Doug Noland: $247 Trillion and (Rapidly) Counting

I chronicled mortgage finance Bubble excess on a weekly basis. Relevant data were right there in plain sight, much of it courtesy of the Federal Reserve. Yet only after the Bubble burst did it all suddenly become obvious. Flashing warning signs were masked by manic delusions of endless prosperity and faith in the almighty “inside the beltway”. These days, data for the global government finance Bubble is not as easily-accessible, though there is ample evidence for which to draw conclusions. It will all be frustratingly obvious in hindsight.

The Institute of International Finance is out with their latest data that, unfortunately, is not made available in detail to the general public. Global debt ended the first quarter at a record $247 Trillion, or 318% of GDP. Even after a decade of historic Credit inflation, global debt continues to expand at (“Terminal Phase”) double-digit rates (11.1% y-o-y).

Global debt growth accelerated during the first quarter to $8.0 Trillion – and surged $30 Trillion over just the past five quarters. In a single data point not to be disregarded, Global Debt Has Expanded (a difficult to fathom) $150 Trillion, or 150%, Over the Past Ten Years. Actually, the trajectory of Bubble-period Credit expansion may seem rather familiar. It’s been, after all, a replay of the reckless U.S. mortgage Credit episode, only on a much grander global scale.

July 10 – Financial Times (Jonathan Wheatley): “The amount of debt in the world increased by nearly $25tn in the year to the end of March, piling more pressure on a global financial system already struggling to deal with rising US interest rates, widening spreads for borrowers and a strengthening US dollar. The Institute of International Finance… said total debts owed by households, governments and financial and non-financial corporations amounted to $247.2tn at the end of March, up from $222.6tn a year earlier and an increase of nearly $8tn in the first quarter alone. ‘The increase in the level of debt, both in absolute terms and relative to GDP, against a backdrop of tightening financial conditions, is, of course, a cause for concern,’ said Hung Tran, the IIF’s executive managing director… The IIF said the debts of non-financial corporations in EMs rose $1.5tn in the first quarter to $31.5tn, the equivalent of 94.4% of GDP…”

A few notable quotes from press reports:

“With global growth losing some momentum and becoming more divergent, and U.S. rates rising steadily, worries about credit risk are returning to the fore – including in many mature economies,” the IIF said.

“Non-financial borrowers in the corporate sector, in the household sector, in the government sector having very high debt levels, will find it very costly and difficult to refinance and borrow more in order to sustain investment and consumption going forward. That is really causing growth to falter, so what I term headwinds to growth.” IIF Executive Managing Director Hung Tran.

“For many emerging markets, which rely heavily on bank financing, higher borrowing costs for banks could be passed through to the corporate and household sectors, so something of a hidden risk in terms of this floating rate borrowing,” said IIF Senior Director Sonja Gibbs.

Bloomberg (Alexandre Tanzi): “Government debt has risen most sharply in Brazil, Saudi Arabia, Nigeria and Argentina, according to the report. Of the four, U.S. dollar refinancing risk is particularly high for Argentina and Nigeria, where over three-quarters of redemptions will be in dollars. About $900 billion is in U.S. dollar-dominated emerging bonds/syndicated loans that will mature by 2020…”

July 10 – Yahoo Finance (Dion Rabouin): “‘The pace is indeed a cause for concern,’ IIF’s Executive Managing Director Hung Tran told Yahoo… ‘The problem with the pace and speed is if you borrow or if you lend very quickly … the quality of the credit tends to suffer.’ That means more governments, businesses and individuals have been borrowing that could have trouble paying the money back. ‘The quality of creditworthiness has declined sharply,’ Tran added… Sonja Gibbs, IIF’s senior director of the global capital markets department, noted that there was an increased risk of sovereign debt crises in a select few developed markets as a result of the increase of debt and financing costs. ‘Government debt is higher than it was prior to the crisis and corporate debt as well,’ Gibbs said… Gibbs added that the United States’ debt growth was particularly worrisome, given that it has now grown to more than 100% of GDP. With the increases in spending from President Donald Trump and Congress, the U.S. will now have funding needs of 25% of its GDP. ‘The U.S. really stands out here because … a lot of that is the expanding budget deficit as well as maturing debt,’ Gibbs said. ‘That’s a lot of financing need affecting the market.'”

U.S. government debt surpassed 100% of GDP during the quarter. Japanese government debt-to-GDP ended the quarter at 224%, the euro area at 101%, the UK at 105% and the emerging markets to 48% of GDP.

