Here’s Another Warning Flag For the U.S. Economy

An index that measures the health of U.S. debt markets has turned negative for the first time since 2009, highlighting a potential drag on broader economic growth in the coming months, Fitch Ratings says.

The U.S. Fitch Fundamentals Index, which takes into account corporate-bond defaults, consumer payments on mortgages and credit cards, credit-rating downgrades of U.S. companies, and other factors, slipped into negative territory during the third quarter. Fitch says the index now has a reading of negative 2, after holding steady at zero for the first half the year.
A negative score indicates that credit conditions — the ease with which companies and consumers can borrow money and the willingness of investors to lend — are weakening compared to the same period last year. That could crimp economic growth because companies often need to borrow cash to grow their business or refinance debt without defaulting. A score of zero means there is no change from the prior year.
The poor reading on the index comes as investors fret that slower growth in China and elsewhere could ultimately hit the U.S. economy. Some big U.S. companies have announced layoffs recently and investors have been demanding higher premiums compared to market benchmarks to buy corporate bonds. Some companies have had to pull bond deals or pay a higher interest rate on their debt offerings than initially expected.
“It’s potentially a warning sign for the broader economy,” said Bill Warlick, senior director in macrocredit research at Fitch Ratings. In the years prior to the financial crisis, “there was a significant shift toward the negative end of the scale.”
Mr. Warlick said the index measures improvements and declines in the rates of change across its various components, so a negative number doesn’t necessarily mean conditions are bad. But it does suggest a downward trend.
The Fitch index measures 10 components, five of which now have a negative reading. Only two are in positive territory, with the other three indicating no change.
The component most heavily in the red is investor recoveries on junk-bond defaults. That’s the amount of money that investors ultimately get back after a company defaults. Fitch says average recoveries declined 45% in the third quarter, compared to the same period last year.
The other areas on a downward trend are consumer payments on credit-card debt, lower-rated companies defaulting on their bonds, and expected corporate spending on big-ticket items like new factories and facilities. Also in the red is the market for credit-default swaps, an insurance-like product that pays out if a company defaults on its bonds. Fitch says these instruments became more costly for investors to purchase in the third quarter.
The only positive components of the index are consumers’ mortgage payments and transportation data on freight and passenger movements, though the transportation figures typically have a one or two month lag. Components that measure the health of the banking system, credit-rating actions and corporate earnings forecasts exhibited no change.

Credit: Wall Street Journal