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Across most of the developed world, interest rates are plunging to record lows—including on corporate debt and mortgages. Yet pundits we read regularly in the financial press suggest this masks a dangerous debt build up amongst businesses and households, with analysts and policymakers fretting publicly it will stifle growth sooner or later.[i] In our view though, the developed world’s private sector isn’t struggling with its debt burden—and doesn’t look likely to for the foreseeable future.

Overall, businesses’ and households’ ability to service their debts look manageable to us. How can we know? The Bank for International Settlements (BIS)—an organisation owned by 60 of the world’s central banks, including the ECB and US Federal Reserve—attempts to monitor potential risks to financial stability around the world. One of the gauges it finds most effective when assessing risks is private non-financial sector debt service ratios.[ii] Debt service ratios measure borrowers’ debt payments relative to their income. In other words, their ability to stay current on the debts they have outstanding. The thinking: If borrowers’ income is well above the debt payments they need to make, they likely have the means to repay debt, avoiding default (failure to make required interest and/or principal payments as scheduled). Tallied across major sectors of the economy—particularly the private sector, which generates the vast majority of economic output—the measure can reveal countries’ potential financial and economic risks.

In the past, relatively high private-sector debt service ratios have occasionally coincided with financial crises and recessions.[iii] However, after a decade spent paring back problematic debts, eurozone businesses and households have greatly improved their ability to pay their remaining financial obligations, rendering them more creditworthy, in our view. Consider: Italy’s private-sector debt service ratio—as of Q4 2018—is close to Germany’s, which has fallen for decades. (Exhibit 1) Spain’s has nearly halved since 2008 (and is currently below the comparable US level). Now, these are backward looking and don’t necessarily say anything about the future. But they also tend to move slowly quarter to quarter, and as such, imply economy-wide default risks for the eurozone’s private sector probably aren’t as bad—or imminent—as some pundits fear.

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Exhibit 1: Lighter Eurozone Debt Burdens

Source: BIS and Centre for Economic Policy Research (CEPR), as of 26/8/2019. German, Italian and Spanish private non-financial sector debt service ratios, Q1 1999 – Q4 2019. Eurozone recession dates according to CEPR.

Similar debt fears for US households and corporations have also arisen in financial news outlets. Student loan, auto and credit card debt are at record highs, whilst Corporate America is supposedly levered to the hilt, according to many financial publications we review.[i] As Exhibit 2 shows, after falling to new lows in 2015 (as mortgage debt unwound), the US private-sector debt service ratio has drifted higher, but it remains well below levels coinciding with past trouble. Whilst there may be pockets of distress, this suggests America’s private sector on the whole probably isn’t having a hard time paying its debts and is on firm footing financially. Indeed, Q2 delinquency rates for US households are near historic lows.[ii] Even amongst what ratings agencies consider the riskiest corporate borrowers, default rates also remain historically low.[iii]

Exhibit 2: US Private-Sector Debt Debacle Isn’t Looming

Source: BIS and National Bureau of Economic Research (NBER), as of 26/8/2019. US private non-financial sector debt service ratio, Q1 1999 – Q4 2019. US recession dates according to NBER.

Record-low long-term interest rates suggest creditors to the developed world’s private sector aren’t too concerned. Forward-looking markets aren’t infallible, but we think they efficiently price in widely known information. In the eurozone, not only are sovereign debt rates at record lows, so are corporate and consumer loan rates.[i] (Exhibit 3) As Exhibit 4 shows, corporate and household leverage ratios (debt divided by total financial assets) are near their lowest in years. Lending to them at low rates likely makes sense given this, in our view. Credit risks—the likelihood of getting paid back with interest—probably aren’t very big. Meanwhile, non-performing loans (loans that are in default or close to default) in Europe continue to decline.[ii]

Exhibit 3: Private-Sector Borrowing Rates at Record Lows

Source: ECB and Centre for Economic Policy Research (CEPR), as of 10/9/2019. Bank interest on loans to households and non-financial corporations, January 2003 – July 2019. Eurozone recession dates according to CEPR.

Exhibit 4: Private-Sector Leverage Ratios

Source: ECB and Centre for Economic Policy Research (CEPR), as of 6/9/2019. Leverage ratio of non-financial corporations and households, Q1 1999 – Q1 2019. Eurozone recession dates according to CEPR.

Other factors besides credit risk influence rates. For example, inflation expectations have a big sway. The anticipated actions of central bank rate setters also typically influence rates. To better isolate default risks, we like to look at credit spreads—the difference between selected corporate bond rates and high-quality government debt yields, which many market participants consider to have little default risk. Here, too, markets expect little disruption in the eurozone, as Exhibit 5 shows by plotting the credit spreads on low-rated eurozone debt. If there were rising risk of default, interest rates—and credit spreads—would likely reflect it, in our view.

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Exhibit 5: Eurozone Speculative Grade Credit Isn’t Signalling Distress

Source: Federal Reserve Bank of St. Louis and Centre for Economic Policy Research (CEPR), as of 9/9/2019. ICE BofAML Euro High Yield Index Option-Adjusted Spread, January 1998 – August 2019. Eurozone recession dates according to CEPR.

Data and markets indicate businesses and consumers remain on sound financial footing, with most able to comfortably make their debt payments. Dour debt sentiment despite an improving outlook suggests reality should be better than expected—a likely boon to eurozone equities.

[i] “IIF Quarterly Global Debt Monitor 2019,” Sonja Gibbs, Khadija Mahmood and Emre Tiftik, Institute of International Finance, 5/8/2019. https://www.iif.com/Publications/ID/3477/IIF-Quarterly-Global-Debt-Monitor-2019--Slide-Deck

[ii] “The Financial Cycle and Recession Risk,” Claudio Borio, Mathias Drehmann and Dora Xia, BIS Quarterly Review, 16/12/2018. https://www.bis.org/publ/qtrpdf/r_qt1812g.htm

[iii] Ibid.

[iv] Source: Federal Reserve Bank of New York, as of 13/8/2019. Quarterly Report on Household Debt and Credit, Q1 2003 – Q2 2019. https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2019Q2.pdf

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[v] Ibid. Quarterly Report on Household Debt and Credit: Total Balance by Delinquency Status, Q1 2003 – Q2 2019.

[vi] “Moody’s - US Speculative-Grade Default Tally Changed Minimally Between First and Second Quarters of 2019,” Julia Chursin, John E. Puchalla and Tom Marshella, Moody’s Investors Service, 31/7/2019. https://www.moodys.com/research/Moodys-US-speculative-grade-default-tally-changed-minimally-between-first--PBC_1188150

[vii] Source: Euro Area Statistics, as of 3/9/2019. Composite cost of borrowing, January 2003 – July 2019. https://www.euro-area-statistics.org/bank-interest-rates-loans?cr=eur&page=2&template=1

[viii] “Banking Union: Non-Performing Loans in the EU Continue to Decline,” Staff, European Commission, 12/6/2019. https://europa.eu/rapid/press-release_IP-19-2932_en.htm

Fisher Asset Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein

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