The Origin of the Next Financial Crisis

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Today, additional evidence that recession — or worse — is in sight.

But first, it appears the “Powell put” may extend the countdown clock…

Since Jerome Powell’s dovish comments on Friday, the Dow Jones has been up and away… as an addict thrills to the promise of additional stimulant.

It leaped another 256 points today.

Both S&P and Nasdaq have been similarly seduced.

The S&P ended the day up another 24 points; the Nasdaq, 73.

Thus Mr. Powell becomes the latest dealer to backstop Wall Street’s addiction to easy credit.

First came the “Greenspan put” after October 1987’s Black Monday.

The “Bernanke put” was on tap after 2008 — and was it ever.

This was of course succeeded by the “Yellen put.”

And now… Jerome Powell.

Meantime, Bernanke and Yellen were able to inflate the balance sheet from a pre-crisis $800 billion to a delirious $4.5 trillion.

Powell could not possibly work an operation on that scale.

This at least partly explains why he has been withdrawing the narcotic since he came aboard — to rebuild his stocks for future use.

But Mr. Powell suggested last Friday that he is willing to call a halt “if needed.”

It may put off reckoning day… but it only intensifies the ultimate and inevitable withdrawal.

Come we now to our evidence that recession is within view…

We have argued previously that sub-4% unemployment means recession is almost invariably close by.

Today we observe that recession is also close when corporate debt attains present heights.

U.S. corporate debt swelled a preposterous $2.5 trillion post-financial crisis… some 40% higher than its 2008 summit.

Corporate debt presently equals some 46% of GDP — the highest percentage on record.

And whenever corporate debt rises to present levels, recession is in the air… at least for the past 40-odd years: (See above chart)

But whom shall we blame?

As is our wont, we point an accusing finger at the Federal Reserve…

Year upon year of ultra-low interest rates hammered borrowing costs lower and lower.

And as we have stated before, corporations have been the largest source of all stock purchases.

But interest rates have been climbing… like water in a flooding basement.

And the cost of existing debt is rising with it.

How will they meet their debts?

Bonds rated “BB” are considered “junk bonds.”

“BBB” is one level removed from junk.

MarketWatch informs us that the volume of the bond market rated BBB currently rises to $2.5 trillion — a record high.

That is, 50% percent of all investment-grade corporate bonds are presently one inch from junk status.

And once they start going over… watch out.

Explains Daily Reckoning associate John Mauldin:

This is the sort of thing that can quickly snowball into a financial crisis. Something similar happened with commercial paper in 2008, but this has the potential to be even worse… and, if it happens, could come at a time when the Federal Reserve and Treasury can’t help much. I see serious risk of a corporate bond crisis in 2019…

Analyst Jesse Colombo is similarly alarmed:

The U.S. corporate debt bubble will likely burst due to tightening monetary conditions, including rising interest rates. Loose monetary conditions are what created the corporate debt bubble in the first place, so the ending of those conditions will end the corporate debt bubble. Falling corporate bond prices and higher corporate bond yields will cause stock buybacks to come to a screeching halt, which will also pop the stock market bubble, creating a downward spiral. 

In conclusion:

There are extreme consequences from central bank market-meddling, and we are about to learn this lesson once again.

From where we sit… the only question is when.

Full article: The Origin of the Next Financial Crisis (The Daily Reckoning)

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