Finance

It was james carville, an American political strategist, who said, in an oft-repeated turn of phrase, that if he was reincarnated he would like to return as the bond market, owing to its ability to intimidate everyone. Your columnist would be more specific: he would come back as the yield curve. If the bond market is a frightening force, the yield curve is the apex of the terror. Whichever way it shifts, it seems to cause disturbance.When the yield curve inverted last October, with yields on long-term bonds falling below those on short-term ones, analysts agonised about the signal being sent. After all, inverted curves are often followed by recessions. But now the curve seems to be disinverting rapidly. The widely watched 10-2 spread, which measures the difference between ten- and two-year bond yields, has narrowed markedly. In July two-year yields were as much as 1.1 percentage points above their ten-year equivalents, the biggest gap in 40 years. They have since drawn much closer together, with only 0.3 of a point between the two yields.Since the inversion of the yield curve was taken as such a terrible omen, an investor would be forgiven for thinking that its disinversion would be a positive sign. In fact, a “bear steepener”, a period in which long-term bonds sell off more sharply than short-term bonds (as opposed to a “bull steepener”, in which short-term bonds rally more sharply than long ones), is taken to be another portent of doom in market zoology.Driving the latest scare is the rising term premium, which is often described as the additional yield investors require to hold longer-dated securities, given the extra uncertainty over such extended periods. According to estimates by the New York branch of the Federal Reserve, the premium on ten-year bonds has risen by 1.2 percentage points from its lowest level this year, more than explaining the recent surge in long-term yields.In truth, though, the term premium is a nebulous thing, and must be treated with caution. It cannot be measured directly. Instead, as with a surprising number of important economic phenomena, analysts have to tease it out by measuring more concrete parts of the financial system, and seeing what is left over. Estimating the premium for a ten-year bond requires forecasting predicted short-term interest rates for the next decade, and looking at how different they are from the ten-year yield. What remains—however large or small—is the term premium.The difficulties do not stop there. John Cochrane of Stanford University’s Hoover Institution points out that, although risk premiums might be more easily estimated at relatively short maturities, the calculations require more and more assumptions about the future of short-term interest rates as analysts move along the curve. When estimates of the term premium are published, they are not typically accompanied by a margin of error. If they were, the margins would get progressively wider the longer into the future the forecast was conducted.There is also surprisingly little history from which to draw when making assessments of changes in the yield curve or term premium. In the past 40 years, there have been perhaps eight meaningful periods of bear steepening, and only in three of them was the yield curve already inverted. The three instances—in 1990, 2000 and 2008—were followed by recessions, but with widely varying lags.Movements in bond markets are therefore both easy and difficult to explain. They are easy to explain because any number of factors could be driving yields, including the Fed’s quantitative-tightening programme, concerns about the sustainability of American debt and worries of institutional decay. Yet attributing bond yields to one factor in particular is fraught with difficulty. And without more clarity on the causes of a move, inferring the future from the shape of the yield curve becomes more like reading tea leaves than a scientific endeavour.One thing is certain, however. Whatever their cause, and regardless of their composition, rising long-term bond yields are terrible news for American companies that wish to borrow at long time horizons, and borrowers who take out new mortgages that will be linked to 30-year interest rates. The effect on the most sensitive borrowers will become only more painful if yields with long maturities remain at such high levels. For anyone concerned about whether a shifting yield curve or a rising term premium signals a looming recession or a nightmare for markets, these simple realities are a better place to start.■Read more from Buttonwood, our columnist on financial markets: Why investors cannot escape China exposure (Oct 5th)Investors’ enthusiasm for Japanese stocks has gone overboard (Sep 28th)How to avoid a common investment mistake (Sep 21)Also: How the Buttonwood column got its name More

