Lately it has been difficult to write about the economy because of all the noise flowing from the election and covid-19 hype. There is a growing reluctance to opine by many economic skeptics because it appears we have been wrong on recent predictions. Only time will tell if this is true due to the huge distortions now evident in the markets. Still, all this tends to diminish confidence in the ability to see what is ahead. This has forced not only me, but other economic watchers to go back and question all we hold true.
Unfortunately, other than moving a few pieces around the board, the recent actions by the Fed only continues to move back the day of reckoning. The “extend and pretend illusion” our economy remains on a sound footing is alive and well. One place this is evident is in the area corporate bond market where many bonds now hold an investment-grade BBB rating. If a company or bond is rated BB or lower it is known as junk grade, this means the probability the company will be able to repay its issued debt is seen as speculative.
In this troubling time of covid-19 where companies are being stressed and tested, we have watched the high yield option-adjusted spreads fall back towards pre-covid levels. The fact we have not seen yields rise as lending standers have tightened indicates the Fed has removed the liquidity problem. This has temporarily masked but has not solved the solvency problem. As the “lag time effect” kicks into gear expect a growing number of defaults and bankruptcies to take place.
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