Blain: "GE’s Credit Meltdown Is Coming At Just The Right Time To Ruin Everyone’s Day"

“Reversion to the mean is the iron rule of markets..”

Let’s have a Brexit Free morning.. see how the dust settles, who kills who, and who is left standing on Monday morning..

Two of the most important of Blain’s Trading Mantras are:

“THE MARKET HAS NO MEMORY”

“THE MARKET’S ONLY OBJECTIVE TO INFLICT THE MAXIMUM AMOUNT OF PAIN ON THE MAXIMUM NUMBER OF PARTICIPANTS”

Bearing these in mind, and what’s going on globally, I’m wondering if its time to set up for the big corporate bond buying moment. There is nothing to be fearful about when it comes to volatility. Just be ready for it. For bond markets to be an opportunity… prices have to move dramatically lower. And I think they will as the market wakes up to smell the proverbial coffee.

Long ago, in a galaxy far far away…

There once was a company in far-off Texas that grew and grew its energy and commodities business into a AAA rated behemoth hailed as “American’s Most Innovative Company” year after year. Everyone was happy. They all got massive bonuses right up to the moment Enron went bust on the back of massive accounting fraud, and bond holders were hosed.

17 years later there is another former AAA corporate darling on the cusp of being downgraded to Junk. After reporting $30 bln of unexpected charges and a shortfall in insurance reserves in October, GE’s bond spreads have ballooned as investors start to panic about accounting probes, crashing demand for its products, worries about its $115 bln debt mountain, and the perception of a liquidity meltdown.

Investors are right to be scared. The last few years has seen a bond binge with spreads dramatically tightening on the back of free money. Now its reversing. Investment-grade bond spreads have widened across the board as the bond market wonders who else might be swimming without their bathing suits…

You have to ask what credit analysts do all day…

Nearly half the $6 trillion investment grade bond market is now rated within a single notch of being downgraded to Junk. Not that ratings actually mean that much – another lesson investors seem to have conveniently forgotten just 10-years after they swore they’d never trust ratings again. It’s just too easy to forget they are just expensive opinions.

Over the last 8 years US corporates have gorged on cheap debt – and used it all to buy-back their own stock or payout the Leveraged buyout funds that own them. Debt has risen while profitability has declined. Converting equity into debt to give cash to owners means they haven’t built new plant to make stuff that will repay debt. That multiplies their vulnerability to rising interest rates. 

Bond covenants have become progressively softer and less onerous even as US corporates have binged on ultra-low rates selling bonds to investors desperate to buy anything yielding half-a-tad more than Treasuries. (For readers unfamiliar with bond market terms like a tad, smidge or a bit, its dead simple; a tad is bit more than a smidge, or is it smidge is tad less than a bit?)

Once again Ratings lie at the centre of the problem. Fund managers still have rules like “only buy investment grade bonds”, so they do - assuming a rating is the guinea stamp (guarantee) of investment quality, and that attaching a slew of As to a bond somehow justifies buying stuff they just don’t really understand.

Another unintended consequence of QE is yield tourism - investors who were safe in the shallow-risk toddler pond of Government bonds found themselves forced into deeper more dangerous waters of high-risk BBB and Hi-Yield Junk in search of meaningful yields. As the default-sharks gather, the inevitable feeding frenzy is about to start….

Yet another consequences of the crash of 2008 are pages of regulatory overkill and rules that have killed bond market liquidity by constraining banks from doing stuff like making markets or acting as brokers. Markets are dramatically less efficient. Bond markets in the most difficult sectors are trading a massively wider bid/offers and become “distressed” at the first sign of trouble. That’s a long way of saying there will be zero liquidity when fear becomes flight. (And that’s why anyone trying to sell illiquid bonds today is discovering they are a distressed seller!)

(Nor has it helped that banks have seen fit to dismiss most of the experienced sales staff who might have understood underlying value and how to trade difficult debt, and replaced them with young graduates who can just about navigate themselves around the daily sales sheet, but understand nothing about providing liquidity.)

