Company borrowing has surged, and corporate bonds outstanding in the US now outnumber mortgage-backed securities. At the end of 2012, there was $8.6 trillion worth of corporate debt outstanding which compares to $8.2 trillion in mortgage-backed securities (please click image for larger view).

It is only reasonable to expect the next crisis to hit will materialise in the (global) corporate bond market and that future QE programs and liquidity provisions will involve corporate bonds. The yield on corporate bonds in many cases is so low that investors are not even being  compensated for the probability of default based on historic default rates. Yield is now being sought in all corners of the world without consideration of underlying risks. As long as yields are higher than the benchmark (which is ZIRP), any yield is attractive. Using a metaphor originally coined by the Economist’s Buttonwood, yield-hungry investors are now picking up dimes in front of the proverbial steamroller. The merits of aggressive central bank monetary policies can be debated, but the effects are certain.

In the US, a new credit cycle has started outside mortgage creation, and the real question is how far this cycle will go and when it will end. Given the historical relationship between credit growth and volatility in the US, our indicators would suggest that we are on the verge of a new volatility cycle in the US.

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Japanese rate volatility has already moved, but we expect other volatilities follow.  The credit cycle leads volatility by about 3 years and based on this we expect to US equity volatility to go higher soon.  As the top chart demonstrates, interest rate and commodity volatility should follow suit.

The participation rate has fallen sharply since 2009, to a 25 year low, and the average duration of unemployment has risen to 40 weeks, series highs.

In addition, the average duration of unemployment has increased, and this has been most pronounced at the longest measured length of unemployment (27 weeks +).  This is self-reinforcing:  the longer a person is unemployed, the more likely they are to remain unemployed as their skills stagnate, and they become less attractive to employers.

The Fed will want to see improvement in the structural issues that riddle US employment.  As these issues are by their nature self-reinforcing and difficult to rectify, this suggests that the self-imposed bar for Fed removal of easy monetary conditions remains high.

We recently got data from March and the increase now looks decidedly parabolic.  Sharp moves in margin debt like this have not usually been associated with positive equity market outcomes.  This gives us cause for concern on a 3-6 month basis.