Central banks have been pigging out on debt – and because of their compulsive consumption, the world is on the brink of a recession. At least if the yield curve is to be believed. This is the conclusion reached by Janus’ Bill Gross in his latest investor letter where he writes that, since the post-Lehman age of quantitative easing began, over $15 trillion of sovereign debt and equities have come to “overstuff” central bank balance sheets, along with over $5 trillion in investment grade bonds trading at negative interest rates.
The years-long effort to renormalize real and nominal GDP growth rates has largely been a failure Gross argues — but as policymakers begin the slow and steady process of raising interest rates, they don’t seem to see what’s coming next. And what’s around the corner looks pretty ugly given how little the cost of short-term financing has to rise in order to really hurt businesses and individuals.
Gross reminds us that the most destructive leverage (remember pre-Lehman subprime mortgages?) always lives at the short end of the yield curve, where monthly interest payments can quickly squeeze (and ultimately suffocate) debt holders.
Sure, governments and the U.S. Treasury can afford the steeper payments — corporations and individuals … not so much.
Policymakers would do well to remember that the last three recessions (1991, 2000, and 2007-2009) were caused by a spike in short-term borrowing costs:
” … since the Great Recession, more highly levered corporations, and in many cases, indebted individuals with floating rate student loans now exceeding $1 trillion, cannot cover the increased expense, resulting in reduced investment, consumption and ultimate default.”
Gross points out that a mere 85 basis point increase in interest rates would nearly double the cost of short-term finance – and that those numbers correspond exactly to the bump in debt costs that sparked those three above-mentioned recessions.
Slow and steady means one thing to policymakers – but it will be a lot more painful for everyone else. And that will inevitably impact consumption and growth.
The debt buffet is closing – do policymakers know where everyone’s next meal come from?
Read the full letter and check out the charts.