By Bilal Hafeez 16-07-2019

Food Fights at the Fed and in the Leveraged Loan Market (Eye on the Market by J.P. Morgan, 9 min listen)

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(You can listen to the podcast by clicking here)

It’s now certain that a Fed cut is coming soon, but what’s driving it? This short, punchy podcast weighs up the probability of legitimate economic reasoning or political bullying. We can draw parallels to the 1970s, when the then Chairman of the Fed, Arthur Burns, caved into Nixon’s pre-election demands to boost the economy, only to end up with stagflation that took a decade to resolve. Fortunately for Jay Powell, Chairman of the Fed, there are a number of structural forces pushing inflation down that didn’t exist 50 years ago – de-unionization, globalization, and internet transparency. Instead, there might be an asset bubble forming. Of note, is the growing covenant-lite loan market, now representing 80% of the whole US leveraged loan market. These could be hiding a decline in underlying quality. Also, practices such as artificially ‘massaging’ earnings using EBITDA add-backs are becoming more common.

Why does this matter? The timing of a default crisis may be postponed with Fed easings, but when those easings happen the loan recovery rates are likely to be much lower – possibly closer to 40% than the historic norm of 70%.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)