Has the turmoil in global markets calmed down?

The volatile sell-off in global financial markets this month has had little impact on global financing conditions, but the risk of further volatility means there is no relief yet for borrowers.

Stock and bond markets have recovered some of the losses triggered in early August by concerns about a U.S. recession and the end of yen carry trades, but remain weaker than a month ago.

The S&P 500 index is still 5% below its peak in July after an initial drop of nearly 10%.

The STOXX 600 index, which tracks Europe's largest companies, also fell in parallel.

Higher and lower credit-rated corporate bonds have offset most of the decline in the risk premium they pay relative to government bonds this year.

But financing conditions have not tightened enough to trigger concerns about a sharper economic slowdown that could prompt further central bank rate cuts.

“We haven't seen moves big enough to significantly change financing conditions for companies or households,” said Chris Jeffrey, head of macro strategy at Legal & General Investment Management.

A closely watched gauge of U.S. financial conditions compiled by Goldman Sachs shows conditions remain historically loose, though they have tightened sharply since mid-July.

Global stock indexes are up nearly 10 percent this year and bond yield spreads are lower than in 2023.

Goldman Sachs predicts that every 10 percent sell-off in U.S. stocks will reduce growth by a little less than half a percentage point next year.

So, with U.S. economic growth still above 2 percent, a significant economic challenge that could spread globally would only occur if there was a much larger decline in stock markets.

INTEREST RATE REDUCTS

Considering that the US Federal Reserve (Fed) will soon start cutting interest rates and that other central banks have already cut interest rates, the most important conclusion to be drawn from the recent turmoil in the markets will be the decline in interest rates.

The yield on 10-year U.S. Treasury notes has fallen more than 50 basis points since early July, while yields on U.K. and German government bonds have fallen more than 30 basis points as investors bet on larger rate cuts.

The decline bodes well for borrowers. Yields on investment-grade corporate bonds in the U.S. have also fallen 50 basis points since the beginning of July.

Credit-worthy companies sold $45 billion worth of U.S. debt last week, at the top end of analyst expectations, according to LSEG's IFR.

The US market had a strong start to the week, with Europe also selling more bonds than a year ago.

“Access to credit doesn’t really seem to be an issue right now,” said Idanna Appio, portfolio manager at First Eagle Investment Management.

“Indeed, the decline in U.S. Treasury yields is paving the way for companies to issue bonds,” said Appio, a former Fed economist.

Yields on even lower-credit bonds have fallen 37 basis points since the beginning of July, meaning conditions have become more favorable for companies that sold $7.2 billion in U.S. bonds last week.

LOW INCOME

Expectations that volatile movements will remain high create uncertainty for borrowers.

Wall Street's “fear gauge”, the VIX, fell below 20 points this week, the lowest level recorded this month. The index is still running well above its January-July average.

August has also been a generally quiet month for initial public offerings, so the volatility has not yet had an impact on stock picking. Normally, increased volatility has a negative impact on stock picking.

Dealmakers said they were optimistic as long as markets remained calm but were aware of the uncertainty ahead.

WHAT EXPERTS SAY

Javier Rodriguez, KPMG's global head of value creation, did not rule out the possibility of IPOs slowing down or stopping.

“There’s no certainty as to what the final picture will look like, but there is a potentially cooling market compared to the last 18 months,” Rodriguez said.

Credit markets saw money flow into investment-grade bonds last week while money flowed into junk bonds, suggesting weaker borrowers are cautious, according to BofA.

Borrowers are unlikely to be worried about outflows as high-yield bond sales globally hit their strongest level in the first half of 2021, LSEG data showed.

But some of the outflows are quite large. According to JPMorgan, the outflows from U.S. leveraged loans were the biggest since the peak of the COVID pandemic in March 2020, as investors were hit hard by the decline in interest rates.

The impact of the decline in carry trades on liquidity conditions also remains a factor to monitor.

“When carry trades go down, funds flee the countries and assets where they finance economic activity. As a result, liquidity conditions tighten in places where growth is being generated, hurting global economic activity,” said Mathieu Savary, chief European strategist at BCA Research.