- JP Morgan said the build-up of global debt is unlikely to pose a threat in 2018, but trouble potentially looms next year.
- They said the continued withdrawal of monetary stimulus by the US Fed lurks as the main catalyst.
- Many advanced economies have seen total debt-to-GDP levels rise by more than 50% in the last 10 years.
Global debt markets got a scare last week as a political crisis sparked a sharp selloff in Italian bond yields, but analysts at JP Morgan said isolated incidents are unlikely to give rise to systemic problems in the second half of this year.
2019, however, could be a different story.
The team assessed whether specific shocks — such as last week’s rout in Italy’s bond market — should be taken as a warning signal about a widespread sovereign debt crisis.
To determine situations where an isolated debt scare becomes the catalyst for a systemic problem, the analysts set out a 3-step template based on historical examples.
1. Large imbalances across multiple countries;
2. A macro or policy shock;
3. A slow or half-hearted domestic response.
Viewed in that context, “2018 seems to still lack a few ingredients” for a systemic shock, the analysts said. “It should be different in 2019, however.”
The second point — a macro or policy shock — was highlighted as the main risk factor.
“The greater and broader challenge could come in 2019 as US Fed policy moves from easy to neutral to restrictive,” they said.
Furthermore, “this threat applies to all over-indebted sectors rather than just sovereigns”.
In addition to government borrowing, corporate debt and household leverage have also risen to record levels amid an era of record-low interest rates.
And not by a small amount.
“About a dozen countries have seen their total indebtedness rise by over 50 percentage points of GDP over the past decade,” the analysts said.
Australia’s debt to GDP ratio has risen by more than 40 percentage points in that time, while China’s has more than doubled.
This chart neatly illustrates the scale of the build-up:
Rising debt levels have also been largely skewed towards developed market economies — not just in terms of total debt-to-GDP, but also the increase in debt since 2008.
Here’s how the debt build-up has played out across different countries:
- Increased government borrowing in the wake of the financial crisis: mostly the US, Europe and Japan;
- A buildup in corporate leverage during an era of easy money: mostly the US, China, Turkey and Chile; and
- Overextended households: mostly Australia, Canada, Sweden, Switzerland, Korea, Thailand
“Against this leverage backdrop, it may be impossible to prejudge which sector in which country will represent the first canary” in the proverbial debt coal-mine, JP Morgan said.
The analysts said recent economic flare-ups are manageable for now.
“These local stresses can ebb and flow throughout 2018, but they still seem too unique (Argentina, Turkey) or too fixable (Italy can manage a moderate fiscal ease) to be systemic for very long,” they said.
However, there is still a reckoning to be faced as major global central banks continue the withdrawal of liquidity that was used to keep the global economy afloat in the wake of 2008’s financial crisis.