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The European Central Bank will almost certainly deliver an interest rate cut today despite the recent surge in euro area government yields, but the central bank may be forced to pause after today as it assesses Germany’s extraordinary fiscal reboot.
As the euro and European shares soar on the trillion euro spending plan, the dollar continues to sink, falling to its lowest point since November’s U.S. election.
Meanwhile, Japan’s yen hit its best level against the greenback since October. Japan’s government debt yields have risen to their highest levels since 2008, with the Bank of Japan set to lift its policy rate again this month.
Back on Wall Street, ailing stock indexes stabilized on Wednesday as U.S. service sector business surveys came in fairly positive and President Donald Trump announced that the U.S. was giving autos a one-month reprieve from the tariff increases on Canadian and Mexican imports.
But traders are nervously awaiting the U.S. payrolls report tomorrow, following news that private sector job creation has softened. U.S. stock futures are back in the red even as global equity benchmarks push higher.
Today I’m taking a look at just how anxious Wall Street is getting and whether credit pricing, deal-making and earnings season deep-dives reveal as much angst as equity indexes.
Trump has delayed his threatened 25% tariffs on auto imports from Mexico and Canada by a month. Pickup trucks might explain why.
* The maker of Jack Daniel’s whiskey says Canada pulling U.S. alcohol off the shelves is ‘worse than a tariff’, as Canadians avoid American goods and even sporting events.
* A historic global trade war, a proposed $1.2 trillion European fiscal bazooka and China emerging as an AI leader are upending global flows of money, possibly marking a turning point for “U.S. exceptionalism”.
* EU leaders are expected to agree to ramp up defence spending and reaffirm their support for Ukraine, after Trump’s suspension of military aid to Kyiv fuels concerns the EU can no longer rely on U.S. protection.
* And finally, shares in a small European rival to Elon Musk’s Starlink satellite operator have soared 600% in four days, following suggestions Ukraine might lose access to the billionaire’s system.
Kicking Wall Street’s tires
Trouble on Main Street usually means trouble on Wall Street – and not just top-line stock prices.
If a rare U.S. economic downturn is indeed back in the mix, with business bamboozled by trade wars and government disruption, then the full gamut of financial market activity and pricing faces a shake-up.
U.S. equities with 35% valuation premiums to Europe, for example, have already felt some of the heat as tensions have risen and economic models flash red.
But the world of corporate credit – particularly the riskier ‘junk bond’ universe of sub-investment grade debt – is usually where you’d seek a reality check on recession fears.
While economic worries typically cut Treasury yields and base borrowing costs, speculative high-yield debt is prone to any uptick in recession risk that almost always tallies with higher bankruptcy and default risks for weaker credit.
And there’s been some wobble there over recent weeks to mirror the equity fright of the past month.
The options-adjusted risk spread on ICE Bank of America’s high-yield U.S. credit index over Treasuries has risen almost 40 basis points in just two weeks – from near historic lows to its widest since October at just under 300bp.
To be fair, this remains extraordinarily benign pricing, with default rates for the grouping expected to remain historically low this year at about 2.5%. And at 300bps, the junk spread is still a sliver below the average of the past year and over a percentage point tighter than the five-year average.
But like the equity market itself, it’s been largely priced for a serene scenario of no economic downturn whatsoever over the horizon – and may need a rethink if those probabilities at least are now rising again as many suspect.
Morgan Stanley’s strategists think the broad investment grade and low grade credit market has held up reasonably well so far over recent weeks but said they were “cautious” about what happens next.
“We are worried this won’t persist if our U.S. growth estimates fall further,” Andrew Sheets and team told clients. “We look for opportunities to hedge and improve quality.”
DEALS STALL
Somewhat counter-intuitively, credit prices have been helped by a stalling of U.S. deals activity this year. Credit risk tends to correlate with ebbs and flows in mergers and acquisitions as the related debt financing goes hand in hand.
But the main reason for the drop in M&A this year is hardly cause for comfort for the underlying credits.
According to Reuters reports, Wall Street executives and investors are running into roadblocks to get deals over the finish line or even to begin exploratory talks – mainly because of the fog over government policy and its impact on the economy.
