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If the US Federal Reserve decides to lower interest rates at its next meeting, what will that mean for corporate debt? So many people think that at the next meeting the Fed is going to lower interest rates because they think that they're going to see signs of economic slowdown. And lowering interest rates gives a boost to the economy by making it easier for consumers and companies to borrow money.
But that would also be a really big deal for the debt market. Bond, debt, and fixed income all mean essentially the same thing. And before we talk about this chart, we need to talk about the way that debt is categorised.
So there are these rating agencies out there, like S&P and Moody's, which you may have heard of. And they assign ratings to companies. Now, the highest rating that you can get as a borrower is AAA. A AAA rating means it's really, really likely that you are going to pay back all of the debt that you owe.
After AAA comes AA, A, and BBB. And these categories are considered investment-grade debt. But once you fall below BBB, then you're in junk bond territory.
Junk bonds are just far less likely to pay back what they owe. And why an investor might want to buy a junk bond? Well, it's because they have higher interest rates. So if you're a lender and you lend to a company that's considered more risky, you can charge them a higher interest rate. And if they pay back that money then you get more money in return if you're the lender than if you were to lend to a safer company.
The chart we're looking at is total return on junk debt going back one year. And it's re-based to 100. The top line is BB. The middle line is B. And the bottom line is that junkiest of junk debt, CCC.
Now, when people started to think that the Federal Reserve was going to lower interest rates, you can see that the total return started going up for BB and B debt. But for CCC, the trend did not quite hold. You can see it didn't go up the same way that BB and B did, even though you might expect it to.
The reason for that is that investors think, hey, there might be an economic recession coming up, maybe because of global trade wars or just a general slowdown. Basically, this is an indication that investors think CCC companies, which are companies that are already far less likely to pay back their debt, are actually going to have a worse time doing so, even though the Fed may lower interest rates.
So just keep in mind, though, if the Federal Reserve is lowering interest rates, it's because the economy is slowing down. Even though companies can maybe refinance their debt at a lower interest rate, which would make it easier to pay that money back, companies that are CCC, i.e. already struggling to pay back debt, may still not have an easier time doing so if a recession is on the horizon.
