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Leverage fears undermine ‘myth-making’ central banks

With central banks loosening their belts so much comes the risk of policy makers getting caught with their trousers down.



With the word ‘unprecedented’ being spoken at, well, such unprecedented levels that it has completely lost its impact, are we all just getting a bit complacent about the real dangers of close to zero-level interest rates and quantitative easing?

The warning signs have been coming through loud and clear this month. Negative-yielding bonds have become a reality, while a consequence is over-leveraging – Morgan Stanley estimates US corporates’ collective debt at a record 2.44 times their collective earnings. And remember, it was over-leveraging that got us into this mess in the first place.

“Leverage has increased by a material amount in each of the past five quarters, and is now at an all-time high for our universe, just barely surpassing the prior peak in the first quarter of 2002,” says Morgan Stanley analyst Adam Richmond.

“The fact that leverage is this high while the economy is still expanding means it will likely peak in this cycle at a much higher level than in the past when a downturn finally hits and earnings drop more broadly.”

James Spence, managing partner at Cerno Capital, comments: “I would argue that the unintended secondary consequences, the distorting affects, of zero interest rates and QE are creeping towards us.”