Chart Of The Week   May 04 2020

The Debt Supercycle’s Second Act

The Debt Supercycle’s Second Act

Mathieu Savary, Global Strategist, BCA Research

Yesterday, BCA Research'sUS Investment Strategy service concluded that the debt supercycle's second act will be a tamed one.

Elected and appointed officials respond to incentives just as surely as individuals outside of government. Legislators will pull fiscal levers to keep the party going and extend their own tenures, while the Fed will do its utmost to preserve its discretion to steer the economy.

The Fed’s pull-out-all-the-stops approach to protecting markets and the economy simply looks like a logical evolution of the Debt Supercycle, which holds that postwar Fed stimulus provoked successive waves of household and corporate borrowing to reflate the economy following recessions. Managing the economy with countercyclical fiscal and monetary policy has helped make recessions less frequent and less severe than they had been under the laissez-faire prewar approach.

Now that a decade of zero and near-zero rates has failed to stimulate private sector borrowing, the Debt Supercycle is played out. Changing consumer preferences and regulatory measures reining in banks’ lending capacity have impeded the credit channel, sharply degrading the Fed’s conventional policy arsenal. Central bankers want to remain in the thick of the action as much as any other bureaucrats, hence the Fed has expanded its remit with unconventional measures.

No one wants to miss a big policy-induced bounce. Investors should buy what the Fed is buying while its purchase programs and lending facilities are operating. That subset includes agency CMBS, AAA-rated CMBS, AAA-rated ABS, investment-grade corporate debt and newly fallen angels in the BB-rated tier. Though they’ve already had a hearty bounce, agency mortgage REITs offer an equity vehicle for playing the Fed-purchase theme, as do the SIFI banks, which are the biggest indirect beneficiary of reduced default rates.