Same Old Same Old
Saturday, July 25, 2015
From Ye Xie’s Bloomberg article: “Emerging-market currencies are in free fall. An index of the major developing-nation currencies fell to an all-time low this week, extending its drop over the past year to 19%, according to data compiled by Bloomberg going back to 1999. The Russian ruble, Colombia's peso and the Brazilian real have fallen more than 30% over the past year for some of the worst global selloffs.”
Other notable currency headlines this week: Thai “Baht Posts Worst Weekly Decline Since 2007…” “Indian Rupee Completes Biggest Weekly Decline in Three Months.” “Asia Currencies Decline as Chinese Data Compounds Growth Concern.” “Ringgit Forwards Extend Weekly Losses as Oil Enters Bear Market.” “Taiwan’s Dollar Posts Third Weekly Drop on Signs Growth Slowing.” “Commodity Currencies at Multiyear Lows.”
Importantly, a “violent” currency market this week succumbed to “disorderly”. Disorderly changes things, including the amount of leverage and risk the speculators will tolerate. After a several month (China-inspired) hiatus, the “hot money” exodus has resumed in earnest. Brazil’s real led the week’s loser list, sinking 5.2%.
From the perspective of the burst global Bubble thesis, Brazil has been near the top of my list of concerns. Regrettably, it is becoming a poster child for the consequences of unfettered global “Wildcat Finance”: Destabilizing financial flows, Credit and speculative excess, corruption and malfeasance, deep structural maladjustment, festering social tension and political instability.
This week saw Brazil post a wider-than-expected Current Account Deficit ($2.5bn). Inflation is currently running above 9%, its currency is in serious trouble, and the central bank is on the hook for enormous quantities of currency swaps. The major state-directed banks are increasingly vulnerable. And the Brazilian economy is expected to contract about 2% this year. Brazil’s Bovespa equities index sank 6.0% this week to a four-month low. Brazil CDS jumped to the highest level since March.
With recent focus on the Chinese stock market and Greek fiascos, Brazil has been flying under the radar. After a tough 2014, Brazil had been perceived in the marketplace as a beneficiary of Chinese stimulus and the expectation for a recovery in commodity prices. The bursting of the Chinese equities Bubble is now spurring a major reassessment of the bullish view. Commodities are in a freefall, and the marketplace has been abruptly forced to dramatically downgrade prospects for the commodities-dominated economies and currencies – Brazil at the top of the list.
Market faith has held strong that policymakers have everything under control. This perception has had a profound impact on global markets – more specifically, the divergent paths of inflating securities prices and deflating fundamental prospects. The view has been that, with (at its peak) $8.0 Trillion of international reserves, China, Brazil and the like have more than sufficient reserve holdings to stabilize their currencies and weather the storm. Bullishness has proved resilient in the face of faltering economic performance and a $500bn decline in reserve positions from their peak. This may be changing, with potentially major ramifications.
There are now estimates that Chinese financial outflows have surged to a $250bn quarterly pace. If correct, one has to sit back quietly and ponder ramifications.
July 24 – Bloomberg (Y-Sing Liau): “Malaysia’s foreign-exchange reserves fell to the lowest in almost five years, signaling the central bank may have intervened to stem the ringgit’s decline. The holdings dropped 4.7% to $100.5 billion as of July 15 from two weeks earlier…That’s enough to finance 7.9 months of retained imports and is 1.1 times short-term external debt… The currency weakened to a 16-year low of 3.8130 a dollar this month, surpassing the 3.8 level at which it was pegged from 1998 to 2005… A drop in reserves below the psychological $100 billion level may further roil the fragile sentiment, Nizam Idris, Macquarie Bank Ltd.’s head of foreign-exchange and fixed-income strategy…, said…”
“A drop in reserves below the psychological $100 billion level may further roil the fragile sentiment.” Such language recalls the 1997 SE Asian currency collapse. Almost overnight, sentiment shifted away from calm confidence that central banks had an adequate arsenal of reserve holdings. Fear then erupted that rapidly depleting reserves might soon be exhausted – forcing central banks to cut their currencies loose. Suddenly, the window was seen closing fast. A devastating rush for the exits ensued and, so quickly, markets dislocated.
A number of currencies under the most acute pressure this week – Brazil (5.2%), Mexico (2.1%), Russia (2.8%), South Korea (1.8%), Turkey (3.2%) and Colombia (3.2%) – are all on the list of countries that saw outsized increases in foreign currency (largely dollar-) denominated bond issuance since the 2008 crisis. I have highlighted over the past 18 months analysis pointing to, in particular, dollar-denominated EM debt as a global financial “system” weak-link. Not atypically, this flashpoint has been held at bay longer than I had expected. The Fed holding rates at zero, BOJ & ECB QE, and serial Chinese stimulus have been instrumental. While complacency has solidified, underlying structural problems have badly festered.
