Futures on the Dow and S&P 500 fell sharply Thursday night and were on track to give up all their prior gains, as the economic impact of coronavirus continued to sweep through the financial system.
As The Wall Street Journal reported Thursday , an upsurge in risky corporate debt could topple the U.S. economy at a time when business activity was grinding to a halt. According to the Journal’s analysis, coronavirus could be the pin that pops the ever-growing debt bubble.
Futures on all three major U.S. indexes traded lower Thursday night, pointing to a volatile start to New York trading on Friday.
The June contract for the Dow Jones Industrial Average was off by as much as 469 points, en route to a low of 19,406.00. At press time, the Dow mini contract was down 159 points.
S&P 500 futures were down 1.7% to 2,362.00. Nasdaq Composite futures declined 0.7%.
The U.S. stock market finished higher in New York trading on Thursday, but not without a fair share of volatility. A huge portion of the gains were concentrated in energy stocks, which rallied on the back of rebounding oil prices.
Beyond the oil and gas sector, markets remained on edge over the coronavirus pandemic. The United States is experiencing an explosion in confirmed cases, with every part of the country now affected.
The historic surge in corporate debt was a problem even before coronavirus became a pandemic. But as corporate borrowers get downgraded due to the health crisis, servicing their debt will become more onerous.
According to The Wall Street Journal , a subset of the now $10 trillion corporate debt mountain could be in serious trouble.
That’s because roughly $1.2 trillion of that total is in leverage loans and junk-rated debt “secured by corporate assets much like mortgages are backed by home.”
This market has ballooned by nearly 50% over the past five years thanks to the allure of higher interest rate payments (corporate borrowers with lower credit ratings pay higher interest to their investors).
As WSJ pointed out, banks that make these loans rarely hold on to them because of post-crisis regulations. Instead, they are sold to money managers or repackaged into other securities.
When prices of loans fall or enter default…
… the losses hit pensions, insurers, and scores of mutual funds and hedge funds, some of which react by selling out, exacerbating market swings.
Corporate debt continues to grow at a time when the global economy is expected to enter a brief but painful recession brought on by coronavirus. Rising debt and economic contraction are a dangerous combination that can lead to spending cuts, layoffs and credit downgrades.
As is often the case during recessions, economic pain leads to a spike in defaults. Data from S&P Global suggest that the next recession could be much more painful for loan investors given the size of corporate debt outstanding.