Because of the structure of household debts, the recent increase in long-term yields is unlikely to have much impact on their debt service ratio.
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- Because of the structure of household debts, the recent increase in long-term yields is unlikely to have much impact on their debt service ratio.
- The data shows no evidence of bunching of corporate bond maturities.
- Because higher yields are associated with higher growth, faster profit growth will likely offset higher interest rate costs.
- The data shows no clear relationship between capex or employment and availability or cost of external finance.
- Listed companies could be more exposed to tighter financial conditions than the average US employer, but the former account for a much smaller share of employment growth than the latter.
- The recent increase in long-term yields is likely to have only a limited impact on US growth.
- I expect the Fed to hike in 2023 and 2024, against market pricing of a 40% chance of a 2023 hike and 2.5 cuts in 2024.
Households Immunized Against Higher Yields
The recent increase in long-term yields has led to concerns over refinancing risks and a steep increase in funding costs next year. In this note, I argue that those concerns are unfounded.
The household debt service ratio (DSR) tends to change only gradually and is much more driven by household debt than long-term year yields (Chart 1).
This is explained by the structure of household debt, which is either on very long maturities or revolving:
- 90% of mortgages are fixed rates, and the most common maturity of mortgages is 30 years.
- Student loans are on a fixed rate, with maturities ranging from 20 (ex ante) to 30 years (ex post).
- Car loans are on fixed rates, with maturities ranging of about 5-6 years.
The main channel of transmission of higher yields is through credit card loans that are on adjustable rates. However, those account for only 6% of total household debt. In addition, those loans are revolving, i.e., do not carry refinancing risks.
Eventually, the higher yields will pass through to household debt service, but this will be a long-term process.
No Sign of Corporate Maturity Wall
Similarly, there is no evidence of a corporate bond maturity wall. For starters, corporate bonds represent only about one fourth of non-financial corporate businesses liabilities (Table 2).
And while there was an increase in corporate borrowing during the pandemic, both bonds and loans, refinancing risks seem limited (Chart 2).
First, the 2020 borrowing spike was followed by a sharp decline: on a 3-yr ma basis, bonds and loan borrowings have been stable and more recently have been falling relative to corporate income (i.e., profits).
A detailed look at corporate bonds maturing over the next few years show no bunching of maturities (Chart 3).
Second, the proceeds of the 2020 stepped-up liability issuance were used to fund the acquisition of liquid financial assets, largely bank deposits (Chart 4). By contrast, an increase in borrowings in 2022 was used to fund mainly share buybacks.
Overall, though, the ratio of bonds and loans over liquid assets remains lower than before the pandemic, which could help corporates weather any difficulties in rolling their debts (Chart 5). In addition, broader leverage ratios such as total liabilities over net worth also remain stronger than before the pandemic.
Faster Profit Growth to Offset Higher Interest Rate Cost
Even if there was a substantial share of corporate bonds maturing next year, the impact of refinancing at higher rates would be offset by faster profit growth. This is because higher yields are associated with higher nominal GDP growth. This relationship could explain the historically limited passthrough from long-term yields to the corporate debt service ratio (Chart 6).
No Obvious Causality From External Finance to Corporate Demand
There is only a weak relationship between corporate demand, i.e., capex (non-residential investment in the GDP data), and employment and changes in financial liabilities and equities, i.e., availability of external finance (Chart 7).
This is hardly surprising since capex tends to be internally funded: corporates have turned net lenders (retained profits have been larger than capex) since the late 1990s (see this academic paper for a discussion of causes and consequences).
There is no obvious relationship either between capex and nominal or real long-term yields (Chart 8). This could reflect that capex could be driven by ‘accelerator variables such as lagged output or sales’ rather than by the cost of capital (see Bernanke and Gertler). Indeed Chart 7 shows that capex behaves similarly to employment, suggesting their drivers may not be that different.
The SPX Is Not the US Economy
The data discussed in this note conveys a more optimistic message on the ‘maturity wall’ than found in the media. This could reflect that financial media are more focused on listed companies that by definition are more financialized than the average American employer. For instance, equity values are likely to be more important for listed than non-listed firms’ capex and employment plans.
However, listed companies tend to be large, and larger firms play a smaller role in job creation. For instance, SPX constituents account for about 15% of total employment, have an average workforce of 55,000, and 97% of them have employment above 1,000. By contrast, 97% of US employers have a workforce of less than 500.
Firms with more than 1,000 employees, however, account for only about 7% of total hires. This suggests that even if listed firms are more exposed to tighter financial conditions than the average American employer, the consequences for employment and growth could be more limited.
In this note, I showed why higher yields may not do much to slow the economy.
This is very much in line with Fed Governor Waller’s (voter, hawk) recent speech. He argued that the combination of strong growth and slower inflation was inconsistent and that either growth would slow, or inflation would accelerate. His conclusion was that ‘if the real economy continues showing underlying strength and inflation appears to stabilize or reaccelerate, more policy tightening is likely needed despite the recent run up in longer term rates.’
This is the first time a Fed speaker has raised the prospect of a 2024 rate hike and is in line with my expectations of one more hike at the December 2023 FOMC meeting and 2-3 more in 2024 H2, assuming no oil shock when the Fed would be forced to tighten more aggressively. This compares with markets pricing only a 40% chance of a hike in December and about 2.5 cuts for 2024.