Time flies by quickly. It’s difficult to believe three years have now passed since the fateful summer 2012 market tumult. More difficult is it to believe that the S&P500 is up 63% from summer 2012 lows. The Nasdaq Composite has gained 84%. The Shanghai Composite is up a staggering 93% in three years (even after recent selling). Amazingly, the biotechs (BTK) have inflated more than 200%.
There are ominous parallels to the late-twenties. The “Roaring Twenties” were a period of growing global imbalances and market instability, along with mounting deflationary pressures.
There was the Fed’s infamous “coup de whiskey” that spurred the fateful 1927 to 1929 speculative run in U.S. markets. Cross-border financial flows turned increasingly destabilizing.
Since 2012, global central banks have been unrelentingly generous with their Whiskey shots.
The results have been troublingly late-twenties-like. Over-liquefied markets have gone wild, masquerading as a “bull market.” And as inflationary Bubbles have run roughshod through global securities markets, real economies have continued to stagnate. Imbalances have expanded. Structural maladjustments have significantly worsened. Global “money” and Credit have deteriorated profoundly. Massive global financial flows have turned hopelessly dysfunctional.
It appears that global markets are heading right into another bout of market tumult, with EM again in the crosshairs. There’s just an astounding amount of suspect debt in the world and too deep structural impairment. And, sure, we’ll all be focused on the inevitable policy responses: I’ll assume some Fed official(s) will broach the possibility of restarting QE if “financial conditions tighten.” The BOJ and ECB will consider boosting their QE programs. The Chinese will propose even greater amounts of spending, liquidity and market support. And will the Same Old Same Old matter much beyond sparking one and two-day panic-buying market convulsions?
It sure appeared that bulls were caught flatfooted by this week’s market downdraft. The view has been that the resilient U.S. economy was largely immune to EM and global issues. This week provided evidence of U.S. corporate earnings vulnerability that to this point has remained largely unappreciated. The view has been that U.S. Credit is largely impervious to global issues.
Cracks may be surfacing in this fallacy as well.
July 21 – Wall Street Journal (Rob Copeland): “Wall Street is preparing for panic on Main Street. Hedge funds are lining up to profit from potential trouble at some ‘alternative’ mutual funds and bond exchange-traded funds that have boomed in popularity among retirees and other individual investors. Financial advisers have pushed ordinary investors into those funds in search of higher returns, a strategy that has come into favor as Federal Reserve benchmark interest rates remain near zero. But many on Wall Street worry that junk bonds, bank loans and esoteric investments held by some of those funds will be extremely hard to sell if the market turns, leaving prices pummeled in a rush for the exits... Liquid-alternative funds manage a cumulative $446 billion, according to fund tracker Lipper, up from $83 billion at the start of 2009."
“Hedge Funds Gear Up for Another Big Short,” was the WSJ headline for the above noted article. “‘They are going to be toast,’ David Tawil, president of hedge fund Maglan Capital LP, said of the funds holding hard-to-sell assets like emerging-market debt and small-capitalization stocks. ‘It will be one of our first levels of shorting the moment we start to see cracks, because it’s ripe with retail, emotional investors.’”
And a replay from last week’s “Fixed Income Watch:” July 17 – Bloomberg (Tracy Alloway): “…Back in 2005, Citigroup estimated that about $2 billion worth of credit index options were trading per month, or roughly $24bn over the course of the year. Last December, the same Citi analysts figured that about $1.4 trillion of the instruments had exchanged hands in all of 2014, compared with $573 billion worth in 2013.”
And for those willing to ponder a transmission mechanism from agitated global markets to the halcyon U.S. securities marketplace, I’ll offer one: The global energy and commodities collapse leads to major deterioration in U.S. resource company debt, dragging down junk bond performance generally. Outflows from junk, bank loan and Credit funds quicken. Importantly, the increasingly risk averse leveraged speculators begin unwinding long holdings – while others move to get short Credit. And already the market would see a profound change in the liquidity backdrop.
But then there’s the looming problem of all this Credit “insurance” that has been written – the old exuberant “writing flood insurance during the drought”. What free “money” - what genius – that is, until it blows up. Recall subprime CDOs?
If those on the wrong side of today’s Big Trade move to hedge/“re-insure” higher-yielding corporate instruments – that would entail huge additional selling/shorting of corporate bonds and Credit into an already weakened marketplace. And there’s that “vicious cycle” problem inherent to Credit Cycles: As corporate Credit conditions tighten, a lot of Credits that appeared sound throughout the over-liquefied boom period look a lot less so. So more shorting, more outflows, and more shorting and hedging… Buying from myriad fund types and structured products evaporates. Significantly less corporate debt issuance… Less “money” for M&A, buybacks and financial engineering. Lower asset prices. Declining Household Net Worth.
It’s worth noting a Friday afternoon Bloomberg headline: “Junk-Debt Market Rocked as Cautious Creditors Stymie New Deals.” And if a little worry about Chinese and Brazilian – to name the most obvious – financial institutions begins to creep into the equation, the backdrop rather quickly turns complex and uncertain.