Mike Dolan
The rude health of U.S. household and corporate balance sheets is partially responsible for the exceptional resilience of the U.S. economy in recent years–but U.S. de-leveraging may start to become a drag that could amplify recession risk.
This month’s release of the Federal Reserve’s quarterly statistics on U.S. financial accounts highlighted the rising asset wealth and modest debt load of households and businesses at the end of 2024.
But when you strip away the impact of the ongoing expansion of the federal government’s mountainous debt pile, a potentially pernicious trend emerges–or so says Morgan Stanley’s Matthew Hornbach and the firm’s U.S. fixed-income team.
Slicing and dicing the data, they reckon the U.S. private sector debt load shrank by 2.4% of gross domestic product in the final three months of last year–the steepest de-leveraging of the private sector since the banking crash of 2008.
The last period of equivalent quarterly debt declines was in the second quarter of 2023 after the regional banking crisis, the team noted, but that was much more modest and reduced leverage in the financial sector accounted for the entire drop.
The drivers of the debt rundown today are all in the non-financial parts of the economy: households, non-financial businesses, and state and local governments. And that’s the first time on record that all three segments reduced leverage in the same quarter.
The catalyst may have been trepidation surrounding November’s U.S. election and Donald Trump’s return to the White House. But there’s good reason to believe the trend has not improved much in early 2025, given subsequent developments including trade uncertainty, planned reciprocal U.S. tariff hikes and related stock market volatility.
“We suspect that the trade tensions arising after the presidential inauguration may limit any rebound – as evidenced by subdued capital market activity,” Morgan Stanley told clients.
“A sustained pullback in private sector debt growth could present a challenge for the US economy,” it added. “At a minimum, a sustained private sector de-leveraging would not be emblematic of a normally functioning U.S. economy.”
The upshot is that the Federal Reserve may be more ready to ease monetary policy than many assume and may be willing to go further than market pricing suggests, making today’s elevated Treasury yields look attractive.
Put down
JPMorgan’s team also believes the likelihood of further substantial Fed easing longer term may be underestimated as the bank now sees the chance of a U.S. recession over the next 12 months as high as 40%.
The JPM strategists question the market’s assumption of a so-called “Trump put” with a higher strike price than the long-assumed “Fed put”.
In other words, many investors thought a stock market swoon on the scale of the one seen so far this year would have caused the new administration to reverse some of its more disruptive plans. But that assumption seems wide of the mark.
JPM’s analysts reckon the government is digging its heels in by signaling an inevitable “adjustment phase” for the economy and markets.
“The damage from sentiment as a result of extreme policies could trigger more Fed easing than in our baseline, especially if the U.S. labor market weakens,” it added. “The path remains narrow with limited room for errors, but the strike of the Fed put could be higher than the one of the Trump put.”
All of this talk of backstops is one reason why the stock market seems keen to bounce as the dire first quarter comes to a close. After all, many in the market may still believe in those “puts” – and the temptation to “buy the dip” is well entrenched in market psychology.
Two big problems remain, though.
One is that U.S. equity and corporate debt markets are nowhere close to pricing in heightened recession risk. High-yield corporate debt spreads are still far too slim to account for any danger ahead.
The other is the chance that neither of the two mooted “puts” materialises at all.
(The author is a columnist for Reuters)
Published – March 25, 2025 03:38 pm IST