When treasury bonds (or t-bills) last yielded as much as they do today—5.5%—punters were relieved that the world had not been destroyed by the millennium bug, Destiny’s Child were atop the charts and the dotcom bubble was going strong. The recent surge in yields has been remarkable (see chart).image: The EconomistYet bank depositors are seeing just a fraction of these increases. The average American savings account yields just 0.45%. Investors, too, are missing out. For the first time in over two decades, at the end of last year the return offered by six-month Treasuries overtook the earnings yield of s&p 500 companies.So retail investors are looking elsewhere. Trading platforms have made short-term Treasury products a big part of their offering. Advertisements for Public, one such platform, ask podcast listeners if they are aware of the meagre savings rate on their deposit accounts. Despite only having been available on the platform since March, Treasuries are now its most purchased asset. One in ten new users buy them as their first trade.Demand for Treasuries reflects a broader move towards safe, high-yielding options. Money-market funds invest in low-risk, short-duration instruments, including Treasuries. More than $880bn has been added to such funds this year, bringing their total value to an all-time high of $5.7trn. As with retail short-dated Treasury accounts, money-market funds are attractive to savers because they are highly liquid, meaning that cash can be withdrawn quickly if required.The growing popularity of such alternatives is upsetting the logic of retail banking. Banks get away with providing interest rates well below the interest they receive from short-term government debt because—as Public’s advertisements identify—many depositors pay little attention. By sucking deposits from the banking system, money-market funds are thought to have contributed to financial instability in the spring.Retail-trading platforms’ expansion has made it easier than ever for depositors to transfer funds into short-dated government debt. That may further erode the discount on savings rates that depositors will accept from banks, and make Treasuries a bigger feature in retail-investment portfolios. Savers will, then, be singing along to one of Destiny’s Child’s better tunes: “Bills, Bills, Bills”.■For more expert analysis of the biggest stories in economics, finance and markets, sign up to Money Talks, our weekly subscriber-only newsletter. More

Big American companies are living in a debt dreamland. Although cheap borrowing has fuelled the growth of corporate profits for decades, the biggest firms have been largely insulated from the effects of the Federal Reserve’s recent bout of monetary tightening. That is because many of them borrowed plentifully at low, fixed interest rates during the covid-19 pandemic. The tab must be settled eventually by refinancing debt at a much higher rate of interest. For now, though, the so-called maturity wall of debt falling due looks scalable.image: The EconomistBut not all companies are escaping the impact of the Fed’s actions. Indeed, there is trillions of dollars of floating-rate debt, with interest payments that adjust along with the market, that has suddenly become much more expensive. This pile of debt consists of leveraged loans and borrowing from private debt markets. Companies seldom hedge interest-rate risks, meaning that they now find themselves paying through the nose—the yield-to-maturity of one index of leveraged loans has leapt to almost 10% (see chart 1). Meanwhile, since American economic growth remains resilient, the Fed’s policymakers warn that interest rates will have to stay higher for longer. This will push more borrowers to breaking-point. A market that has grown vast is now asking two miserable questions. How bad will things get? And who, exactly, will lose out?Since the global financial crisis of 2007-09, companies have borrowed fast and loose. UBS, a bank, estimates the value of outstanding American leveraged loans at around $1.4trn and the assets managed by private credit lenders at more than $1.5trn. The two types of debt are more alike than they are different. Both have grown to service the private-equity buy-out boom of the past decade. Traditional leveraged loans are arranged by banks before being sold (or “syndicated”) to dozens of investors, whereas private lending involves just a handful of funds, which usually hold smaller loans to maturity, creating a less liquid and more opaque market.Increasing numbers of borrowers are now hitting the rocks. Since 2010 the average annual default rate in the leveraged-loan market has been less than 2%. According to Fitch, defaults rose to 3% in the 12 months to July, up from 1% a year earlier. The ratings agency reckons that they could shoot up to 4.5% in 2024. Restructurings and bankruptcies on this scale amount to spring cleaning rather than the deep distress felt during the financial crisis, when loan defaults exceeded 10%. But if rates stay higher for longer, as central bankers predict, the tally of troubled firms will grow. Although all companies with unhedged floating-rate debt balances are vulnerable, those loaded with debt in private-equity buy-outs at high valuations during the recent deal boom are especially at risk.image: The EconomistSlowing profit growth means that borrowers are finding it harder to afford their floating-rate debt. JPMorgan Chase, a bank, analysed 285 leveraged-loan borrowers at the end of June, before the Fed’s most recent rate rise. Firms where borrowing consisted only of leveraged loans saw their annual interest expense soar by 51% year-on-year. Their fortunes are diverging sharply from those that instead tapped high-yield bond markets for fixed-rate funds. According to the study, the interest expenses of such businesses have increased by less than 3%. Coverage ratios, which compare a firm’s profits with its interest costs, have begun an ominous decline (see chart 2).In the private debt market, where default rates tend to be higher, borrowers are confronting similar woes. According to Bank of America, interest costs now consume half of profits at firms where loans are held by the largest business-development companies, a type of investment vehicle. A big rise in distress would not only make it harder to find institutions willing to plough money into private debt funds, with investors normally attracted by the promise of smooth returns, but also spill over to the leveraged-loan market.Now that a reckoning looks imminent, attention is turning to which investors will be left holding the bag. Lenders today expect to recover less of their investment after a firm defaults than in earlier eras—and this year so-called recovery rates across junk-rated debt have been well below their long-run averages. According to Lotfi Karoui of Goldman Sachs, another bank, the rise of borrowers that rely solely on loans, rather than borrowing from bond markets too, could depress recoveries still further. This trend has concentrated the pain caused by rising interest rates. It is also likely to leave less value for leveraged-loan investors when they find themselves round a restructuring table or in a bankruptcy court, since there will be more claims secured against a firm’s assets.Other long-term trends could exacerbate the leveraged-loan market’s problems. Maintenance covenants, commitments that lenders can use as a “stick” to force a restructuring, have all but disappeared as the market has matured. In 2021 nearly 90% of new loans were “covenant-lite”. This could mean that companies take longer to reach default, and are in worse health when they get there. Excessive “add backs”, flattering adjustments to a company’s profitability measures, might also mean that leveraged borrowers are in worse shape than the market believes.The performance of private markets is also being closely scrutinised. Advocates for private debt have long argued that they are better suited to periods of higher defaults, since the co-ordination costs between a small group of lenders are lower, making the correction of vexed balance-sheets easier. If private markets do indeed fare better than leveraged loans during the forthcoming turmoil, it would bolster their attempts to attract finance in future.Problems in floating-rate debt markets are unlikely to cause a financial crisis, but the murkiness and growing size of private markets in particular mean that regulators have decided to take a closer look. In August America’s Securities and Exchange Commission announced rules to increase transparency, including demanding quarterly financial statements. The following month, the International Organisation of Securities Commissions, a global regulatory body, warned about the risks of leverage and the opacity of private debt markets. Few investors, however, think they need help predicting a coming crunch. ■For more expert analysis of the biggest stories in economics, finance and markets, sign up to Money Talks, our weekly subscriber-only newsletter. More

