US companies find borrowing conditions improving as markets rally

Surging share prices and falling borrowing premiums are making it easier for companies to access fresh cash, as an index of US financial conditions returns to levels last seen before the Federal Reserve started raising interest rates more than two years ago.

The Chicago Fed’s National Financial Conditions index — which measures how easy it is for companies to borrow money — this month reached its loosest level since January 2022.

The reading comes even though the Fed has yet to start lowering rates, which have sat in a range of 5.25 to 5.5 per cent for the past 10 months, their highest level in 23 years.

The index — in which lower numbers indicate loose conditions — has fallen as rising markets help mitigate the pressures of high rates on corporate America.

At the beginning of the Fed’s tightening cycle in March 2022: “There was an expectation that these higher interest rates would have more of an impact in general on the economy,” said Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions.

But now it had become clear that the effects would be “very selective” and felt by companies with lower credit quality and higher debt levels, rather than “broad based”, he added.

After weeks of fluctuations, investors are broadly betting that the US central bank will cut rates once or twice by the end of this year. This has helped to fuel a sharp rise in companies’ equity valuations, while intense investor demand has pushed down the gap between corporate and US government borrowing costs, meaning it is now more attractive for businesses to borrow.

Wall Street’s S&P 500 index is up about 11 per cent already in 2024. It touched a fresh all-time high this week after April’s consumer price inflation reading came in at 3.4 per cent, down from 3.5 per cent in March and ending four straight months of inflation above forecasts.

The figures also pushed government bond yields lower as prices rose, reflecting growing expectations of the Fed loosening monetary policy this year.

Meanwhile, corporate bond spreads, or the premiums paid by companies to borrow over the US Treasury, are also hovering around multiyear lows.

But some investors caution that the loosening in financial conditions — together with inflation data that is still well above the Fed’s 2 per cent target — has made it less likely the US central bank will cut interest rates.

“At this point in time, [the loosening of financial conditions] is one more piece of evidence, at a minimum, that the Fed should not cut rates,” said Robert Tipp, chief investment strategist at fund firm PGIM.

That is in part because loose financial conditions are an indication of the strength of the US economy. “Hopes of a soft [economic] landing are not overblown,” said Tipp. “This is an expansion that has shown tremendous resilience and that is after rates had gone up, and a regional banking crisis.”