From Nomura, with our emphasis:
According to today’s official People’s Daily [link here and Bloomberg writeup here], an “authoritative” person who was not identified indicated that China should not support growth by adding leverage. “High leverage will lead to high risk; if not well controlled, it will lead to systemic financial crisis and negative growth”. Considering China’s severe structural problems, this “authoritative” person believes that “China’s economic growth trend in future should be ‘L-shaped’, rather than ‘U-shaped’, not to mention ‘V-shaped’”, which suggests that growth will trend lower. This individual believes China should avoid using strong stimulus to raise investment growth in the short term, as it would create larger problems later. For now, the most important thing, in this person’s view, is to push forward supply-side reforms (i.e., cutting over-capacity, reducing property inventory etc.) and actively but steadily reduce leverage.
By Deutsche’s Zhiwei Zhang — you can link these charts to asset bubbles and booming egg futures pretty easily btw:
As he says:
Bank credit growth and M2 growth used to track each other quite well in China. It is intuitive. In a simple world where banks’ main business is to channel deposits into loans, the two should correlate well. But this is no longer the case.
Last year, retailer N Brown hiked the interest rate it advertised to customers who buy on credit. The move was a fairly large one, from 44.9 per cent to 58.7 per cent, the highest advertised annual percentage rate for any equivalent retailer, but it didn’t get much attention. The London-listed company, which owns brands like Jacamo, J D Williams and SimplyBe, didn’t shout about it in filings or on calls with analysts.
Which might be because nothing had really changed — N Brown had previously been advertising the wrong rate to customers. Read more
Well, maybe some of you can. More than that and it could get tricky for China.
Here’s BofAML’s David Cui:
Since 2015, eight SOE bond issuers have run into repayment problems; four since February.
He was cast out into the earth, and his angels were cast out with him… But, crucially, they didn’t lead the market.
From Morgan Stanley’s credit strategy team:
Summing up, we think $150Bn is a reasonable estimate for fallen angel volumes [bonds that have dropped to junk status from investment grade] over the next two years (using the current index), with that number growing if oil remains even lower for longer, but especially if fundamental stress spreads beyond commodities in a bigger way.
Fallen angel volumes of this magnitude are meaningful in absolute terms, and to reiterate, could become even larger assuming a US recession. However, we believe it is important to put these numbers in context.
Earlier this week we looked at the performance of loans originated by the likes of Lending Club and Prosper Marketplace and wondered what an uptick in delinquencies in conjunction with a hike in rates, particularly for risky borrowers, might signal about economic conditions.
In fine Alphaville tradition, the first comment was a sceptical “more data, please”. So we thought it worth revisiting and digging into more detail, particularly in light of weakness in the subprime auto loan market.
The data, we would suggest, are pretty clear: credit quality is deteriorating. Read more
REUPDATING because this seems good from HSBC:
On Friday afternoon, Bloomberg News reported that the People’s Bank of China (PBoC) is raising some banks’ reserve requirement ratio (RRR) to curb their lending behaviour. This report rattled investors’ nerves, given that it was inconsistent with China’s weak macro-economic outlook. In an effort to pursue better communication with the market, the central bank issued a statement on Friday evening stating that it has reviewed banks’ lending behaviour in 2015 and decided that a small number of banks no longer qualified for the lower differentiated RRR. However, it also added that some banks, which previously did not enjoy the differentiated RRR, have pursued prudent lending and are now qualified for the lower RRR. The effective date of the latest adjustment is 25 February 2016 (Thursday). Clearly, the initial media report was “lopsided”. We are of the view that the impact of the adjustment is likely to be insignificant for the money market. More importantly, the central bank’s proactive clarification of the media report, along with the recent decision to permanently hold open market operations (OMOs) on a daily basis, underscores its strong desire to anchor money market rates…
Updating at top because apparently PBoC governor Zhou Xiaochuan hasn’t heard about this selective RRR increase. That’s the same Zhou who is keen to up the comms capacity at the central bank. We’ll update again when we/ the PBoC get some clarity.
Just now, via Bloomberg: Read more
Do click to enlarge, any complaints to UBS, where credit also resides:
It’s all a bit messy at the moment — European banks, Japanese banks post the BoJ’s move negative, er other stuff — but it’s not really clear what’s actually going on.
This seems like a decent list of possibilities, from Citi’s Steven Englander:
We think the following concerns are weighing on the market.
