Did seven years of zero percent rate policy, three rounds of quantitative easing (QE) and “Operation Twist” provide a consequence-free credit boom? Or will “too-low-for-too-long” monetary manipulation eventually lead to a credit bust – one with adverse effects for asset prices as well as economic growth?
It is not particularly difficult to understand that the mid-2000s credit expansion became an unsustainable bubble for households. At the pre-crisis peak in the fourth quarter of 2007, household financial obligations as a percent of disposable income had reached an eye-popping 18%. As of July 1, 2017, the American household burden was only 16%. Americans are in much better shape, right?
Unfortunately, borrowing costs have jumped considerably since last year. Tens of millions of consumers who face rising credit card and other variable rate commitments are seeing their household financial obligations as a percent of disposable income climb significantly. And while Americans may not find themselves quite as strained as they were leading into the Great Recession, they may not be in a strong enough position to increase spending dramatically in 2018 and beyond.
Household debt levels may not be as menacing as they were in the previous credit boom-bust cycle. On the other hand, corporations have never been as leveraged as they are right now. Additionally, excesses in corporate credit preceded each of the three previous recessions.
Consider corporate debt-to-GDP. The late 1980s corporate credit boom gave way to an early 1990s credit bust. The late 1990s corporate credit boom buckled under the pressure of an early 2000s credit bust. And the mid-2000s credit expansion? Corporations were forced to deleverage in response to the financial crisis of 2008.
Keep in mind, 200-basis point increases in the 10-year Treasury bond yield marked the peak in each of the aforementioned leveraging booms. In the same vein, a 200-basis point move on this go-around would occur with the 10-year hitting 3.36%. (Note: The 10-year yield hit its record low of 1.36% in July of 2016.)