Shares of Bank Of China, Agricultural Bank of China, Industrial and Commercial Bank of China and China Construction Bank rose in early trading.
China’s sovereign wealth fund Central Huijin Investment expects to continue increasing holdings over the next six months.
Central Huijin’s move is seen as a bid to renew confidence in China’s fatiguing stock market.

Bank of China is one of the major state-owned banks in China. Pictured here is a branch in Shanghai on March 27, 2023.
Bloomberg | Bloomberg | Getty Images

China’s sovereign wealth fund, Central Huijin Investment, increased its stake in four of the country’s biggest banks late Wednesday in what is seen as a move to renew confidence in its stock market.
Bank Of China, Agricultural Bank of China, Industrial and Commercial Bank of China and China Construction Bank shares rose between 2.43% and 4.73% in early trading on Thursday, while the broader CSI 300 index gained 0.69%.

Central Huijin boosted its stake in each lender by 0.01 percentage point for the first time since 2015. It said it would continue to increase holdings over the next six months, according to filings.
“Huijin’s buying sends strong signal of the topdown view, and tends to help to shore up market confidence,” said Hao Hong, chief economist of Grow Investment Group.
Investor confidence in China’s stock markets has been shaken by turmoil in its real estate sector as property giants such as Evergrande and Country Garden struggled to repay debt. So far this year, the CSI 300 is down nearly 5%.
All eyes will now be on China’s third-quarter GDP data, which is due to be released next week. More

A box of Ozempic, a semaglutide injection drug used for treating Type 2 diabetes made by Novo Nordisk.
George Frey | Reuters

Check out the companies making big moves midday.
Novo Nordisk — The Danish drugmaker stock added 6.27% after saying late Tuesday it was halting Ozempic’s kidney disease treatment trial after a committee said an analysis showed signs of success. Eli Lilly, which makes diabetes drug Mounjaro, rose 4.48%.

