Global Investing

Rollover risks rising on high-yield bonds

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Emerging market corporate debt is in high demand, as we pointed out in this article yesterday.  But we noted headwinds too, not least the amount of debt that will fall due in coming years as a result of the current bond issuance bonanza.

David Spegel, head of emerging debt research at ING in New York is highlighting a new danger — that of the exponential increase in speculative grade debt, especially from developed markets, that is up for rollover in coming years. A swathe  of credit rating downgrades for European companies this year mean that many fund managers who bought high-grade assets, have now found themselves holding sub-investment grade paper.  He calculates in a note this week that $47 billion of “junk” rated European paper will find itself up for refinancing in the first half of next year, more than double the levels that were rolled over in the first half of 2012.

It gets worse. The big danger now is that as Spain and Italy tumble into the junk-rated category (Ratings agency S&P on Wednesday cut Spain to BBB-, just one notch above junk) their blue-chip companies may well have to follow suit.  Spegel estimates over $100 billion in Spanish and Italian BBB rated corporate bonds are due next year. If these slip into speculative grade, it would triple the amount  of high-yield paper that needs refinancing in the first six months of 2013.

The picture is slightly less dire in the United States next year but it worsens in 2014  when high-yield debt redemptions total $121 billion, or a 60 percent jump from 2012 levels, Spegel says, adding:

Should risk-appetite sour…refunding may prove problematic for many global speculative grade corporates, in which case we could look forward to significantly higher global default rates as soon as 2014.

See the graphic below for the high-yield debt rollover picture in coming years:

 

 

Euro emigration – safety valve or worker drain?

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Four years of relentless austerity in many of the euro zone’s most debt-hobbled countries have forced many of their youngest and sometimes brightest workers to grab the plane, train or boat and emigrate in search of work. For countries with a long history of emigration, such as Ireland, this is depressingly familar — coming just 20 years after the country’s last debt crisis and national belt-tightening in the 1980s crescendoed, with the exit of some 40,ooo a year in 1989/90 from a population of just 3-1/2 million people.

The intervening boom years surrounding the creation and infancy of the Europe’s single currency and expansion of the European Union eastwards saw huge net migration inflows back into the then-thriving euro zone periphery  — Ireland, Greece, Portugal, Spain and Italy — and created a virtuous circle of rising workforces, higher demand for housing/goods and rising exchequer tax receipts.

But all that has gone into reverse again since the credit, property and banking crash of 2008.

A case for market intervention?

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As we wait for ECB Mario Draghi to come good on his promise to do all in his power to save the euro,  the case for governments intervening in financial markets is once again to the fore. Draghi’s verbal intervention last week basically opened up a number of fronts. First, he clearly identified the extreme government bond spreads within the euro zone, where Germany and almost half a dozen euro countries can borrow for next to nothing while Spain and Italy pay 4-7%,  as making a mockery of a single monetary policy and that they screwed up the ECB’s monetary policy transmission mechanism.  And second, to the extent that the euro risks collapse if these spreads persist or widen further, Draghi then stated  it’s the ECB’s job to do all it can to close those spreads. No euro = no ECB. It’s existential, in other words. The ECB can hardly be pursuing “price stability” within the euro zone by allowing the single currency to blow up.

Whatever Draghi does about this, however, it’s clear the central bank has set itself up for a long battle to effectively target narrower peripheral euro bond spreads — even if it stops short of an absolute cap.  Is that justified if market brokers do not close these gaps of their own accord?  Or should governments and central banks just blithely accept market pricing as a given even if they doubt their accuracy?  Many will argue that if countries are sticking to promised budgetary programmes, then there is reason to support that by capping borrowing rates. Budget cuts alone will not bring down debts if borrowing rates remain this high because both depress the other key variable of economic growth.

But, as  Belgian economist Paul de Grauwe argued earlier this year,  how can we be sure that the “market” is pricing government debt for Spain and Italy now at around 7% any more accurately than it was when it was happily lending to Greece, Ireland and Portugal for 10 years at ludicrous rates about 3% back in 2005 before the crisis? Most now accept that those sorts of lending rates were nonsensical. Are 7%+ yields just as random? Should governments and the public that accepts the pre-credit crisis lending as grossly excessive now be just as sceptical in a symmetrical world? And should the authorities be as justified in acting to limit those high rates now as much as they should clearly have done something to prevent the unjustifiably low rates that blew the credit bubble everywhere — not just in the euro zone? De Grauwe wrote:

Investors hungover after wine binge

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During this depression, it would appear that investors are no longer finding solace in turning to the bottle.

Fine wines are being hit hard by the global downturn, with the Liv-ex Fine Wine 100 index down 7.4 percent on the year, according to July’s Cellar Watch Market Report.

