This post will be a short one as I am on vacation and traveling. Other than Russia’s escalating maneuvering in Syria and the U.S. Navy’s intent to sail some serious ships across through the Spratly Islands, four things that really stood out this past week were 1) the deteriorating credit condition of commodity companies (especially Chinese), 2) the delicacy of emerging market credit, and 3) that for the first time ever U.S. 3-month treasuries were sold at a yield of 0% on 10/5/15.
First ZeroHedge on David Stockman’s Contra Corner walked through Macquarie Bank’s report “Further deterioration in China’s corporate debt coverage.” Basically, looking at the entire universe of CNY22tn in corporate debt, the “percentage of EBIT-uncovered debt went up from 19.9% in 2013 to 23.6% in 2014…”. In 2007 only 4 companies (all in the cement sector) had “uncovered debt (companies that can’t cover a full year of interest expense with profit).” In 2013 approximately 1/3 of companies couldn’t cover their debt and corporate debt was at CNY4tn for just the commodity sector. In 2014 “more than half of the cumulative debt in this sector was EBIT-uncovered and approximately CNY2tn in debt was in imminent danger of default and particularly for base metals companies.
Second, Gillian Tett of the Financial Times aptly highlighted why the Fed is right to be concerned about emerging markets in her article: The credit bubble, the bears and the central bankers. There is the sheer size of the amount of emerging market corporate debt “as the IMF noted in its latest financial stability report, between 2004 and 2014 EM corporate debt increased from $4bn to $18bn, with much of the growth occurring after 2008.” Further that “Citi has estimated the global private-sector money creation over this period and their conclusion is that 3/4 of all global private money creation in the past five years has occurred in EM. More specifically, since 2000 $8bn of flows have gone into EM – and this has generated $5bn of private EM credit each year.” As Matt King, analyst at Citi, put it “the EM bubble is so big that it is far from clear central banks could plug the gap if (or when) this money creation slows down; the world is reaching a point of ‘credit exhaustion.’”
Third, as covered in the Financial Times by Patrick McGee on Monday, October 5, 2015, for the first time ever, US 3-month treasuries were bought for a yield of 0%. $21bn of zero-yielding three-month treasuries were sold. Keep in mind that the lowest bid currently permitted for a US bill auction is 0%, “but ahead of the sale, four week and three-month bills have been trading at negative yields in the secondary market.” By Tuesday, the four-week bill was quoted at -3bp and the 3-month at -1bp. As a result, Wrightson Icap (a research company) is forecasting “that the debt limit will be raised in the first week of November and that the Treasury will start to ramp up issuance aggressively the following week. We could see the four-week offerings return to $40bn within a couple of weeks after Congress acts.” Also on Monday, the US auctioned 6-month bills yielding 0.065%, the lowest in 11 months. Recall that before the financial crisis, 3-month treasuries routinely yielded more than 4%, but have been less than 0.2% since April 2009 reflecting the Fed maintaining an overnight borrowing band of zero to 0.25%. Until Monday the record low was 0.005%. “Negative yielding bonds have become far more pronounced with Finland, Germany, France, Switzerland, and Japan all selling five-year debt at negative yields… Switzerland in April became the first government in history to sell benchmark 10-year debt at a negative interest rate.” Don’t forget that the U.S. 10-year still yields close to 2%, that’s practically stratospheric in relation to similarly rated debt in Europe and Japan.
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