If the Global Financial Crisis (GFC) of 2008-09 contained a single lesson, it’s that leverage cycles with rapidly expanding balance sheets and deteriorating credit standards often don’t end well. Left mostly unchecked, as they often are, these cycles can leave the real economy in a precarious position when the cost and availability of credit tightens up, as it inevitably does. After nine interest rate hikes from the U.S. Federal Reserve since 2015 (and five from the Bank of Canada since 2017), that’s the world we’re living in today.

The good news is that the balance sheets of U.S. households are in good shape compared to the pre-crisis years. That’s important, because consumption by households is about two-thirds of U.S. gross domestic product (GDP). The bad news is that the same cannot be said for corporate and federal government balance sheets.

In its first ever Financial Stability Report, published in November 2018, the U.S. Federal Reserve expressed concern about historically high levels of corporate debt (Figure 1) and its deteriorating credit quality. Over the past decade, cheap and easy corporate credit has underpinned stock buy-backs (borrowing to purchase own shares) and buy-outs (borrowing to acquire other firms). Much of this activity has been funded by the issuance of BBB-rated investment-grade corporate bonds, high-yield bonds (also known as junk or speculative bonds) and levered loans (sub-prime business loans).

Figure 1

U.S. Corporate Indebtedness is Around Record Highs

Ratio of business (non-financial) and household sector credit to GDP

Source: Federal Reserve Board, Financial Stability Report, November 2018.

The upshot is that the U.S. corporate debt market now has the lowest overall credit quality in 30 years. Almost 50% of the $5 trillion investment-grade corporate debt market is rated BBB, a notch above junk (Figure 2). That proportion exceeds the previous record set during the dot-com bubble of the early-2000s.

If credit rating agencies found reason to downgrade some BBB-rated bonds, more companies would face higher borrowing costs as their bonds are relegated to junk status. Higher yields are required in the junk bond market to compensate investors for the additional risk. In other words, an increase to companies’ cost of funds could be triggered by a decline in their perceived credit-worthiness, irrespective of movements in market interest rates.

Figure 2

Credit Quality of U.S. Corporate Debt is Historically Poor

Credit rating of investment grade corporate bond market (% of debt outstanding)

Source: Market Watch, November 30, 2018.


U.S. corporate credit markets have dried up in recent months, as concerns mount about the imminent refinancing of this debt at higher interest rates. About $2.6 trillion worth of U.S. investment grade debt is set to mature – and potentially will need refinancing at higher interest rates – between 2019 and 2021 (Figure 3).

Figure 3

U.S. Corporate Debt Set To Feel the Pinch of Higher Borrowing Costs

U.S. corporate bonds maturing over the next 5 years - investment grade & high yield (junk)

Source: Market Watch, November 30, 2018.


Meanwhile, U.S. federal government debt has nearly doubled as a percent of GDP compared to the pre-2008 years (Figure 4). Most of this debt increase accumulated in the immediate aftermath of the GFC. Fiscal consolidation efforts to wind back this debt are yet to begin. Indeed, the U.S. government continues to run very large annual budget deficits even though the economy is operating at full employment.

Figure 4

U.S. Federal Government Indebtedness is Historically High

4A: Total debt/GDP ratio

4B: Annual change in ratio

Source: Federal Reserve Bank of St. Louis.

The deleveraging of the corporate and government sectors could drag on U.S. growth prospects over the medium term. The good news is that households, responsible for the lion’s share of GDP, are better placed to absorb these adjustments. Nevertheless, with roughly three-quarters of Canada’s exports (and slightly more than half of B.C.’s exports) going to the United States, this is an important watchpoint for Canadians.