Asset Markets Smell of Gunpowder... "Beware of Credit Risk" [Weekend Money]

Domestic Equity and Credit Risks Amplified Among Global Assets

Special Attention Needed for Marginal Firms and Private Credit

The Middle East crisis, which began with airstrikes by the United States and Israel on Iran, is increasing risk levels across global asset markets. Concerns over supply chain disruptions and rising oil prices are simultaneously impacting all major asset classes, including equities, bonds, foreign exchange, and credit.

Asset Market Risk Levels by the Numbers... Only Credit Risk Rises Sharply

Korea Investment & Securities compared the risk levels of different asset classes—equities, bonds, foreign exchange, and credit—by converting them into normalized values ranging from 0 to 1. These figures are standardized based on a composite of indicators such as volatility, investor capital flows, and credit spreads. The closer the value is to 0, the more stable the asset class; the closer to 1, the nearer it is to the most risky phase in the past three years.

According to this standard, global equity risk is at 0.4, indicating stability, and both bond and foreign exchange risk remain low. Domestic equity risk has risen to 0.5, which is relatively high, but this is largely due to domestic factors, such as the sharp rise in stock prices and net selling by foreign investors since the beginning of the year, rather than the Middle East conflict. Credit risk has notably increased from 0.04 at the start of the year to 0.34 now. While this is not an absolutely high level, it stands out because it is rising particularly rapidly compared to other asset classes.

If Oil Prices Rise, So Does Inflation... Expectations for Rate Cuts Diminish

Risk Components by Asset Class

The channel through which credit risk is being stimulated is oil prices. As tensions in the Strait of Hormuz have destabilized oil supplies, oil prices have surpassed $80 per barrel. In addition, more vessels are rerouting around the Cape of Good Hope instead of passing through the Red Sea and Suez Canal, driving up shipping rates as well.

An economist at Korea Investment & Securities projected, "Even if the WTI crude oil price rises only to around $90, it will likely exert an additional upward pressure of 0.3 to 0.5 percentage points on the month-over-month headline (consumer price) inflation rate in the United States, with a lag of one to two months."

If inflation rises, expectations for interest rate cuts by the US Federal Reserve may weaken. Weaker expectations for rate cuts lead to tighter funding conditions, and companies with a low interest coverage ratio (an indicator of how much operating income can cover interest expenses) are the first to feel the pressure. The credit spread for high-yield companies with poor credit ratings—the additional interest paid compared to Treasuries—has already risen to 950 basis points, its highest level since May last year.

Opaque 'Private Credit' Also a Variable... "Continuous Monitoring Needed"

Another area to watch in the credit market is private credit loans. Private credit refers to companies raising funds through private equity funds or similar channels, rather than through banks or the public bond market. Most of these loans are on floating interest rates, meaning that when rates rise, interest burdens increase immediately.

Hyunjong Jung, a researcher at Korea Investment & Securities, pointed out, "Private credit loans, which are affected by floating interest rates and are subject to high information asymmetry, making potential bad debts difficult to identify, could also be significantly impacted." Unlike the public market, where external parties can more easily assess internal conditions, the opaque nature of private credit means that the emergence of bad debts may be delayed, underscoring the need for ongoing monitoring.

Jung added, "If the Middle East conflict is quickly brought under control this month, the impact on the inflation trajectory and monetary policy path in the first half of the year will be limited." However, if oil prices remain above $90 for more than three months, the US inflation rate could rise to the mid-3% range, and corporate funding conditions could deteriorate in earnest.

For now, the market is leaning toward the view that the current conflict will not be prolonged. While the short-term (within three months) outlook for Brent crude has climbed to $85 per barrel, the medium- to long-term outlook (six to twelve months) remains at $65. Rather than an immediate crisis, the current situation leaves open the possibility that credit risk could expand further depending on how the conflict unfolds. Jung emphasized, "It is necessary to monitor whether credit risk continues to expand and to remain alert to the possibility that corporate funding conditions may worsen."

This content was produced with the assistance of AI translation services.