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Different credit channels can explain a large part of the transmission gap. The Euro area’s credit is predominantly bank lending, with around 88 per cent of corporate debt financed through floating rate loans. However, in the US, the majority of corporate debt financing comes from capital markets, which are largely based on fixed rates. 

As a result, the transmission of rate hikes to the US economy has been blunted by the large amount of fixed-term debt that was issued by companies in the immediate aftermath of the Covid-19 pandemic. Borrowers who locked in relatively low fixed rates will feel the pain of dramatically higher interest rates only when they refinance, but the big squeeze has yet to arrive. To illustrate this dynamic, as of August, the increase in effective rates for investment grade bonds in the US was less than one tenth of policy rate hikes, and the effect on high yield bonds was even smaller.

As we have been flagging all year, the combination of a hot and tight labour market and persistent inflation have kept the Federal Reserve from reversing its hiking course. But while the transmission of tighter policy may be slow, the gravity of restrictive rates will eventually set in, especially given the debt maturity walls and refinancing needs on the horizon for the next few quarters. The confluence of these factors means that we retain the view that a recession in the US is the most likely outcome next year.

Max Stainton

Max Stainton

Global Macro Strategist

Yi Hu

Yi Hu

Investment Writer