In short, GE’s credit meltdown is coming at just the right time to ruin everyone’s day. Its not as if thing aren’t bad enough already…  

When I was a lad, the trip upstate to see the Treasurer of GE was one of the most fearsome of tasks for a young debt origination banker. I’d try to explain demand and the success of the fantastic deals we’d just completed for Ford and GM, and have these dismissed as irrelevant as they had nothing in common with GE. I was unsubtly told If I wanted GE’s debt funding business, I better be prepared to “pay to play” by providing lots of cheap MTN funding before I’d get a public bond mandate from them.

20 years later and GE still has $115bln of outstanding debt. Prices on the benchmark GE 4.4% 2035 bond longer-dated bonds have crashed from near par to near 82% in recent weeks. I imagine I’d get my arm bitten off if I offered them new funding today. Or maybe not.. I read a comment yesterday: “GE does not plan to raise new debt until 2020, so the recent increase in bond yields will not increase current interest expenses.. the company plans to pay down debt through asset sales before returning to bond markets.”  Am I convinced? That sounds like a company facing a classic liquidity squeeze. What is Plan B if asset sails don’t work fast enough?

Its spread will likely widen further. Banks and other lenders are buying credit default protection. A few weeks ago, the Commercial Paper market effectively slammed shut to the name. If the rating is further cut to junk, then there will be a wave of enforced bond sales from buyers who can only hold Investment Grade Paper – further widening the pain.

Corporate defaults are a fact of life – a fact many US bond pundits are now waking up to. Recent new deals across the Investment Grade sector have struggled to achieve much market excitement. I can’t help but be amused by bond analysts writing stuff about how attractive bond spreads look at these levels. It feels to me like a crisis is brewing…

Very simple question… why would you buy mega risky high yield debt at 6% when I can sell you absolutely solid secured asset backed alternative debt at 7-8% that’s uncorrelated to the coming debt debacle?

Meanwhile….

Fed Head Jerome Powell is warning the Fed’s rising rate campaign may stall next year on the back of slowing demand overseas, the likelihood of fading fiscal stimulus next year, and the effects of the Fed’s previous hikes now being felt across the economy.

That could mean we’re looking at any big bond correction on credit fundamentals being capped by a slow down in rate rises – the new normal economy of lower growth and constrained inflation?

When bond prices do correct they are going to look very good value if we are into a new normal. Which is why I’m wondering if its time to go bottom fishing on a crash – but in very selective names.

16 Nov 2018

Blain's Morning Porridge, submitted by Bill Blain

What's Behind Today's Dramatic Curve Steepening

As we noted earlier today, long-end yields on both the 10Y and 30Y Treasury have blown out in the past two days, sending the 10Y above 2.96%, the highest level since the Fed rate hike...

... which in turns has dramatically steepened the yield curve by just under 10bps, from a multi-year low just last Friday, to the steepest since the end of June.

What's behind the move?

The answer, according to BofA, is simple: While the Fed controls the front end of the yield curve, the ECB and BOJ are in charge of the back end, or as the bank summarizes:

Front=D.C., back end=Frankfurt+Tokyo

Clearly this is a simplification as rate hikes have some impact on the back end as well as do other stories - such as the big ongoing pension reallocation trade. But as BofA notes, "consider that when the ECB recently communicated the end to QE they did so in a super-dovish way by guiding negative interest rates way into the future, which led to bull flattening in the back end of the US Treasury curve (fig 11)."

Fast forward to today, as we reported earlier, we saw the opposite effect - i.e. a meaningful bear steepening - in large part (other part was President Trump's pushback on rate hikes) a response to news headlines suggesting that the BOJ is contemplating tweaking its QE program to steepen the back end of the JGB curve, shown in fig 12 below.

