What could really sink the global economy

Economy

What could really sink the global economy

Published

4 years ago

March 14, 2020

Harry Miller

Looking to take advantage of low interest rates, companies have rushed in recent years to issue bonds whose proceeds could be used to grow their businesses. Corporate debt among non-banks exploded to $75 trillion at the end of 2019, up from $48 trillion at the end of 2009, according to the Institute of International Finance.

As the coronavirus spread— touching off a plunge in oil prices and a collapse in travel, and shutting factories from Italy to China — there is increasing alarm that companies in the energy, hospitality and auto sectors won’t be able to make their bond payments. That could trigger a spree of ratings downgrades and defaults that would further destabilize financial markets and compound the economic shock.

“This certainly is another match being lit [near] the bonfire of corporate debt liabilities,” said Simon MacAdam, global economist at Capital Economics. “There’s definitely potential for systemic risk.”

The coronavirus shock

Investors became increasingly anxious about corporate debt this week as stocks sold off and crude prices nosedived. The ability to buy or sell securities in corporate debt markets has become much more difficult. And the extra returns that investors are demanding to hold corporate debt over more stable government bonds have shot up, signaling that they’re now viewed as much riskier holdings.

Savers are getting destroyed by super low interest rates

The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) has dropped 8% this week, while the iShares iBoxx $ Investment Grade Corporate Bond ETF has fallen more than 10%. Bank of America told clients on Friday that volatility had skyrocketed and outflows from corporate bond funds were at record highs.

The anxiety is pegged to companies that rely on stable energy prices and tourism to generate cash. When business gets tougher for these firms, it could prevent them from servicing their debt, leading to defaults. Ratings agencies could also start downgrading many of these companies, forcing some bondholders to sell.

“Default and downgrade risks have increased to their highest levels since the start of the current business cycle,” Lotfi Karoui, chief credit strategist at Goldman Sachs, told clients this week.

Much of the risk lies with energy companies, which have ramped up borrowing in recent years to build pipelines and fund other projects. Those companies now face acute pressure due to plummeting oil prices, which have dropped 50% since early January amid evaporating demand for fuel and the implosion of an alliance between major energy producers Saudi Arabia and Russia that had helped prevent oil from flooding onto global markets.

“Oil producers who were depending on the higher prices to pay back their loans so they could drill for oil are under a significant amount of stress,” said Andy Lipow, president of Lipow Oil Associates, a consultancy based in Houston.

Investors dumped shares this week in two US energy companies that Morgan Stanley said are at risk of default within the next year: Chesapeake Energy (CHK) and Whiting Petroleum Corporation (WLL). Chesapeake’s stock fell to 15 cents on Thursday, while Whiting shares closed at 75 cents.

Airlines, hotels and cruise lines are also in trouble as restrictions on movement grow and more people hunker down at home. A ban on travel from Europe to the United States, announced by the Trump administration on Wednesday, eviscerated airline shares. Budget carrier Norwegian Air, which is heavily indebted, said it would temporarily lay off up to half its workers after its stock dropped 22% on Thursday.

“Coronavirus’ rapidly increasing effect on air travel is placing downward pressure on global airline credit profiles, especially as there are risks that demand takes materially longer than previous shocks to recover,” Fitch Ratings said Thursday. It is monitoring American Airlines (AAL), which has a significant amount of debt, as well as Alaska Air (ALK), which is based in Seattle, the site of a significant outbreak in the United States.

A flight arrival information board displays cancelled flights at an airport in Japan.

Automakers are under the microscope, too, as factories in Italy shut down, with more potential closures looming across Europe and in the United States as the number of infections rises in those areas. The industry was already in its third year of a sales recession because of falling demand for vehicles and the US-China trade war.

Who holds the debt?

With the risk of downgrades and defaults growing, the focus for investors then turns to who holds those liabilities, which could rapidly lose their value.

