Corporate Credit, Housing, and the Next Recession

This time, it’s the riskier segments of the corporate credit market – not housing – that could trigger the next downturn.

More than a decade ago, a financial crisis sparked in part by a burst housing bubble plunged the U.S. economy into recession. What might cause the next downturn?

Admittedly, economists have been bad at forecasting recessions, to say nothing of their ability to foresee the trigger. Unexpected events, such as the emergence of the coronavirus, can send markets and the economy into a tailspin.

Nevertheless, while our baseline forecast calls for a period of weakness to give way to a moderate recovery during 2020, it is worth asking what might kill the U.S. expansion, now in a record 11th year.

Here, we share two themes – focused on the potential causes of the next recession – from our latest outlook, “Seven Macro Themes for 2020,” which distills key points from our recent quarterly Cyclical Forum. We follow a suggestion by PIMCO advisor and Nobel laureate Richard Thaler to engage in a premortem – an exercise intended to mitigate groupthink and overconfidence in a particular baseline scenario.

In doing so, we asked our U.S. team to assume that the economy falls into recession in 2020 and suggest a plausible narrative of how and why this happened. The team zoomed in on vulnerabilities in the riskier segments of the corporate credit market that could exacerbate a slowdown of growth and turn it into a recession. The story goes as follows:

Potential cracks in the corporate credit cycle

In 2017 and 2018, due in part to a notable increase in nonbank loans to U.S. small and midsize firms that couldn’t get credit from banks, the corporate credit impulse (i.e., the change in overall credit flows, which is highly correlated with GDP growth – see chart below) accelerated dramatically. These firms benefited from strong global growth and U.S. fiscal stimulus and drove the acceleration in private-sector job growth. However, when GDP growth decelerated during 2019 from 3% to 2%, private credit lending ground to a halt and, in addition, banks tightened standards on commercial and industrial loans.

This chart is a graph that shows U.S. nominal year-over-year GDP growth overlayed with the U.S. corporate debt impulse, from year-end 2005 to September 2019. The debt impulse, a measure of the change in overall credit flows, turned negative in 2019, while nominal GDP growth in September had fallen to 4%, down from a recent peak of 6%.

According to Federal Reserve data, private credit is a roughly $2 trillion market, or 9% of U.S. GDP, which makes a slowdown in this engine of credit growth seem manageable in the context of a robust labor market and healthy consumers.

However, if growth slows further in 2020 rather than picking up during the year as in our baseline, the riskier segments of the credit market would seem vulnerable. Private credit, leveraged lending, and high yield debt have been concentrated in businesses that are highly cyclical and have riskier credit profiles. Moreover, despite solid bank equity positions, post-crisis regulation creates incentives for banks to ration credit when heading into a downturn. With speculative grade lending currently around 35% of GDP, stress across these sectors would be more than enough to contribute to a recession.

Again, our base case is that growth picks up in the course of 2020 and thus the “financial accelerator” does not kick in to propagate a default cycle and recession (note that the term was introduced by current PIMCO advisor Ben Bernanke and co-authors in 1996). However, in our view, these corporate credit vulnerabilities warrant close attention, especially if growth should fall short of our and consensus expectations this year.

Housing and the next recession

In contrast to the 2008–2009 recession, which had its roots in defaults on risky mortgage loans tied to an inflated housing sector, we expect the housing market to be an area of strength in the U.S. economy this year and beyond. The decline in mortgage rates in 2019 has brought buy-to-rent and payment-to-income affordability ratios back to November 2016 levels. Moreover, credit score requirements for new mortgages have eased year-over-year.

Meanwhile, the excess homes built pre-crisis have finally been digested and we are entering a period of overall scarcity across the U.S. Housing vacancies and inventories are at their lowest levels since 2000, while household formations are once again picking up, arguing for an increase in investment needed to grow the housing stock. Our mortgage team expects U.S. home prices to appreciate by some 6% cumulatively over the next two years.

Read PIMCO’s latest Cyclical Outlook, “Seven Macro Themes for 2020,” for further insights into the 2020 outlook for the U.S. and global economy along with takeaways for investors.

Read Now

Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.

The Author

Joachim Fels

Global Economic Advisor

View Profile

Latest Insights



PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the Securities Institutions Act (WplG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH- . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.