Conflicting trends in a bifurcated U.S. economy are creating challenges for central bankers trying to determine their next move and investors determining where to allocate their next dollar. On one hand, the stock market continues to reach unprecedented heights, with more companies now sporting market caps exceeding $1 trillion. As the wealthy have seen their asset bases expand in the last year, they’ve increased their investment activities by participating in both traditional and nascent markets, which has put upward pressure on prices in most asset classes. On the other hand, consumers lower down the income ladder are facing mounting challenges due to high interest rates and the elevated cost of basic goods. Importantly, the excess savings that this latter group accumulated during the pandemic has mostly been depleted, even as the wealth of those in the highest income deciles continues to grow.
What does this mean for credit markets? This concentration of wealth has caused capital markets to be far more generous than would be expected in an elevated interest rate environment. As a result, many highly levered companies have been able to postpone potential problems by refinancing their debt.
But the mixed signals the Federal Reserve is receiving – e.g., booming financial markets, low but rising unemployment, and declining but still elevated inflation – make it unlikely that the central bank will cut interest rates aggressively in the near term. If interest rates stay well above their ten-year average for an extended period of time and pockets of the economy weaken, companies with unstable capital structures may find it increasingly challenging to keep kicking the can down the proverbial road. Thus, we believe credit investors should proceed with caution and avoid assuming that major concerns about corporate credit are all in the rearview mirror.
Download PDF
