December 14, 2018

Markets Are Revealing the Sum of All Risks

Take the tightening of corporate credit that is underway, with interest rates for riskier companies soaring. It has echoes of the not-too-distant past. In the mid-2000s, American automakers were overleveraged and facing a difficult environment. General Motors and Ford bonds were cut to junk status in 2005.

Bondholders and credit ratings agencies lost confidence in those industrial icons’ corporate debt, causing plenty of pain for the automakers’ employees and stock prices. But the overall economy kept humming along. (It was a recession rooted in other sectors, three years later, that dragged American automakers toward bankruptcy.)

Similarly, it’s easy to look at the slowdown in home sales and building activity, for example, and fear that it could lead to a repeat of the 2008 recession.

But in that episode, housing starts peaked in January 2006. For nearly two years, the economy largely held up; as housing contracted, other sectors grew. It was only after the housing downturn triggered a financial crisis that a recession began in December 2007.

In terms of a slowing global economy, in 1998 an emerging markets crisis seemed to endanger a booming American economy enough that the Federal Reserve cut interest rates late that year to try to guard against damage. As it turned out, 1999 was a boom year.

What these episodes all show is that adjustments — whether in the credit markets, the housing market or emerging markets — tend to cause huge economic disruption only if there are compounding factors, or inadequate policy responses.

Already in the last couple of weeks, top Federal Reserve officials have softened their tone about how high they will eventually push interest rates.

Article source: https://www.nytimes.com/2018/11/21/upshot/what-could-go-wrong-with-the-economy-the-markets-are-offering-hints.html?partner=rss&emc=rss

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