At least one reserve bank globally is starting to ponder the question that many central banks across the world will soon inevitably be asking: what happens if we cut to zero and the economy continues to falter?
This has led Australia to start considering QE, following in the footsteps of a world full of central bankers all offering each other as much confirmation bias necessary to continue to walk down the path of eventual economic destruction.
In Australia, the reserve bank has cut to 1% and “nobody expects them to stop cutting,” according to News.com.au. The bank released this chart days ago, showing that market is expecting further cuts.
The average of all expectations is for the market to fall to 0.37% by September 2020. That exact outcome is described as “unlikely”, but the RBA could have rates at 0.25% or 0.5% by then. That would only leave room for one or two more cuts before rates are at zero.
Then what? Destroy your currency and print your way out of your problems.
Apparently convinced that economies only exist as permanent booms now, the RBA said last week that it would begin a program similar to QE in the United States, wherein the central bank would buy financial assets in exchange for cash. The RBA is considering buying Australian government bonds.
“We could take action to lower the risk-free rates further out along the term spectrum,” said the RBA Governor.
Justifying this nonsense, the article then gives the quintessential example of how QE bond buying works in practice:
Bonds are how the government borrows. Here’s how it works in simplified terms:
The government offers to sell a piece of paper that says, “Australia will pay you back a million dollars in 10 years” (a 10-year bond).
Someone buys that for, let’s say, $900,000.
In this way the government just borrowed $900,000 and the $100,000 difference, spread over 10 years, is the return on investment for the buyer. The return on investment in bonds is known as the yield. It is usually expressed as a percentage, and it’s really important.
Yields change constantly in the secondary market as people trade the bonds they buy at varying prices.
When the RBA buys Australian Government bonds from the people who hold them, it is expected to have an effect on bond yields. The reason? Bidding to buy bonds will push up their price. The price of a bond determines the return on it, aka the yield.
The higher the price, the lower the yield. For example, imagine if someone bought that 10-year bond mentioned earlier for $1 million, it would have a yield of 0 per cent.
The RBA has said that by buying bonds, it is seeking a “spillover” effect, where it hopes to reduce bond yields across the market, which would in turn encourage economic activity.
The RBA Governor said:
“Europe’s the best example… They’ve also had success in lowering government bond yields, which is a risk-free rate, and therefore they’ve had success in lowering interest rates across the economy for private borrowers as well.”
But even the author of the article, economist Jason Murphy, couldn’t do the mental gymnastics necessary to pretend that QE makes sense at this point.
“What’s crazy about all this is we are talking about an extraordinary kind of monetary policy when the economy is not extraordinarily bad,” the article states.
“Australia is talking about bringing it in now. There’s something disconcerting about that,” it concludes.
This reckoning with Beijing’s authority was baked into the cake 22 years ago when the Union Jack came down over Government House…
It is impossible not to admire the bravery and commitment pro-democracy demonstrators display daily as they clog Hong Kong streets, shut down its airport, and disrupt the territory’s beating heart in Central, the commercial and financial district. But neither can one deny the tragic fate that appears near as Beijing stiffens its resolve and signals the threat of military intervention.
The futility of all action, the necessity of any: Maybe those protestors building barricades and hurling Molotov cocktails at tear-gassing riot police are reading Camus in their off- hours.
There is no question of Chinese President Xi Jinping compromising Beijing’s authority to mollify those now in their third month of protests across Hong Kong. He is too firm a believer in the primacy of the Chinese Communist Party to entertain any such risk. But there is too much at stake for the Chinese president to order mainland troops or police units into the territory short of a decisive challenge to the local administration’s ability to govern. This accounts for Beijing’s restraint over the past 10 weeks.
The best outcome in prospect now — and the chances of this appear slim at the moment — is that Xi will authorize influential political allies in Hong Kong to frame a set of reforms sufficient to isolate demonstrators by eliminating the broad public support they have to date enjoyed. In any other resolution of this crisis, the democracy advocates in the streets stand to lose everything. Even as they number in the hundreds of thousands, they are simply no match against a government intent on centralized control over a nation of 1.4 billion.
