Corporate Debt - Currently Not An Issue

Updated: Dec 2, 2019

US Government Debt is increasing at a pace greater than $1T annually as the tax cuts have decreased tax receipts at a greater pace than new taxes raised through increased economic activity. Of course, spending keeps going up regardless of what party is in charge of anything. Government debt can be an issue a number of ways:

- interest payments on the debt can crowd out discretionary spending

- it can cause higher interest rates for mortgages and corporate debt

- ultimately it could cause the US to default if we can no longer service out debt

Given the extremely low interest rate environment, the first two issues have not materialized and we are a long way from the third given Japan's current debt is twice it's GDP while US debt is roughly equal to its GDP.

Government spending is unfortunately unlikely to decrease regardless of what happens short of a default (or maybe until one, regardless a long long way off), so spending might 'change' but will still exist for virtually all government programs.

What we can look at more closely is the effect government debt has on corporate debt more specifically in the form of warnings received on the level of corporate debt and the amount of debt to be reissued or 'rolled over' over as it matures.

Below is a chart from McKinsey from an article about 2 years ago. The article discussed the high level of corporate debt maturing globally, but especially in the US as corporations used extremely low-interest rates to reissue maturing bonds as well as issue new debt (some of which was likely used for stock buybacks). At the time many people were talking about rising US Treasury interest rates and how it could cause a debt problem for corporations given the 'massive' amount of corporate debt maturing and likely to be re-issued, likely sending interest rates higher or much higher.

At the same time, the Federal Reserve was starting to sell off its balance sheet (redeeming it's US Treasury holdings purchased during QE programs) and that would add another $500B/yr to the amount of debt needing to be financed. Interest rates were rising in the second half of 2017 and many were concerned about the effect that increasing deficits, Federal Reserve selling and corporate re-issuance would have on the ability of corporations to service their debt.

In Jan 2018 the 5 Year US Treasury Note was at 2.25%. Over the next 21 months it fell to 1.3% and currently sits at about n 1.6%. If we look back to when much of this debt was issued, we see generally similar rates with short rates lower and long rates higher.

In other words, the problem did not materialize. Given that we're actually past the peek of maturing corporate debt (potentially requiring re-issuance) and the Federal Reserve is no longer liquidating its balance sheet, even with increasing US debt issuance it likely that corporate debt issuance is going to be an issue for some time. And, that means that interest rates are not likely to go substantially higher regardless of Fed policy. Corporate debt is not currently an issue.

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