DaVita, Fresenius Medical Care, Baxter International — Shares of dialysis services providers DaVita and Fresenius Medical Care sank 16.86% and 17.57%, respectively, on Novo Nordisk’s news. Baxter International, which makes products for chronic dialysis therapies, slid 12.27%.
Exxon Mobil, Pioneer Natural Resources — Exxon Mobil shares fell 3.59% after the largest U.S. oil and gas producer agreed to buy shale rival Pioneer Natural Resources for $59.5 billion in an all-stock deal, or $253 per share. Pioneer stockholders will receive 2.3234 shares of Exxon for every Pioneer share held. The deal, Exxon’s biggest since its acquisition of Mobil, is expected to close in the first half of 2024. Shares of Pioneer rose 1.44% following the news.
Humana — Shares slipped 1.39% after CEO Bruce Broussard said he will step down from his position in the latter half of 2024. The company named Jim Rechtin of Envision Healthcare as his successor.
Amgen — The biopharma stock added 4.55% following an upgrade from Leerink to outperform. Analyst David Risinger cited an expanding earnings multiple and pipeline newsflow as catalysts.
Shoals Technologies — Shares gained 5.26% after being upgraded to buy from neutral at Goldman Sachs. The investment bank cited valuation and the potential for gross margin upside.

Ally Financial — The provider of loans to midsize businesses dropped 2.12% after CEO Jeffrey Brown announced plans to step down, effective Jan. 31, 2024.
Walgreens Boots Alliance — The pharmacy chain added 0.98% after former Cigna executive Tim Wentworth was named CEO effective Oct. 23.
Coherent — The stock popped 5.23% in midday trading. Coherent announced Tuesday that Japanese companies will invest $1 billion in Coherent’s silicon carbide business. On Wednesday, B. Riley upgraded shares to buy from neutral, saying Coherent’s silicon carbide business could be worth more than the Street’s current estimate.
Plug Power — The battery company climbed 5.31% after forecasting a sharp rise in revenue to roughly $6 billion by 2027, according to a regulatory filing.
Take-Two Interactive Software — Shares gained in midday trading but closed 0.34% lower after being upgraded by Raymond James to outperform from market perform. The firm said it sees a path to more consistent video game releases and a reasonable valuation based on Take-Two Interactive’s Grand Theft Auto 6 release soon.
— CNBC’s Michael Bloom, Hakyung Kim, Yun Li and Lisa Han contributed reporting. More

Jerome Powell, chairman of the US Federal Reserve, arrives to a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, DC, US, on Wednesday, March 22, 2023. 
Al Drago | Bloomberg | Getty Images

Federal Reserve officials at their September meeting differed on whether any additional interest rate increases would be needed, though the balance indicated that one more hike would be likely, minutes released Wednesday showed.
While there were conflicting opinions on the need for more policy tightening, there was unanimity on one point – that rates would need to stay elevated until policymakers are convinced inflation is heading back to 2%.

“A majority of participants judged that one more increase in the target federal funds rate at a future meeting would likely be appropriate, while some judged it likely that no further increases would be warranted,” the summary of the Sept. 19-20 policy meeting stated.
The document noted that all members of the rate-setting Federal Open Market Committee agreed they could “proceed carefully” on future decisions, which would be based on incoming data rather than any preset path.
Another point of complete agreement was the belief “that policy should remain restrictive for some time until the Committee is confident that inflation is moving down sustainably toward its objective.”
The meeting culminated with the FOMC deciding against a rate hike.
However, in the dot plot of individual members’ expectations, some two-thirds of the committee indicated that one more increase would be needed before the end of the year. The FOMC since March 2022 has raised its key interest rate 11 times, taking it to a targeted range of 5.25%-5.5%, the highest level in 22 years.

Since the September meeting, the 10-year Treasury note yield has risen about a quarter percentage point, in effect pricing in the rate increase policymakers indicated then.

