Fed Chair Janet Yellen offered a bit of a surprise in her semiannual Monetary Policy Report in front of Congress on Tuesday. It may seem like a bit like Alan Greenspan’s moment regarding irrational exuberance.
While Yellen has signaled that rates will likely remain low and monetary policy will remain accommodative, she identified in the “financial stability” portion of the speech and an accompanying filing which areas of the market now looked frothy. These include low-grade debt (junk bonds) and leveraged loans. An accompanying filing, which is not a part of the testimony, identifies smaller companies, social media and some biotech as well.
Is this a Yellen version of Alan Greenspan’s “irrational exuberance” wording?
Yellen warned about investors reaching for yield and perhaps taking on too much risk. We have further highlighted which moves have been seen since. Yellen said:
The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest.
Shares of Twitter Inc. (NYSE: TWTR) were down 1.3% and fell from almost $39 Tuesday morning to $37.85 on Yellen’s comments. Facebook Inc. (NASDAQ: FB) fell some 1.7% to $66.75 from above $68 earlier in the session. We would be quick to point out that Facebook at least trades at a multiple on earnings, while Twitter still has to trade on a multiple of revenues because it has not been profitable.
We would also highlight two exchange traded product issues rather than identifying specific names. SPDR Barclays High Yield Bond (NYSEMKT: JNK) was flat at $41.42 on the day. iShares Nasdaq Biotechnology (NASDAQ: IBB) fell from over $258 to under $256 since the speech brought the comments.
The warning is clear here. The Fed is watching junk-bond issuance as “valuations appear stretched and issuance has been brisk.” It is also monitoring developments in the leveraged loan market.
Note that S&P’s daily report on Tuesday morning showed that the Speculative-Grade Composite Spread narrowed to 401 basis points on Monday.