If the US Federal
Reserve decides to lower interest rates
at its next meeting, what will that mean
for corporate debt? So many people think
that at the next meeting the Fed is going to lower
interest rates because they think that they’re going to
see signs of economic slowdown. And lowering interest rates
gives a boost to the economy by making it easier for
consumers and companies to borrow money. But that would also be a really
big deal for the debt market. Bond, debt, and
fixed income all mean essentially the same thing. And before we talk
about this chart, we need to talk about the
way that debt is categorised. So there are these rating
agencies out there, like S&P and Moody’s, which
you may have heard of. And they assign
ratings to companies. Now, the highest rating that you
can get as a borrower is AAA. A AAA rating means it’s
really, really likely that you are going to pay back
all of the debt that you owe. After AAA comes AA, A, and BBB. And these categories
are considered investment-grade debt. But once you fall
below BBB, then you’re in junk bond territory. Junk bonds are just far
less likely to pay back what they owe. And why an investor might
want to buy a junk bond? Well, it’s because they
have higher interest rates. So if you’re a
lender and you lend to a company that’s
considered more risky, you can charge them a
higher interest rate. And if they pay back
that money then you get more money in
return if you’re the lender than if you were
to lend to a safer company. The chart we’re looking
at is total return on junk debt going
back one year. And it’s re-based to 100. The top line is BB. The middle line is B.
And the bottom line is that junkiest
of junk debt, CCC. Now, when people started
to think that the Federal Reserve was going to
lower interest rates, you can see that the
total return started going up for BB and B debt. But for CCC, the trend
did not quite hold. You can see it didn’t go up
the same way that BB and B did, even though you
might expect it to. The reason for that is
that investors think, hey, there might be an
economic recession coming up, maybe because of global
trade wars or just a general slowdown. Basically, this is an
indication that investors think CCC companies, which
are companies that are already far less likely to
pay back their debt, are actually going to have
a worse time doing so, even though the Fed may
lower interest rates. So just keep in mind, though,
if the Federal Reserve is lowering interest rates,
it’s because the economy is slowing down. Even though companies can
maybe refinance their debt at a lower interest rate,
which would make it easier to pay that money back,
companies that are CCC, i.e. already struggling
to pay back debt, may still not have an easier
time doing so if a recession is on the horizon.