The Loss of Moneyness

Doug Nolan


It was as if global markets pulled elements from the 1994 bond market dislocation, 1997’s Asian Bubble collapses, the 1998 Russian/LTCM fiasco, and the 2008 market crash – and synthesized them for a week of ridiculous market instability and dysfunction.

Thursday was an extraordinary day of global market panic – The “Worst Day Since the 1987 Market Crash” – “Biggest VaR Shock In History.” Add the “worst week for Credit in Decade.” It was the dreadful global de-risking/deleveraging episode – a disturbing case of synchronized liquidation, market illiquidity and dislocation. Global markets – stocks, bonds, Credit, derivatives, currencies and commodities - were all convulsing and “seizing up.”

The Dow sank 2,353 points, or 10.0% Thursday, with the S&P500 sinking 9.50%. Italy’s MIB index collapsed 16.9%, Germany’s DAX 12.2%, Spain’s IBEX 14.1%, and France’s CAC40 12.3%. Major equities indices were down 14.8% in Brazil, 12.7% in Poland, 11.5% in Hungary, 8.3% in Russia, 8.2% in India and 10.8% in Thailand. Japan’s Nikkei traded down as much as 10% in early-Friday trading before ending the session with a 6.1% loss.

Equities markets almost appeared orderly compared to Credit market mayhem. An index of U.S. high-yield CDS surged 92 bps to 685 bps, capping off a six-session surge of 317 bps to the highest level since the crisis. For comparison, this index spiked 138 bps in seven weeks to 485 bps during the late-2018 dislocation. An index of investment-grade CDS jumped 21 bps Thursday to 139 bps, with a six-session surge of 73 bps to the highest level since 2011.

March 12 – Bloomberg (Katherine Greifeld): “Bond ETFs are highlighting signs of liquidity stress in broader markets, with cash prices trading at persistent and deep discounts to the value of the underlying assets. The $31 billion iShares iBoxx $ Investment Grade Corporate Bond ETF closed at a discount of 3.3% to its net asset value on March 11, the largest such divergence since 2008… Meanwhile, the $23 billion iShares 20+ Year Treasury Bond fund’s price has dropped 5% below its net-asset value, the most ever. And even the U.S. municipal market is feeling the squeeze: The VanEck Vectors High Yield Municipal Index ETF traded at a record 8.3% discount on Wednesday.”

March 12 – Bloomberg (Alexandra Harris): “Libor-OIS expands to 61.1bp, the widest level since May 2009, from 52.6bp the prior session as funding pressures in the credit market continue to build.”

The iShares High yield ETF (HYG) sank 4.0% Thursday and 5.9% for the week. After ending last week at an all-time high, the iShares Investment-grade ETF (LQD) dropped 4.8% Thursday and 8.4% during the week. There were issues as well in mortgage-backed securities and municipal debt markets. After closing the previous Friday at a record low yield, benchmark MBS yields surged an eye-popping 48 bps to 2.37%. A couple Bloomberg headlines: “A Day of Hell: The Muni Market’s Worst Day in Modern History,” and “For the Muni-Bond Market, It’s the Worst Week Since 1987.” Across the derivatives markets, it was utter mayhem.

Emerging market (EM) bonds were ravaged. Yields on Brazil’s local currency 10-year bonds surged 125 bps to 8.29% in Thursday trading. Yields jumped 98 bps in Hungary (to 2.97%), 76 bps in Russia (7.98), 71 bps in Colombia (7.65%), 55 bps in South Africa (9.81%), 44 bps in Mexico (7.72%) and 39 bps in Romania (4.52%).

For the week, local currency 10-year yields surged 292 bps in Ukraine, 127 bps in Mexico, 113 bps in Brazil, 107 bps in Turkey, 95 bps in Philippines, 92 bps in Russia, 88 bps in Chile, and 84 bps in Indonesia.

“Carry trades” blowing up.

EM dollar-denominated bonds were not spared the bludgeoning. Thursday’s upheaval saw yields spike 172 bps in Ukraine (to 11.09%), 76 bps in Brazil (4.36%), 67 bps in Turkey (7.26%), 62 bps in Russia (3.66%), 61 bps in Mexico (4.12%), 45 bps in Philippines (2.76%), 38 bps in Indonesia (2.88%), and 36 bps in Chile (2.64%). For the week, yields surged 284 bps in Ukraine, 120 bps in Mexico, 107 bps in Brazil, 107 bps in Turkey, 87 bps in Russia, 86 bps in Chile, 82 bps in Philippines, and 74 bps in Indonesia.

In EM currencies, the Russian ruble fell 2.6% Thursday, the Colombian peso 2.6%, Mexican peso 2.5%, Czech koruna 2.3%, Chilean peso 2.1%, South African rand 2.1%, Polish zloty 2.0% and Turkish lira 1.7%.

Curiously, Thursday’s bigger moves were in “developed” currencies.

The Norwegian krone sank 4.7%, the Australian dollar 3.8%, the New Zealand dollar 2.9%, the Swedish krona 2.4%, the British pound 1.9% and the Canadian dollar 1.1%. For the week, the Mexican peso dropped 8.3%, the Norwegian krone 8.1%, the Australian dollar 6.5%, the British pound 5.9%, the Brazilian real 4.3%, the South African rand 3.7%, the New Zealand dollar 3.4%, the Swedish krona 3.2% and the Canadian dollar 2.8%.

It’s fair to say that trading was in particular disarray wherever the levered funds have been active. Especially Thursday, markets traded as if cluster bombs besieged the leveraged speculating community.

Italian government yields surged 58 bps Thursday to 1.76%. With German bund yields little changed on the day, the Italian to German yield spread widened a remarkable 58 bps in one session. Greek yields jumped 50 bps (to 2.04%), with Portuguese yields up 32 bps (to 0.72%) and Spanish yields rising 25 bps (to 0.51%). For the week, Italian yields spiked 71 bps and Greek yields surged 70 bps. Yields were up 52 bps in Portugal and 41 bps in Spain. Ominously, safe haven German bund yields jumped 17 bps despite all the mayhem.

March 9 – Bloomberg (John Ainger and Anooja Debnath): “Fund managers are being faced with a collapse of liquidity as they try to handle record market moves. Investors say it is becoming increasingly difficult to trade due to the extent of swings on a day that saw 30-year Treasury yields drop the most since the 1980s and a fall in U.S. stocks so sharp that trading was halted minutes from the open. Even before today financial conditions were tightening at the fastest pace since the 2008 crisis. ‘I have yet to find liquidity,’ said Richard Hodges, a money manager at Nomura Asset Management, whose bets on Italian and Portuguese bonds last year put him in the top 1% of money managers. ‘There is none.’”

March 12 – Financial Times (Joe Rennison and Colby Smith): “Investors and analysts are warning about deepening cracks in the world’s largest government bond market. Strange patterns have started to emerge, such as drops in the price of US Treasuries — a traditional haven — even while riskier assets such as stocks have been squeezed by fears that the coronavirus outbreak will spark a global recession. Some are warning that the patterns could lead to the unwinding of one of the market’s most popular trading strategies — with potentially serious consequences.”

As global markets “seized up,” safe haven Treasury bonds were notable for providing minimal offsetting benefit. There was actually a point late in Thursday’s session where yields were higher on the day (before ending the session down 6bps to 0.81%).

For the week, 10-year Treasury yields surged 20 bps – changing the calculus of Treasuries as a hedge against the risk markets and systemic risk more generally. Seeing the Treasury market succumb to illiquidity and dislocation could have been the most troubling aspect of a deeply troubling week.