1. US economic fragility means there is no one to depreciate against
2. Too many simultaneous issues and policy coordination unlikely.
3. QE/negative rates have lost their financial market impact,
4. QE/negative rates have lost their economic impact
5. QE/negative rates are constrained by bank profits
But his colleague Matt King has a somewhat more involved, if not entirely separate, explanation for what he says is, at the surface, an orderly sell-off but which hides a number of indicators under “extreme stress”.
Basically, it’s all about bank balance sheets coming under pressure. Less basically, he suggests these dislocations “raise awkward questions about the entire narrative which led to the wave of post-crisis bank regulation.” Read more
The credit cycle is long in the tooth by anyone’s reckoning — just how long in the tooth is a different question.
How about four-fifths of the way there? Read more
Even if Third Avenue’s recent shuttering and Stone Lion’s closing of its $400m credit fund — which was run by former Bear Stearns high-yield bond traders Gregory Hanley and Alan Mintz according to the FT — are less a signal of worse to come and more just the closing of idiosyncratic (heavily juiced up) funds, it’s still, according to Goldman, going to be the worst non-recession year for HY since 1983.
With our emphasis:
HY returns have sunk to their lowest level on the year as the pressure from lower oil prices continues to constrain risk appetite. As we go to press, the HYG ETF is down roughly 5% year-to-date. If the weakness persists until the end of the year, 2015 could become the worst non-recession year for HY
First, and with thanks (?) to BofAML for the header:
HY returns to net outflows for 2015 US high yield funds reported -$3.4bn (-1.6%) net outflows this week, the largest outflow recorded since August 2014’s -$6.75bn, after the Malaysian Airlines plane was shot down over eastern Ukraine.
From Deutsche, there are worse ways to sum up this year in credit…
Late stages of every credit cycle, by definition, are built on a theory as to why this time is different.
This type of attitude was prevalent going into 2015, when credit markets largely dismissed the oil sector distress, choosing to believe that this was an isolated issue and will stay that way. Historical evidence pointed to the contrary, where no earlier precedents existed of the largest sector being in distress and the rest of the market remaining firm. Today, two out of three sectors in US HY have more than 10% of debt trading at distressed levels.
Or, charted: Read more
Alternate title: How much credit would a credit checker check if a credit checker could check credit?
Just when you think nothing can stop the march of cheap (in this case US) debt…
A simple question come for you, via UBS’s Matthew Mish and Stephen Caprio: will credit markets be able to absorb the refinancing needs of lower quality high yield and leveraged loan borrowers?
By Christopher Balding, Professor of Economics at Peking University, HSBC Business School, and blogger at Balding’s World.
One of the major questions facing investors and analysts of the Chinese economy is how to size up credit… or more specifically the non-performing loan risk lurking in the system.
About a year ago — a few days before Opec spooked the world with its decision to wage war on shale producers with an oil production race to the bottom, but following a few months of steady oil declines post the Fed’s decision to start signalling an upcoming tightening path — we speculated regarding a what if scenario based on the hypothetical eventuality of no petrodollars :
So, hypothetically, the world has reached its current credit limit. Which, again hypothetically, explains this kind of thing. From Citi’s credit maven, Matt King:
Put aside, for now, any fears you may have that it will be hard to sell corporate bonds at reasonable prices should lots of other people also want to sell corporate bonds.
A chart of the US high yield debt default rate, the Federal Funds Rate, and high yield spreads over time suggests years of time before anyone need fret about credit quality. Or as Robert Michele of JP Morgan Asset Management puts it:
Credit cycles don’t end because of a lack of liquidity; they end because default rates rise. That generally happens after the US Federal Reserve has finished raising rates and has removed the proverbial punchbowl. When we look at the high yield market today based on spreads versus the US Fed funds rates versus defaults, we see that issues in credit tend to come approximately 12 to 18 months after the Fed rate cycle is completed, hence the three to five year time frame we’re predicting, if we presume the Fed will do about 2 years of tightening after starting later this year.
Deutsche Bank’s annual study of defaults has landed. Thoughts on how the next cycle for corporate borrowers might be affected by flatter yields curves below, but first a reminder of just how little money has been lost to bad debts since 2009.
We can’t overstate how low overall defaults are. The 2010- 2014 cohort is the lowest 5-year period for HY defaults in modern history (quality adjusted). To protect for default risk in BB and Single-B rated bonds over this period, investors would have only required 27bps and 94bps respectively. Current EUR/USD BB spreads are 301/350bps and Single-Bs 598/527bps. Indeed in CDS, Crossover now has 10 full years of default history. The peak 5 year default period was the 12% seen in Series 8-10 (late 2007 to late 2013). Relative to its ratings, average default risk for this index should now be around 20%. So this reiterates that recent history and average history in default terms remain remarkably far apart.
