Why earnings could shift focus back to equities rather than loans
Loan issuance and the shutdown
Loan issuance last week suffered, just as bond issuance did, due to the shutdown. For the same reasons, issuers would rather wait than issue into potentially adverse market conditions. Approximately $12 billion priced last week, which was down from the $30 billion the week prior. The number of deals didn’t drop as much, though, as many small deals hit the market.
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Year-to-date issuance is now at a record $485 billion. The pace of issuance should once again pick up after the shutdown ends, and this will help lift loan prices. In fixed income markets, increased primary issuance can drive the secondary market as new relative pricing benchmarks are established.
Implications of potentially strong Q3 earnings
Strong Q3 earnings would mean credits are stronger and hence spreads would come down and bond and loan prices climb higher. However, the effect of flows running away from fixed income and into equities may be more meaningful.
In the scenario where the shutdown resolves within a week and the market absorbs it relatively easily, then the only true result of the shutdown is that the Fed will likely extend its bond buying program for longer to make up for the dent caused by the shutdown. So the flows into high yield bonds imply that October tapering is out of the question. Depending on the length of the tapering, perhaps even December is out of the question.
The downside risk of piling onto bonds is that with Q3 earnings season about to start, if companies start to show unexpected strong earnings, mainly from overseas subsidiaries, then tapering may still be feasible in December. It’s likely, though, that the Fed will stick to domestic metrics of economic health to decide on tapering and not on corporate earnings driven by external factors, though it’s important to consider the likely investor reaction to strong earnings, which may move flows away from bonds and back into equities, and not so much back into loans.