Banks are less exposed to risky corporate debt than they were to bad mortgages in 2008, according to Capital Economics’ MacAdam. But that doesn’t mean there isn’t potential for a corporate debt crisis to reverberate through the financial system.

Oil prices keep tumbling, with no sign of stopping

One issue is the growing number of corporate bonds that are rated BBB, at the very low end of the spectrum of what is considered “investment grade” debt. If those bonds get downgraded to high-yield or “junk” status, investment funds could be forced to dump them based on their mandates. That could further stress the market and cause liquidity to dry up.

In 2011, corporate bonds rated BBB made up about a third of the market, according to Capital Economics. Today, such bonds account for nearly half of it.

Lots of debt issued by energy companies fits that description. An estimated 67% of investment grade debt issued by energy companies is rated BBB, compared to 50% overall, according to Morgan Stanley. And $34 billion of BBB-rated energy debt is already on negative credit watch from one or more ratings agencies.

Plus, so-called “shadow banks” — or financial entities that face far less regulation than traditional lenders — have snapped up large amounts of corporate liabilities. A decade of persistently low interest rates has pushed down yields on safer government bonds, encouraging private equity firms, hedge funds and even pension funds to buy riskier assets with higher returns.

“As the economic cycle matures and investors have picked all the low-hanging fruit — the good, solid investments that give a solid return and aren’t too risky — you’re naturally going to be looking for riskier and riskier things that years ago you wouldn’t have touched with a barge pole,” MacAdam said.

Emre Tiftik, director of global policy initiatives at the Institute of International Finance, said it’s difficult to determine just how vulnerable these players are.

“We really don’t know that much about private equity and hedge fund exposure,” he said.

Seeding systemic risk

In its most recent financial stability report, the International Monetary Fund raised the alarm about piles of risky corporate debt, which it said could amplify problems and deepen the next recession.

The group conducted a stress test based on a hypothetical economic shock that’s half as severe as the 2008 global financial crisis. The results suggested that corporate debt worth $19 trillion from eight countries — China, the United States, Japan, the United Kingdom, France, Spain, Italy and Germany — is at risk of default in a future downturn of that magnitude because companies would struggle to generate enough cash to meet repayments. That would be 40% of all corporate debt.

A wave of defaults, or even a series of rating downgrades and repricing, would shake the financial system.

“The credit market is moving quickly towards the point of no return, where the turn in the credit cycle becomes inevitable and irreversible, as funding sources dry up, issuers face liquidity crunch, credit losses rise, investors rush for the exit, and face extremely thin liquidity on the way out,” Oleg Melentyev, head of high-yield credit strategy at Bank of America, told clients Friday.

And while this is a standard end to a credit cycle, Melentyev said, it appears to be playing out at three to four times normal speed.

Should the situation deteriorate further, it will also have economic consequences as companies hurry to reduce their debt burdens, the IMF noted. There could be waves of layoffs, and business investment could fall off. Defaults would also hit banks and could lead to less lending. Companies could find it more difficult to borrow during the period when they need it the most.

This would exacerbate a global recession caused by the coronavirus, which a growing number of economists now warn is a real possibility.

The expectation is that if the world does tip into recession, it would be sharp but short, with the global economy bouncing back as soon as the threat of the virus recedes. But credit risk in the system incorporates a big question mark.

“Debt is an automatic destabilizer,” MacAdam said.

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Economy

China Wants Everyone to Trade In Their Old Cars, Fridges to Help Save Its Economy – Bloomberg

Published

2 hours ago

April 24, 2024

Harry Miller

China’s world-beating electric vehicle industry, at the heart of growing trade tensions with the US and Europe, is set to receive a big boost from the government’s latest effort to accelerate growth.

That’s one takeaway from what Beijing has revealed about its plan for incentives that will encourage Chinese businesses and households to adopt cleaner technologies. It’s widely expected to be one of this year’s main stimulus programs, though question-marks remain — including how much the government will spend.