That would help financial institutions suffering in the  present environment with a lack  domestic yield opportunities, and has manifested in a prompt jump in global bank stocks.

One way to steepen the back end of the JGB curve would be to widen the band on 10-year JGB yields from 0-10bps presently to 0-25bps or even 0-50bps.

Incidentally, this also highlights the biggest risk to US credit spreads, i.e. that the support from super-easy foreign monetary policies declines over time. Obviously the BOJ is far from meeting its policy goal of just-shy-of-2% inflation so the impact of any monetary policy change should be limited for now. However, any serious discussions of adjusting YCC in Japan, and the biggest casualty would be not JGBs but long-bonds in the US. Alternatively, should the BOJ announce nothing next week and keeps the 10Y target range at 0-10bps, watch yields tumble and the curve pancake even more as the latest batch of Treasury shorts is steamrolled.

Fonte: qui

Jim Rickards: No Place Will Be Spared When The Credit Crisis Tsunami Comes Crashing Down

Jim says the next credit crisis will come crashing down like a tsunami, and no one on earth will be spared by it. Here’s why…

by Jim Rickards of Daily Reckoning

So many credit crises are brewing, it’s hard to keep track without a scorecard.

The mother of all credit crises is coming to China with over a quarter-trillion dollars owed by insolvent banks and state-owned enterprises, not to mention off-the-books liabilities of provincial governments, wealth management products and developers of white elephant infrastructure projects.

Then there’s the emerging-markets credit crisis, with Turkey and Argentina leading a parade of potentially bankrupt borrowers vulnerable to hot money capital outflows and a slowdown of growth in developing economies.

Close on their heels is the U.S. student loan debacle, with over $1.5 trillion in outstanding debts and default rates approaching 20%.

Now we’re facing a devastating wave of junk bond defaults. The next financial collapse, already on our radar screen, will quite possibly come from junk bonds.

Let’s unpack this…

Since the great financial crisis, extremely low interest rates allowed the total number of highly speculative corporate bonds, or “junk bonds,” to rise 58% — a record high.

Many businesses became highly leveraged as a result. There’s currently a total of about $3.7 trillion of junk bonds outstanding.

And when the next downturn comes, many corporations will be unable to service their debt. Defaults will spread throughout the system like a deadly contagion, and the damage will be enormous.

This is from a report by Mariarosa Verde, Moody’s senior credit officer:

This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default… A number of very weak issuers are living on borrowed time while benign conditions last… These companies are poised to default when credit conditions eventually become more difficult… The record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.

Many investors will be caught completely unprepared.

Each credit and liquidity crisis starts out differently and ends up the same. Each crisis begins with distress in a particular overborrowed sector and then spreads from sector to sector until the whole world is screaming, “I want my money back!”

The problem is that regulators are like generals fighting the last war. In 2008, the global financial crisis started in the U.S. mortgage market and spread quickly to the overleveraged banking sector.

Since then, mortgage lending standards have been tightened considerably and bank capital requirements have been raised steeply. Banks and mortgage lenders may be safer today, but the system is not.

Meanwhile the Fed is raising interest. It’s undertaking QE in reverse by reducing its balance sheet and contracting the base money supply. This is called quantitative tightening, or QT.

Credit conditions are already starting to affect the real economy. New cracks are appearing in emerging markets, as I mentioned. I also mentioned that student loan losses are skyrocketing. That stands in the way of household formation and geographic mobility for recent graduates.

Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch.

It doesn’t matter where the crisis begins. Once the tsunami hits, no one will be spared.

The stock market is going to correct in the face of rising credit losses and tightening credit conditions.

No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act.

That’s why the time to buy gold is now, while it’s cheap. When you need it most, once the crisis hits, it’ll cost a fortune.

Chinese Shadow Bank Lending Unexpectedly Crashes, Sending Total Credit Creation To Two-Year Low

According to most flow-tracking economists (and not their clueless, conventionally-trained peers) when one strips away  the noise, there are just two things that matter for the global economy and asset prices: central bank liquidity injections, and Chinese credit creation. This is shown in the Citi charts below.

