Monetary policymakers’ non-financial corporate debt conundrum

‘Global debt is now more than three times global GDP.  That is a headwind to growth and makes us vulnerable to another period of financial stability.’ This was part of the conclusion from a recent speech by the Bank of Canada’s Carolyn Wilkins entitled ‘The Age Of Leverage’.  She also made the point that the financial system is safer than a decade ago. This, though, is not the same as saying monetary policy is more effective.

It is ironic, in that trying to save the global economy all those years ago, a side effect of global central banks’ policy of ‘financial repression’ is the explosion in debt. I say ‘side effect’, because part of the intension of quantitative easing (QE) was to push investors into riskier assets. A large element of the explosion has been in non-financial corporate debt.  

Indeed, there is still plenty of money around for investing in this area of the ‘risky asset’ spectrum.  As Informa Global Market's (IGM) Credit Team note - the recent Volkswagen deals attracted €5.1bn for the €2.75bn on offer, and this is a company which has had more than a few troubles of late!

The aforementioned speech by Wilkins noted that global debt now totals $240trn, which is $100 trn higher than just before the financial crisis and remember three times global GDP (IIF data). This is some leverage ratio for the global economy and, it all needs to be refinanced on a regular basis.  

With this in mind, is it any wonder the financial markets are so much more sensitive to tighter financial conditions than in the past?  This in turn amplifies attempts by central banks to move the policy needle in any direction, but it seems a more restrictive policy, even when interest rates are historically low, sends the markets into tailspin, even when economies are performing ok.  

This suggests the level of debt and its refinancing, rather than just in the interest rate, have become a crucial issue for the markets and policy levers, and therefore restricts central banks’ ability/desire to tighten.

Further, the more debt there is, the more free cashflow that is required to service it.  This is money that could be used for investment and lending to the real economy, which should lead to improved economic growth prospects pushing inflation, and inflation expectations, back to target.  

This is the aim of unconventional policy (negative rates and QE). In the world of old, economic growth lowered debt burdens, but over the last decade, it seems more and more debt is required to obtain the same rate of economic growth. This in turn implies the structure and functioning of economies has changed.  

If this is true, then an important question is what does this mean for central bank policy?  Ergo, are interest rates and even unconventional policy the way to influence the economy within an inflation targeting framework or does the framework need to be changed or maybe jettisoned all together?  As Wilkins notes, the debt level is a headwind to economic growth. 

Marcus Dewsnap is Head of Fixed Income Strategy at IGM. 

More from Marcus Dewsnap:

• The US economic growth engine that might impact the ECB, 5 Oct 2018
• 10-years on from Lehman collapse and still relatively easy money in Europe, 11 Sep 2018
• Curve steepening needs more than just BoJ machinations, 26 Jul 2018