Macroscope | How are asset prices so high amid spiralling US debt, Fed recession warnings?

The US yield curve has continued to flatten and San Francisco Federal Reserve chief John Williams felt the need last week to speak of “the next recession and what we should do to prepare for it.” That might seem odd with US equity markets buoyant and other asset prices extremely well-bid. Or perhaps there is an explanation.

A record-shattering US$450 million was paid last week for a painting by Leonardo da Vinci. While the scarcity value of a da Vinci painting helps explain much of the price, the size of the winning bid is surely also a reflection of how years of global money printing by central banks has fuelled asset price inflation.

Yet, while US$450 million is a lot of money it’s nowhere near US$12.96 trillion. That latter figure represents total aggregate US household debt as of September 30, according to data released by the New York Fed last week. Household debt is now 16.2 per cent above its trough in the second quarter of 2013, the report said.

Joe Sixpack, the archetypal American working man, is swimming in debt at the same time as earnings rises in the United States remain pretty subdued. And with the Federal Reserve on course to raise interest rates again next month, more increases are expected in 2018.

Indeed, even as he contemplates how to prepare for “the next recession” the Fed’s Williams remains comfortable with the idea that “assuming inflation is running at our goal of 2 per cent in the future, the typical, or normal short-term interest rate would be 2.5 per cent.”

Elsewhere, banks such as Goldman Sachs and JP Morgan are now forecasting four Fed rate increases in 2018 as opposed to the three currently implied in Federal Reserve policymakers’ own projections.

And in its “top trade recommendations” for 2018 published last Thursday Goldman forecast “that the yield on 10-year US Treasury Notes will head towards 3 per cent next year.” The yield was 2.35 per cent at the end of last week.