The illiquidity risk in corporate credit

Such virtuous circle will lead to excessively high prices and will eventually become a vicious circle, which will end the increase in prices and the potential bubbles formed in the process.

Central banks know that in the last two cycles, the overheating was too fast in the financial markets, and before the real economy was able to get warm with strong inflations, markets finally turned around and led to financial instability.

Reaching long-lasting financial stability and economic recovery are two difficult goals to be obtained at the same time. It is possible that the same will happen in this cycle, because central banks don’t have tools so as to make both objectives flow at the same speed.

Measures to avoid excessive risks in markets may depress the economic growth –after all, long-lasting balance is complicated. However, central banks will only be worried about financial bubbles as long as they can trigger a contagion to the real economy.

We must be very careful about the corporate credit, which has grown faster than equities and their risk premiums –which are close to minimum levels. A fast increase in short-term rates in the US would lead to fast outflows –especially in the High Yields.

If this movement were too abrupt and the central banks didn’t respond accordingly, this would lead to a situation of illiquidity, because some High Yields would not have purchase positions.

If markets were facing such situation, the consequences for the real economy would be significant.