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May 18, 2022 | Premium Service | As the Federal Open Market Committee raises interest rates and ends the massive purchases of securities under quantitative easing or QE, the liquidity is running out of the global capital markets. Readers of The Institutional Risk Analyst know how this movie ends. Bond spreads are widening and new issue volumes are falling like a rock. The vast output gap in global GDP caused by the Ukraine War is being exacerbated by the FOMC’s actions, only confirming our view that deflation remains the key risk to the US economy as 2022 progresses.
Even as new bond issuance volumes are falling, spreads on high-yield securities are rising, a danger sign for the US economy and also the equity markets. Once HY credit spreads rise above 500bp over the Treasury curve, this indicates that the capital markets are not functioning properly. The sharp increase in credit spreads since January 2022 has resulted in a decline in equity valuations, wiping out trillions of dollars in aggregate paper wealth.
The 3.5 trillion yen (about $27 billion) loss by the Softbank (SFTBY) Vision Fund illustrates the losses being taken by many investors that foolishly deployed cash into various crypto frauds and aspirational stocks, both public and private. Below we discuss how these negative trends are likely to affect specific sectors as the year progresses.