In an analysis that may rival that infamous "McKinsey report" from early 2015 which found that not only had there been no deleveraging since the financial crisis but that total global debt has risen to an unprecedented $199 trillion as of 2014, or up by $52 trillion in 7 years, earlier today S&P Global Raters issued a new report in which it forecasts that global corporate debt is set to rise by 50% over the next four years, rising from $51.4 trillion currently to $75 trillion by 2020 as a result of easy central bank monetary policy and low interest rates.
Not surprisingly, the world's biggest credit creator, China, is expected to account for the bulk of the credit growth, with the nation projected to add $28 trillion or 45% of the $62 trillion in expected global demand increase (the other $13 trillion of the $75 trillion total are refinancings). The U.S. is estimated to add $14 trillion, or 22%, in new debt, with Europe adding $9 trillion, or 15 percent.
In the latest attack on unorthodox monetary policy yet, S&P notes that central banks may be trying to reinflate their economies, but they’re doing so to the detriment of credit quality. “Central banks remain in thrall to the idea that credit-fueled growth is healthy for the global economy. In fact, our research highlights that monetary policy easing has thus far contributed to increased financial risk, with the growth of corporate borrowing far outpacing that of the global economy.”
Continuing their assault on central banks, authors David Tesher, Paul Watters and Terry Chan say that "nearly half of corporate debt issuers are estimated to be highly leveraged, strongly suggesting that a correction in global credit markets is unavoidable. In fact, analysts believe that the credit correction began in late 2015 and will likely stretch through the next few years as defaults spike."
This is best visualized in a recent report from Morgan Stanley which indeed shows that if history is precedent, the current default cycle will continue for a long time.
Here, once again, S&P explains how global central banks are now trapped: they no longer wish to push rates lower on one hand, but on the other any sharp spike in rates would wreak havoc on global credit markets, and the financial system in general. As a result, S&P considers a correction in the credit markets to be “inevitable.” The only question, as MarketWatch notes, is degree of that unwinding. An unexpected sharp economic slowdown and an aggressive reversal of ultra-low interest rates pose big risks to what otherwise could be an orderly drawdown of the global pile of IOUs.
The problem is that the default cycle has already started, and any sharp changes to interest rates will only accelerate it. As we pointed out last week, there has already been a sharp uptick in corporate defaults. Global corporate bankruptcies reached a milestone 100 so far in 2016 in July. That puts the current tally, led mostly by U.S. energy companies, up more than 50% from the same time last year. In fact, the last time the global count was higher at this point in the year was in 2009, during the financial crisis, when it reached 177. At this pace, 2016 is set to see a new all time high number in corporate defaults.
At this point the authors coin a new term, “crexit” or “heightened sensitivity to unexpected developments similar to the U.K.’s referendum to leave the European Union could lead to a crisis of confidence and rapid departure of both lenders and lower-quality borrowers from the debt markets.” Call it a sudden "exit" of the entire credit market as buyers, unsure of what comes next, stage a buyers strike and leave trillion in rolling over debt without a chance of getting refinanced.
The paper also touches on the poor use of proceeds from these trillions in debt, which instead of going toward new growth, has been largely used - especially in the US - to prop up markets and repurchase stock. And while so far, easier corporate credit has served its purpose, helping nurse along a slow recovery, mostly by way pushing the stock market to record highs amid a flurry of share buybacks and a Chinese credit-funded malivestment deluge, this will all end badly according to S&P.
“Indeed, the credit build-up has generated two key tail risks for global credit. Debt has piled up in China’s opaque and ever-expanding corporate sector and in U.S. leveraged finance. We expect the tail risks in these twin debt booms to persist.”
The conclusion is about as dire as anything one could read on a tinfoil fringe blog:
"A worst-case scenario would be a series of major negative surprises sparking a crisis of confidence around the globe. These unforeseen events could quickly destabilize the market, pushing investors and lenders to exit riskier positions (a ’crexit’ scenario). If mishandled, this could result in credit growth collapsing as it did during the global financial crisis.”
For now, however, the music is still playing so the dancing must go on.