The Fed’s ‘logical panic’ adds more fuel to the world’s debt pile
The Fed has pumped up Wall Street again, but there are still plenty of worries for global markets. (Reuters: Lucas Jackson)
The past six weeks have seen markets shift rapidly between white-knuckled anxiety, through an exuberant rebound, to “Hey, wait a minute”.
This week in finance:
- US-China trade talks resume in Beijing, China trade balance (Thursday)
- Australian business (Tuesday) and consumer confidence (Wednesday) data are released this week
- ASX results season reports include; JB HiFi (Monday), Amcor (Tuesday), Cochlear and CSL (Wednesday), South32, Woodside and AMP (Thursday).
This week’s pause for reflection was inspired by a number of disappointments; hopes for a resolution of US-China trade tensions were kicked further down the road (again), the outlook for the global economy became even cloudier and corporate earnings’ forecasts ratcheted down a notch or two.
No doubt some profits were simply taken off the table given the easy money made since the start of the year.
It poses the question why was that money so “easy”? What happened to repair the 20 per cent bite the bears took out of Wall Street — the Australian market fell a less vertiginous 11 per cent — between October and Christmas?
The belief the Federal Reserve would back off its ambitions helped change sentiment, as did a couple of tweets from the @realDonaldTrump account, talking up a trade deal with China.
The Trump trade tweets may not have been on the money, but betting on the Fed to soften its stance paid off handsomely.
Fed chairman Jerome Powell did not so much slowly tightening things, he wrenched the monetary jalopy into a U-turn.
His statement that, “In light of global economic and financial developments” the Fed would be “patient” and was prepared “to use its full range of tools” if things got really nasty, meant money printing, aka quantitate easing (QE), was back in the mix.
QE was the unconventional monetary plumbing tool the Fed pulled out of its back pocket to open jammed liquidity taps in the depths of the global financial crisis.
Rather than slashing interest rates, which was limited once they hit zero, the Fed — quickly followed by the other big central banks in Europe and Japan — bought trillions of dollars worth of bonds to drive down borrowing costs and flood the world’s banks with new money to lend.
As the International Money Fund noted in its Global Financial Stability Report late last year, the unconventional policies have seen, “total nonfinancial sector debt — borrowings by governments, nonfinancial companies, and households — expand at a much faster pace than the growth rate of the economy”.
The idea was once things had stabilised, the central banks would just allow the bonds to be run off to maturity. Pfft, gone.
It was supposed to be a relatively short-term addiction, but as it is said, “old habits die hard”. Dangerous habits often have an even stickier end.
A concerted money printing operation by global central banks already appears to have kicked in weeks before Mr Powell opened up about the possibility of getting back on his “full range of tools”.
2MG Asset Management’s Mike Mangan says since the market meltdown scare in December, the four largest central banks have increased the size of their balance sheets by $US428 billion ($603.3 billion) to global liquidity across the last month.
That’s a big change to the $US1.2 trillion of liquidity central banks drained out the financial system in the previous nine months.
The big four central banks had been shrinking their balance sheets until equity markets crumbled in December. (Supplied: 2MG Asset Management, Bloomberg)
A very logical panic
“It is entirely logical central bankers should panic at the first whiff of market trouble,” Mr Mangan said.
Mr Mangan argues the world is so loaded up with debt — and in particular corporate, bank and government debt — any market correction risks spiralling out of control into global financial crisis-type abyss, or worse.
Data compiled by the Institute of International Finance recently showed global debt has swelled to $US250 trillion, which is a bit more than three times the size of total global GDP.
The corporate and bank sectors account for more than half of that. They are also hold the riskiest debt.
As the IMF Global Financial Stability Report pointed out rather nervously there are also about $US1.3 trillion of so-called leverage loans lurking out there.
These are loans extended to already financially stretched companies, or companies with less than pristine credit histories. Lenders carry higher risk and borrowers pay more.
The loans ae pooled, chopped up and syndicated to various lenders in individual tranches. Starting to sound familiar?