The Federal Reserve was a busy bee. Last week’s emergency 50 bps fell flat in the marketplace. The New York Fed on Monday raised the size of its overnight repo liquidity operations 50% to $150 billion. It also more than doubled the size of the two-week repo facility to $45 billion.

These measures were “intended to ensure that the supply of reserves remains ample and to mitigate the risk of money market pressures that could adversely affect policy implementation.” Whatever the intention, they suffered the same fate as the emergency cut.

The Fed was back Tuesday to boost overnight operations to $175 billion, while adding a $50 billion one-month “term repo.”

Still no pulse.

Thursday’s “seizing up” brought out the “whatever it takes,” “insurance”, shock and awe bazookas. It was surreal listening to analysts on Bloomberg and CNBC trying to comprehend exactly what the Fed had announced. I appreciated the Financial Times (Colby Smith and Brendan Greeley) effort: “The Fed would now offer up at least $500bn in three-month loans, beginning immediately, with another $500bn of three-month loans on Friday.

It said it would also provide a $500bn one-month loan on Friday that settles on the same day. It also said it would continue to offer $500bn of three-month loans and $500bn one-month loans on a weekly basis until April 13, on top of its ongoing programme of $175bn in overnight loans and $45bn in two-week loans twice per week.” Holy Crap: Desperation.

The Dow surged almost 1,500 points in a matter of minutes. Hopes that prospects for Trillions of Fed liquidity had finally reversed the markets were quickly dashed as prices reversed lower to end a day of panic at session lows.

Japan’s Nikkei traded down 10% in early-Friday trading, as overnight S&P500 futures dropped another 3%. On prospects for aggressive global fiscal and monetary stimulus, Japanese and Asian stocks cut their losses. European stocks rallied sharply, with major indices up near double-digits by the time U.S. exchanges began trading.

The S&P500 opened 6% higher, though most of the gain had disappeared after a couple hours. No rest for the weary. The Fed had yet another announcement, stating it would be purchasing longer-term Treasuries (instead of T-bills) in its monthly QE purchases (acquiring $37 billion by the end of the day).

The President scheduled a coronavirus press conference during the final hour of the market session. The Dow rallied 1,500 points in the final 34 minutes of trading, as “Stocks Retrace 90% of Thursday’s Epic Plunge with Late-Day Surge.” Well-orchestrated.

March 13 – Financial Times (James Politi, Lauren Fedor and Courtney Weaver): “Steven Mnuchin, the Treasury secretary, said US authorities will do ‘whatever we need to do’ to boost liquidity in financial markets and help the US economy weather the coronavirus outbreak, including action by the Federal Reserve and a deal with Democratic lawmakers for more fiscal stimulus. ‘There will be liquidity available, whatever we need to do, whatever the Fed needs to do, whatever Congress needs to do. We will provide liquidity,’ Mr Mnuchin said… Mr Mnuchin said he was in constant contact with Jay Powell, the chairman of the Federal Reserve, as well as US business leaders, about mitigating the impact of the spreading disease.”

Crude collapsed 25% Monday. Bitcoin collapsed 41% during the week.

For the week, palladium collapsed 37%, platinum 17% and silver 16%.

Gold dropped 8.6%.

Sugar and Cattle were down almost 10%, as the Bloomberg Commodities Index sank 7.8% for the week.

The S&P500 dropped 7.6% Monday; rallied 4.9% Tuesday; fell 4.9% Wednesday; sank 9.5% Thursday; and surged 9.3% Friday. Circuit breakers were triggered at least twice – and I don’t recall anything quite like it, even during 2008. It was a week when, to those paying attention, the potential for a crisis much beyond the scope of 2008 became readily apparent. We witnessed more than a glimpse of how global financial collapse could materialize.

March 12 – Financial Times (Gillian Tett): “This decade, America’s equity market has been like a drug addict. Until 2008, investors were hooked on monetary heroin (ie a private sector credit bubble). Then, when that bubble burst, they turned to the financial equivalent of morphine (trillions of dollars of central bank support). Now, in the wake of Thursday’s historic equity market crash, they must contemplate a scary question: has this monetary morphine ceased to work? Think about it. Ever since 2016, the Federal Reserve has tried to wean the markets off its quantitative easing measures and ultra-low rates. But whenever markets have wobbled — as they did last year in the repurchase sector — the Fed always returned with a new monetary fix. That has helped to sustain a startling bull market in equities and bonds.”

“Coordinated fiscal and monetary stimulus” – Wall Street’s new catchphrase. Aggressive fiscal stimulus has begun – with deficits already running at 5% of GDP. Rates could be cut to near zero next week – with the unemployment rate at 60-year lows and stocks only four weeks from all-time highs. QE will begin in earnest, with the Fed’s bloated balance sheet at $4.222 TN - having expanded $500 billion over the past six months.

I’m reminded of how a few highly-levered mortgage companies filed for bankruptcy in 1998 (after the LTCM crisis) without ever missing a Wall Street earnings estimate. It’s full crisis-management mode without even a negative GDP print.

I certainly appreciate the seriousness of the unfolding crisis. But I do ponder what the government response will be after the Bubble has deflated and policymakers are confronting a deep recession and financial calamity.

With all the put options and hedges in the marketplace, I don’t doubt the capacity to incite a short squeeze and higher market prices. But I doubt fiscal and monetary stimulus will resuscitate the Bubble in global leveraged speculation.

Illiquidity and market dysfunction have been exposed. Huge losses have been suffered and “money” will flee popular (and overcrowded) leveraged strategies (i.e. risk parity). I also suspect confidence in derivatives has also likely been shaken.

Liquidity risk will be a persistent for global markets.

It started with Alan Greenspan imagining the wonder of market-based finance - with a little helping (visible) hand from central bankers. I referred to the “Moneyness of Credit” throughout the mortgage finance Bubble period.

With the implicit backing of the federal government, the GSEs and Wall Street luxuriated in the capacity to turn endless risky mortgage loans into perceived safe and liquid “AAA” securitizations and instruments. Money – with the perception of safety and liquidity – enjoys insatiable demand. When it comes to financing runaway Bubbles, “money” is incredibly dangerous.

“Moneyness of risk assets” has been fundamental to my global government finance Bubble thesis. Dr. Bernanke collapsed interest rates, forced savers into the securities markets, and repeatedly employed the government printing press (QE) to backstop the markets – in the process nurturing the perception of safety and liquidity for stocks, corporate Credit, government bonds and derivatives.

An enterprising Wall Street was right there with ETFs, index funds, “passive” investing, myriad derivatives and other low-cost products for speculating on the ever-rising stock market.

Risky securities and financial structures were transformed into perceived safe and liquid “investment” products. Only a moron doesn’t believe in buying and holding like the great Warren Buffett. Cash is trash. Disregard risk and avoid active managers that invariably underperform index products.

It was history’s greatest speculative Bubble – and it has burst. “AAA” wasn’t risk free – and this recognition changed everything. Those levered in “AAA” were suddenly suspect. Perceived money-like liabilities (repos, derivatives, securitizations, etc.) abruptly lost their “Moneyness” and the run was on.

Myriad perceived safe and liquid financial instruments/strategies lost their Moneyness this week (fiscal and monetary stimulus notwithstanding, I don’t think it’s coming back).

The run was on. With risks illuminated, leverage must come down.