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10-year Treasury yield

At the same time, a handful of central bank officials, including Vice Chair Philip Jefferson, Governor Christopher Waller and regional Presidents Raphael Bostic of Atlanta, Lorie Logan of Dallas and Mary Daly of San Francisco, have indicated that the tightening in financial conditions may negate the need for further hikes. Of the group, Logan, Waller and Jefferson have votes this year on the FOMC.
“In our view the Fed has belatedly converged on the lowest-common-denominator idea that the rise in yields means there is at present no need to raise rates again,” wrote Krishna Guha, head of global policy and central bank strategy at Evercore ISI. Guha added that officials want to wait before locking themselves in to a longer-term position on rates.”
Markets waffled following the minutes release, with major sock averages slightly higher heading into the close. Traders in the fed funds futures market pared back bets on additional rate hikes — down to just 8.5% in November and 27.9% in December, according to the CME Group’s FedWatch gauge.
Members in favor of further hikes at the meeting expressed concern about inflation. In fact, the minutes noted that “most” FOMC members see upside risks to prices, along with the potential for slower growth and higher unemployment.
Fed economists noted that the economy has proven more resilient than expected this year, but they cited a number of risks. The autoworkers’ strike, for one, was expected to slow growth “a bit” and possibly push up inflation, but only temporarily.
The minutes said consumers have continued to spend, though officials worried about the impact from tighter credit conditions, less fiscal stimulus and the resumption of student loan payments.
“Many participants remarked that the finances of some households were coming under pressure amid high inflation and declining savings and that there had been an increasing reliance on credit to finance expenditures,” the minutes said.
Inflation data points, particularly regarding future expectations, generally have been indicating progress toward the central bank’s 2% target, though there have been a few hiccups.
The Fed received some bad inflation news Wednesday, when the Labor Department said that the producer price index, a measure of inflation at the wholesale level, rose 0.5% in September.
Though that was a bit lower than the August reading, it was above Wall Street estimates and took the 12-month PPI rate to 2.2%, its highest since April and above the Fed’s coveted 2% annual inflation target.
The PPI tees up Thursday’s release of the consumer price index, which is expected to show headline inflation at 3.6% in September, and core excluding food and energy at 4.1%. More

Goldman Sachs said Wednesday that it agreed to sell its fintech lending platform GreenSky to a group of investors led by private equity firm Sixth Street.
The deal, which includes a book of loans created by Goldman, will result in a 19 cents per share reduction to third-quarter earnings, Goldman said in the statement.
The New York-based bank is scheduled to disclose results Tuesday.

David Solomon, CEO of Goldman Sachs, during a Bloomberg Television at the Goldman Sachs Financial Services Conference in New York on Dec. 6, 2022.
Michael Nagle | Bloomberg | Getty Images

Goldman Sachs said Wednesday that it agreed to sell its fintech lending platform GreenSky to a group of investors led by private equity firm Sixth Street.
The deal, which includes a book of loans created by Goldman, will result in a 19 cents per share reduction to third-quarter earnings, Goldman said in the statement. The New York-based bank is scheduled to disclose results Tuesday.

The move is the latest step CEO David Solomon has taken to retrench from his ill-fated push into retail banking. Under Solomon’s direction, Goldman acquired GreenSky last year for $1.7 billion, overruling deputies who felt the home improvement lender was a poor fit. Months later, Solomon decided to seek bids for the business amid his broader move away from consumer finance. Goldman also sold a wealth management business and was reportedly in talks to offload its Apple Card operations.
“This transaction demonstrates our continued progress in narrowing the focus of our consumer business,” Solomon said in the release.
The bank is now focused on its core strengths in investment banking and trading and its push to grow asset and wealth management fees, he added.
Goldman will continue to operate GreenSky until the sale closes in the first quarter of 2024, the bank said.
The expected hit to third-quarter earnings includes expenses tied to a write down of GreenSky intangibles, as well as marks on the loan portfolio and higher taxes, offset by the release of loan reserves tied to the transaction, Goldman said.

