The Credit Crunch

As a full-fledged member of the Gloom and Doom Club, this Newsletter continually searches for tell-tale signs of oncoming disaster. The real question is when. October 2017 was marked by further stock market gains with the correction coming only in February 2018. H2 2018 is now a candidate for the hard times as is 2019. The so-called recovery has reached a ripe old age, so the odds are good that something painful will happen soon.

The Fed is up to raising interest rates, and that usually leads to a recession. Another 50 bps might do the trick. A flattening yield curve is a promising sign, but an inverted yield curve almost always precedes a recession. Another problem is that this time is different. The difference is almost a decade of ZIRP and NIRP, QE, swollen central bank balances, central banks intervening in the markets and most frightening of all, the huge debts that have been amassed since the last crisis.

The BoJ has become the largest holder of ETFs in Japan while the SNB has amassed a stock portfolio worth billions. The Fed wants to unload a large portion of its $4.5 trillion balance. So one may well ask what is going to happen with the Fed raising interest rates and trimming its balance while the Treasury needs to borrow $ 1 trillion just to cover the budget deficit.

The global slowdown has already started as EM dollar debt weighs heavily upon companies that borrowed cheaper dollars at low rates. Refinancing all those loans is going to cause problems without even considering how the debt can be serviced. But that problem is outweighed by the plight of the Americans as they struggle against a flattening yield curve. The Treasury is going to find it continually more difficult to service the debt and find buyers for US paper. The SNB can keep up the stock market but not provide credit.

China may be exacerbated by the Trump administration`s insistence on imposing tariffs and sell off more and more of its US debt while simultaneously not buying any more of it. With the Treasury sucking up what capital is available in a rising interest rate environment, the scene is set for a credit crunch as companies seek to refinance low-interest debt that was used for share buyback programmes. The Trump tax cut boosted Q1 earnings, but that was a one-time shot. As credit tightens, so does the noose of debt. It is when one needs credit the most that it becomes most elusive. Insolvency is the result.

Walter Snyder

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