In The Case Of Debt-Laden Firms, The Fed Cut May Be Too Late

Investment strategists believe that even if the Federal Reserve cuts interest rates later this year, it will not be sufficient to boost the stocks and bonds of highly indebted companies, since funding access is already becoming more restricted following the global banking turmoil, which has started making borrowing more difficult. 

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Following the collapse of three American lenders and the credit crisis at Credit Suisse Group AG earlier this month, a key gauge of US financial conditions showed they had deteriorated to their worst level since May 2020. A recent survey by the Federal Reserve Corporation's Senior Loan Officers indicated that lending standards have tightened across the board in US banks. 

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“If the Fed cuts interest rates, credit spreads will widen, and more importantly, there may not be enough credit available for companies to roll over their USD debts. This will cause difficulties for many Asian companies, including those with USD debts, to roll over their USD debts. Financials and businesses with plenty of USD debt are something I would stay away from." suggested a Trade Algo analyst.

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A system of calibrated monetary tightening may be needed to contain inflation and avoid the threat of recession or financial instability, but such caution is reflecting growing concerns that the Fed may make a serious mistake in this gamble. Having recently experienced a banking crisis, these worries have been intensified, and the US central bank chief recently hinted that there might be more rate increases next year, to add to the official assurances that no policy reversal is expected this year. 

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It is estimated that the effective fed funds rate will drop from the current range of 4.75% to 5% to around 4.2% by December as markets redouble their bets for a Fed rate cut. 

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With the potential for a recession in the United States, JPMorgan Asset Management has reduced its exposure to high-yield debt.

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Investing in the healthcare and utility sectors, specifically, has proven to be a good way to withstand recessions, since both sectors have strong balance sheets that are insulated from rising borrowing costs. 

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Trade Algo strategists are positioning in more defensive parts of the tech market, namely sectors less sensitive to inflation and growth.

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Analysts with Trade Algo believe that the banking sector in the United States is making strides in tightening lending standards, which could have a significant impact on the market.  

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“A tightening of lending standards in the banking sector is likely to pressure credit creation, which will likely accelerate the path to a US recession,” a Trade Algo analyst concluded.