Those tranches are called collateralised loan obligations (CLOs). That’s it, a not-too-distant relative of the collateralised debt obligations (CDOs) cobbled together out of the US subprime debt were basically the root cause of the global financial crisis.
But hey, financial markets have learned their lesson with this stuff, haven’t they? Really, what could go wrong?
Credit market headwinds
$US11 trillion in corporate debt is due to mature in the next four years. (Reuters: Gary Hershorn)
A report released last week by the big global credit ratings agency Standard & Poor’s (S&P) found $US11 trillion in corporate debt it rated is scheduled to mature between now and the end of 2023.
Things are not exactly plain sailing at the moment in credit markets.
“Credit market issuance is slowing, with multiple headwinds that have been straining the market, including central bank policy normalisations in the US and Europe, the uncertain terms of Brexit, and slowing economic growth in China as well as in much of the developed world,” Diane Vazza, head of S&P’s fixed income research, said.
The credit ratings agency described the ability of corporates to repay that mountain of debt as “largely manageable”.
“Largely manageable” doesn’t sound like a cast-iron guarantee, and it assumes something nasty like a market meltdown doesn’t happen again.
And that’s what’s worrying Mr Mangan and many others managing large licks of money.
“The big mistake central bankers made in 2008 was failing to recognise the contagion impact of subprime debt,” he said.
“It took the fall of Lehman [Brothers] some 18 months after subprime first emerged as an issue, before the monetary fire brigade turned up.
“That’s why central bankers need to panic any time a correction starts to spiral out of control, as was threatened last Christmas Eve.”
‘Stop the 50 Bs’
It was an issue US President Donald Trump was well ahead of the curve on, sending his central bank boss a very public rocket in the midst of the December market swoon.
Needing to keep the message short and sharp, below 280 characters, Mr Trump fired off a tweet right across the White House south lawn and straight down Constitution Avenue to the Fed’s HQ.
“Don’t let the market become anymore illiquid than it already is. Stop the 50 B’s. Feel the market, don’t just go on meaningless numbers, good luck,” it said.
While the “stop the 50 B’s” may have been rather cryptic to most, down at the Fed, and on Wall Street, they knew exactly what it meant; end the monthly $US50 billion run-off of the multi-trillion asset base built up during the post-financial crisis money-printing binge.
Many in the investment banking/fund manager world had long blamed the monthly run-off for some unnerving market wobbles.
Clearly, the President found more merit in the bankers’ argument than the Fed’s. A short while later the Fed agreed too.
However, some find it all rather disheartening, including 2MG’s Mr Mangan.
“Trade wars, Venezuela, Huawei, US shutdown, slowing economies et al are all very important. But it’s ‘the 50 Bs’ that overrides everything else,” Mr Mangan said.
“That being the case, there is a very high probability January’s bull market kicks on.”
As Mr Mangan points out, the return to a bull equity market may well continue even as global economic conditions deteriorate.
“Take Italy. Now officially in recession. Italian stocks just experienced their best January since 2011,” he said.
“The US S&P [500 index] has just had its best January since 1987, but EPS [earnings per share] forecasts fell the most in three years.”
As Mr Mangan says, it’s all about the 50 Bs overriding almost everything else.
The question remains, are these bloated central bank balance sheets sustainable?
The architects of QE would say “no”, otherwise why was it always the intention to run them off with the 50 Bs.
If they are not sustainable, what happens on the day of reckoning?
Someone will have to pick up the tab. It’s unlikely to be the banks. As we’ve already learned, they have been deemed too big to fail.
In the short term though, the market sails blithely on, content a “dovish” Fed outweighs soft earnings forecasts, the US and China still failing to find common ground and the global economy cooling rapidly.
Friday was a bit iffy, with a late-session surge finally hauling the S&P500 into marginally positive territory for the week.
ASX had a much better week, up 3.6 per cent, but that can be put down to a post-royal commission relief rally in banks stocks and iron ore heading towards $100 a tonne.
Futures trading points to a more muted start to the local market this week.
