Two More Crash Warnings as Fed Gets Ready To Sell Assets

September 19, 2017

Following the report of the UK-based Adam Smith Institute last week that City of London banks were more overleveraged than in 2007 and "an accident waiting to happen," two new warnings emerged today of the bigger crash threat from the U.S. and European corporate bond markets.

Deutsche Bank chief credit strategist followed up CEO John Cryan's remarks last week that the central banks had created "bubbles everywhere," with a warning that "asset prices globally are the most elevated in history." This history involved is since 1800, and the measures complicated. But the bank is clearly reporting that the credit, or bond markets, are closer than ever before to the highest global average price possible, meaning the lowest global average interest rate possible. Their report says "While they remain this high there is always a risk of a sudden correction that could be destabilising to a financial system and global economy that seems to require such elevated asset prices."

The report also points to the epidemic in Europe and the United States of bond issues with "lite" or no covenants, meaning the company's ability to repay cannot be judged. A homey example is given by Jared Kushner's family real estate company, which owes billions in loans on which it has lacked the revenue even to pay interest.

The latest quarterly report of the Bank for International Settlements contains a warning about a potential corporate debt crisis or collapse. It estimates that 10% of all European non-financial firms are "zombie companies" which have become completely dependent on borrowing at near-zero interest rates, and will go bankrupt with any significant rate rise. They estimate that the ratio in the U.S. corporate sector is 16% "zombies." Recall that the IMF 2017 global review three months earlier estimated that 20% or more of U.S. non-financial firms would "default" with any significant rate rise, not necessarily the same as going bankrupt; so this is an equally serious warning. "Ultra-low rates have allowed these companies to keep operating.... "In the event of a slowdown or an upward adjustment in interest rates, high debt service payments and default risk could pose challenges to corporates, and thereby create headwinds for GDP growth."

BIS says investors still think the central banks will return to quantitative easing as soon as any market quakes. "This underlines just how much asset prices appear to depend on the very low bond yields that have prevailed for so long."

This week the Fed is deciding whether to start selling assets, pushing interest rates up if it announces that.