This month's chaotic sell-off in financial markets has had little impact on global financing conditions, but the potential for increased volatility means borrowers are still facing challenges. Equity and corporate debt markets have recovered some of their losses, which were initially triggered by fears of a US recession and the unwinding of a popular yen carry trade in early August. Despite this, they remain significantly weaker than a month ago, with the S&P 500 still 5% below its July peak after an initial drop of nearly 10%. European stocks have also suffered similar declines. Corporate bonds, both high and low-rated, have largely recovered from their year-to-date declines in risk premiums over government bonds. However, financing conditions have not tightened sufficiently, even during the peak of the sell-off, to raise concerns about a more severe economic slowdown that could prompt central banks to cut interest rates.
"We haven't seen significant enough movements to materially alter financing conditions for corporates or households," noted Chris Jeffrey, head of macro strategy at Legal & General Investment Management. Indeed, a closely-watched measure of US financial conditions by Goldman Sachs indicates that while they have tightened since mid-July, they remain historically loose and more accommodative than most of last year. For instance, global stocks are up nearly 10% this year, and credit spreads are lower than in 2023. Goldman estimates that each additional 10% sell-off in equities would reduce US economic growth by just under half a percentage point over the next year, with a potential total impact of just under a percentage point if other markets react similarly. Given that US growth remains above 2%, a substantial drop in equity markets would be needed to cause significant global economic repercussions.
With the US Federal Reserve poised to start cutting rates soon and other central banks already doing so, the recent market turmoil has led to a decrease in borrowing costs. US 10-year Treasury yields have fallen by more than 50 basis points since the beginning of July, and yields on UK and German government bonds have dropped by over 30 basis points each as investors anticipate more aggressive rate cuts. This is beneficial for borrowers, with US investment-grade corporate bond yields also declining by 50 basis points since July. Highly-rated companies raised $45 billion from US bond sales last week, according to LSEG’s IFR, indicating confidence despite the sell-off. There were also more bond sales in Europe compared to a year ago, and the US market started this week strongly.
"It doesn't appear that access to credit is currently a significant issue," stated Idanna Appio, portfolio manager at First Eagle Investments. "In fact, lower Treasury yields are creating an opportunity for companies to enter the market," added Appio, a former Fed economist. Even junk bond yields have decreased by 37 basis points since July, making conditions more favorable for lower-rated companies, which raised $7.2 billion from bond sales in the US last week. However, the expectation of continued high volatility creates uncertainty for borrowers. The VIX index, often referred to as Wall Street's "fear gauge," fell below 20 points this week, its lowest this month, but remains significantly higher than its average from January to July. With August typically being a quiet month for initial public offerings, the impact on equity fundraising, which usually suffers during periods of high volatility, remains to be seen.
Dealmakers remain optimistic as long as markets stay calm but are aware of the potential for future uncertainty. Javier Rodriguez, global head of value creation at KPMG, did not rule out a slowdown or halt in IPO deals. "There is no certainty about the final outcome, but potentially a less heated market compared to the last 18 months," he said. In credit markets, while investment-grade bonds saw inflows last week, junk bonds experienced outflows, according to BofA, reflecting caution towards weaker borrowers. With global high-yield bond sales reaching their highest first half of the year since 2021, according to LSEG, these outflows are not yet alarming. However, some were substantial, with outflows from US leveraged loans, which suffer when interest rates fall, being the largest since the peak of the Covid pandemic in March 2020, according to JPMorgan. The impact of the carry trade unwind on liquidity conditions also remains a risk to monitor.
"When carry trades collapse, funds exit countries and assets that support economic activity," explained Mathieu Savary, chief European strategist at BCA Research. "This results in tighter liquidity conditions where growth is generated, which negatively affects global economic activity."