It follows a $504 million second-quarter impairment on GreenSky disclosed in July.
The Sixth Street group includes funds managed by KKR, Bayview Asset Management and CardWorks, according to the release.
Private equity groups have played key roles in several of the banking industry’s asset divestitures since the start of the year, providing funding for the PacWest merger with Banc of California, for example.
Read more: Goldman Sachs faces big write down on CEO David Solomon’s ill-fated GreenSky deal More

The stock sell-off that hit regional banks this year has exposed lenders including Zions and Comerica to the risk of being delisted from the S&P 500 index.
The banks, each with market capitalizations of around $5 billion, were the fourth- and sixth-smallest members of the 500 company listing as of this week, according to FactSet.
That leaves the companies in a similar position to Lincoln National, which got shunted from the S&P 500 last month and placed into a small-cap index.

A customer enters Comerica Inc. Bank headquarters in Dallas, Texas.
Cooper Neill | Bloomberg | Getty Images

The stock sell-off that hit regional banks this year has exposed lenders including Zions and Comerica to the risk of being delisted from the Standard & Poor’s 500 index.
The banks, each with market capitalizations of around $5 billion, were the fourth- and sixth-smallest members of the 500 company listing as of this week, according to FactSet.

That leaves the companies in a similar position to Lincoln National, which got shunted from the S&P 500 last month and placed into a small-cap index. Blackstone, the world’s largest alternative asset manager, took Lincoln National’s spot.
This year’s regional banking crisis has already caused changes in the composition of the S&P 500, the most popular broad measure of large American companies in the investing world. Silicon Valley Bank and First Republic were removed from the benchmark after deposit runs led to their government seizure. More changes may be coming, especially if the industry faces a protracted slump, according to analysts.
“It’s absolutely a risk,” Chris Marinac, research director at Janney Montgomery Scott, said in an interview. “If the market were to further change the valuation of these companies, especially if we have higher rates, I wouldn’t rule it out.”

Banks begin disclosing third-quarter results Friday, led by JPMorgan Chase. Investors are keen to hear how rising interest rates affected bond holdings and deposits in the period.
Companies that no longer qualify as large-cap stocks are at heightened risk of demotion from the S&P 500. There were seven members valued at $6 billion or less at the end of August. Two of them were removed the following month: insurer Lincoln National and consumer firm Newell Brands.

Those that join the benchmark often celebrate the milestone. The popularity of mutual funds and ETFs based on the index means that new members typically see an immediate boost to their stock price. Those that get demoted can suffer declines as fewer money managers need to own shares in the companies.

S&P guidelines

To be considered for inclusion in the S&P 500, companies need to have a market capitalization of at least $14.5 billion and meet profitability and trading standards.
Members that violate “one or more of the eligibility criteria for the S&P Composite 1500 may be deleted from the respective component index at the Index Committee’s discretion,” according to S&P Dow Jones Indices’ methodology.
Still, that doesn’t mean Zions or Comerica are on the cusp of a delisting. The committee that decides the composition of the S&P 500 looks to minimize churn and accurately represent reference sectors, making changes only when “ongoing conditions warrant an index change,” according to S&P.

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Shares of regional banks ZIons and Comerica have tumbled this year.

For instance, after the onset of the Covid pandemic in March 2020, many retail S&P 500 companies temporarily violated the profitability rule, but that didn’t result in widespread demotions, according to a person who has studied the S&P 500 index.
S&P Dow Jones Indices declined to comment for this article, as did Comerica. Zion’s didn’t immediately return a message seeking comment.
Besides Zions and Comerica, KeyCorp and Citizens Financial are the only other S&P 500 banks with market caps below the threshold for inclusion in the index, according to an Aug. 31 Piper Sandler note. KeyCorp and Citizens, however, each have market caps of greater than $10 billion, making them less likely to be impacted than smaller banks.
After Blackstone became the first major alternative asset manager to join the S&P 500 last month, analysts said that peers including KKR and Apollo Global may be next, and they would likely replace other financial names. KKR and Apollo each have market capitalizations of greater than $50 billion.
“Perhaps more demotions of low-market cap financials are to come,” Wells Fargo analyst Finian O’Shea said in a Sept. 5 research note.
– CNBC’s Gabriel Cortes contributed to this article. More