The “hot money” is now fleeing countries, markets and instruments - marking a momentous change in the flow of finance and global marketplace liquidity.

The critical issue is not so much the coronavirus and its economic impacts, as it is the uncertainty associated with the pandemic as a catalyst for the piercing of history’s greatest global Bubble.

We’ll get through this, but the world is today poorly prepared for the great challenges it now confronts.

Sunak’s Budget: a spending spree to get the job done

The thrust of the UK chancellor’s Budget is welcome. Yet it will not transform prospects in the near term

Martin Wolf


© James Ferguson


Rishi Sunak, the UK chancellor of the exchequer for less than a month, did exactly what he was appointed by Prime Minister Boris Johnson to do. He delivered on commitments to raise government spending, especially on investment, and “level up” the country’s more economically backward regions. He also produced a sensible response to coronavirus.

The fact that this rising Conservative star is a brilliant son of immigrants from India displays the party’s traditional embrace of fresh talent. This flexibility shows even more in the Budget’s repudiation of what the party stood for under David Cameron and George Osborne.

Gone are austerity and small government: this is now a party of high spending and big government. Its programme is “welfare nationalism”.




Rightly, the chancellor started with Covid-19. He noted the close co-ordination with the Bank of England’s welcome measures. But there are some things a government alone can do. The state is protector and insurer of last resort. A pandemic is precisely the sort of thing it exists to deal with. Mr Sunak promised the National Health Service “whatever extra resources” it needs.

Thank heavens the UK, like other civilised countries, recognises that health is a public good of the highest importance. We should never want people to refuse to go to the doctor or a hospital because of lack of money, especially during an epidemic of a highly infectious disease.

In all, Mr Sunak stated, there was £7bn to support people and businesses, £5bn to support the NHS and other public services, and an additional fiscal loosening of £18bn, to support the economy — a total of £30bn. This amounts to an overall fiscal loosening of about 1.5 per cent of gross domestic product. Nobody knows whether this amount will be enough.




Nobody knows what course the disease will take.

Nobody knows how badly it will damage the economy.

Mr Sunak is right that the shock should be “temporary”. But a temporary shock can have permanently damaging effects if the response is not strong and persistent enough.

The ­coalition government of 2010-15 was not, alas, the only one to have failed to understand that after the 2008 global financial crisis. One hopes that this ­government does understand it and will take the health and economic actions needed to get the country through this shock as well as is possible.

While the coronavirus outbreak is the immediate concern, the striking feature of the government’s new approach is described by the Office for Budget Responsibility quite directly:

“The Government has proposed the largest sustained fiscal loosening since the pre-election Budget of March 1992 . . . Relative to our pre-measures baseline forecast, the Government’s policy decisions increase the budget deficit by 0.9 per cent of GDP on average over the next five years and add £125bn (4.6 per cent of GDP) to public sector net debt by 2024-25.”




Gone is the idea of trying to shrink government: according to the OBR, total managed expenditure will rise from 39.3 per cent of GDP in 2018-19 to 40.7 per cent in 2024-25.

Gone is the notion of low taxes: public sector current receipts will rise from 37.5 per cent of GDP to 38.5 per cent over the same period.

Gone is the goal of budget balance: public sector borrowing will rise from 1.8 per cent of GDP to 2.2 per cent.

Gone, too, is the aim of declining net debt: it will fall from 80.6 per cent of GDP in 2018-19 to 75 per cent in 2021-22, but then stabilise.

This is a remarkable turnround.

The ­government will probably meet its manifesto targets for the current budget, maximum net investment and the ratio of debt interest to revenue. But it will not meet all three of its legislated targets.

The chancellor has, rightly, announced a review of the fiscal framework. But the big judgment has been made: in an era of ultra-low real interest rates, it makes sense for the government to borrow to spend, especially on investment. I have been arguing this for a decade. The decision to cut investment right after the financial crisis was a classic bit of Treasury idiocy. Now, when the UK is close to full employment and running a large current account deficit, is no longer the ideal time to raise investment sharply. But it is still a risk worth running provided the money is well spent, which one has to doubt, given the hurry. Yes, interest rates might rise and financing might become more difficult, as the OBR notes. But these risks should be manageable.




The thrust of the additional spending — towards health, education, scientific research, innovation and infrastructure — is welcome. Yet none of this seems likely to transform economic prospects in the near term. Growth is forecast to average just 1.4 per cent a year up to 2024, about as fast as it can.

The fiscal expansion provides a largely temporary boost. On the crucial issue of Brexit, the OBR reports that this has already reduced potential GDP by about 2 per cent, relative to what it would otherwise have been.

When the UK leaves the transition at the end of this year, the costs will rise further, particularly if, as seems quite likely, no trade deal is reached with the EU. The nationalist part of the new Tory agenda still has substantial damage to inflict.

Apart from this, perhaps the striking feature of the Budget is its timidity on carbon taxation and indeed any other important aspect of fiscal reform. One must hope that Mr Sunak bends his mind to these crucial issues more boldly in his second Budget, in the autumn. The UK’s fiscal system is a mess. It needs a thorough overhaul. Mr Sunak has the brains to do the job. He should try.

So where are we now? The immediate answer is in a year of unavoidable uncertainty and worry. We also have a government that is striking out on a ­radical new path of welfare nationalism, partly in sensible directions, notably on public spending and investment, and partly in foolish ones, notably on Brexit.

The chancellor, as he told us many times, tried to get the job done. But there are large and worrying uncertainties, some external and some self-inflicted.

The job is not done. It never is.

Will the coronavirus trigger a corporate debt crisis?

With companies having gorged on cheap money, a reckoning may be coming

Andrew Edgecliffe-Johnson in New York and Peggy Hollinger, Joe Rennison and Robert Smith in London




Since 1925, the Grand Ole Opry has featured the music of countless country and bluegrass stars, from Bill Monroe to Dolly Parton.

As Ryman Hospitality Properties built a hospitality and entertainment empire around the original Nashville radio show, the parent company’s debt grew to over $2.5bn, but its chairman insisted that its balance sheet was “really strong”.

That held through last week, when Ryman’s buildings escaped the tornado that hit Nashville, but another storm has since ripped through corporate debt markets. As coronavirus fears have consumed investors, warnings over the potential of a rising debt load to push companies towards collapse are beginning to be tested.

After Ryman’s hotel customers cancelled 77,000 room nights last week, at a potential $40m cost to revenues, Standard & Poor’s placed its credit rating on watch for a potential downgrade.

The rating agency’s response shows how a public health crisis is prompting a sudden reassessment of corporate credit risk, raising doubts about borrowers that had long been seen as stable. That is changing how markets view sectors from cruise lines to retailers, forcing companies as large as Boeing and United Airlines to review their borrowings, and posing the risk of financial institutions being saddled with problem loans.

As Colin Reed, Ryman’s chairman, said last week: “We’ve had lots of experience in this type of thing, but this is a little weird.”

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Companies have gorged on cheap debt for a decade, sending the global outstanding stock of non-financial corporate bonds to an all-time high of $13.5tn by the end of last year, according to the OECD, or double where it stood in December 2008 in real terms.

Borrowing costs had tumbled after central banks lowered interest rates to jolt their economies following the 2008 financial crisis. Investors, starved of yield from safer government bonds, saw lending to riskier companies as a way to juice returns.

“There’s a large universe of middle market companies that on the back of an 11-12 year credit cycle have continually been able to borrow and reborrow from one lender to another,” observes Mohsin Meghji of M-III Partners, a turnround veteran who has restructured companies from Sears to Sanchez Energy. “These companies have been limping along by virtue of rates having been very low. They haven’t really deleveraged.”

Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, estimates that one in six US companies does not earn enough cash flow to cover interest payments on its debt. Such “zombie” borrowers could keep putting off the crunch as long as debt markets kept letting them refinance. But now a reckoning is coming.




The consequences showed up most vividly this week in the oil and gas sector as a price war between Riyadh and Moscow compounded the market’s coronavirus concerns, plunging almost $110bn of US energy company bonds into distressed territory.

“The timing of this is a massive punch in the gut for US upstream oil and gas companies,” Mr Meghji warned.

But the risks extend far beyond oil and gas. As Paloma San Valentin, managing director for the Americas at Moody’s, put it this week, there is now a “growing risk to corporate credit quality around the world”.

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The phones have started ringing at restructuring groups as directors and investors seek advice on how to navigate the uncertainty.

Rating agencies, still smarting from their reputation for moving slowly in the last crisis, are already sounding the alarm on companies that are most exposed to travel cancellations, disrupted supply chains and consumers’ deferred discretionary spending.

Moody’s has lowered its sales forecast for the auto industry and cut its outlook for the airline, lodging and cruise industries to negative. The US cinema operator National Amusements joined cruise ship companies such as Carnival and Royal Caribbean on S&P’s “watch negative” list.

Bonds from US car-rental company Hertz have been smashed, with yields on its longer-dated bonds hitting 10 per cent. Cinema chain AMC saw a £500m bond that was trading close to face value at the start of the year fall as low as 66 pence in the pound on Wednesday.

Meanwhile, carmakers, electronics groups and chemicals companies all remain vulnerable because of supply chain interruptions.




The market swings are also changing the calculus on mergers and acquisitions, posing a test to leveraged deals like the recent €17.2bn private equity deal to buy Thyssenkrupp’s lifts business.

And they have raised new doubts about companies with turbulent pasts that had been trying to earn back investor confidence. Bonds in WeWork, the lossmaking office company, have dropped from about 90 cents on the dollar to 68 cents.

The tally of defaults that preceded the market’s coronavirus shudder provides some pointers to where the exposure may be most acute. Eight of this year’s 20 large defaults have come from the consumer sector, S&P found, including US retailer Pier 1 Imports. A bankruptcy filing from McClatchy extended the sorry record of advertising-dependent local newspaper owners, and while there have been only two oil and gas defaults so far this year, the rating agency expects that number to rise.

At 282 companies in December, S&P’s “weakest links” list of low-rated junk bonds on which it has a negative outlook was at its longest since the crisis era of July 2009.

Such lists fail to capture how many smaller companies are at risk of falling into financial trouble. Julie Palmer, regional managing partner of Begbies Traynor, a UK restructuring group, estimated that 490,000 UK companies were already displaying signs of distress before the virus hit. “If coronavirus affects even 5 per cent, that would double the rate of corporate insolvencies,” she said.

Big banks were likely to focus on the largest corporate clients, putting smaller companies “well back in the queue”, said Campbell Harvey, finance professor at Duke University’s Fuqua business school. “These small and medium-sized firms are often crucial links in the supply chain. If these links are broken, it will be much more difficult to recover from a recession,” he warned.

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More than $320bn of US debt sitting on the lowest rung of the investment grade ladder now yields more than 5 per cent, according to Ice Data Services figures, previously a rate attached to much riskier companies.

The list includes household names, from General Motors and Ford to embattled retailers Nordstrom and Kohl’s. One name on the list, Occidental Petroleum, slashed its dividend this week to guard against further declines.

Restructuring experts said investors scanning for vulnerability should watch those companies with largely fixed capacity and high costs which would be hard hit by a significant drop in demand. Almost $840bn of bonds rated triple B or below in the US are set to come due this year and roughly $270bn of US bonds now trade below 90 cents on the dollar. Many companies have already been locked out of refinancing or selling new debt.




Ryman Hospitality Properties built a hospitality and entertainment empire around the former Grand Ole Opry. Hotel customer cancellations due to the coronavirus have left the company’s bonds at risk of a credit rating downgrade © (c) Giuliachristin | Dreamstime.com


Several companies, even in hard-hit sectors such as airlines and cruise lines, have managed to refinance. Often, though, lenders were imposing new demands such as interest rate floors or “material adverse clause” provisions, noted Jennifer Daly, a partner at King & Spalding, the law firm.

Others are in a worse plight. Intu, the UK shopping centre owner, now faces a painful debt restructuring after its planned £1.5bn rights issue collapsed last week.

The debt market is now pricing in material uncertainty around an upcoming €725m bond maturity for CMA CGM, even though the French shipping group has stressed that it has enough cash to repay the bond without raising new debt.

Veterans of past crises note that this one will also present opportunities, both for well-capitalised lenders with a long-term focus and for companies with stronger balance sheets.

“If you are running a business and have five-year horizons . . . [coronavirus] is not going to be the only thing that matters,” said Ian Stewart, chief economist of Deloitte. Governments may well step in to avoid strains on corporate balance sheets turning into a wider solvency crisis. He adds: “Policymakers are massively incentivised to act on this.”

As they navigate a suddenly changed lending market, companies are weighing both greed and fear.

“In the market at least, it’s hard to tell what’s spreading more quickly, the fear or the virus itself,” said King & Spalding’s Ms Daly. “My advice to clients universally has been ‘wash your hands, protect against the downside and then don’t waste a crisis’.”

That may fall short of a country and western lyric. But it is more comforting than the Grand Ole Opry refrain to which some corporate borrowers can now relate: “Too much month at the end of the money.”

Angela Merkel and Emmanuel Macron: Europe’s missed chance

German and French leaders’ hesitation could be fatal

Philip Stephens



© Ingram Pinn/Financial Times


History is alert to sins of commission — big choices with bad consequences that leaders come bitterly to regret. Think of the Iraq war. Sometimes, though, the mistake takes the form of a hesitation — a decision deferred, a choice put aside.

These sins of omission are harder to spot, but often every bit as wrecking in their impact.

Germany’s chancellor Angela Merkel has something to think about in this respect.

This month’s Munich Security Conference, the annual gathering of international security elites, focused on the pervasive sense of drift and fragmentation in western democracies.

“Westlessness”, the organisers called it. Think of the accretion of bad news represented by US president Donald Trump’s belligerent unilateralism, European powerlessness in the face of chaos in the Middle East, Brexit and rising political extremism in Europe’s democracies.

The transatlantic divide was on full display. Mike Pompeo, the US secretary of state, delivered a paean to America-first nationalism. Winning for the west was all about safeguarding national sovereignty.

No one else, however, must elevate their sovereignty above taking instruction from Washington.

At least Mr Trump, I found myself thinking while listening to this shallow bombast, is honest in his bigotry.

US senators and members of the House of Representatives turned out in force — the Democrats scarcely hiding fears that their party may hand Mr Trump a second term by choosing a candidate who cannot win; internationally-minded Republicans half-apologising for US foreign policy.

Unless I misheard him, Lindsey Graham, the senator for South Carolina often seen on our television screens defending Mr Trump, heaped praise on the distinctly unTrumpian notion of multilateralism.

If Europe’s differences with the White House are routinely played out in public, the relationship that has really soured is that between Paris and Berlin. Age and temperament have always militated against the idea of Ms Merkel and France’s Emmanuel Macron as soulmates.

