No More Room to Increase Leverage - A New Approach Required!

The policy response to the global crisis remains so forceful that it has prevented any real deleveraging from happening. Leverage has actually increased globally which has actually been the intended goal of most policymakers today.

By most objective measures, we are deep into the longest period ever of excessively easy monetary policies. During the great recession, rates were set at zero and they expanded their balance sheet by $1.4T.  More to the point, after the great recession ended, the Fed continued to expand their balance sheet another $2.2T.  Today, with unemployment below 5% and inflation close to 2%, the Fed’s radical dovishness continues. If the Fed was using an average of Volcker and Greenspan’s response to data as implied by standard Taylor rules, Fed Funds would be close to 3% today. In other words, and quite ironically, this is the least “data dependent” Fed we have had in history.

Simply put, this is the biggest and longest dovish deviation from historical norms ever seen. The Fed has borrowed more from future consumption than ever before, and despite the US global out-performance, the US still currently has the most negative real rates in the G-7.

Every single leading indicator we have points to wider credit spreads. It doesn’t matter if you look at:

  1. Accounting Relationships (cash flow to debt, capex to EBIT) or
  2. Economic Relationships (corporate debt-to-GDP, lending growth YoY), or
  3. Market Relationships (yield curves flattening).