Troubling developments are unfolding in the credit markets, signaling potential economic distress. The federal funds rate, hovering above 5%, echoes levels last seen in 2007 before the economy plunged into a major recession and financial crisis. Cracks within the markets are becoming audible, with commercial property loan delinquencies reaching five-year highs. A distressing number of office loans bundled into commercial mortgage-backed securities (CMBS) are now at least 30 days overdue, prompting investors to withdraw from CMBS and driving up borrowing costs.
Credit card delinquencies are also a cause for concern, with Capital One, Discover, and Bread Financial experiencing rising rates since April. The 18 to 29 age group seems to be particularly affected. Moreover, personal savings rate data reveals a significant shift. During the lockdowns, the personal savings rate reached a record high of nearly 34%, primarily due to individuals staying at home and the government injecting cash into the economy. However, as inflation started to rise, households quickly depleted their savings to cope with price increases, resulting in a personal savings rate of only 4.6% today, far below the pre-pandemic average of 7.3%. This decline was an unfortunate consequence of the inflation offsetting the benefits of savings. Since winter 2021, savings rates have remained below pre-pandemic levels as households needed to resort to credit card borrowing to make ends meet. However, the delinquency data indicate that this unsustainable trend is reaching its conclusion.
Nevertheless, the impact of high interest rates has not fully manifested as many borrowers have yet to refinance their debts. Oleg Melentyev, head of high-yield credit strategy at Bank of America, has uncovered a fascinating insight. Although global interest rates have risen from 1% in 2021 to approximately 4% presently, the average interest rate has only increased by 0.5% due to borrowers’ avoidance of refinancing. Should all interest rates ultimately reset to reflect the prevailing 4% market rate, borrowers worldwide would face a staggering cost of around $8 trillion. To put this into perspective, that sum is roughly equivalent to the combined gross domestic product of Germany and Japan, the third- and fourth-largest economies globally. This alarming observation highlights the underlying issue plaguing most developed countries: their tremendous debt burdens. Despite claims of deleveraging after the 2008 financial crisis, the reality is quite different. In the United States, household debt as a percentage of GDP peaked at around 98.2% in mid-2009 and has only slightly decreased to 72.3% today. Conversely, business debt has risen from 73.7% to 75.4% during the same period. Overall private-sector debt has fallen from its peak of 234% of GDP to the current 218%, which paints a less-than-inspiring picture of deleveraging efforts.
Deleveraging failed to materialize primarily because the Federal Reserve utilized quantitative easing and other unconventional monetary tools to suppress interest rates and bolster borrowing. However, with rising interest rates, the system now faces a severe stress test. There appear to be two potential paths forward. The Federal Reserve can either continue to raise interest rates or maintain them at their current levels, which would likely lead to a financial crisis. Alternatively, the high interest rates may trigger a recession not accompanied by a financial crisis, prompting the Federal Reserve to resort to quantitative easing and other measures in an attempt to revive the economy. Unfortunately, this perpetual credit cycle seems to confine us to a state of uncertainty. The Federal Reserve metaphorically seeks to control the temperature of the economy, but in reality, its interventions resemble intravenous injections that provide temporary relief but fail to address the underlying issues. This approach leaves the American economy unstable and disoriented, rendering long-term investment decisions elusive. Such “therapy” is undoubtedly harmful and counterproductive.
In conclusion, the credit markets are experiencing troubling developments that could potentially lead to an economic crisis. Commercial property loan delinquencies, rising credit card delinquencies, and low personal savings rates are among the concerning signs. The implications of rising interest rates and the enormous debt burdens in developed countries warrant serious attention. The failure of deleveraging efforts post-2008 financial crisis has left the system vulnerable and in need of a real stress test. The Federal Reserve’s decisions regarding interest rate hikes will play a crucial role in shaping the future trajectory of the economy. However, it appears that the perpetual credit cycle and the Fed’s reactive approach offer little stability and hinder long-term investment decisions. A comprehensive and sustainable solution is necessary to address these challenges and promote a healthier economic landscape.
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