BIS Fears "Bulge Of BBB Debt" And "Financial Cycle" Default Waves

In its 4th quarter review, the BIS is concerned about the rise in near-junk debt, fearing "waves" if the economy sinks.

Easy Credit, Elevated Valuations, Bulge of BBB Debt

Claudio Borio strikes an ominous tone in the BIS 4th Quarter "On the Record" Media Review, emphasis mine.

Despite the tightening in the period under review, from a longer-term perspective US financial conditions are still comparatively easy. This is so even if one considers the stock market rout - in fact, valuations remain rather elevated. Despite the steady increase in credit spreads, nowhere are easy financial conditions more evident than in the leveraged loan market, which continues to be overstretched. And the bulge of BBB corporate debt, just above junk status, hovers like a dark cloud over investors. Should this debt be downgraded if and when the economy weakened, it is bound to put substantial pressure on a market that is already quite illiquid and, in the process, to generate broader waves.

Since the early 1980s economic downturns have been triggered more by financial booms gone wrong than by monetary policy tightening to quell inflation flare-ups.

The market tensions we saw during this quarter were not an isolated event. As already noted on previous occasions, they represent just another stage in a journey that began several years ago. Faced with unprecedented initial conditions - extraordinarily low interest rates, bloated central bank balance sheets and high global indebtedness, both private and public - monetary policy normalization was bound to be challenging especially in light of trade tensions and political uncertainty. The recent bump is likely to be just one in a series.

Financial Cycle and Recession Risk

In "The financial cycle and recession risk", Claudio Borio, Mathias Drehmann and Dora Xia make a case that indicators of the state of the financial cycle do a better job than a flatter yield curve in signalling recession risks.

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