In the Trenches: Bridge Out?
December 14, 2018·0 comments·In Brief
The global financial system was built to feel safer, but the safeguards designed to prevent crashes have instead encouraged more risk. Now central banks are stepping back from the policy that held everything together, and four unmistakable warning signs suggest the collision they prevented a decade ago is becoming inevitable.
• Capital is fleeing emerging markets at the fastest pace since the financial crisis. Higher U.S. interest rates have reversed the synchronized global growth narrative that drew investors in just a year earlier. The smaller the emerging market economy, the harder the hit to its currency and growth trajectory.
• Europe's structural flaws are becoming visible as the ECB tapers its support. The eurozone was built on a false assumption: that sovereign debt issued by different countries would always carry the same risk. Italian bonds have only recently begun to price that assumption as wrong.
• Median income households can no longer afford homes, yet homeownership rates stay artificially low. Years of ultra-low rates and government intervention created subsidized housing for those who refinanced. New buyers face a 43% increase in annual housing costs compared to three years ago, with wage growth stuck near 1%.
• Corporate debt has reached the exact level that preceded every recession in the past three cycles. Banks and companies gorged on borrowing at a moment when sovereign wealth funds and other traditional safe-money holders were desperate for yield. That desperation is now ending as safer opportunities reemerge.
• Central banks know the warning signs and are already changing course, but the question is whether recognition comes soon enough. The Fed has already walked back its hawkish rhetoric. The real test comes with the ECB's decision and whether it can manage the consequences of withdrawing stimulus while Europe slows.
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