News in Charts: Cutting rates in times of robust solvency

Jerome Powell’s speech at Jackson Hole was followed by a more aggressive than expected cut of 50 basis points. Everything seemed lined up for further cuts. Come October however, the nonfarm payrolls reported by the Bureau of Labor Statistics showed that US job numbers increased by the most in six months in September, pointing to a resilient economy. The majority of jobs were added in the education and healthcare, and leisure and hospitality sectors. Moreover, revisions to past data showed that the economy added 72,000 more jobs in July and August than previously estimated. This could mean fewer rate cuts for the rest of the year than previously expected.

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Fathom’s Global Outlook, Autum 2024: a change is coming envisions a ‘higher for longer’ environment, where the economy remains resilient with growth staying in positive territory but probably decelerating into next year. It is always hard to measure the resilience of the economy, but one place to look is the job market. Another is corporates. The most aggressive policy rate tightening in decades raised fears that the cost of interest companies had to pay on their debt would result in an increase in corporate failures, potentially harming the economy in the short run.

However, the results of the latest fiscal year are encouraging, suggesting that at the end of the tightening cycle, corporates remained in a healthy state. Specifically, there is stability on the solvency profile of all sectors. Even better off by as much as 1.4% from the previous fiscal year — in particular the travel and leisure sector that suffered so much during the pandemic. Companies in the tech sector had cash flows 20 times greater than their interest expenses by the end of the fiscal year 2023. That went down to only 3.7 times in the auto sector.

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Corporates have generally been blamed for greedily passing on all the post-pandemic inflationary pressure to consumers. That may be true for a few, but the majority of them used the elevated margins to rid themselves of debt burden and improve their and not to produce higher return on equity (ROE) to satisfy shareholders. Specifically, the volatility on the ROE is low since 2022. That is because US corporates improved their profit margins by 4% and asset turnover by about 5% post-2021, while they decreased their equity multiplier by almost 10% giving rise to a net-zero effect on return on equity. Considering the patterns in the ROE components combined, it seems that corporates used their increased revenue and extended equity base to deleverage, and not necessarily to super-charge performance

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The robust earnings outlook is reflected in the patterns of corporate yields. The spread between the yields of BBB-ranked and AAA-ranked corporate bonds (commonly known as the default spread), tracks the equity risk premium and reflects aggregate default probability.

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Even as receded, as indicated by the robust corporate solvency and earnings outlook. The result of the upcoming US election and what it may entail for the US economy poses a headache. Another source of headwinds for the largest economy in the world, and driver of global growth, is the geopolitical risk which is steadily on the rise since the start of the Russo-Ukrainian war and the escalating conflict in the Middle East. Both of these factors have been the focus of rigorous analysis in Fathom’s latest Global Outlook and various research outputs.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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