The escalating protests across Hong Kong were a long time coming. So was Beijing’s refusal thus far to give way to any of the demonstrators’ substantive demands, apart from suspending an extradition bill. The protesters are right: They were promised autonomy, civil liberties and democratic government by way of the “one country, two systems” principle China committed to once it reassumed sovereignty from Britain in 1997. Beijing is right, too: Sovereignty is to be defended as a precept beyond negotiation. Once the Union Jack came down over Government House, no foreign power could credibly purport to tell China how to govern its own real estate. The foreign ministry in Beijing made this clear in a bluntly worded statement two years ago.
From China’s point of view, the markedly pro-American character of at least some of the protestors is concerning as Beijing considers the U.S. a destabilizing force in its sphere of influence.
Government House in 2005. (CC BY-SA 2.0, Wikimedia Commons)
In truth, the Sino–British Joint Declaration signed in 1984, setting the terms for the transition of power 13 years later, was never more than a face-saving instrument to spare London the embarrassment of handing over Hong Kong to an authoritarian government ruling on Leninist principles. In the breach, the Basic Law, the mini-constitution that document established, now proves fatally short on detail. It sustains the democratic aspirations of Hong Kong’s 7 million people while opening the door to Beijing’s self-serving interpretations and its creeping interventions into Hong Kong’s courts, legislature and other governing institutions.
What began in late April as a narrow demand that the Hong Kong government withdraw legislation allowing the extradition of criminal suspects across the border to China has mushroomed into a mass movement challenging Beijing to accept authentically democratic political processes in what is formally known as the Hong Kong Special Administrative Region. This is the showdown baked into the cake 22 years ago.
China’s error in pushing its extradition law without testing the local waters reflects another misjudgment, this one further back in history. In the decades after the 1949 revolution, the flood of mainlanders who took refuge in Hong Kong developed a separate identity of their own: They became “Hong Kongers” or “Hong Kong people,” precisely as they are now. The British missed this during the final decades of colonial rule simply because it made no difference to them. Beijing, which considers blood and descent the determinants of one’s status, still fails to understand that “Hong Kong Chinese” has come to mean something different from “Chinese.”
It would be difficult to overstate what is consequently at stake for Hong Kong as demonstrators continue to fill its public space. “We are at a crossroads,” Martin Lee, a long-honored democracy advocate,told The New York Times last Monday. “The future of Hong Kong — the future of democracy — depends on what’s going to happen in the next few months.”
June 9, 2019, demonstration in Hong Kong against the extradition bill. (Hf9631, CC BY-SA 4.0, Wikimedia Commons)
Carrie Lam, Hong Kong’s beleaguered and widely disliked chief executive, agreed with Lee in the grimmest possible terms. “Violence, no matter if it’s using violence or condoning it, will push Hong Kong down a path of no return,” she said after the demonstrators shut down the airport for two days earlier this week. Hong Kong stands poised, she added, at the brink of “a very worrying and dangerous situation.”
Dangers for Xi
Not to be missed, this crisis is worrisome and dangerous for Xi, too. Given it is the most serious challenge he has faced from political opponents since he took office seven years ago, his reputation as an adroit statesman, well-earned in cases such as North Korea, is on the line. A clumsy move now would obliterate Xi’s dedicated effort to advance China as a responsible regional power and a global power in the making. This is the first direct test of Xi’s alternative — efficient, authoritarian, a depoliticized populace — to Western democracy. He does not want it to end as an echo of Hungary in 1956.
Hong Kong is less important to China than it once was, given Shanghai’s growth as the mainland’s preferred financial center. But a goodly number of Chinese companies still raise goodly amounts of money in Hong Kong capital markets; roughly 1,500 multinational corporations have regional headquarters in the territory.
Hong Kong is the mainland’s hood ornament, in short. If a single soldier with a People’s Liberation Army uniform were to appear on a Hong Kong street, the territory’s status as a global financial center with reliable legal and administrative systems would shatter instantly.
China’s President Xi Jinping.
