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Excess Corporate Leverage Meets Higher Rates

Wed, Apr 25, 2018 - 7:29am

Originally published at The Boock Report

Most of the conversation with this continued rise in interest rates mostly swings back to what it means for stocks. The glass half full case, of course, is rates are rising for the right reasons. That historically has worked for a period of time before we cross a rubicon. I argue again that there is no free lunch to 7 years of zero rates and multiple rounds of QE for both markets and the economy. As for what rising rates mean for the US economy, here is a chart of total business debt as a percent of nominal GDP as of Q4. At 72% we are basically at the level we were at during the depths of the Great Recession in Q1 2009 while the US economy today is in the 9th year of an expansion. Corporate debt is where the leverage excess is and why this rise in rates matters so much this time around.

corporate debt

Coincident with the rise in US Treasury rates, the average 30-year mortgage rate broke out to the highest level since September 2013 at 4.73%, according to the MBA, up a large 7 bps on the week. Mortgage applications though did hang in there as purchases saw no change w/o/w and are still up 11.3% y/o/y. Refi's fell just .3% w/o/w but remain down 16% y/o/y. I'd say that the resilience of purchases is a combination of a rush to act in light of higher mortgage rates at the same time consumers are more confident in their job and hopes for better pay. If one hasn't refinanced yet, who knows what they have waited for.

The US dollar is finally getting a bid in response to the rise in US rates as the index is at the best level since mid-January. Of note is the rise in REAL rates which is why the dollar is trading better. The 5 yr REAL yield is at the highest level since October '09. In the face of this, I still think gold trades great and remain positive on the precious metals. I view the dollar bounce as only a temporary counter trend rally.

After the more bullish stance seen in last Thursday's AAII measure of sentiment, today's II got more bullish too. Bulls rebounded by 4.4 pts to 48 while Bears were down slightly to 19.6 from 19.8. Those expecting a correction made up the balance with a 4.2 pt decline. The Bull-Bear spread at 28.4 is at a 3-week high. Bottom line, when Bulls got to the low 40's a few weeks ago that was a good sentiment set up for a rally and we got one from below 2600 in the S&P to above 2700 last week. As we are now closer to 50, it helps to give a backdrop to the negative action the past few days. Again, sentiment always follows price and in this very choppy action in stocks, it's become an even more valid contrarian indicator.

Aluminum prices are little changed after the wild ride over the past few weeks. After rallying by 30% it dropped by 10% the past 2 days after the US imposed deadline was extended in complying with the Russian sanctions. It seems that the US administration didn't fully appreciate the reach of Rusal in global markets, particularly in Europe and the Europeans complained loudly. 

For daily macroeconomic analysis and asset class positioning, visit boockreport.com.

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