Stumbling at every hurdle

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Financial markets are odd sometimes. For weeks they have fretted about the outcome of the Greek election and its impact on the future of the euro zone as a whole. But today they appeared to dismiss the outcome despite a result that was about as positive as global investors fearful for euro zone stability could have hoped for.  So what gives?

The logic behind the weeks of trepidation was fairly simple and straightforward. After an inconclusive election on May 6, a second Greek poll on June 17 was due to give a definitive picture of whether Greeks wanted to stay in the euro and with all the budgetary conditions necessary to keep EU/IMF bailout funds in place.  If a victory for parties wanting to scrap the bailout agreement and austerity led to a halt of EU/IMF funds, the fear was that Greece would inevitably be forced out of the single currency bloc in time too. And if that unprecedented event happened, then a chain reaction would be hard to avoid.  If one country goes back to its domestic currency, despite all its debts being denominated in euros, investors would then find it impossible not to assume at least some element of euro exit risk for fellow-bailout recipients Portugal and Ireland and possibly even Spain and Italy, where doubts remain about their market access over time.

Extreme tail risk or not, this set the scene for the jittery markets that ensued during the Greek electoral hiatus of May 6- June 17. Athens stocks lost more than 17%;  Spanish 10-year government bonds lost more than 7% and the euro/dollar exchange rate was down almost 4%. etc. The fear of euro-wide contagion was so-great that the Spanish bank bailout in the interim had a little or no positive impact. And with the global economic growth picture weakening in tandem with, and partly because of, the euro mess, then prices reflecting world demand in general were hit hard by concerns that another shock to the European banking system could trigger a reversal of trillions of euros of European bank lending from around the globe. Crude oil dropped almost 14%, broad commodity prices and emerging market equities lost about 8%.

Sell in May? Yes they did

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Just how miserable a month May was for global equity markets is summed up by index provider S&P which notes that every one of the 46 markets included in its world index (BMI)  fell last month, and of these 35 posted double-digit declines. Overall, the index slumped more than 9 percent.

With Greece’s anti-austerity May 6 election result responsible for much of the red ink, it was perhaps fitting that Athens was May’s worst performer, losing almost 30 percent (it’s down 65 percent so far this year).  With euro zone growth steadily deteriorating, even German stocks fell almost 15 percent in May while Portugal, Spain and Italy were the worst performing developed markets  (along with Finland).

The best of the bunch (at least in the developed world) was the United States which fell only 6.5 percent in May and is clinging to 2012 gains of around 5 percent. S&P analyst Howard Silverblatt writes:

Investors face a battle for clarity

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How are we looking? Fluid, very fluid!

In a classic case of call and response, the latest twist of the euro saga has seen the crisis escalate sharply in Spain and Italy (with the attempted cleanup of Bankia the latest trigger for a surge in government borrowing rates in both) only to see the European Commission today invoke major policy responses including the proposed use of the new European Stability Mechanism (ESM) to directly recapitalize euro banks, a single banking union, a euro-wide deposit protection system and even pushing back Spanish budget deadlines by a year.

It seems clear from this that they see Spain and Italy – which seem to be trading in tandem regardless of their differences – as the battleground for the survival of the euro. The gauntlet is down for next month’s summit, though the absence of a roadmap to Eurobonds per se will disappoint and markets are not going to sit quietly for a month. Moreover, the Grexit vigil has another fortnight to run before any clarity and the latest polls are not going in the direction other euro governments had hoped, with anti-bailout parties still in the lead. And we can only assume Ireland votes in favour of the now notional fiscal pact tomorrow as per opinion polls, though there’s always an outside chance of an upset.

Three snapshots for Wednesday

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On Friday 283 companies in the S&P 500 had a dividend yield higher than the 10-year Treasury yield, at yesterday’s close this had fallen to 266 but remains very high compared to the last 5-years.

Italian consumer morale plunged to its lowest level on record in May as Italians’ pessimism over the state of the economy plumbed new depths.

Three snapshots for Tuesday

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The euro zone just avoided recession in the first quarter of 2012 but the region’s debt crisis sapped the life out of the French and Italian economies and widened a split with paymaster Germany.

Click here for an interactive map showing which European Union countries are in recession.

Three snapshots for Monday

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The yield on 10-year  U.S. Treasuries, fell to their lowest levels since early October today, breaking decisively below 1.80 percent. That compares to the dividend yield on the S&P 500 of 2.28%.

The European Central Bank kept its government bond-buy programme in hibernation for the ninth week in a row last week. The ECB may come under pressure to act as  yields on Spanish 10-year government bonds rose further above 6% today.