Jon Lonski, Moody's Analytics Capital Markets, on the Economy

June I assume it's safe to assume that stock futures are still on the Amsterdam to get -- across the board still pretty much down not significantly. But. Down and get a gold is down as well and tonight and smiling over here oil is down 65 cents at ninety most heated tank again yeah I do have -- A John Laats is the chief economist of Moody's analytics and he joins us today to talk about the bond market we're gonna. Squeeze some questions in here about Europe too because that's the lead story of the day the French elections of course. John -- would grade would you give the domestic corporate bond market in today's environment good morning. Well I would give it a in relatively solid grade -- solid B. Yeah after reelected companies especially non financial companies have gone to great lengths to be strengthened balance sheets. And did that has led to. -- an improvement in credit quality regarding the ability of these companies -- -- the end adverse macro development but that's the a weak point right there at the macro outlook still remains very shaky. And as a result. The yield. That investors demand from corporate bonds. Remained. Well above the yields on comparably dated treasurys securities. What's this spread now John V in terms of like game high investment -- say I'd be amber. You know high high quality investment grade bond between that and Europe's treasury. Okay without you know mentioning any names I would say right now league high quality. Industrial company bond. Probably pays roughly one and a half percentage points more than treasuries. In more normal times -- back in 2000 toward 2005. That particular spread. Would be roughly. One point one. Percentage points so there is that additional premium. All we true. Heightened uncertainty. That stems from the unresolved situation in Europe and he's still very weak economic recovery in the United States and I might get this is different world today we don't have the same confidence. And the government's ability -- the Federal Reserve's ability and to rescue the economy in the event of a harsh. Recession. Do you ever have people that suggest to you because I I I have to tell AA I I feel a little more confident in a company like. And an old GE or or IBM that I do in the US treasury I mean I'd almost prefer to buy a ten year. Corporate bond from a solid company that I would a treachery is the yields on the -- -- looking at the yield on the -- I think right now John it's about 188. Right there hit a lot of downside risk in the event the economy strengthens -- inflation and somehow takes off on its own. Where -- foreign investors start dumping treasuries. The treasury bond yield could jump very sharply in Europe and the -- to a very important point in that it is one of the reasons why treasury yields are so low is because of an extraordinary. Safe haven bid. Portrait creatures investors worldwide that ordinarily might Cold War. A Euro denominated government debt that are. Refusing to consult they'd rather put the money in US treasuries and avoid -- very uncertain. A situation in Europe with the corporate bonds will be our multinationals the other operations worldwide. So. Here risks are not concentrated in the United States and that would add to the lord. Of perhaps investing one of these big in try and multinational industrial corporations. -- are a lot of investors in US treasuries are they buying it because they think they might make money on the currency besides just the interest rate I'm just trying to think of like a Saudi. Hedge fund or something like that would be by US treasuries because they say yeah I might only make 2% on the yield but I'm gonna make another 5% on the currency. Why not and there's also a -- a carry trade type of play treasuries and that is. If you can borrow money at very low interest rates short term which he can in this particular environment in a pathetic Iraq. That the federal funds rate remains. Quote the 0% until until late 2014. Well then why not borrow at a very low interest rate. Something no we are less than 1% reinvest the proceeds and the ten year treasury paid one point eight. And that particular difference in yield is your prophet. Kind of like a homeowner refinancing is mortgage right. At a lower -- Yeah I think that we know what eventually happened to to a lot of those individuals -- Had to have a lot of faith. It and it that the collateral the underlying price of the security in this case does not decline in price because all of that and unforced -- jumped. By treasury bond yields will be the consequences be their stronger than expected economic activity but for now. The labor market remains weak as we saw on Friday war some unexpected surge by price inflation. John I was rating Moody's report and I noticed a significant uptick in the quality or the ratings at least a high yield bonds what's happening there why why. Why are we seeing so many high yield there what are previously known as junk bonds. Wire how are they making these improvements in their credit quality. Well -- of several factors first of all chuck has been helped by what has been a very strong showing. By corporate profits since 2000 and I middle of 2000 and -- And when you add to that effect that companies have been very conservative about adding debt this much faster growth of profits. Relative -- debt. Allows for an improvement in high yield credit quality many high yield companies took some of these profits and used it to. I'll retire outstanding debt and their body to improve there are credit quality. Moreover we have had this environment of very low interest rates this was not expected. Back at the height of the crisis in late 2008 early 2009. As a result of this deep. Launch in the absolute level of high yield borrowing costs many of these companies have refinanced outstanding bond debt reduce their interest cost. They've also been. Able to. Substitute short term bank debt with immediate maturities war. The four with bond debt to all offers him water maturities and thus more. Protection from any unforced seeing declining. Economic activity. The impact of emanate I I've actually be a surprise that we haven't seen more. Mergers and acquisition activity with how does that affect the bond market when you get a flurry of -- activity. And and it do you anticipate that that's going to happen in the coming months. Well you know during the early stages of a wave of M and a activity which tends to happen. Is that it's. Financially stronger companies purchase financially weaker companies and as a result the credit rating of the financial weaker company gets raised in the last week -- When emanate -- it gets under way. You'll have more upgrades and downgrades related to M and a activity for high yield. Companies in the opposite for -- that's been great financially stronger companies. It's not give it to the later stages of the credit cycle that you flying -- and -- eight tends to be of the net. Detriment to corporate credit quality. And they dropped sharply the first quarter it was down by 40%. Or so from a year ago that was a surprise. Companies are perhaps. Movie to the sidelines as far as Germany is concerned out of deference to what -- stemming from. The upcoming November election -- and more all work. We have to remember that many companies still feel very an easy about the risks posed by the unstable situation in Europe. That is speaking of that after the elections in France are you more possible. The more optimistic or more pessimistic about Europe after the fact the socialists winning the presidential election inference. These victory by the socialist was not a surprise. We state and we also have us some political turmoil. In Greece in response to harsh austerity measures. Perhaps if there's reason for optimism it might be the that. When you're imposing fiscal austerity on a country you have to be careful. That's the remedy does not end up making the patient worse off with this is the situation we don't want chemotherapy who killed the patient. And maybe this is a warning. Is that a fiscal austerity should be applied any more measured manner so that it does not have the effect. Of deepening existing recessions. While it so knee your Europe basically in the camp that may be -- is on -- something that the austerity measures were too severe. Well -- just -- said that directional but an open question. You know whatever problems that we could ideas that you don't want to go ahead and have. Budget tightening that is so severe. That'd deepened the recession -- invite doing so he adds to the borrowing needs of the government in question that doesn't make any sense. Got it got it all right well John I appreciate your time thank you very much for joining us is -- and Mike -- As John Lonsky he's the chief economist at Moody's analytics. And in June with that really means it in and what I gleaned from that conversation was that. This fear stock market selloff may not be as severe as initially anticipated because what he is it suggesting is that you're gonna see. Some of these austerity measures backed off. And that might actually be good for the economy according to John really you know interesting though -- -- well yeah they. I've always maintained lunatic when he -- -- future -- not out of the current com we'll talk about that because. In -- relevant in this case.