In a time of what to most, if not the market - yet - appears to be a forming perfect storm of trade wars, quantitative tightening, record global debt, a "terrible trio" of rising rates, oil price, and a surging dollar, Bank of America's European credit strategist Barnaby Martin has laid out what he believes is his biggest concern for the remainder of the year – and the downside risk scenario: an escalation in trade tensions between the US and Europe.
As increasingly more economists have pointed out in recent days, President Trump is only likely to back down on trade skirmishes once visible signs in the US emerge of either economic, market and/or political pain. And one look at the S&P 500, which is just shy of 2,800 and all time highs, these signs have been lacking.
But, as Martin notes, if the US/Europe tit-for-tat trade dispute progresses to autos, or even a broader range of goods, then it is likely to be growth-sapping for the Eurozone.
Our economics team highlight that these scenarios could lower Eurozone growth by between 0.3% and 0.7% (depending on the range of US tariffs and the response of the currency). Yet Eurozone growth next year is forecast to be just 1.7%.
In other words, US-EU trade wars could crimp Eurozone growth to the extent that the economy would only be growing marginally above its long-term trend rate of growth (~1%). This would imply slower progress in reducing economic slack, keeping inflation subdued.
But as Martin warned two weeks ago when he explained why, in his view, Europe simply can not have any more recessions - and thus QE can not end - for the simple reason that some €800BN in BBB rated bonds are in danger of becoming fallen angels, resulting in a corporate bond crisis...
... a slowing of inflation momentum in Europe would risk the market pivoting to worrying about debt levels again, i.e. realizing just how massively mispriced everything is with QE over.
To Martin, "this would be the “Quantitative Failure” narrative."
Meanwhile, as the IIF updated just yesterday, there are still many market fragilities when it comes to debt levels after years of loose monetary policy (or rather, as Bloomberg again explained today, the record debt is there because of central bank policies) . The next chart from Martin shows total non-financial sector debt by country, split by government, corporate and household debt.
Here Martin notes that that plenty of countries already have total non-financial debt in excess of 250% of GDP, and in particular a number of European countries. And the fragilities are across many parts of the economy. For instance, note the high numbers for:
- Household debt in Denmark, the Netherlands and Switzerland;
- Corporate debt in Sweden, Ireland, Spain, Netherlands and Belgium; and
- Government debt in Japan and Italy
Moreover, the BofA strategist adds that from a flow rather than a stock point of view, a number of countries have seen a rapid rise in their debt/GDP levels during the last decade, especially those where leverage was low after the Global Financial Crisis. Note, for instance, the jump in:
- Household debt (Chart 14) in Sweden, Canada and Norway, commensurate with property prices having risen dramatically here; and
- Corporate debt (Chart 15) in China, Switzerland, France (and Belgium – although the number is exacerbated by the tax environment).
BofA won't be the only one concerned about the level - and repricing - of corporate debt. As we reported last month, one man's crisis is another man's opportunity, and it is none other than distressed investing legend Howard Marks and his Oaktree, that is already eagerly looking forward to what it described as a "flood of troubled credits topping $1 trillion as rising interest rates overwhelm low-quality loans and bonds."
Speaking at the Bernstein Strategic Decisions Conference, Oaktree Capital's Chief Executive Jay Wintrob said that when the cycle turns it will be faster and larger than ever as "fallen angels" proliferate, and added ominously that "there will be a spark that lights that fire."
It increasingly appears that Trump's global trade wars could be just the spark that lights that particular conflagration.