Not yet buried, not even dead, firms are taking on more leveraged debt. In last week’s US print edition of the Economist, two articles make for chill reading.
The first article that heads the Finance and Economics section is titled, What Goes Up – The American economy. After emailing the current economic growth and the causes of it, the article suggests that things are likely to change. And this was written before last week’s midterms.
The theory is that the impact of the recent tax cuts will start to fade. Yes, this must be the case though there will surely be some residual net-increase in spending and change in behavior as a result. Tariffs are brought up as drag on demand; again this is likely true though there will also likely be some positives as local businesses, shielded from foreign imports, may seek new money to build up local services and supplies leading to some organic growth.
For me, the real risk is investment. Apparently that is falling again, after an uptick (due to tax breaks?). Investment, from primary R&D by central government through to capital investment by firms for plant and equipment, is really important. It is a key part of what will drive the next wave in productivity. We need to keep a watchful eye on all aspects of investment.
Finally the consumer is held up as the trump card, if growth is not to decline in the next year or so. Consumer spending is by far the largest component of US GDP. If spending here keeps up, business may yet increase again investment in response to growing demand.
With Congress split, the likelihood is that broad policy changes will not change- either the House won’t pass the Presidents policies or the President will veto, or the senate will not pass, anything significant the House desires. So my feeling is that growth may yet continue but slow down slightly, which would still be a good thing.
The second article is titled, Load Bearing. It reports that, “Authorities from the IMF to the Fed’s ex-boss are worrying about a booming corporate-credit market”. The credit being analyses here are leveraged loans. These loans are being chopped up into smaller trenches and sold to buyers with different risk appetites. Sound familiar?
The more important news is that we are talking of about $1.2 trillion dollars. Yes, that’s a big number and apparently it is twice as much as six years ago. Some of these loans are refinancing debt (about a 1/3, according to the article) and more is used to finance M&A.
These leveraged loans are attractive to some investors as they have offered good returns at a time when interest rates are low. This is a good example of unexpected and unintended consequences (and economic behavior) that has come about due to excessive periods of low or near-zero interest rates. Such rates mess with your funding approaches. Couple this with the principle, put up long ago, that lowering interest rates drives investment: not many IT or business transformation (i.e. large) projects I know about were conceived of simply because the Fed dropped rates.
The article explains how demand for these loans has led to lowering of standards, and a likely rise in defaults. Again, sound familiar?