The median interest coverage ratio for the investment grade credit index is just below 7, and for high yield, it is just below 4. Lower-rated credits are more vulnerable to interest rates staying higher for longer because lower-rated credits, by definition, have higher debt-servicing costs.
Recent developments in interest coverage ratios show that Fed cuts and continued strong earnings are starting to help investment grade companies, see charts below. Meanwhile, high yield companies are still seeing a downtrend in coverage ratios driven by higher debt-servicing costs.
The Fed cutting interest rates and continued strong earnings will be helpful for both investment grade credit and high yield credit. But as interest rates stay elevated, debt-servicing costs will weigh more heavily on high yield companies, and investment grade credits with lower debt-servicing costs will be more attractive.
This happens to be exactly how monetary policy works: Companies with higher debt-servicing costs and lower coverage ratios are hit harder by Fed hikes and interest rates staying higher for longer.
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