The Fed started raising rates in March 2022, and the effects are clear. Higher costs of capital have pushed more and more companies into bankruptcy. This is the idea behind raising rates: to slow the economy down with the ultimate goal of getting inflation back to 2%. Every day there are companies that cannot get new loans or refinance, and this trend higher in bankruptcies will continue as long as interest rates stay high.

Arguments for US long rates moving higher are QT, the large government budget deficit, BoJ YCC exit, and the significant amount of T-bills outstanding, which need to be rolled into longer-dated Treasury bonds and notes, see chart below.

Arguments for US long rates moving lower are peaking inflation, slowing growth, and the Fed being done with raising rates.

Fed hikes had an immediate negative effect on the manufacturing sector because the goods sector is more sensitive to interest rates.

With interest rates remaining high and consumers running out of excess savings, the next shoe to drop in 2023H2 is the service sector.

The divergence between manufacturing and services is likely why high yield spreads have not yet widened the way they usually do, see chart below.

Since the Fed started raising rates, credit fundamentals have continued to deteriorate. The higher cost of capital is putting significant downward pressure on interest coverage ratios across IG, HY, and loans. Cash flow coverage is declining, and leverage is rising, see charts below.

The pressure on corporate balance sheets is the direct result of the Fed keeping the costs of capital at high levels, and with rates staying high for a couple of years, the ongoing deterioration in credit fundamentals will continue to have a negative impact on employment growth and capex spending, and ultimately GDP.

Our credit market outlook is available here.

The total market cap of US corporate bond markets is now at $9 trillion. BBB market cap is currently at $3.7 trillion, and single-A is at $3.4 trillion, see chart below.

Financials have a weight of almost 50% in the European IG index and 33% in the US IG index, see chart below. For the high yield index, financials also have a higher weight in Europe than in the US. For the US, the sectors with the biggest weight in the HY index are consumer discretionary, communications, and energy.

Ninety-one percent of US investment grade bonds are trading below par, see chart below.

Modified duration measures the expected change in a bond’s price to a 1% change in interest rates. The charts below show that since the Fed started raising rates, index duration has declined both for high yield and investment grade, with high yield duration currently standing at 4% and investment grade duration at 7.5%.

Twenty percent of the high yield index trades with yields higher than 10%, see chart below.