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Fed Quietly Confirms Fears About Stock Market’s $10 Trillion Powder Keg

Last Updated September 23, 2020 1:27 PM
Laura Hoy
Last Updated September 23, 2020 1:27 PM
  • The Fed published its December meeting minutes to little fanfare.
  • A paragraph within the meeting summary suggests central bankers are becoming uncomfortable with the ballooning corporate debt bubble.
  • Warnings that the stock market can’t keep marching higher have started to look more credible.

For months, warnings about market bubbles and a potential stock market crash have been ringing throughout Wall Street. Now, the US Federal Reserve has subtly added its voice to the chorus of alarm bells.

The central bank’s most recent meeting minutes suggest that some of its members are becoming concerned that the Fed’s easy-money policies have inflated a dangerous corporate debt bubble. The bank’s decision to keep interest rates low throughout 2020, they warned, could exacerbate the problem.

Fed Minutes Confirm Corporate Debt Bubble Worries

Traders are likely applauding the Fed’s decision to keep interest rates unchanged in December, as well as the bank’s intention to maintain low rates for the remainder of 2020.

But that kind of thinking is exactly what the bank is worried about, according to the summary of its latest meeting.

federal reserve, jerome powell, stock market
Some of the Fed’s members expressed concerns about the repercussions of the bank’s easy-money policies. | Source: REUTERS/Jonathan Ernst

According to the Fed’s meeting summary, some from the bank are worried that its own policies will continue fueling the corporate debt bubble  and make the next US recession even more severe. 

A few participants raised the concern that keeping interest rates low over a long period might encourage excessive risk-taking, which could exacerbate imbalances in the financial sector.

The concerned few also,

remarked that such policies could be inconsistent with sustaining maximum employment, could make the next recession more severe than otherwise, or could strengthen the case for the active use of macroprudential tools to guard against emerging imbalances.

Essentially, the bank has been forced to make a decision— pain now, or pain later. Apparently, the majority of central bankers opted for the latter. 

Corporate Debt a $10 Trillion Concern

The Fed isn’t the only one to sound the alarm on the worrying amount of debt US businesses have racked up while interest rates were low.

Corporate debt has risen by 50% since the financial crisis, bringing the grand total to just under $10 trillion . 

corporate debt bubble chart
Corporate debt is on the rise. | Source: Deloitte 

Over the next five or six years, about half of that debt is going to mature, the result of which could be catastrophic. Many US corporations that used cheap debt to finance buybacks and acquisitions will likely have to refinance at higher rates, putting a strain on corporate earnings and, in turn, share prices. 

Debt isn’t the only thing set to pressure corporate earnings in the quarters ahead. Wage growth is also likely to weigh on earnings throughout 2020 as low unemployment and pay hikes take a bite out of profits. 

Emre Tiftick, a debt specialist at the Institute of International Finance, called the wave of cheap borrowing  among US corporations an “unexploded bomb,” noting that, “we really don’t know what will trigger the explosion.”

Has the Fuse Already Been Lit?

According to some, the market is already on borrowed time. Some say that US manufacturing data has trouble brewing under the surface.

ISM new orders have been falling for more than a year, indicating weak demand and pain ahead.

Others point to a housing market collapse as a potential powder keg as home prices soar to unsustainable levels. 

With all of those factors simmering beneath a decade-long bull market, tension with Iran could be the final push into a downward spiral.

The US stock market’s rally screeched to a halt on Friday on news that Donald Trump ordered an airstrike in Baghdad.  As stocks had been trading near all-time highs, a swift recovery is unlikely.

Only time will tell whether Friday’s stock market pullback will turn into something larger, but one thing is for sure— the market’s recent rally is unsustainable.

Now that the Fed has confirmed worries that quantitative easing has pumped up the corporate debt bubble, a stock market crash looks all but inevitable.