A trader from BGC Partners, a global brokerage company in London’s Canary Wharf financial centre waits for European stock markets to open early June 24, 2016 after Britain voted to leave the European Union in the EU BREXIT referendum. REUTERS/Russell Boyce

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LONDON, June 15 (Reuters Breakingviews) – Jerome Powell and Christine Lagarde are in a tight spot. The Federal Reserve boss and his European Central Bank counterpart want to raise rates to curb soaring inflation. To do so, they’ll have to face down market expectations of a u-turn if equity and credit markets sink.

A return of the “Fed Put” is quite possible. Ex-Fed chair Alan Greenspan routinely cut rates when stock markets swooned. In 2019 Powell himself rowed back on the unwind of crisis-era quantitative easing amid market ructions.

With the U.S. S&P 500 Index in bear market territory after falling 21% since January, Powell may fear for consumer morale. If higher funding costs saw companies dramatically cut spending or struggle to raise funding, calls would grow for a pause in rate hikes, or even more bond-buying programmes, like those enacted amid Covid-19 in 2020.

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That said, the S&P 500 is still at February 2021 levels, above where it was pre-pandemic. Meanwhile the extra yield that companies rated junk pay over benchmark rates is still only three times that paid by those deemed investment grade, in line with its 10-year average, according to ICE Bank of America indexes. The Chicago Fed’s national index shows appreciably looser financial conditions than in previous crises.

No wonder. While companies have lots of debt, it’s low-cost and extended bond maturities reduce the risk of a sudden wave of defaults. Only a third of U.S. companies rated sub-investment grade BB+ or lower have credit maturing through 2024, according to S&P Global. Funding costs have risen, but not to Fed Put levels. On average, debt issued by U.S. investment grade companies only pays around 140 basis points of extra yield over benchmark rates, as per the ICE Bank of America Index. In early 2016, a year the Federal Reserve paused rate hikes, that spread reached 230 basis points. BNP Paribas analysts estimate the Fed would need corporate spreads to exceed 200 basis points to loosen policy again.

In Europe, Lagarde is probably more worried about government funding conditions. If the yields of weaker sovereigns spiraled, euro zone breakup fears could reignite. The ECB could therefore backpedal sooner than the Fed, and renew purchases of weaker countries’ bonds even as it raises rates to stem inflation. Yet while the spread between Italian and German government debt has soared to around 240 bps, that’s still only early 2014 levels, before the central bank started buying debt. Italian spreads would need to hit 350bps for the ECB to take action, Capital Economics reckons.

Market signals can change quickly, of course. But right now, they provide intellectual cover for Powell and Lagarde to stick to their inflation-battling guns.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)


The European Central Bank called an unscheduled meeting of its governing council on June 15 to “discuss current market conditions.”

The S&P 500 Index has lost 21% year to date, as of June 14, as rising inflation forced central bankers to hike rates and curtail bond purchases in a bid to stem price increases. The STOXX 600 Europe Index has lost around 16% in the year to date.

Italy’s 10-year borrowing costs reached 4% on June 13, the highest level since early 2014.

The yield on bonds issued by U.S. companies deemed investment grade has roughly doubled since the start of the year to around 5% as of June 14, according to ICE Bank of America Index.

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Editing by George Hay and Pranav Kiran

Our Standards: The Thomson Reuters Trust Principles.

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

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