As we enter the final fiscal quarter of 2019, the skies are darkening on the U.S. economy and I believe will only get worse as the quarter progresses.
Key segments of gross domestic product, primarily business investment (not only capital spending but also in the hiring of labor) and government spending have been operating with a great deal of leverage. This leverage greatly enhanced GDP growth over the past two years and now will exacerbate economic decline. While I do not believe the Fed will ease at its Oct. 30 meeting, the board will all but say that it will ease at their Dec. 11 meeting. I think the 10-year Treasury will challenge its all-time low in yield of 1.36 (set July 2016) before the year is out.
U.S. business capital spending had been strong up until the last few months. Much of this investment was supercharged by the sharp cut in corporate taxes at the end of 2017. Additionally, before 2017, there was historically cheap and plentiful funding for businesses, both investment grade and non-investment grade, afforded by the high yield bond and loan markets.
Regarding the above mentioned cheap and affordable funding, the high yield leveraged loan market has ballooned to $1.3 trillion over the last three to four years. Rates have been historically low for non-investment grade credits and protective covenants, normally found in loans to lower-credit borrowers, have been loosened or abandoned all together. Covenants protect lenders by establishing triggers that warn lenders if cash flow or capital gets below established levels. If covenants are triggered, lenders can stop borrowers from embarking on additional expenditures. The lack of covenants increases the risk for the lenders.
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