Massive U.S. Debts Could ‘Trap’ Powell as Fed Fights Inflation
(Bloomberg) — The U.S. went on a borrowing binge last year and the hangover could make it harder for the Federal Reserve to fight inflation without crashing the economy.
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Corporate debt has surged $1.3 trillion since the start of 2020 as borrowers took advantage of emergency Fed action as the pandemic spread, slashing interest rates and backstopping financial markets to keep credit flowing. More debt held by more companies suggests potential risks as borrowing costs rise from currently low levels.
That could create financial stability concerns for Fed Chair Jerome Powell and his colleagues as they debate removing pandemic support in the face of what a report Friday showed were the hottest price rises in almost 40 years. And a tough task: Not since Alan Greenspan’s time has the U.S. central bank tried to navigate the economy back to price stability from too-high inflation.
Powell’s challenge is to try to curb price pressures without large costs to employment or growth, a move that would likely anger both political parties and blotch his record with the first Fed-assisted hard landing since the 1990-1991 downturn.
“They are in a difficult position,” said Jeremy Stein, professor of economics at Harvard University and a Fed governor from 2012 to 2014. If inflation is more persistent “and they really have to hike rates significantly, you can imagine what happens to asset valuations: There’s just a tremendous amount of interest-rate sensitivity in markets.”
The Fed’s Financial Stability Report on Nov. 2 noted that key measures of vulnerability from business debt, including leverage and interest cover ratios, were back at pre-pandemic levels.
But it also discussed risks to asset prices from a sharp rise in interest rates that could slow growth and lead to harmful losses.
Intense market volatility has swayed the Powell Fed before. Officials paused after raising rates in late 2018 in the face of severe swings in stocks and bonds and cut rates three times the following year.
Financial stability remains on policy makers’ minds. Minutes of their November meeting show that a number of them raised it during their deliberations, as they decided to start scaling back bond buying.
Powell said last week that officials would consider accelerating their reduction of asset purchases when they meet Dec. 14-15 to end the program a few months earlier than mid-2022, as initially planned.
Wrapping the taper up sooner gives the Fed scope to raise rates earlier and faster if inflation fails to ease next year as expected. But record levels of debt may force them to temper their actions.
More Slowly
“They may move a little bit more slowly to see how things develop, and whether problems do come up in the U.S. — at least in the non-financial corporate business sector,” said William English, professor at Yale School of Management and a former senior Fed economist. “That will be just another source of uncertainty for monetary policy.”
The Fed’s emergency response to the pandemic included unprecedented support for the corporate sector. And while the intervention wasn’t massive compared to some of the Fed’s pandemic…
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