Corporate credit still cheap despite rising rates

Corporate credit is defying the Fed's push for tighter money.

Driving the news: Recently, corporate bond yields have fallen relative to Treasuries, meaning businesses lending conditions are still highly stimulative. It is one of many signs that markets have not tightened nearly as much as might be expected, given the Fed's policy U-turn.

Why it matters: The Fed's strategy to rein in inflation is premised on tightening the screws on credit — but based on the results so far, it may need to get even more aggressive.

By the numbers: Since the Fed's shift began in early November, the 10-year Treasury yield has surged (from 1.55% to 2.83%), as has the average rate for a 30-year fixed-rate mortgage (3.09% to 5.00%).

• Initially, corporate borrowing costs rose faster, as typically happens when the Fed tightens, which is partly how monetary policy slows the economy. But in the last month, the usual pattern hasn't applied: The spread between risk-free rates and corporate bond yields has narrowed.
• Last week, Aaa-rated bond yields were 1.07 percentage points higher than Treasury yields, according to Moody's data, about the same spread as early November and down from 1.55 percentage points on March 8. It averaged 1.62% in the decade of the 2010s.

One likely factor: The Fed's decisive moves toward "quantitative tightening" will mean shrinking its $9 trillion bond portfolio by up to $95 billion a month. The policy has more direct effects on Treasuries and mortgages (via runoff of mortgage-backed securities) than on corporate bonds.

Still, narrowing corporate debt spreads are evidence that — for all the talk of recession risk — conditions remain highly accommodative for corporate America. Also, the S&P 500 is down only 4.8% since the start of November, hardly the kind of drop that signals tightening.

• As of last week, Goldman's Financial Conditions Index, which incorporates rates, stock valuations and credit spreads, showed financial conditions were looser than nearly all of the 2010s.

Yes, but: There is also the risk of overdoing it, and causing a freeze-up of business credit that causes a recession, or a crisis.

What they're saying: "It’s tough to pinpoint a yield level where this would 'break' the market or the economy," Mike Larson of Weiss Ratings tells Axios.

• But given high inflation, rising rates and volatility, "it’s the kind of thing that could definitely cause problems for corporate America the more the Federal Reserve decides to tighten the screws."

The bottom line: Corporate credit is still very flush. If the Fed really wants to slow down the party, it appears to have lots of work to do.