These considerations, hardly lost on Xi and his advisers, leave forceful intervention by the PLA or mainland police units the remotest possibility— Xi’s nuclear option. The PLA’s garrison in Hong Kong recently released a video of troops training to quell demonstrations with machine guns; its contingent in Shenzhen, the industrial city opposite Hong Kong on the mainland, made similar footage public last week. But these can be counted as gestures, signals, warnings without words. Restraint remains the order of the day until Xi comes up with a coherent strategy in Hong Kong. He does not yet have one.
What has so far amounted to Beijing’s daily improvisations effectively dead-ended when demonstrators shut down the airport last week: That was the first step along Lam’s “path of no return.” What is next remains unclear, but “next” is likely to arrive within a few weeks at the outside. For the moment, Xi’s best option is to work through Beijing’s allies in government and the private sector to swing public opinion away from the demonstrators in favor of some form of de-escalation.
Michael Tien, a Hong Kong legislator who supports Beijing, recently urged it to accommodate some of the demonstrators’ demands for a more authentically representative political process. While it is a sliver, there is a middle ground here. Tien has a precedent to cite: China offered a series of political reforms in response to the Umbrella Movement five years ago. They were rejected for not going far enough; the probability of a similar response this time has to be counted high.
The long view of Hong Kong is not in the demonstrators’ favor. The Sino–British accord put the one-country, two systems principle in place for 50 years; come 2047, Hong Kong is to be a Chinese city like any other. The halfway mark in this interim approaches. This suggests the current crisis is best understood as a step along a bumpy path — a path with neither an exit nor a return.
According to a new report from law firm Haynes and Boone LLP, bankruptcies in the upstream sector are increasing this year as energy spot prices remain subdued amid a cyclical downshift in the economy.
So far, 26 exploration and production (E&P) firms have filed for bankruptcy through mid-August, with debts totaling $10.96 billion. The firm noticed a surge in bankruptcies began in May, following a -23% correction in WTI prices from mid-April to mid-June.
In 2018, 28 E&P firms filed for bankruptcy, posting $13.2 billion in debt, while 24 firms asked for protection in 2017 with $8.5 billion in debt. The firm points out that insolvencies in the energy patch are gaining momentum.
“So far this year there has been an uptick in the number of filings,” Haynes & Boone said.
Oil and gas prices have remained depressed for 2019.
The law firm said it’s hard to tell if a new bankruptcy wave is imminent, but said, “some stakeholders may have given up hope that resurgent commodity prices will bail everyone out,” especially operators who have been on the verge of bankruptcy.
“For these producers, the game clock has run out of time to keep playing ‘kick the can’ with their creditors and other stakeholders,” the firm warned.
Buddy Clark, a Haynes & Boone partner, told Reuters that many of 2019’s bankruptcies are pre-planned, Chapter 11 restructurings, where creditors agree in advance on restructuring plans.
“I don’t think you will see a lot of Chapter 7 (liquidations),” he said. “When you see Chapter 7s is when there are no assets left. Typically, there are always assets left.”
Natural Gas Intelligence believes a bankruptcy wave for the upstream sector could be nearing. This is because operators across the country have been scaling back since oil crashed -44% in 4Q18. Producers have been faced with margin compression, high debt loads, and oversupplied markets so far this year.
Haynes and Boone said 22 oilfield service (OFS) companies have filed for bankruptcy since last year, most notable was the bust of Weatherford International last month.
The midstream sector has so far weathered the slowdown without the same financial stress of the upstream sector.
Haynes and Boone recorded 192 E&P bankruptcies since 2015 totaling $106.8 billion in debt and recorded 185 OFS bankruptcies involving $65 billion of debt over the same time.
And with SocGen’s Albert Edwards warning about a deflationary bust, it seems that the inflation downturn could force commodity prices much lower, could kick off the tidal wave of energy bankruptcies during the 2020 election year.
And here we thought that the WSJ report on Trump wanting to buy Greenland was a joke.
Speaking on the TV circuit on Sunday, White House economic adviser Larry Kudlow confirmed that the US president is really mulling the purchase of world’s largest island: “It’s an interesting story,” Larry Kudlow told Fox News Sunday. “It’s developing. We’re looking at it. We don’t know.” He also reminded host Dana Perino that “years ago” another US President, Harry Truman, also considered buying the 2,166,086-sq-km island, 80 percent of which is covered with ice.
