Put inflation aside. Growth fueled by debt is the real wild card.


Economic data has been phenomenal lately, taking the US stock market to new highs as investors celebrate the end of last year’s global nightmare.

And so it’s a tricky time to be a killjoy, even if only hypothetically.

The fiercest debate among market participants this year has revolved around inflation – will it be more than transient or not – and whether the Federal Reserve – will it end up late or not? But what if this framing is wrong? What if the big question is whether growth is transient, and if it is, then what?

For its part, the Fed has acknowledged better-than-expected economic improvement while hammering out the message that any corresponding rise in inflation will be short-lived and a full recovery far away. “Most participants indicated that the pandemic continued to pose significant risks to the economic outlook,” including risks resulting from more contagious viral strains and fatigue from social distancing, the rate-fixing branch said. the Fed in its March meeting minutes released on Wednesday.

While many economists and investors dismiss such apprehension and revel in a repeat of the Roaring Twenties, some warn that the recovery so far is fragile, based on massive fiscal and monetary stimulus and astronomical leverage. which presents the mirage of a rapidly improving economy.

“Everything we see is temporary,” says David Rosenberg, chief economist at Rosenberg Research. He predicts slower growth by the fourth quarter which he says won’t start worrying investors until August.

Put aside, for now, the strong jobs report, the purchasing manager indices and consumer confidence readings in recent weeks, and even the producer price index released on Friday. . Take a step back and it’s clear how much consumer spending – which accounts for roughly two-thirds of gross domestic product – has become tied to what is supposed to be emergency tax assistance. Monthly retail sales figures tell the story of spending, which has become dependent on household checks that began last year, dropping sharply between rounds.

Then consider the consumer credit report released on Wednesday which showed a much larger than expected boom of $ 27.6 billion in February. This credit increase, the biggest month-over-month increase since November 2017, comes as $ 2 trillion in loans went into forbearance during the pandemic, allowing more than 60 million borrowers to default. $ 70 billion on their debt payments by the end of the first quarter of 2021, according to a group of economists led by Susan Cherry of Stanford University.

In a sign of trouble, recent reports indicate that one in 10 subprime car loan borrowers are now more than 60 days past due, the highest on record. Another sign of excess, margin loans are exploding. In late February, investors borrowed a record $ 814 billion from their portfolios, the fastest annual clip since 2007 and up 49% from the previous year, according to data from the Financial Industry Regulatory Show. And in another sign, the business buy now-pay-later

To affirm

(ticker: AFRM) in its most recent quarter, reported 4.5 million active customers and $ 2.1 billion in gross cargo volume, up 52% ​​and 55%, respectively, from the last year.

The consumer element of the overall debt picture is, of course, only the tip of the iceberg. “Everyone’s focused on the reopening party,” says Rosenberg. “I think of the Fed’s inability to raise rates because of leverage,” he says, referring to corporate debt and the Fed’s inability to raise interest rates above 2.5% in its latest tightening cycle, to follow immediately with rate cuts. leading to the pandemic. “And now that leverage is on steroids.”

In a recent investor report, economists at Citigroup reported global debt-to-GDP ratios that exceed WWII highs for advanced economies and reach new highs for emerging market economies. As for the United States, Fitch Ratings said in March that federal debt will approach 109% of GDP this year, while general government debt will reach 127% of GDP in 2021, before surpassing 130% by 2023. Analysts wrote there that very low interest rates, which have kept debt servicing costs down, will eventually rise despite the Fed’s commitment to a prolonged period of extremely accommodative monetary policy.

Catherine Mann, Citi’s chief global economist, warns against such a feedback loop. She says that as long as the economic growth rate exceeds real, or inflation-adjusted, interest rates, investors shouldn’t be too worried about high debt-to-GDP ratios. This is currently the case. But the problem is, you don’t know when the markets will start signaling that debt is on an unsustainable path and requires higher rates, she says.

Therein lies the enigma. In the context of the feedback loop described by Mann, where the cost of servicing the debt becomes much higher, the Fed may decide to wait longer to raise rates in order to avoid making the situation worse. This would presumably help make it easier to take on more debt, and it begs the question: If the Fed’s ability to raise rates is more limited than investors appreciate, then what?

For Rosenberg, a so-called Debt Jubilee is the inevitable result. In this scenario – in fact a default by hyperinflation – the US Treasury would put a large sum on the Fed’s balance sheet and the Fed would then print the money. Behind Rosenberg’s logic lies the idea that the Fed has become increasingly aggressive with its tools, probing the outer limits of monetary policy with each cycle and raising concerns about how it will tackle the next downturn. with zero rates and so many unconventional measures already deployed.

Whether something as extraordinary as a Debt Jubilee is in America’s future, one thing is clear: The growth needed in the United States to emerge from a precarious debt-to-GDP ratio is a long way off. to be guaranteed. The “right” kind of spending and debt that drives things like productivity and capital investment will help strengthen the economy. Not so strategic spending and debt, however, will erode the growth needed to keep high debt levels sustainable.

For now, it might be helpful for investors to shift some attention from the inflation side of the economy to the growth side. While economic growth looks excellent at first glance, the very elements driving it look a bit toxic.

Write to Lisa Beilfuss at [email protected]


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