They could have been partners.Instead, the relationship has broken down. Mr Macron, taking to the stage in Munich, showed impatience and frustration with the inertia that nowadays passes as Germany’s foreign policy. Ms Merkel was at once physically absent and omnipresent — her precarious hold on power the subject of excited gossip in every conference corner.

Politically beleaguered, she exudes contempt for Mr Macron’s supposed grandstanding.

German and French leaders rarely start with the same worldview — the strength of the fabled axis has always resided in a shared effort to overcome entrenched disagreements. No longer.

The clash came to a head in November at a dinner hosted by the German President Frank-Walter Steinmeier. The angry exchanges, first reported by the New York Times, were, by the account of witnesses, extraordinary.

Ms Merkel complained bitterly that she spent all her time gluing back together crockery broken by the president’s pursuit of his grandiose projects. Mr Macron’s equally sharp response was that each effort he had made to raise Europe’s sights to the global challenges was met with silence or obstructionism.

They had had a precious opportunity to work together. Now, Mr Macron saw little purpose in engaging someone who had run out of political road at home.Think back to the spring of 2018.

The two leaders had political space and capital. Mr Macron was still in the first flush of his 2017 presidential victory. After a difficult period, Ms Merkel had assembled a coalition to underwrite her fourth term. She had long complained of the absence of a “serious” partner.

Now she had one. Both had seen enough of Mr Trump to know that Europe had to take charge of its own affairs. The EU needed to start building an economic union to underwrite the euro and to develop its own foreign and security policies as the US stepped back — all the while managing the combustible Mr Trump.

Nothing happened. Mr Macron launched his initiatives. Ms Merkel buried them in the sand, occasionally conceding a tiny step forward when the pressure became embarrassing. Mr Macron was dressing up French projects in European clothes, her officials would snipe. There was too much hot air, and not enough gritty policy detail. Paris was careless of smaller EU states.

German voters did not want grand schemes.

There may well have been some truth in such criticisms. French presidents have a habit of breaking crockery. Ms Merkel’s responses, though, offered nothing in the way of engagement. Instead of presenting its own plans, Berlin shuffled and stalled. Those listening carefully to Mr Steinmeier’s Munich speech would perhaps have detected a hint of sympathy for Mr Macron.

Maybe the chancellor did want to preserve EU unity. More cynically, she was anxious to avoid anything that might destabilise her domestic position. The irony is that she now looks weaker than ever, with no guarantee she will survive in office beyond this year.

Only last month Ms Merkel, in an interview in the Financial Times, described the EU as Germany’s “life insurance”. Her answer to US disengagement?

“We in Europe, and especially in Germany, need to take on more responsibility.”

This is what she could have done in 2018. The moment has passed.

The hesitation — the absence of leadership — will now define her legacy.

The Next Phase of China’s Fight with the Coronavirus

By: Phillip Orchard



The Communist Party of China would like you to know it’s winning the war against the coronavirus, and that we all have Xi Jinping to thank. That’s been the core message from Chinese state media over the past few weeks, which marked a major turning point in the crisis.

Internally, China’s massive mobilization against the virus appears to have stemmed the tide, with new infections slowing to single digits and Chinese industry gingerly getting back to work.

And as the outbreak became a pandemic, Western governments’ spotty responses have put both Beijing’s early missteps and its later successes in a more favorable light.

It’s been a boon to Beijing’s propagandists, who can now call attention to China’s triumphs and the world’s woes. Their messaging has also made it clear that Xi and his inner circle will emerge from the public health crisis intact – and perhaps even stronger. Xi has commanded the decisive battles in the “People’s War” against an invisible enemy, at least according to state media hell-bent on elevating the president to almost Mao-like status.

But if Xi is safe on his throne, his realm is not. The Chinese economy is, to put it plainly, in really bad shape. Nearly every problem Beijing couldn’t figure out how to fix has been made an order of magnitude worse by the coronavirus crisis. And while the virus going global may be a shot in the arm for China’s hype machine, its spread may very well shut down the country’s most promising roads to a rapid recovery.

Xi’s Glorious Battle

A month ago, the CPC was reeling. The epidemic had become nearly uncontainable, and Xi’s tightly centralized decision-making structure and a culture of censorship were at least partially to blame.

This created pressure both at home and abroad, forcing Beijing to implement a twist on Mao’s Hundred Flowers Campaign and relax the restrictions on independent reporting and to censor social media with a lighter touch. The outrage that followed, particularly after the death of whistleblowing doctor Li Wenliang, scared Beijing, forcing it into a series of clumsy moves to squelch dissent.

Beijing was also forced to postpone its annual National People’s Congress, which the CPC relies on to align the machinery of the state with its agenda. For much of this time, Xi himself was conspicuously absent from the spotlight. When the central government finally launched a campaign to demonstrate its command of the crisis response, it was led not by Xi but by Premier Li Keqiang, the closest thing Xi has to a rival in the Politburo Standing Committee. But as soon as the outbreak looked like it would soon crest in early February, Xi was firmly back out in front.

The pillars of power in China are often described as “the three Ps”: the People's Liberation Army, personnel and propaganda. And by becoming the public face of the government’s response, Xi has demonstrated his control over each of them.

In early February, he deployed the PLA, which answers directly to him as chairman of the Central Military Commission and had been noticeably absent from the response in January, to build hospitals, transport supplies, ensure public order and dispatch medics to the front lines in Wuhan.

If Xi were losing control over key personnel appointments, he wouldn’t have been able to replace the party leadership in Hubei province with a pair of loyalists. Finally, the propaganda machine has gone into overdrive in lionizing the president. State media has begun referring to the president as “the People’s Leader” and, particularly during Xi’s long-awaited visit Wuhan this week, equating his leadership in the fight against coronavirus to Mao’s command of the Communist Party’s civil war victory in 1949.

This matters more than mere symbolism. By effectively elevating Xi to Mao-like status, the Communist Party is wrapping its own legitimacy in Xi’s cult of personality even more tightly, making it near-impossible for rivals to dislodge him.

Still, there are at least two other “Ps” that also matter. The first is the public, which for now appears to broadly support the CPC. To be sure, there are glimpses of discontent over Beijing’s mismanagement – and not just in social media circles where outfoxing censors has become something of an art form.

Doctors in Wuhan haven’t stopped speaking out about the government’s suppression of information about the virus. An exceedingly tone-deaf speech given by Wuhan’s party chief calling for a “gratitude education campaign” for the city’s residents ahead of Xi’s inspection tour had to be buried by censors after earning so much backlash.

And leaked videos showed Chinese Vice Premier Sun Chunlan getting showered with insults from quarantined citizens during her own visit to Wuhan. But this has yet to translate into any sort of mass movement on the streets.

This is, in part, because the country has been effectively in lockdown. (Indeed, the digital systems put in place to combat the spread of the virus will be useful in combating attempts to mobilize against the government going forward.)

It’s also because there’s no prominent opposition figure or party to rally around. (This is why any signs of a major split in the PLA or Politburo would be so important). But the power of the state’s messaging machine shouldn’t be dismissed.

Propaganda is more effective when it contains nuggets of truth. Beijing can reasonably point to the lockdowns in Italy and elsewhere to make the case that its own response was within bounds, and it can point to the severe shortage of medical masks, testing kits, hospital beds and so forth in places like the U.S. to make the case that, whatever its flaws, the CPC’s model of governance is superior to Western democracies in a crisis.