Rhetorical question, just to share this chart from Dominik Winnicki and team at Barclays (click to enlarge)…
Is that the calming fragrance of sanguinity? Perhaps. Lets return to the bond market and the state of answers to the question: what will happen if, when, maybe, interest rates go up instead of down.
The fear, simply put, is that at some point there will be an awful lot of sellers of bonds, and very few natural buyers. For the corporate bond market in particular, banks don’t hold as many bonds as they used to, and can’t take the sort of risks that buying big piles of bonds when everyone else is selling would imply.
If you are in a job, say manager of a bond mutual fund, where you have to give customers their money when they ask for it, this might make you nervous. If when maybe that day comes. Read more
Over in Mac McQuown’s Sonoma Valley workshop, courtesy of Bloomberg Markets…
McQuown says his eBond will enable investors to jettison their credit risk because the swap, which is essentially a form of insurance, will cover their losses should the debtor fail. To garner such protection now, an investor must purchase a swap separately to cover a bond. Read more
Could the real cause of today’s financial malaise have less to do with greedy bankers, bad regulation and poor monetary policy, and more to do with the effects of the information technology age on banking?
That at least is the argument proposed in a new book, “The end of banking – money, credit and the digital revolution” by Jonathan McMillan, a collective pseudonym for two authors who are keeping their identities secret, but who hail from the world of banking and academia.
Not to say the financial system was free of instability before the IT age, it’s just that the way in which the instability was dealt with was entirely different. Read more
Who doesn’t like to start the day with a nice hot cup of vindication? There will be plenty of time to recognise those who have been warning about a lack of real liquidity and the chance of real volatility later. For now the question is what to do?
Credit strategist Alberto Gallo of RBS, who has been on team no-liquidity for a while, says wait and see.
What do we do now? We wait a bit longer. Our high yield macro-spread model shows cash should trade at around 500bp in € vs 400bp currently. European high yield spreads are still below last year’s tantrum levels, while US HY spreads are just getting there (508bp). Compared to previous bull market selloffs, this isn’t a short one – but could still last for a while longer.
Cross-posted from Lex Live — which is Lex’s new, free (you don’t even have to register) blog giving an insight on what Lex writers are reading and thinking…
Not that negative zone – Europe: Read more
If you buy this…
… keep reading. Read more
From UBS’s Wang Tao on the sharp slowdown in Chinese credit creation last month (with our emphasis):
China’s July credit data came in sharply weaker than expected. July new RMB lending declined to 385 billion from 1.1 trillion in June. More importantly, new total social financing (TSF) was only RMB 273 billion, led by the drop in new bank lending and a 400 billion shrinkage of bank bill acceptances. As a result, credit growth slowed visibly and our credit impulse plummeted (Figure 1).
Given recent signs of further policy easing and persistently low interbank rates, the market has been expecting additional monetary and credit support. Today’s credit data are therefore a negative surprise. However, we do not believe these data reflect a credit tightening by the PBC – as evidenced by recent policy intentions expressed by the Politburo and the central bank, as well as ample interbank liquidity and strong credit growth in June which surprised on the upside.
RBS have joined the chorus of concerns about dangers in credit markets from thin trading volumes and a lack of risk takers making markets.
The bank also, it turns out, has a measure for trading lubricacity:
Our Liquid-o-Meter shows liquidity in the credit markets has declined around 70% since the crisis, and it is still falling. We define liquidity as a combination of market depth, trading volumes and transaction costs: all have worsened. We also measure the premium for illiquidity: it is at a record low, meaning investors are not getting paid to take liquidity risk.
More on the topic of liquidity, which we’re choosing to understand as the ability to buy or sell when you want to without paying a lot for the privilege. Markets composed of rational, or at least reasonably calm, buyers and sellers. That sort of thing.
From San Francisco comes a video of JP Morgan’s Jan Loeys, shot in the straight-to-camera style of a 1970s news bulletin which lends the whole thing a certain gravitas. The message is to think about liquidity, and to prepare for its possible absence. Read more
You may detect a sceptical tone there, but the question is real: does it matter if something unexpected occurs in the world of credit and rates?
We’ve been on this point for a while — assessment of risk is sticky, until it’s not — but were struck by a recent conversation with a market maker about his clients:
Everyone is acting like an LTCM.