According to Kudlow, Denmark – which incorporates Greenland as a self-governed territory – should sell it to America because “Denmark is an ally.”
“Greenland is a strategic place… they’ve got a lot of valuable minerals,” he explained, and he is right: Danish surveys have found that the owner of the island would stake a claim to around 900,000 sq km of the continental shelf in the Arctic Ocean.
And on Sunday afternoon Trump himself confirmed the report was legitimate when he said speaking to reporters that Greenland is “strategically interesting” and “we’d be interested, but we’ll talk to them a little bit. It’s not No. 1 on the burner, I can tell you that,” the president said.
“It’s just something we’ve talked about,” Trump told reporters when asked about the idea. “Denmark essentially owns it. We’re very good allies with Denmark. We’ve protected Denmark like we protect large portions of the world, so the concept came up.”
“Essentially, it’s a large real estate deal. A lot of things can be done. It’s hurting Denmark very badly, because they’re losing almost $700 million a year carrying it. So they carry it at a great loss,” he said.
As we reported last week, the Wall Street Journal said that Trump “listened with interest” as his advisers discussed Greenland’s strategic location and vast natural resources, directing them to study the possibility of acquiring the island for the US. Not even the fact that Greenland is an autonomous country with over 56,000 people and its own local government, appeared to faze Trump, and while it relies on Denmark for two thirds of its budget, Copenhagen couldn’t sell it even if it wanted to.
So far, no willingness for the latter has been expressed – quite the contrary. Denmark’s prime minister, Mette Frederiksen, ruled out that the country would or could sell Greenland to the U.S. saying “Greenland isn’t for sale, Greenland isn’t Danish, Greenland is Greenlandic,” Frederiksen said Sunday during a visit to Greenland, according to local newspaper Sermitsiaq. “I keep trying to hope that this isn’t something that was seriously meant.”
Sorry Mette, it was quite serious.
“It’s important for us to point out that selling Greenland is not an option. Nobody can sell a country like that. Denmark doesn’t own Greenland and you can’t sell something you don’t own,” Aki-Matilda Hoegh-Dam, a Danish MP elected in Greenland has said.
As a reminder, Greenland is part of the Kingdom of Denmark but has extensive home rule. Trump is due to visit Denmark Sept. 2-3.
Greenland’s Foreign Minister earlier responded to the report by saying that the island was “open for business, but we’re not for sale,” while various Danish politicians blasted Trump’s ambitions as “completely ridiculous” and an “April Fool’s joke.”
#Greenland is rich in valuable resources such as minerals, the purest water and ice, fish stocks, seafood, renewable energy and is a new frontier for adventure tourism. We’re open for business, not for sale❄️🗻🐳🦐🇬🇱 learn more about Greenland on: https://t.co/WulOi3beIC
While so far it has been confined to the realm of the absurd, one possible escalation was penned by the New Yorker’s Andy Borowitz with “Denmark Offers to Buy U.S.” And why not: whereas a mortgage on Denmark would cost even Trump a pretty penny, it was a Danish bank – the third largest – that is now offering a -0.5% negative rate mortgages, i.e., it is paying people to pay take out a mortgage. Surely the magic of helicopter money means that even a country as expensive as the US can be purchased by the highest bidder once negative rate mortgages are thrown in…
For years, this website and many others (such as Goldman), had been warning that in the brave new world of activist central banks in which there is virtually no risk left as any downturn is met with aggressive central bank interventions, there is also no liquidity as central banks themselves have displaced all other actors and have flooded the market with artificial liquifity, and as a result “liquidity has become the new leverage” when it comes to specific risks plaguing various assets, and especially corporate bonds.
Yet while the warnings came and went, bond spreads – both investment grade and junk – continued to grind ever tighter as yields tumbled across the entire fixed income universe, and in some European cases, “high” yield bond yields even turned negative.
All that appears to have come to a long overdue end in recent weeks, as liquidity premiums for both IG and junk bonds have suddenly jumped higher. In a recent bond market analysis, Goldman strategists looked at the relative value performance of illiquid vs. illiquid bonds, with the results of Goldman’s estimates of the average spread pickup provided by illiquid bonds over their liquid peers in the IG and HY markets shown in the chart below.
