With everyone focused on the 5th anniversary of the Lehman failure, we are taking a quick look at how the world’s developed (G7) nations have fared since 2008, and just what the cost to restore “stability” has been. In a nutshell: the G7 have added around $18tn of consolidated debt to a record $140 trillion, relative to only $1tn of nominal GDP activity and nearly $5tn of G7 central bank balance sheet expansion (Fed+BoJ+BoE+ECB). In other words, over the past five years in the developed world, it took $18 dollars of debt (of which 28% was provided by central banks) to generate $1 of growth. For all talk of “deleveraging” G7 consolidated debt has been at a record high 440% for the past four years. So in the G7, which is a good proxy for the developed world, debt continues to increase whilst nominal growth remains extremely low thus ensuring that the deleveraging process has yet to start. As Deutsche Bank states, “at best we’re stabilising the ratio at or around record highs.”
As for the implications for interest rates, they are quite clear:
In an ultra low interest rate environment (short and long-term rates), it’s possible to carry this debt in a low growth environment but with little deleveraging taking place it creates a fragile environment that leaves these economies vulnerable to shocks and policy errors.
If rates were to rise notably from these ultra low levels, this could be just such a shock. This is why in spite of the recent sell-off, rates are likely to stay lower for longer as the alternative could be highly destabilising given the extreme debt burden being carried across large parts of the world.
Or, said otherwise, once the 10Y drifts ever higher and breaches the proverbial 3.50% “Disorderly Rotation” level, that will be precisely the level at which Bernanke will have no choice, liquidity implications for the TSY and repo markets be damned, but to give up on forward guidance and step right back in. One wonders how long until bond traders realize just this and call his bluff.
Source: Deutsche Bank