Cheap debt isn’t on the horizon.
The Federal Reserve’s vow to bring inflation down to its target 2% annual rate means investors should brace for the central bank’s policy rate to peak around 5% in June, but to stay near a 2.5% “equilibrium rate” for some time, according to Torsten Slok, chief economist at Apollo Global Management.
Slok has been calling the malaise dogging financial markets since last year an “asset price recession,” not an economic one. On Friday, he expanded the argument, saying that while the fed-funds rate is expected to peak in the coming months (see chart), investors shouldn’t count on a return to near-zero Fed rates that prevailed for much of the past 15 years.
He said a 2.5% equilibrium interest rate, “which keeps the economy at full employment and inflation at 2%” has implications for investors as it resets higher, including “a wide range of consequences for corporate America and financial markets,” in a Friday client note.
Fed-funds futures traders on Friday were expecting a small 0.9% chance of a rate cut in September from the current 4.25%-4.5% range, with the odds of easing rising to 22.1% by December, according to the latest CME FedWatch tool.
Higher borrowing costs can cut into corporate profits and impact credit spreads, or the level of compensation bond investors demand above a risk-free benchmark to act as creditors to counties, municipalities, businesses and even the U.S. mortgage market.
Spreads on U.S. investment grade corporate bonds have climbed to about 1.3% this week from a pandemic low below 0.9% as the Fed has raised rates, according to the ICE BofA US Corporate Index. But the full cost of borrowing also incorporates the 10-year Treasury TMUBMUSD10Y,
Slok also singled out prices of technology and growth stocks as influenced by higher rates. The tech-heavy Nasdaq Composite Index COMP,
U.S. stocks were higher Friday, but the S&P 500 index SPX,