More corporate and US debt, and Fed trying to keep party going = mid-2000s all over again

I’ve mentioned a few times this year that I’ve been getting flashbacks to 2006, and not just because Dems won big during the midterm elections. I got more of those memories from headlines like this one from this week “Fed urged to get more serious about U.S. corporate debt risks.”

Bankers, executives and investors are warning Federal Reserve officials behind closed doors that record leveraged lending to companies from lightly-regulated corners of Wall Street could make any economic downturn harder to manage.

With the second-longest U.S. expansion in its advanced stages, the worry is that a key part of the credit market could be particularly vulnerable to a slowdown, as highly-indebted companies face a greater risk of default.

Well, that seems like a problem. Tell me more.

Scott Minerd, managing partner at Guggenheim Partners, said President John Williams and some of his colleagues at the New York Fed were "taken aback" when he told an advisory meeting that he did not think the Fed could safely avoid a messy recession in the face of the credit build-up and other risks.

"Because it is now so extreme, any attempt to rein in credit expansion is going to ultimately blow up," Minerd said at the Reuters Global Investment 2019 Outlook Summit this month.

Credit spreads - or the difference between government and corporate borrowing costs - have already widened to a two-year high for both investment-grade and high-yield debt. In what could be a taste of things to come, General Electric Co's bonds tumbled this month as it scrambled to raise cash.

Minerd said the Fed and other regulators did not yet seriously consider a scenario in which credit spreads would rise much further prompting regulators to force liquidations at insurers and other firms that had bought so-called collateralised loan obligations, or CLOs. Like the CDOs behind the housing crisis, CLOs bundle corporate loans into a single security.

So because there is so much corporate borrowing out there, Minerd seems to be saying to the Fed “Keep rates low so we can keep the musical chairs game going with all this debt, or else some companies will go under.” That doesn’t seem especially healthy.

And then I got a break in my work around Noon (1pm Eastern) today, and saw the markets doing this.

So what happened around Noon Eastern? Federal Reserve Chair Jay Powell spoke to a bunch of rich elite types in NYC, and it caused the speed freaks on Wall Street to start buying.

In a speech before the Economic Club of New York on Wednesday, Powell said, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.”

In October, Powell suggested the Fed was a “long way” from neutral…

Powell’s speech also follows the release of the Fed’s financial stability report on Wednesday morning, which called out what the Fed sees as valuations in financial markets that are “generally elevated” and show investors exhibiting a “high tolerance for risk-taking, particularly with respect to assets linked to business debt.”

The report adds that, “debt owed by businesses relative to gross domestic product (GDP) is historically high, and there are signs of deteriorating credit standards.”

So if interest rates are kept relatively low, it lessens the chances of loans costing more, and allows corporate America to keep borrowing with fewer consequences.

Of course, what it also will do is drive this credit Bubble to become even bigger, since there are no underlying increases in the real economy to back up the added activity, and there will either be a return of inflation (from too much demand and money flying around), or the Bigger Bubble pops and the inevitable recession becomes even worse to deal with.


And there’s a counter-pressure on the Fed right now. Not only is there a lot of corporate debt out there that needs to be paid back, but Uncle Sam is also trying to get money to pay for his massive budget deficits, and foreigners don’t seem as willing to send money to the US to help him out.

Some auctions since late October had the weakest foreign participation rates in nearly a decade, a Reuters analysis of U.S. Treasury sales shows. At the same time, auction sizes are rising fast, with bond issuance this quarter projected to set a record of $83 billion after deducting maturing debt.

“We do worry about where demand for Treasuries is going to come from, given the ongoing significant increase in supply,” said Torsten Slok, chief international economist at Deutsche Bank….

Foreign investors - both private funds and official entities such as central banks - have been lynchpin participants in the $15.3 trillion U.S. Treasury market for years. And while overall foreign holdings have remained steady at roughly $6.2 trillion, their participation has not grown materially in several years.

The Treasury market, meanwhile, has mushroomed in size, leaving foreigners to account for just 40.5 percent of the market as of September versus nearly 50 percent in January 2013.

A sustained slackening in foreign demand for Treasuries could hurt the U.S. economy. Lower demand means the government must increase the interest it pays out to attract buyers. Those higher federal borrowing costs not only add to the U.S. budget deficit, they also tend to push lending rates higher for consumers and corporations, which could knock the second-longest U.S. economic expansion off track.

Hey, I got a weird thought. Maybe we shouldn’t have passed a GOP Tax Scam that blew up our deficit, which put upward pressure on interest rates while allowing corporations to have more money floating around that they could leverage into the casino of secondary debt, and basically be used for anything BUT job creation? Nah, that’s crazy talk!

That being said, the Fed Chair's hints at fewer rate hikes combined with concerns about “cracks in the US economy’s performance” in the future seem to have caused a “flight to quality”, with the 10-year bond yield dropping from 3.23% earlier this month to less than 3.06% today.

While those lower long-term rates might make long-term borrowing a better deal and help the flagging housing market stay afloat for a bit, shorter-term rates are still higher and likely to stay there, making us closer to the “inversion” which has been followed with a recession every time in the last 40 years.



As of today, the blue line is at 0.25%, and the red line is at 0.66%. But the 30-year bond actually rose by 2 basis points, partly reflecting those deficit pressures. Which brings me to mention one more headline today that gave me flashbacks to the years right before the Great Recession - "U.S. New-Home Sales Fall in October, Missing Projections".

Sales of new U.S. homes fell in October to the weakest pace since March 2016 as rising borrowing costs and elevated prices keep buyers out of the market.

Single-family home sales fell 8.9 percent from the prior month to a 544,000 annualized pace, according to government data Wednesday. That was below all estimates in Bloomberg’s survey of economists, which had called for 575,000, and compares with September’s upwardly revised pace of 597,000.

The median sales price dropped 3.1 percent from a year earlier to $309,700, the lowest since February 2017, though still out of reach for many potential buyers.

Yep, it’s very 2006-ish these days, for all the good and bad reasons.