Rate Hike Odds Rise Again: Fed Concerned About Corporate Leverage

Despite anemic GDP forecasts for third and fourth quarter, the Fed appears to have convinced the market that it will finally hike rates in December.

by Mish

Odds of at least one hike hit 69.2% today, up from 65.1% yesterday. Is something on the Fed’s mind?

Fed Officials Concerned by Rising Corporate Leverage

According to the minutes from the late September policy meeting, released Wednesday, some members of the Federal Open Market Committee worried that some corporations are using ultralow rates to do more than their usual borrowing.
“A few participants expressed concern that the protracted period of very low interest rates might be encouraging excessive borrowing and increased leverage in the nonfinancial corporate sector,” the minutes say.
Leverage carried by companies rated investment grade and below investment grade has hit record levels, far exceeding the highs reached around the time of the financial crisis, according to statistics from Moody’s Investors Service.
Median debt at junk-rated companies is five times earnings before interest, taxes, depreciation and amortization, or Ebitda, according to Moody’s data. That compares with 4.2 times in 2008. The debt ratio for investment-grade companies is 2.6 times Ebitda, compared with 2.2 times in 2009, Moody’s data show.
Leverage can amplify gains as strategies perform well on the way up but magnify losses on the way down. In the last crisis, investors were forced to sell securities to cover losses and companies chose to forgo needed expenditures to cover interest payments.

Record Borrowing Surge

Falling GDP Estimates

  • Atlanta Fed GDPNow: 1.9% -Down from peak of 3.8%
  • Markit 3rd Quarter Estimate: 1.0%
  • FRBNY Nowcast 3rd Quarter: 2.3% – Down from peak of 2.7%
  • FRBNY Nowcast 4rd Quarter: 1.6% – Down from peak of 2.1%

Too Late to Worry

By the time the Fed starts worrying about something, it’s far too late. The damage has already been done.

The Fed could have and should have been hiking years ago (assuming there was a Fed).

Instead, it appears the Fed just may be hiking right as recession hits, or potentially after one has already started. At best, the economy is merely weakening from an already borderline state.

Related Economic Reports

Finally, please take a look at what I have been doing with Real Gross Domestic Income (RGDI) and Real Gross Private Domestic Investment (RGPDI): Real GDI, GPDI Recession Indicators Take II.

Those indicators have a huge recession warning flashing right now.

Mike “Mish” Shedlock

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