The Fed released a report on Monday that spotlighted rising levels of risky corporate debt as a large potential threat to the US economy.
The main points of concern are an augmented number of leveraged loans, which grew by 20% last year and currently stands as a a $1.1 trillion market, as well as high asset prices and rising levels of borrowing by businesses.
"Borrowing by businesses is historically high ... with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards," the Fed stated in its financial stability report.
A lot of the hefty returns in the fixed income department can be accredited to the more benign outlook on interest rates, as the Fed begins to ease its monetary policy. This has helped the investment grade sector yield total returns of 5.6% so far this year, after a 2.2% loss in 2018. Moreover, the high yield market has had an 8.3% return, after last year's loss of 2.3%.
The report also touched on some external economic shocks that could prompt a recessionary turn, including spillover effects from Brexit, the ongoing US-China trade war and waning global economic growth.
Even though the defaults on the aforementioned loans are currently low, the Fed is concerned that businesses are treading a path very similar to the one that led into the 2008 economic crisis, and that fixed income returns are perhaps deceptively high at the moment.
This analysis is based on the notion that positive gains right now are fragile, and could topple at any moment given some reasonable negative influence: "Any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses."
Special attention will be given to the current underwriting standards and procedures used by sellers of leveraged loans, which, if designed clumsily, could lead to the creation of loans that are ineffective and carry high default risk.
"Credit standards for new leveraged loans appear to have deteriorated further over the past six months . The share of newly issued large loans to corporations with high leverage-defined as those with a ratio of debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) above 6-increased in the second half of last year and the first quarter of this year and now exceeds previous peak levels observed in 2007 and 2014, when underwriting quality was poor," the report states.