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Economy

German Business Outlook Hits One-Year High as Economy Heals – BNN Bloomberg

Published

3 hours ago

April 24, 2024

Harry Miller

(Bloomberg) — German business sentiment improved to its highest level in a year — reinforcing recent signs that Europe’s largest economy is exiting two years of struggles.

An expectations gauge by the Ifo institute rose to 89.9. in April from a revised 87.7 the previous month. That exceeds the 88.9 median forecast in a Bloomberg survey. A measure of current conditions also advanced.

“Sentiment has improved at companies in Germany,” Ifo President Clemens Fuest said. “Companies were more satisfied with their current business. Their expectations also brightened. The economy is stabilizing, especially thanks to service providers.”

A stronger global economy and the prospect of looser monetary policy in the euro zone are helping drag Germany out of the malaise that set in following Russia’s attack on Ukraine. European Central Bank President Christine Lagarde said last week that the country may have “turned the corner,” while Chancellor Olaf Scholz has also expressed optimism, citing record employment and retreating inflation.

There’s been a particular shift in the data in recent weeks, with the Bundesbank now estimating that output rose in the first quarter, having only a month ago foreseen a contraction that would have ushered in a first recession since the pandemic.

Even so, the start of the year “didn’t go great,” according to Fuest.

“What we’re seeing at the moment confirms the forecasts, which are saying that growth will be weak in Germany, but at least it won’t be negative,” he told Bloomberg Television. “So this is the stabilization we expected. It’s not a complete recovery. But at least it’s a start.”

Monthly purchasing managers’ surveys for April brought more cheer this week as Germany returned to expansion for the first time since June 2023. Weak spots remain, however — notably in industry, which is still mired in a slump that’s being offset by a surge in services activity.

“We see an improving worldwide economy,” Fuest said. “But this doesn’t seem to reach German manufacturing, which is puzzling in a way.”

Germany, which was the only Group of Seven economy to shrink last year and has been weighing on the wider region, helped private-sector output in the 20-nation euro area strengthen this month, S&P Global said.

–With assistance from Joel Rinneby, Kristian Siedenburg and Francine Lacqua.

(Updates with more comments from Fuest starting in sixth paragraph.)

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Economy

Parallel economy: How Russia is defying the West’s boycott

Published

9 hours ago

April 23, 2024

Harry Miller

When Moscow resident Zoya, 62, was planning a trip to Italy to visit her daughter last August, she saw the perfect opportunity to buy the Apple Watch she had long dreamed of owning.

Officially, Apple does not sell its products in Russia.

The California-based tech giant was one of the first companies to announce it would exit the country in response to Russian President Vladimir Putin’s full-scale invasion of Ukraine on February 24, 2022.

But the week before her trip, Zoya made a surprise discovery while browsing Yandex.Market, one of several Russian answers to Amazon, where she regularly shops.

Not only was the Apple Watch available for sale on the website, it was cheaper than in Italy.

Zoya bought the watch without a moment’s delay.

The serial code on the watch that was delivered to her home confirmed that it was manufactured by Apple in 2022 and intended for sale in the United States.

“In the store, they explained to me that these are genuine Apple products entering Russia through parallel imports,” Zoya, who asked to be only referred to by her first name, told Al Jazeera.

“I thought it was much easier to buy online than searching for a store in an unfamiliar country.”

Nearly 1,400 companies, including many of the most internationally recognisable brands, have since February 2022 announced that they would cease or dial back their operations in Russia in protest of Moscow’s military aggression against Ukraine.

But two years after the invasion, many of these companies’ products are still widely sold in Russia, in many cases in violation of Western-led sanctions, a months-long investigation by Al Jazeera has found.

Aided by the Russian government’s legalisation of parallel imports, Russian businesses have established a network of alternative supply chains to import restricted goods through third countries.

The companies that make the products have been either unwilling or unable to clamp down on these unofficial distribution networks.

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