There is an interesting separation between the recent drop in equity prices and credit products. Traditionally, a huge sell-off in equities reverberates through credit hitting corporate bonds first and then bank loan pricing. This time, it is barely happening. Back in late 2007, we saw this “sympathetic coordination” between equities and credit before there started to be legitimate credit concerns beginning with housing and capital markets liquidity. So what is different now?
The answer is – we are not sure. Despite the DJIA retrenching 2,000+ points, credit spreads in bank loans have moved only two basis points. That move is not out of the ordinary and there are still plenty of buyers of credit. By yesterday, and particularly this morning, we would normally get at least a pause in some industries and loan types.
Part of the answer is that there is still strong liquidity available in the market which was not the case in 2007 and 2008. The other partial answer is - we still have strong fundamentals given the recent employment report, target inflation numbers and general economic strength. This could be an ironic twist that it is the change in interest rate expectations that is causing a sharp selloff in equities but not credit. Longer term fixed rate loans have been hit harder than floating rate product which is in-line with this thesis.
Credit supply remains constrained, and both small business and corporate earnings/cash flow look like the strongest they have been in recent times. While any major equity drop and jump in market volatility gets our attention and makes us devote more resources to risk management, so far, credit spreads are hanging in there and borrower sentiment, at least anecdotally yesterday, remain unchanged. It is too early to conclude that this week’s stock sell-off was just a blip and not a harbinger of greater negative systemic change, but we remain optimistic.
Submitted by Chris Nichols on February 06, 2018