the S&P 500 and European stocks both taking a hit.
While higher and lower-rated corporate bonds have seen some recovery in the risk premium they pay over government bonds, financing conditions have not tightened significantly enough to raise concerns about a sharper economic slowdown that could prompt central bank interest rate cuts.
Chris Jeffrey, head of macro strategy at Legal & General Investment Management, noted that there have not been substantial enough moves to materially impact financing conditions for corporates or households. Despite the recent market turbulence, a gauge of U.S. financial conditions compiled by Goldman Sachs shows that conditions remain historically loose and more accommodative than in much of last year.
Global stocks are still up nearly 10% this year, and credit spreads are lower than they were in 2023. Goldman estimates that even a potential further 10% sell-off in equities would only reduce U.S. economic growth by just under half a percentage point over the next year, indicating that it would take a much larger drop in equity markets to significantly impact the global economy.
With the U.S. Federal Reserve expected to begin cutting rates soon and other central banks already doing so, the recent market volatility has led to a decrease in borrowing costs. U.S. 10-year Treasury yields have dropped more than 50 basis points since the start of July, while yields on UK and German government bonds have also fallen as investors anticipate steeper rate cuts.
This decline in borrowing costs is good news for borrowers, as U.S. investment-grade corporate bond yields have also decreased significantly since July. Highly-rated companies have been able to raise substantial amounts from bond sales, indicating confidence in the market despite the recent selloff.
However, expectations of continued volatility create uncertainty for borrowers. The VIX index, Wall Street’s „fear gauge,“ remains elevated compared to its January-July average, signaling ongoing market uncertainty. While money flowed into investment-grade bonds last week, junk bonds saw outflows, suggesting caution around weaker borrowers.
Dealmakers are cautiously optimistic as long as markets remain calm, but there is a sense of uncertainty looming. Javier Rodriguez, global head of value creation at KPMG, acknowledged the potential for a cooled-down market compared to the past 18 months, which could impact IPO deals in the pipeline.
Overall, while global financing conditions have weathered the recent market turbulence, the risk of further volatility remains a concern for borrowers. The impact of the recent sell-off on liquidity conditions and the potential for continued market uncertainty highlight the need for vigilance in the coming months.
