Global debt — when is the day of reckoning?

Central banks and companies still have ways of kicking the can down the road

Laurence Fletcher




How worried should we be about debt? The answer is not straightforward.

First, the bear case. In short, debt is just too big for comfort. Global debt has swelled 50 per cent in the decade since the credit crisis, according to Standard & Poor’s, the rating agency. Government debt in the eurozone is higher than before the financial crisis, as are, in some cases, household debt-to-income ratios.

Meanwhile, private equity firms’ debt-to-earnings ratios are approaching pre-crisis levels, suggesting they are again comfortable with taking on more debt on the companies they buy. So-called covenant-lite deals with low investor protections are the norm.

If this all goes wrong, it could be ugly, with broad ramifications for investors and economies.

For instance, a downturn could trigger downgrades on the huge number of bonds that just scrape into the investment-grade ratings, leading to a wave of forced selling by funds that cannot hold debt below triple-B.

So-called “financialisation” — whereby companies take on more, cheap debt to boost equity market returns — could also mean less resilience when things start to sour. Andrew McCaffery of Aberdeen Standard Investments, points to a potential “rapid negative feedback loop into economic activity”.

A side effect of higher debt levels could be that investors and economies start to feel the effects of a sell-off or a slowdown more quickly than they might otherwise have done.

But, bulls point out, immediate triggers for a day of reckoning are lacking. US housing debt is down since the crisis. US economic growth remains robust. And, if there is stress, it is not showing up yet: corporate defaults in both developed and emerging markets remain rare.

Fraser Lundie, co-head of credit at Hermes Investment Management, said corporate borrowers (even those with low ratings) still had wriggle room to avoid repayment problems. They can use levers such as dividend cuts to help bondholders, shifting some of the strain on to equity holders instead. Indeed, Mr Lundie said he had used market jitters over triple-B bonds as a buying opportunity.

Sadly for debt bears waiting for their moment of glory, borrowers are likely to be able to keep paying back high levels of debt for some time because, quite simply, it is cheap. Central banks and companies still have ways of kicking the can down the road.

A sweep higher in inflation or a dive in global growth would, of course, throw the bullish case off course. Until then, some market watchers are keeping the faith. “I’m very worried [about debt] if you have a long time horizon. I’m not at all worried if you have a short time horizon,” said David Lafferty, chief market strategist at Natixis.

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