And if indeed it is just these two variables that matter, then the world is set for a turbulent phase because while global central banks liquidity is set to reverse a decade of expansion, and enter contraction some time in Q3 as the great "liquidity supernova" begins draining liquidity for the first time since the financial crisis...

... the latest Chinese credit creation data released on Tuesday, added significantly to the risk of a "sudden global economic stop" after the PBOC reported that in May, China's broadest monetary aggregate, the Total Social Financing, just posted it smallest monthly increase since July 2016, confirming that Beijing's shadow deleveraging campaign is accelerating and gaining even more traction, even if the threat of a global deflationary spillover is rising by the day.

A quick look at the numbers reveals that there was not much of a surprise in traditional new RMB loans, which rose RMB1150bn in May, slightly below consensus RMB1200bn, growing 12.6% yoy in May.

However, it was the sharp, unexpected plunge in Total social financing growth, which attracted attention and which rose only RMB 760.8bn in May, almost half the consensus print of RMB1300bn, and sharply below April's RMB1560bn increase.

Of the main TSF components, the drop in shadow bank lending was particularly sharp: this has been the area where Beijing has been most focused in their deleveraging efforts as it’s the most opaque and riskiest segment of credit. And, as the chart below show, the aggregate off balance-sheet financing posted its biggest monthly drop on record in May.

As Bloomberg's Fielding Chan noted, in contrast to the sudden collapse in shadow banking liabilities, bank loans were relatively stable, even though the expansion in outstanding credit slowed further, implying a slightly heavier drag on growth.

Indeed, the lass granular M2 reading also posted a growth slowdown, rising only 8.3% in May, unchanged from April, and below the 8.5% consensus estimate.

Commenting on the ongoing slowdown to China's credit creation, Goldman said that May money and credit data are the result of a tug of war between two forces:

• On the one hand, the PBOC adopted a looser monetary policy stance, which provided more ample liquidity to financial institutions.
• On the other hand, the financial regulators kept tight controls, which depressed non-RMB loan credit supply, while the recent surge in corporate defaults probably made financial institutions more cautious as well. ril.

Still, while previously Chinese credit had an marked, if delayed, impact on the economy, the relationship between monetary variables and real activity variables has become unstable over the past 2 years, as Morgan Stanley noted recently. This has been affected by a number of factors such as: stronger exports and consumption, both of which are less debt dependent than investment; rapid financial innovation in terms of payment and deposit systems; and the changing structure of credit, which has different impacts on the "real economy".

Given all these changes, Goldman notes that it's hard to know the right level that is consistent with the desired level of activity growth. The government has adopted a "tweak as you go" policy. The level of broad credit growth is likely to be viewed as being at the low end of the suitable range, and authorities may take some measures to prevent it from falling to a lower level, especially given the ongoing trade dispute is already posing downside risks to growth. Such measures could include further RRR cuts.

Alternatively, how much longer can China, and the world, keep ignoring the all-important slowdown in Chinese credit? To be sure, the economy has been surprising resilient this year, buoyed in part by solid global demand. Bloomberg's view is that growth will slow in 2H, as headwinds from credit, slowing exports, and a cooling property sector become stronger.

Meanwhile, the push to curb credit growth even as risks from trade tensions with the U.S. rise suggests strong determination to deleverage the economy.

Finally, the risk is that China hikes too far as it keeps in line with the Fed's own rate hikes: we expect that PBOC will increase its interest rate by 5bps later today, as well as tighten its reverse repo and MLF facility, after the Fed hikes by 25bps. How much higher can China afford to rise rates, and slow its economy, as it tries to prevent capital flight toward the US. We will find out as soon as the market realizes that between central banks and China, there is virtually no new liquidity creation.

Fonte: qui