Dec 19, 2018 04:40 pm
By Trey Reik, Senior Portfolio Manager, Sprott Asset Management USA, Inc.
As we enter the holiday season, we close out our review of fundamentals suggesting Fed tightening is nearing completion. Our contention remains that the Federal Reserve’s dual policy agenda of simultaneous rate hikes and balance sheet reduction is crimping global dollar liquidity to the significant peril of reigning financial asset valuations. In our November report, we examined the Fed’s concern over deteriorating underwriting standards amid runaway corporate borrowing. In this letter, we provide a brief update on recent developments in leveraged lending, and then turn our attention to a critical economic sector being pressured by Fed rate hikes: U.S. residential housing. We look forward to circulating, in mid-January, a comprehensive update on gold’s prospects for 2019 and beyond.
We have made the case that Fed tightening is already destabilizing the most vulnerable segments of the corporate borrowing spectrum. In a cruel irony of a central bank-dependent financial system, growing recognition that Fed rate hikes are winding down is pressuring the $1.3 trillion leveraged loan market. During recent years, the inferior pedigree of leveraged borrowers has offered intrepid investors the perceived protection of floating interest rates. As the Fed has tightened, leveraged loan yields have risen in concert — sweet! Now that probabilities for 2019 rate hikes are plummeting, logic would suggest prospects for the most challenged of corporate credits should actually be improving. Counterintuitively, however, yield-manic investors, sensing evaporating floating-rate protection, are abandoning the leveraged-loan ship at alarming rates.
Figure 1: S&P/LSTA Leveraged Loan Price Index (December 31, 2016 – December 16, 2018). Source: Bloomberg.
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