What could cause a problem? Two years ago, a sudden and impressive rise in bond yields from low levels was widely seen as the culprit. A sudden change in the cost of long-term money can mess up stock markets. The following chart, from David Kostin, chief U.S. equity strategist at Goldman Sachs Group Inc., shows that any rise beyond two standard deviations in a month (which would now require a rise of 34 basis points, or to about 2.2% in short order) tends to cause problems for stocks. The speed of the move in yields, rather than their level, has the greatest impact:

How likely is an increase on that scale? The determined easing policies of central banks make it look far less likely than it was two years ago. Against that, there is heavy bond issuance to fund the growing U.S. deficit, much of which is being swallowed by the Federal Reserve. And as was the case two years ago, the reasons for optimism about stocks also tend to be reasons for higher bond yields. If the global economy is really doing so well, shouldn’t yields be a bit higher?

It is always dangerous to bet on a stock market slide when central banks are helping as keenly as they are at present. But the stock market does indeed look over-extended. The risk of an event to parallel February 2018, if not the epic excitement of March 2000, is real. Whether this comes to pass depends primarily on bond yields.

A World Of Debt

The Institute of International Finance’s latest debt statistics show that the global debt-to-GDP ratio has now topped 322%. That is the highest on record. For China, this figure is 310%, also a record.

While the increase is broad-based and global, the IIF’s sectoral breakdown shows that the big buildup is in exactly the areas that were not so much of a problem during the global financial crisis. Financial sector debt is now lower as a proportion of GDP than it was at the end of 2007, on the eve of the critical phase of the crisis, while households are barely any more leveraged than they were then. These sectors were of course at the center of the problems.

Unfortunately, non-financial firms have piled up leverage since then, while government debt is a much greater share of GDP. The tactic then was to get through the crisis by putting the government’s credit rating behind stricken banks, and to substitute government for financial debt. Financial repression, effectively forcing investors to buy government debt, has enabled that policy to work until now. Can it continue?