The War Isn’t Over

The other “P” is prosperity. Breakneck growth was already becoming impossible to sustain. In February, the economy effectively ground to a halt. As many as a third of Chinese businesses remain shut down, with many more operating at only partial capacity.

As was made clear by anemic credit growth figures released this week, Beijing's chronic struggles with getting liquidity to small and medium-sized businesses – which account for as much as 80 percent of employment in China, and more than half of which say they can’t last two months on their savings – persist.

Even “shadow banking" hit a three-year low in February. This is good news for Beijing’s long-term battle against reckless lending, but it’s bad news in the current environment.

We’ve noted that China would be reasonably well-positioned for a “V-shaped” recovery once it could contain the virus enough to restart its manufacturing engine – that is, so long as it could keep systemic risks in, say, the financial or property sectors from rupturing. That’s basically what happened following the SARS epidemic in 2003. Once people can actually get back to work en masse, it won’t be hard to rev up Chinese factories and services sectors.

The pace of the recovery will therefore depend primarily on demand. Massive stimulus spending and the state sector will help here. But with the mass, short-term loss of wages likely to drag down domestic consumption for at least a month or two more, external consumption will once again be the key.

This is why the global spread of the crisis is such a problem for China – especially since it's happening at a pace that’s likely to last months and may surge again in the fall. Prolonged disruptions to trade would be bad enough for Chinese exports, which dropped more than 17 percent in January and February alone.

The more European and the U.S. economies slow down, the more Western demand for Chinese goods will dry up. In this light, “doomsday scenarios” like the one put out by the United Nations predicting a $2 trillion hit to global gross domestic product somehow seem optimistic.




Meanwhile, stress on financial markets in the West – combined with the likely boost to anti-globalization political forces and the broad awareness among multinational corporations that supply chains have become overly dependent on China – will blunt investment and capital flows into China.

Despite China’s impressive capacity to screen just about everyone for the virus at just about every factory door or airport gate, it’s not impossible for the virus to come back. Additional mass quarantines, of course, could be incalculably disruptive. (One silver lining of the global slowdown for Beijing: The collapse of oil prices will have mixed effects on the Chinese economy, but on the whole it will do more good than harm.)

For almost a decade now, we’ve been waiting for the next big shock that would test the resilience of the CPC-led system. The assumption has been that the most likely shock would come from external forces. Turns out, the shock came from within, spread to the rest of the world and now looks likely to boomerang back. There’s nothing China’s propagandists can do about it.

What EU Budget Talks Say About Europe’s Future

By: Antonia Colibasanu



As is often the case with the European Union, negotiations over the EU’s next long-term budget have so far produced more meetings and debates than concrete solutions. Talks over the 2021-27 budget, referred to within the bloc as the multiannual financial framework, have revealed not only the state of the EU’s internal divisions but also the depth of the problems it currently faces.

Negotiations have been further complicated by Brexit, of course, but the drama also revolves around disagreements between some of the EU’s core members. Germany and France continue to debate what the EU’s priorities should be going forward.

And based on their conduct during the negotiations, it’s clear that their focus is increasingly shifting away from the EU’s traditional areas of concern, including supporting its poorer member states, in favor of more modern priorities and, of course, their own economic well-being. This reveals the fragility of the EU’s core.

Competing Visions

Through the seven-year budget, the EU will define its long-term development strategy, so in a sense, the current negotiations aren’t about money but about the basic principles the union wants to promote. The EU’s budget has always been geared toward supporting big political projects: the single market in the 1980s, the adoption of the euro in the 1990s, the enlargement process in the first decade of the 2000s.

Over the past decade, it was focused on helping the bloc’s economies recover from the 2008 financial crisis to bolster EU cohesion at a time when the bloc could have easily ruptured under the strain of economic meltdown.

Now that the EU is facing the departure of one of its members, not to mention an increasingly challenging global environment, it needs another big political project to help unite its remaining parts. To that end, the European Commission, which initiates discussions on the long-term budget, has submitted two major ideas for consideration by the EU Council, which is responsible for approving the new framework. One is the Green Deal, a plan to make the EU carbon neutral by 2050.

The other project attempts to boost the EU’s global profile and is focused on defense and security.

Though the two plans aren’t incompatible, they promote competing visions for the EU’s future. In times of economic growth, the bloc could pursue both, but these are uncertain times, and given that some member states are loathe to spend more money on EU projects than they already do, the bloc will likely have to choose between the two projects.

The Green Deal's biggest backer is Germany, but it’s also supported by countries such as Austria and Luxembourg that produce relatively high amounts of green energy and thus want to support funding for modern infrastructure that can help distribute this energy throughout Europe. At its core, the Green Deal seeks to promote environmentally friendly initiatives and clean energy.

One of the first steps toward this vision was meant to be a sustainable finance strategy, which the European Commission hoped to secure in December. Energy producers, however, rejected the first draft of the proposal because it excluded nuclear energy and natural gas as well as other fossil fuels from the list of green activities that would be eligible for EU funding.

France, the Czech Republic, Hungary, Poland, Slovakia, Romania, Bulgaria and Slovenia – countries that depend on these sources of energy – also rejected the initial proposal, though the EU later agreed to include nuclear as a clean source.




Talks on the Green Deal have also triggered discussions over how the EU defines “projects of common interest” that are financed through EU funds – especially as they pertain to energy infrastructure. So, if European-produced natural gas is not considered eco-friendly under the Green Deal, infrastructure that supports the production and distribution of this energy source will no longer be eligible for European funding. Eastern European countries like Romania and Poland that want to avoid relying on Russian energy are naturally opposed to such a narrowly defined criteria of green energy.

Germany, on the other hand, is the Continent’s largest producer of renewable energy and therefore has no problem with limiting funding to renewable energy. While it’s also a supporter of the Nord Stream 2 pipeline, which will deliver Russian natural gas to European markets, the new regulations will not affect the pipeline’s construction.

Considering the Green Deal’s zero tolerance for coal, Poland and Romania may have to face the prospect of moving away from coal mining, which will come with its own consequences for the local population, without any support from the EU. Similarly, France, the largest European producer of nuclear energy, has been reluctant to exclude nuclear projects from EU funding, hence why French President Emmanuel Macron has been raising the nuclear issue every chance he gets lately.

France is the biggest supporter of the other major project competing for EU funds, dubbed Geopolitical Europe, or “L’Europe Geopolitique” as it was originally called. As part of this vision, Macron has been pushing for more spending on defense and security, focused on border control and research and development.

Not coincidentally, France has a large defense industry and wants to increase production and export of its own military goods. It even sees Russia as a potential partner in this regard.

France has also supported measures to increase member states’ joint contributions to the EU budget to over 1 percent of the EU’s gross national income, which, according to Macron, would allow the EU to expand its global presence and eventually increase its export potential. Net contributors Denmark, Sweden, Austria and the Netherlands – the so-called frugal four – want to cap contributions at 1 percent, while Germany has agreed to a slight increase above 1 percent.




The EU’s non-frugal members, especially France, have also suggested eliminating rebates – a partial refund given to net contributors. The frugal four plus Germany want to keep their rebates. This will be one of the most contentious budget issues – particularly for Germany, where the electorate is increasingly frustrated that their country is expected to carry a larger burden for funding the EU than other members.

Cohesion

The main divide over the long-term budget is between the bloc’s two leading members: Germany, which is Europe’s economic powerhouse and wants the EU to continue to work to its advantage, and France, which sees an opportunity with Britain’s exit to shape the EU to its own benefit.

