The spread of coronavirus could blow the lid on the next financial crisis and push the U.S. economy into recession.
That’s according to an analysis of corporate debt relative to GDP, one of the most reliable indicators of recession.
The U.S. economy is sitting on a mountain of corporate debt that could set off the next major financial crisis as coronavirus reaches pandemic proportions.
As David J. Lynch of The Washington Post noted in a Mar. 10 article, corporate debt usually spikes just before recession hits:
Like clockwork, non-financial corporate debt as a percentage of gross domestic product (GDP) surges in the lead up to a recession, which is defined as back-to-back quarters of declining growth. That’s exactly what we’ve seen during major economic downturns over the last 40 years.
In 2001 and 2009, corporate debt relative to GDP hit 45%. It now exceeds 46%. That’s equivalent to more than $10 trillion.
While the U.S. economy has staved off recession under President Trump, growth has waned since the administration’s tax cuts were implemented in 2018.
The U.S. economy has expanded more than 2% in each of the last four quarters, but has only exceeded 3% annual growth once over that period (and that followed an abnormally weak Q4 2018).
President Trump has promised an emergency fiscal response to revive plunging stock markets and a cooling business climate hit hard by coronavirus. This includes the possibility of payroll tax cuts and medical leave for hourly employees.
So far, the only immediate response from government has been an emergency interest-rate cut by the Federal Reserve. One of the many downsides of ultra-loose monetary policy is it encourages the same reckless behavior that allowed corporations to sell record amounts of bonds at historically low interest rates.
The surge in corporate debt isn’t just limited to creditworthy companies. As The Washington Post noted, there has been a dramatic increase in borrowing by firms just one level above “junk” status.
Some corporate borrowers were downgraded recently over coronavirus-related headwinds. Businesses tied to travel, tourism and hospitality have been hit especially hard.
Downgrades are expected to continue as the economic outlook deteriorates over coronavirus and the oil-price shock instigated by Saudi Arabia.
With so many S&P 500 companies issuing negative earnings guidance for the first quarter, more corporations could find themselves struggling to repay their debt. A slowing economy will dampen revenue and earnings, making debt serviceability all the more challenging.
With the number of confirmed coronavirus infections surging past 116,000, many economists expect global GDP to flat-line this year. The Institute for International Finance said last week global GDP growth could be as low as 1% in 2020. Meanwhile, Rabobank said Tuesday that a “global recession is now all but certain.”
If debt continues to grow as the economy slows, a new cycle of spending cuts and layoffs could ensue. Credit downgrades could lead to higher borrowing costs even in a favorable interest-rate environment.
The Federal Reserve is attempting to keep the debt bubble inflated, with the likes of Eric Rosengren even suggesting that the central bank could start buying stocks to rev up the economy. Thankfully, Rosengren isn’t a voting member of this year’s Federal Open Market Committee (FOMC). The scary thing is Rosengren is probably the most hawkish regional Fed Bank president alongside Esther George.
Even if the Fed lowers interest rates (and it will), the corporate debt bomb could still explode as the economy grinds to a halt. Coronavirus may render the Fed’s conventional policy tools obsolete, if record consumer and business debt haven’t done so already.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.
Last modified: June 13, 2020 12:24 AM UTC