To see non-productive U.S. government debt, the foundational “Core” of global finance, inflate so rapidly should be quite distressing. Worse yet, extreme Credit excess is systematic, as debt balloons also at the “Periphery”. From my analytical perspective, we’re witnessing catastrophic, all-encompassing “Terminal Phase” excess. The first quarter saw emerging market debt rise by $2.5 trillion, or about 18% annualized, to a record $58.5 TN. EM Non-financial Corporate debt surged $1.5 TN, or about 25% annualized, to $31.5 TN – and now exceeds 94% of GDP. One big final blow-off setting the stage for crisis.

From the FT (Jonathan Wheatley): “‘The emerging market bond market has grown tremendously over the past decade but trading volumes have not kept pace,’ said Sonja Gibbs, senior director at the IIF. ‘When you combine a rising rate environment, stronger dollar and low levels of liquidity, you have a recipe for volatility and the exacerbation of any periods of market strain.'”

My thesis holds that the global Bubble has been pierced at the “Periphery.” Not atypically, this follows on the heels of remarkable “Terminal Phase Excess,” including phenomenal Credit growth and massive “hot money” inflows. The “hot money” has now reversed; de-risking/de-leveraging dynamics are taking hold. Market complacency is at least partially explained by the sizable reserves the emerging markets have accumulated over recent years, resources the marketplace sees available for stabilizing currencies and Credit systems.

July 9 – Wall Street Journal (Chelsey Dulaney): “Emerging-market central banks are tapping a roughly $6 trillion stash of foreign-exchange reserves as they struggle to contain deepening currency declines. Policymakers across the developing world built up foreign reserve buffers over the past year, capitalizing on investor interest in higher-yielding emerging market assets as global growth remained sanguine. In the first five months of 2018, the central banks added $114 billion to their reserves, the fastest pace of accumulation since 2014…”

The problem, also noted by the WSJ: “Emerging-market central banks used roughly $57 billion in foreign reserves in June, which would rank as the largest monthly intervention since late 2016…” Brazil is said to have burned through $44 billion to support its faltering currency. EM reserve data will be monitored closely over the coming weeks and months. Dwindling reserves will incite a rush to the exits.

There’s been considerable market focus on recent woes in Brazil, Turkey and Argentina. But from a more global systemic perspective, I would at this point focus on heavily indebted Asia. Interestingly, Asian currencies were down again this week. The Chinese renminbi declined 0.7%, the Japanese yen 1.7%, the South Korean won 0.7%, the Singapore dollar 0.6%, and the Thai baht 0.5%. Over the past month, the renminbi is down 4.4%, the won 4.1%, the baht 3.5%, the Indonesia rupiah 3.2% and the Singapore dollar 2.2%.

The unfolding trade war is indeed a major issue for EM, arriving at a most inopportune juncture. Financial conditions have already tightened meaningfully throughout Asian markets, though I would contend that the issue goes much beyond trade. Let’s start with a China Credit Bubble update:

Total Aggregate Finance expanded $176 billion during June, up from May’s $115 billion but 16% below estimates. Aggregate Finance grew $1.36 TN during the first-half, about 18% below comparable 2017. The growth in Bank Loans surged $274 billion in June, up from May’s $175 billion to the strongest expansion since January. Meanwhile, key “shadow banking” components contracted. At $106 billion, growth in Household (chiefly mortgage) borrowings remained strong.

June’s jump in Chinese bank lending surely emboldens those with the view that Beijing has everything in control – that Chinese officials will adeptly commandeer the financial system to ensure sufficient Credit growth and liquidity. It likely won’t be that simple. Chinese banks and corporations have issued enormous quantities of marketable debt over recent years, a significant portion denominated in dollars. Moreover, a massive bank lending campaign at this stage of the cycle will not be confidence inspiring.

It’s also worth reminding readers than China’s international reserve holdings have declined about $900 billion from 2014 highs to $3.112 TN. China now faces the dilemma that their maladjusted economic system will require several trillion ($) of annual Credit growth. Yes, Beijing can dictate lending from state-directed financial institutions. But aggressive reflationary measures risk spurring capital flight and currency turmoil. A disorderly devaluation would be highly problematic for those on the wrong side of dollar-denominated debt.