But there are splits among other members of the bloc too, due in part to proposed cuts to cohesion funds and agriculture funds, both of which could be cut by over 10 percent in the upcoming budget. Eastern European members have benefited most from cohesion funding, which has helped build new infrastructure and reform public sectors. (Eighty-five percent of public funds in Eastern European member states are financed by EU money.)

In addition, since the 2008 economic crisis, the economies of Southern Europe have been kept alive by cohesion and agriculture funds from the EU. Therefore, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Malta, Poland, Portugal, Romania, Slovakia, Slovenia and Spain – the so-called “friends of cohesion” – are campaigning to reduce these cuts.

The recent focus on the budget, however, has overshadowed another major problem for the EU: competitiveness. While Europe has some of the best education systems in the world, it has become increasingly hard to translate it into skills that generate profitable economic activities and innovation.

This is in part due to advantages given to people with seniority over younger, less experienced job seekers. It is also due to generous and overly burdened pension systems that governments are compelled to support or, if they don’t, face widespread public backlash.

European economies are also generally geared toward old industries and state involvement, rather than innovation and new industry. Even the European Commission’s plans to support digitization and innovation through funds that would be administers by the states highlight the government-centric nature of Europe.

The Bigger Picture

Europe, moreover, faces some major problems outside its borders that have not been addressed in discussions over the budget. While the Geopolitical Europe project focuses on building Europe’s military capabilities, it doesn’t indicate what threats they’re meant to address. Not that there aren't plenty to choose from.

Russia is still a threat on Europe’s eastern frontier, and Turkey is slowly becoming a regional power having recently partnered with Russia both in the Middle East and in North Africa in operations that could threaten European energy supplies and send more migrants to the Continent’s shores.

The consequences of these threats will be felt most by Eastern European countries, which are increasingly turning to each other and the United States in the belief that Western Europe is reluctant to respond to their concerns. Regional alliances are therefore emerging: Central Europe has the Visegrad Group, while Eastern Europe has the Intermarium and the Three Seas initiative.

These new groupings see the U.S. as an alternative source of support and funding. On Feb. 15, during the Munich Security Conference, U.S. Secretary of State Mike Pompeo said Washington would pledge up to $1 billion for energy projects in Eastern Europe to help reduce the region’s reliance on Russian natural gas. Pompeo’s announcement highlights the divisions between Eastern and Western Europe, and reveals how the United States’ priorities on the Continent differ from those of Western European states.

It also shows that the EU’s eastern member states continue to hedge their bets and increasingly seem to trust the U.S. more than they trust Brussels when it comes to their security needs. The talks over the EU’s budget will continue to highlight these divisions, as member states face tough choices over how best to protect their interests, both within and outside of the EU.

Covid-19 presents economic policymakers with a new sort of threat

It mixes demand and supply effects




THE ONLY thing we have to fear is fear itself, or so reckoned Franklin Roosevelt. In many an economic downturn that is true—an anxiety-induced reluctance to spend is the main threat to prosperity.

For now, the world is treating the outbreak of covid-19, a disease caused by a coronavirus that is now responsible for more than 2,000 deaths, as no exception. Central banks across Asia are easing monetary policy while governments prepare spending programmes to limit the economic damage.

Covid-19, however, is not a conventional economic threat. Efforts to contain the virus are limiting activity by shutting factories and disrupting supply-chains. Such shocks to supply are harder to manage than anxiety-induced frugality among firms and investors. When people stop spending, growth slows and inflation falls. But when supply is constrained, prices can accelerate even as the economy wobbles.

Economists first grappled with supply shocks in the 1970s, when reductions in food and oil supplies ended three decades of unprecedented growth and ushered in “stagflation”. Supply shocks divided the profession.

Predictably, there was a row over whether governments should prioritise fighting rising unemployment or high inflation. In a victory that would shape central banking for decades, the inflation hawks eventually won.

Like the oil and food shocks of the 1970s, the covid-19 epidemic poses an unexpected threat to a mainstay of global production. For as long as the mobility of Chinese workers is limited, shops, offices and factories in the world’s largest exporter will sit idle. As a result, firms dependent on supplies from China are running down inventories and curtailing operations.

On February 17th Apple warned investors that supply-chain problems were limiting iPhone production and would reduce its revenues. Hyundai, a carmaker, has cut production in South Korea because of parts shortages. On February 18th Jaguar Land Rover, a British carmaker, said that it could start to run out of parts in two weeks’ time, and that it had flown in emergency supplies from China in suitcases.

But whether the understanding of supply shocks forged in the 1970s still applies is unclear. In practice, the distinction between shocks to demand and those to supply is fuzzy. In a paper published in 2013 that revisited the era of stagflation, Alan Blinder of Princeton University and Jeremy Rudd of the Federal Reserve argue that supply alone cannot explain the soaring unemployment of the 1970s.

In fact, they say, price increases had demand effects that mattered more. They raised uncertainty, reduced households’ disposable income and eroded the value of their savings.

Subsequent experience supports this more nuanced view of the effect of supply shocks. Soaring oil prices in 2007 gutted household consumption in America and helped push its economy into recession. The earthquake, tsunami and resulting nuclear disaster that struck Japan in 2011 dealt a blow to Japanese industry which, like China’s, occupies important supply-chain niches.

The catastrophe led to a sharp decline in output and exports (and a long-term shift in economic activity away from the most affected regions), but despite the disruptions Japan remained in deflation.

Higher tariffs should, in theory, disrupt supply and boost prices. But to date the main economic effect of the trade war being fought by America and China has been dented confidence, derailed business investment and tumbling interest rates.

The covid-19 outbreak is hitting China’s demand for commodities and its tourists’ travel plans. Both effects drag down global demand in a conventional way, as they did after the outbreak of SARS in 2003.

Circumstances today are also very different from the 1970s. Crucially, global inflation remains oddly subdued. That means policymakers can provide stimulus without exacerbating an ongoing inflation problem. Support seems warranted in China, where lost sales could give way to lay-offs, further cuts to spending, and a deep slump.

Economies with close links to China are also moving, rightly, to shore up spending. Japan’s decision to raise consumption tax last year, a move that contributed to an annualised decline in GDP of 6.3% in the fourth quarter of 2019, looks spectacularly ill-timed in hindsight.

Should covid-19 sweep across the world, the global economy as a whole will surely need a dose of stimulus, much as China does today. The main complication then would be a lack of central-bank ammunition, as interest rates are already low.

But even if the virus stays contained, governments of less affected countries could have their hands full. Policymakers facing temporary supply shocks must reassure the public that growth and inflation will eventually return to normal—as modern central banks now try to do when oil prices spike. Continued disruption, though, requires adjustment.

New suppliers must be tracked down, new contracts written and new customers found. Frustrated firms could decide the time is right to wash their hands of China. The effects of such changes are hard to predict.

Ill at ease

If China’s economy slumps further in response, it could exert a deflationary pull on economies in the West. But if decades of economic integration, which many economists credit with holding down global inflation for the past two decades, goes into reverse, then dormant price pressures could awaken.

Macroeconomic policymakers could once again be confronted with the painful decision of whether or not to fight rising inflation during an economic downturn.

For policymakers beset by unknowns, both overreaction and underreaction present serious risks. The time to build more resilience into production chains and financial systems has sadly passed.

Perhaps the most important lesson of the 1970s is one the world ought to have appreciated before the arrival of the epidemic—shocks happen, and can transform well-worn economic terrain into something less familiar with frightening speed.