The key takeaway from Exhibit 1 is that the illiquidity premium, i.e., the spread differential between illiquid and liquid bonds, has been drifting wider in both the IG and HY markets, reaching its highest level in two years. The underperformance of illiquid bonds is further illustrated in the next chart, which shows the cumulative excess return (rates-hedged) on a long-short strategy involving illiquid vs. liquid bonds.
As the chart clearly shows, the poor showing of illiquid bonds has been particularly pronounced in HY, with liquid bonds outperforming by 2% over the past two weeks.
As with the relative value of high vs. low price bonds, Goldman thinks the risk-reward in being long illiquid bonds remains poor despite the new highs made by the illiquidity premium, especially when considering recent market repricing events of illiquid securities such as those of Woodford, H2) Asset Management, GAM and so on.
Why is this happening? While we provided an extensive response in “$1.6 Trillion Fund Spots A New, Ticking Time Bomb In The Market“, Goldman writes that aside from the more fragile post-crisis market microstructure, weak growth sentiment, lingering policy uncertainty, and relatively expensive valuations leave ample scope for further underperformance of illiquid bonds (and let’s not forget the pernicious artificial liquidity provided by central banks and HFTs).
Of course, if the market is finally starting to correctly account for an illiquidity premium, one will expect a violent bond dispersion in both IG and HY, and that is precisely what is happening because as the chart below shows, dispersion is surging from rock-bottom levels, with Goldman warning to “brace for a new regime.”
Pointing to the above chart, Goldman warns that “bond-level dispersion in the IG and HY markets has begun to rise, having been muted in the years prior to that.” Specifically, the bank uses two measures to capture bond-level dispersion: the first measure shown in the left panel of Exhibit 3 is calculated as the normalized standard deviation (coefficient of variation) of monthly excess returns across the bond constituents of the iBoxx IG and HY indices. The second measure shown in the right panel of Exhibit 3 is a normalized inter-decile range, i.e., the difference between the 90th and 10th percentiles of monthly excess returns divided by their sum.
Both measures tell the same story: until recently, dispersion was at or near post-crisis lows, but it has started to trend upwards – a trend that will only gain more momentumif the market continues to punish illiquid bonds, going forward. Key to this view is the increased differentiation in the capital management plans of large issuers in IG as well as rising idiosyncratic risk in HY, particularly in Energy, Retail, Healthcare, and Pharma.
And finally, speaking of idiosyncratic risk, in what may be the most troubling consequence (or perhaps cause) of the market’s sudden fascination with liquidity or the lack thereof, Goldman notes that after a very long hiatus, HY defaults are once again on the rise.
Indeed, as Goldman writes, “headlines about bankruptcies and restructuring plans have recently intensified. And while the 12-month trailing issuer-weighted default rate remains at a benign level, higher frequency indicators show a notable acceleration in the pace of defaults. This is illustrated in Exhibit 4, which shows that the 12-month issuer-weighted default rate stands at 3%. The 3-month trailing HY default rate (annualized) now stands above 5% and has been steadily rising since bottoming out at 1.3% in November 2018.”
What may come as a surprise to most is that on a dollar basis, 2019 has been a banner year for default volumes with over $36 billion notional of defaulted bonds year to date, which is on track to surpass the $43 billion in 2016 as the highest year for notional default volumes in the post-crisis era (Exhibit 5).
In short a default tide has already appeared, however thus far, defaults have been highly concentrated among Energy issuers, a trend that reflects structural as opposed to cyclical challenges. The lingering weakness in oil prices coupled with weak growth sentiment may push issuers in other structurally-challenged sectors towards defaults.
Will the default tide become a tsunami? That depends on whether or not the economy slides into a full-blown recession. Here, Goldman’s US economics remains optimistic and does not expect to occur in the near term, as such the bank’s bond strategists think “defaults are unlikely to move meaningfully higher.” Of course, it won’t be the first time Goldman has been massively wrong about something, and to gauge what the market really thing, keep an eye on just how far it is willing to punish and sell off illiquid names: that will be the best tell if the market thinks that i) a recession is coming and ii) corporate bonds will be the among the first asset class to get crushed once the US economy contracts.
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