Markets on Friday’s close:
- ASX SPI 200 futures -0.1pc at 6,007 ASX 200 (Friday’s close) -0.3 at 6,071
- AUD: 70.9 US cents, 62.5 euro cents, 54.7 British pence, 77.8 Japanese yen, $NZ1.05
- US: Dow Jones -0.3pc at 25,106 S&P500 +0.1pc at 2,708 NASDAQ +0.1pc at 7,298
- Europe: FTSE -0.3pc at 7,071 DAX -1.1pc at 10,907 EuroStoxx50 -0.5pc at 3,136
- Commodities: Brent oil +0.6pc at $US61.97/barrel, Gold +0.3pc at $US1,314/ounce, Iron ore $US92.29/tonne
This week the ASX results season kicks up another gear with about 20 per cent of the top 200 dropping mainly first half numbers.
The first week didn’t provide great insights apart from softish reports from the banks — interim from CBA and first quarter from NAB (buried under the avalanche of news of the departure of both chief executive and chairman).
Forward looking commentary hasn’t been bullish and more worries in the weaker consumer and housing sectors are likely to be recurring themes in coming weeks.
Both business conditions and confidence (Tuesday) and consumer confidence (Wednesday) are the key pieces of data on the local front this week.
All measures are trending down, which generally is not an indicator of better times ahead.
Housing finance (Tuesday) is also out and it is reasonable to guess it won’t be strong, particularly in the investor sector.
However there was flicker of hope with better clearance rates at home auctions in Sydney and Melbourne over the weekend.
Trade talks resume
Events overseas are likely to dominate market sentiment.
Trump administration heavy-hitters, treasury secretary Steve Mnuchin and trade representative Robert Lighthizer return to Beijing for another chat with Chinese officials to try and sort their differences.
Perhaps the best that can be hoped for is an extension of the March 1 deadline to wrap things up.
US/China trade talks and Chinese trade data will shape market sentiment this week (ABC News, Alistair Kroie)
Mr Trump and Democrat leaders are back in talks about “the wall”.
Lack of progress probably means the government shutdown will resume on Friday.
The key number from Australia’s perspective is China’s trade figures (Thursday).
Both imports and exports fell in December, showing (a) the domestic economy and demand were cooling, and (b) regional economies were not doing too much better and US tariffs were biting.
The consensus view is things have deteriorated further in January and that’s bad news for our big commodity exporters
|Company results||Amcor, Aurizon, Bendigo & Adelaide Bank, JB Hi Fi half year; GPT full year|
|Company results||Boral, Challenger, Transurban half year|
|Home loans||Dec: RBA series, falls accelerating to around 2pc MOM|
|Business survey||Jan: NAB series, conditions and confidence are falling sharply and that’s a worry|
|Company results||Beach Energy, Carsales, Computershare, CSL, Dexus, Orora, Vicinity Centre half year|
|Consumer confidence||Jan: Westpac series, the pessimists are in the ascendency again|
|Company results||AMP full year; ASX, Goodman, Newcrest, South 32, Suncorp, Telstra, Treasury Wine, Woodside half year|
|Company results||Domain, Link, Medibank Private, Sims Metal, Whitehaven Coal half year|
|CH: Foreign reserves||Jan: Still holding above $US3t|
|UK: GDP||Q4: Pretty insipid growth around1.4pc YOY|
|US: Business optimism||Jan: Mildly optimistic|
|US: Inflation||Jan: Core CPI rate expected to be around 2pc YOY|
|US: Budget update||Dec: Still in deficit|
|EU: GDP||Q4: Also insipid growth, only a little above 1pc YOY|
|US: Durable goods orders||Dec: A proxy for business investment, may tick up a bit|
|CH: Trade balance||Jan; A surplus, the decline in both imports and exports could pick up|
|US: Retail sales||Dec: Pretty flat for December, around 0.1pc MOM|
|US: Industrial production||Dec: A 0.2pc increase over the month forecast|
|CH: Inflation||Jan: Consumer inflation around 2pc, producer inflation a fair bit weaker|