In keeping with Bernanke’s cautionary remarks about the unsettled state of the markets, some debt market participants worry that the recovery will prove short lived. While few are forecasting a return to the near paralysis of early in the year, the combination of continued caution among lenders and a deteriorating economy could make debt dearer and more difficult to come by.
The Wall Street Journal, in “Is Debt Thaw on Borrowed Time?” while recounting various signs of improvement in the corporate loan market, also warns of the potential for credit tightening:
“There’s no question the tone in the market is getting better,” says Jim Casey, co-head of leveraged finance at J.P. Morgan Chase.
He adds, however, that “there is some concern that this might be a short-term window of opportunity for issuers, since investors are still very focused on default rates and the potential severity of a recession.”
Banks and debt investors are treading carefully. While they are more open to financing deals where one corporation buys another, many are still somewhat reluctant to fund leveraged buyouts by private-equity firms…..
Investment banks, which incurred big losses after selling a lot of buyout debt at heavily discounted prices, are committing only to deals they can underwrite at a profit. And investors don’t want to be caught wrong-footed if corporate defaults spike.
“Risk tolerance is still pretty low,” says Daniel Toscano, a managing director of leveraged and acquisition finance at HSBC Securities in New York.
In “Is It Really Different This Time?” in Barron’s, Randall Forsyth notes that fixed income markets often price in a recovery after a round of monetary easing, but then resume their trajectory as the economy continues to flag:
There’s been a hiccup in every decline in the two-year Treasury note yield in the four major cycles since the mid-1980s. (The two-year T-note is the most actively traded security on the planet and reflects expectations about the Fed’s next move. [Robert] Kessler [of Kessler Investment Advisors] oncentrates on this portion of the yield curve and adjusts the effective duration of the portfolio by adding or subtracting leverage.)
But, after those temporary blips, the two-year note yield fell again, and onto new lows for the cycle….
The recurring script seems to be that after the initial phase of the financial squeeze that leads to the first cuts in interest rates, Wall Street essentially thinks that this monetary easing has cured all ills. But, while that addresses the problems of the financial markets, the economic woes in the real economy take longer to cure. That realization leads to the final downleg in rates, Kessler says.
That’s still to come, he continues. “Phase Two will be worse than Phase One,” he says. It will come when consumers pull up to the gas pumps and then have nothing left to spend on anything else. Combined with the impact from soaring food costs, that point isn’t far away…
As for inflation, Kessler also observes that it’s curious that with crude oil hitting $126 a barrel, gold hasn’t made net headway in three months. Tuesday, June gold futures lost $15.30 to $869.60 an ounce even as crude futures set a new mark.
While the charts of the current cycle looks almost like those of its three predecessors, Kessler fingers an important difference.
Then, the Fed could fuel a recovery by dropping interest rates. Housing, especially, would respond forcefully and lead the rest of the economy to recovery. But in past cycles, the mortgage market could readily provide credit to prospective buyers; not so any more. Credit this time is tighter, not by the Fed’s doing, but mortgage originators, which play an integral role in the process.
Consumers, Kessler continues, came out of the 1980s with high savings rates and liquid assets. Now, they’re tapped out because of a lack of savings in the past few years. And to sustain spending in excess of poor income growth, Americans used credit to keep spending. The limits on that are becoming apparent.
All in all, it really is different this time, Kessler says, invoking the mantra used by blinkered bulls for years. It is worse, he asserts, given the little response he sees in the real economy from the rate cuts that have taken place.
Stocks have rallied coming out of past credit cycles, but you have to be brave to expect the same this time, he contends. Treasury yields, however, are likely to fall to new lows once this inflation scare blows over, Kessler concludes.