Capital Markets Resemble a Saint Bernard

The week kicked off with a Sunday evening U.S. Federal Reserve announcement about subpoenas received. As the week progressed, Iranian tensions continued, the administration signaled continued interest in Greenland, and President Trump followed up on proposed credit card interest rate cap assertions by backing a bill that would subject card issuers to more regulation while lowering merchant costs. Although markets have had a lot to digest and broad-market indices seemed not to move in aggregate, we are encouraged that market responses have emerged just below the surface. We would have concerns if markets adopted a “Teflon-esque” reaction function, which we have seen at other historical junctures (e.g., the dot.com bubble and subsequent fallout). In general, broad markets, as captured by the S&P 500 or major bond indices, react to phenomena that would alter consumption, trade, corporate spending, or market functioning — and none of the headlines appear to deeply impact those categories. To be sure, individual headlines and their collective sum are important and bear further, albeit brief, mention. We will devote a more fulsome response to the Fed matter later in this piece.

Top-of-mind geopolitical tensions like Venezuela, Greenland, Iran or simmering issues with Russia/Ukraine, China/Taiwan and a host of other elements are what we continue to term “edgeless,” or difficult to forecast in terms of resolution timing, perceived economic impact and resultant market reaction. These events carry significant human considerations, and each situation carries the opportunity to further isolate major powers and redirect trade (note that President Trump hinted at tariffs to entice a deal on Greenland today). Edgeless phenomena are often treated as reactionary outcomes by markets: Buying and selling will occur once the next stage of a given event happens, but, for now, the broader impacts appear contained. U.S./China trade relations are the most significant in the near and long term, and markets are likely more focused on pending Supreme Court legislation outcomes than seemingly isolated events that do not yet alter core economic trends.

Potential credit card legislation and interest rate caps carry more potential economic weight given how consumption-driven most western economies are — especially the United States. This week, several credit card companies and banks that issue credit cards have seen negative share price reactions. However, given the hurdles to pass credit card legislation, strong vocal opposition by select banks on pending legislation, and what it may mean for bank lending appetites, share prices have recovered about half of what they lost earlier in the week. 

Fed headlines remain in the spotlight, especially following Sunday’s announcement that the Department of Justice served subpoenas to Fed officials. With our consistent nonpartisan perspective, investor perceptions regarding market functioning are correlated with market participation. For an analogy, consider how you or I feel about our local farmer’s market. If we felt that prices were set unfairly, food quality undercut standards, or the hours of operation were erratic and undependable, we wouldn’t go back and would seek our vegetables from other sources. Without projecting bias, U.S. capital markets remain the most liquid among global peers, and further U.S. government debt and currency issuance retains cornerstone status.

Even though its mandates are borne out of Congressional authority, the Fed is viewed as an independent entity serving the American people through promoting full employment, price stability and moderate long-term interest rates. Most market pundits focus on the first two mandates, but the third is arguably the most important as borrowing costs, both here and abroad, are set off of U.S. Treasury bonds. The Fed does not issue bonds, but their interest rate targets are key in pricing.

Fed policy is critical right now given more mixed economic trends. The Fed and its staff economists have a difficult task when setting interest rate policy; their policies require predictive thinking and acknowledging the lag between policy change announcements and their uptake in the economy. Any perceived interference or influence on Fed thinking risks implications for U.S. borrowing costs. While we do not think the subpoenas in and of themselves warrant immediate concern, markets keep receipts on aggregated concerns. 

It is early and most of the technology companies that make up the “Magnificent Seven” report earnings later in the quarter (Microsoft reports 1/28, Meta (formerly Facebook) 1/28, Tesla 1/28, Apple 1/29, Alphabet (formerly Google) 2/4, Amazon 2/6, and NVIDIA 2/25).  While we have a few weeks before some of the tech heavyweights report, we did get a key earnings report from Taiwan Semiconductor (TSM), which provides a meaningful read-through to the broader tech ecosystem.

Founded in 1987, TSM is a dedicated semiconductor foundry whose services and geographical reach have grown over time — North America represents 70% of revenue, so TSM provides insights into production. TSM manufactures semiconductors based on integrated circuit designs provided by their customers in addition to testing and other services. TSM had strong earnings and sales, beating estimates across most financial metrics.

The most important takeaway was TSM’s capital expenditure (capex) plans with management announcing up to $56 billion in capex this year, which is a 30% increase over 2025. They also cited plans to increase capex for the next three years. Markets cheered both the earnings as well as the capex plans, and related companies including semiconductor equipment stocks, such as Holland’s ASM Lithography, rose in sympathy. What we will be looking for is what underlies the capex increase. For example, is it sustainable demand from customers, agreements tied to the U.S.-Taiwanese trade deal announced Wednesday, preemptive spending in an increasingly competitive market, or an overextrapolation of true long-term demand? As you will hear from us throughout this year and beyond, we are actively gauging returns from artificial intelligence spend and how markets differentiate winners from losers in this environment.

First, let’s define credit spreads; Wall Street lingo that sounds more complicated than it is. In bond-market terms, a spread is the difference in yield between one bond and another bond that matures at the same time, with yield defined as the annual rate of cash flows a bond holder can expect to receive through maturity as a percentage of the total bond price, assuming the bond issuer makes good on their promised payments. Typically, spreads are computed using U.S. government bonds as the basis, such that a bond earns a yield premium over a U.S. Treasury bond of the same maturity.

So if I own a fictitious Acme Incorporated corporate bond that matures 10 years from today that yields 6.8%, and I compare it with the equivalent U.S. government bond, which in this case is the U.S. 10-year Treasury bond that yields 4.2%, the spread or difference in yields between the two bonds is 2.6%. That spread exists for lots of reasons, but mostly because the U.S. government can tax and has a military to back its sovereignty; Acme is a company and can neither tax nor field a military, and it promises to pay back bondholders as a function of its cash position and ability to translate product or service sales into liquidity for creditors (and worst case sell assets).

When credit spreads get very low, or tight, markets do not demand extra compensation for issuers like Acme or others. This situation occurs when the global economy remains in relatively good shape, company balance sheets are strong, debt issuance and demand have been steady, and default activity has been subdued. While these are all supportive conditions for low credit spreads, there is always a risk that companies see low credit spreads as an opportunity to issue more debt at less expensive levels. Like most things in financial markets, creditors and issuers can grow complacent: While the current environment appears to justify low global credit spreads, we are actively watching issuance and absorption trends along with economic fundamentals to gauge how sustainable current levels may be.