July 12 – Bloomberg (Lianting Tu and Finbarr Flynn): “A rout in China’s dollar-denominated junk bonds is getting worse as mounting defaults send traders running for cover. Rising trade tensions are also adding to longer-existing difficulties created by the nation’s push to cut excessive leverage. Junk bonds from China have been more volatile this year than such securities from all of Asia. The average yield for the nation’s speculative-rated notes has surged to 10.5%, the highest since 2015, according to ICE BofAML indexes. Few expect a rebound anytime soon.”

July 12 – Bloomberg (Andy Mukherjee): “Donald Trump has made Asian high-yield investors nervous wrecks. First, there are the obvious casualties of his trade war against China. Lenovo Group Ltd.’s bonds are down to 87.4 cents on the dollar from more than 100 cents at the start of the year. Then there’s the collateral damage of his greenback-boosting, late-cycle fiscal stimulus, which is making investors worried about Asian currency weakness. Indonesian notes are swimming in a sea of red ink… Liquidity in Asian high yield is so bad that, after a little haggling, a bond quoted at 94 cents on the dollar can be had for 91 cents. Sellers are panicking.”

After widening 120 bps in four weeks, Asian high-yield spreads on Wednesday were at their widest level since the Chinese mini-crisis back in Q1 2016. China CDS ended last Friday’s trading at a 13-month high (73bps). As noted above, the rout over the past two months has left Chinese junk yields at the highs since early-2015.

“[US Treasury] Yield Curve at its Flattest Since August 2007,” was a Friday evening Financial Times (Joe Rennison) headline. “The measure is an important signal for investors of when the Federal Reserve may curtail its policy tightening and is also seen as a warning of a coming recession if it turns negative, which last happened in 2006.”

I viewed the flat yield curve back in 2007 as more of a warning of Bubble Fragility than an indicator of imminent recession. But with U.S. mortgage finance at the epicenter of the Bubble back then, the bursting Bubble coincided with an abrupt end to Credit expansion and economic growth. I view today’s flat Treasury curve as again signaling Bubble Fragility. The big difference, however, is that global (as opposed to U.S.) finance is at today’s Bubble epicenter. Heightened fragility in China, Asia and EM, more generally, risks global financial turmoil and economic vulnerability.

The unusual backdrop is creating quite a dilemma for the Federal Reserve. Cracks in the Global Bubble’s “Periphery” are putting downward pressure on Treasury yields, in the process loosening U.S. financial conditions in the face of cautious Fed rate increases. The booming U.S. economy at this point beckons for restrictive monetary conditions, yet a more hawkish Fed risks spurring a dollar melt-up and full-fledged EM financial crisis.

The GSCI commodities index sank 3.6% this week. Copper dropped another 1.7%, boosting y-t-d declines to 16%. Zinc fell 5.7% this week, lead 5.6%, Aluminum 2.4% and Platinum 2.1%. WTI Crude dropped 3.8%. In the agriculture commodities, Soybeans dropped 6.7%, Corn 4.9%, Wheat 3.5%, Sugar 4.8% and Coffee 3.8%.

From the currencies to market yields and yield curves to commodities, markets are signaling trouble ahead. The great irony is that Cracks at the Global Periphery now work to prolong “Terminal Phase Excess” at the “Periphery of the Core” – certainly including higher risk U.S. corporate Credit. And booming debt markets feed highly speculative equities and assets Bubbles right along with an overheated U.S. Bubble Economy. After years of Easy Street, central banking has turned into quite a hard challenge.

July 10 – Bloomberg (Danielle DiMartino Booth): “Much has been made of the degradation of the $7.5 trillion U.S. corporate debt market. High yield offers too little, well, yield. And ‘high grade’ now requires air quotes to account for the growing dominance of bonds rated BBB, which is the lowest rung on the investment-grade ladder before dropping into ‘junk’ status. And then there’s the massive market for leveraged loans, where covenants protecting investors have all but disappeared. How does that break down? Corporate bonds rated BBB now total $2.56 trillion, having surpassed in size the sum of higher-rated debentures, which total $2.55 trillion, according to Morgan Stanley. Put another way, BBB bonds outstanding exceed by 50% the size of the entire investment grade market at the peak of the last credit boom, in 2007… In 2000, when BBB bonds were a mere third of the market, net leverage (total debt minus cash and short term investments divided by earnings before interest, taxes, depreciation and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times.”


Original Post 14 July 2018



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Categories: Doug Noland, Perspectives