When China Sneezes

The COVID-19 outbreak has hit at a time of much greater economic vulnerability than in 2003, during the SARS outbreak, and China's share of world output has more than doubled since then. With other major economies already struggling, the risk of outright global recession in the first half of 2020 seems like a distinct possibility.

Stephen S. Roach




NEW HAVEN – The world economy has clearly caught a cold. The outbreak of COVID-19 came at a particularly vulnerable point in the global business cycle. World output expanded by just 2.9% in 2019 – the slowest pace since the 2008-09 global financial crisis and just 0.4 percentage points above the 2.5% threshold typically associated with global recession.

Moreover, vulnerability increased in most major economies over the course of last year, making prospects for early 2020 all the more uncertain. In Japan, the world’s fourth-largest economy, growth contracted at a 6.3% annual rate in the fourth quarter – much sharper than expected following another consumption-tax hike.

Industrial output fell sharply in December in both Germany (-3.5%) and France (-2.6%), the world’s fifth- and tenth-largest economies respectively. The United States, the world’s second-largest economy, appeared relatively resilient by comparison, but 2.1% real (inflation-adjusted) GDP growth in the fourth quarter of 2019 hardly qualifies as a boom.

And in China – now the world’s largest economy in purchasing-power-parity terms – growth slowed to a 27-year low of 6% in the last quarter of 2019.

In other words, there was no margin for an accident at the beginning of this year. Yet there has been a big accident: China’s COVID-19 shock. Over the past month, the combination of an unprecedented quarantine on Hubei Province (population 58.5 million) and draconian restrictions on inter-city (and international) travel has brought the Chinese economy to a virtual standstill.

Daily activity trackers compiled by Morgan Stanley’s China team underscore the nationwide impact of this disruption. As of February 20, coal consumption (still 60% of China’s total energy consumption) remained down 38% from the year-earlier pace, and nationwide transportation comparisons were even weaker, making it extremely difficult for China’s nearly 300 million migrant workers to return to factories after the annual Lunar New Year holiday.

The disruptions to supply are especially acute. Not only is China the world’s largest exporter by a wide margin; it also plays a critical role at the center of global value chains.

Recent research shows that GVCs account for nearly 75% of growth in world trade, with China the most important source of this expansion. Apple’s recent earnings alert says it all: the China shock is a major bottleneck to global supply.

But demand-side effects are also very important. After all, China is now the largest source of external demand for most Asian economies. Unsurprisingly, trade data for both Japan and Korea in early 2020 show unmistakable signs of weakness.

As a result, it is virtually certain that Japan will record two consecutive quarters of negative GDP growth, which would make it three for three in experiencing recessions each time it has raised its consumption tax (1997, 2014, and 2019).

The shortfall of Chinese demand is also likely to hit an already weakening European economy very hard – especially Germany – and could even take a toll on a Teflon-like US economy, where China plays an important role as America’s third-largest and most rapidly growing export market.

The sharp plunge in a preliminary tally of US purchasing managers’ sentiment for February hints at just such a possibility and underscores the time-honored adage that no country is an oasis in a faltering global economy.

In the end, the epidemiologists will have the final word on the endgame for COVID-19 and its economic impact. While that science is well beyond my expertise, I take the point that the current strain of coronavirus seems to be more contagious but less lethal than SARS was in early 2003. I was in Beijing during that outbreak 17 years ago and remember well the fear and uncertainty that gripped China back then.

The good news is that the disruption was brief – a one-quarter shortfall of two percentage points in nominal GDP growth – followed by a vigorous rebound over the next four quarters. But circumstances were very different back then. In 2003, China was booming – with real GDP surging by 10% – and the world economy was growing by 4.3%. For China and the world, a SARS-related disruption barely made a dent.

Again, that is far from being the case today. COVID-19 hit at a time of much greater economic vulnerability. Significantly, the shock is concentrated on the world’s most important growth engine. The International Monetary Fund puts China’s share of global output at 19.7% this year, more than double its 8.5% share in 2003, during the SARS outbreak.

Moreover, with China having accounted for fully 37% of the cumulative growth in world GDP since 2008 and no other economy stepping up to fill the void, the risk of outright global recession in the first half of 2020 seems like a distinct possibility.

Yes, this, too, will pass. While vaccine production will take time – 6-12 months at the very least, the experts say – the combination of warmer weather in the northern hemisphere and unprecedented containment measures could mean that the infection rate peaks at some point in the next few months. But the economic response will undoubtedly lag the virus infection curve, as a premature relaxation of quarantines and travel restrictions could spur a new and more widespread wave of COVID-19.

That implies, at a minimum, a two-quarter growth shortfall for China, double the duration of the shortfall during SARS, suggesting that China could miss its 6% annual growth target for 2020 by as much as one percentage point. China’s recent stimulus measures, aimed largely at the post-quarantine rebound, will not offset the draconian restrictions currently in place.

This matters little to the optimistic consensus of investors. After all, by definition shocks are merely temporary disruptions of an underlying trend. While it is tempting to dismiss this shock for that very reason, the key is to heed the implications of the underlying trend. The world economy was weak, and getting weaker, when COVID-19 struck.

The V-shaped recovery trajectory of a SARS-like episode will thus be much tougher to replicate – especially with monetary and fiscal authorities in the US, Japan, and Europe having such little ammunition at their disposal. That, of course, was the big risk all along.

In these days of dip-buying froth, China’s sneeze may prove to be especially vexing for long-complacent financial markets.


Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

The Fed Put Has No Clothes

The coronavirus concern in equity markets has been sharpened by a realization that the Fed can’t save our portfolios

By Justin Lahart


For quite some time, many investors operated under the assumption that Fed policy was sure to keep pushing stocks higher. / Photo: Mark Lennihan/Associated Press .


In the widespread disruption sown by the novel coronavirus epidemic, investors find themselves facing an economic problem the Fed can’t solve for them. Because rates were already so low, the central bank’s ability to help bolster the economy using conventional tools is severely limited.

After next week’s meeting, when the Fed is likely to cut rates deeply, it will have even less or, if it cuts its target range on overnight rates by a full percentage point, none at all.
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Up until last month, many investors were operating under the assumption that the Fed’s easy-money policy was destined to keep pushing stocks higher.

They had, after all, just come through a year in which Fed policy-makers reversed their rate-hike plans and then, worried about what trade disputes and slowing global growth might do to the U.S. economy, lowered their target range on rates three times.

It was back to the Fed put, in other words—the notion that, like a put option on a stock, the Fed effectively was insuring investors against market downturns. To some, it seemed the Fed was actively boosting stocks.

Even as the trade and global slowdown worries faded, and even though the unemployment rate was at its lowest level in more than 50 years, the central bank showed no inclination to take last year’s rate cuts back.

In fact, the central bank was in the midst of rethinking its approach to inflation. It seemed to be moving toward a policy of not raising rates until inflation stayed over its 2% target for a while.

Nor would the Fed lean against stocks even if valuations kept pushing higher, since the politics of doing that would be so fraught—especially with all the criticism the central bank had already been getting from President Trump.

It was part of why stocks rallied by so much starting in the latter part of last year, pushing valuations sharply higher. That placed equities at a much higher starting point as investors began to understand the seriousness of the coronavirus pandemic.

Worse, as stocks tumbled investors realized that the net they thought Fed policymakers were holding out for the market as it performed its high-wire act wasn’t there at all.

It is yet another reason why so many are assuming the brace position at the same time.