Super Credit Bubble
Doug Nolan
Global “Risk Off” gathers momentum by the week.
Crisis Dynamics fester, as global central banks coalesce around a united front for battling inflation.
The reality that central bankers will aggressively hike rates until something breaks has begun to sink in.
Last Friday’s Jackson Hole selling pressure carried over into this week for U.S. equities.
The S&P500 declined 3.3%, with the broader market suffering greater losses.
The Semiconductors were slammed 7.1%.
U.S. high yield Credit default swap (CDS) prices surged another 30 to a six-week high 528 bps, with a portentous three-week gain of 107 bps.
After a brief reopening, it appears the junk bond market is again closed for new issues.
Investment-grade CDS traded up to six-week highs.
JPMorgan CDS rose seven this week to a six-week high 88 bps.
Citi CDS jumped nine to a one-month high 103 bps, and Goldman CDS gained seven to a six-week high 112 bps.
It’s worth noting that Credit Suisse CDS traded Thursday to 230 bps, surpassing July’s spike to decade highs.
August 31 – Bloomberg (Alexander Weber):
“Euro-area inflation accelerated to another all-time high, strengthening the case for the European Central Bank to consider a jumbo interest-rate hike when it meets next week.
Consumer prices in the 19-nation currency bloc jumped 9.1% from a year ago in August…
The question now is whether the data are enough to nudge the ECB toward the 75 bps rate increase that some on its 25-strong Governing Council want debated…
‘There’s an urgent need for the Governing Council to act decisively at its next meeting to combat inflation,’ Bundesbank chief Joachim Nagel said...
‘We need a strong rise in interest rates in September. And further interest rate steps are to be expected in the following months.’
Six Governing Council members have said publicly that they think a rate move of more than 50 bps should be discussed, with money markets putting the probability of 75 bps at more than 60%.”
With the ECB poised to launch a more aggressive tightening cycle next Thursday, the rout in European bonds – a global market weak link - runs unabated.
Italian yields jumped another 14 bps (three-week gain 77bps) to 3.84%, trading this week to the high since the June spike.
Greece yields surged 23 bps (three-week gain 96 bps) to 4.18%, the high back to June 16th.
German bund yields rose 14 bps to the high since June 29th (1.53%).
European high-yield (“crossover”) CDS dropped a notable 30 bps in Friday trading.
This will surely be reversed when trading resumes next week, unless there’s a reversal in the Friday decision to delay the reopening of Nord Stream 1.
And with the Bank of England fixated on its inflation fight, UK yields surged 32 bps this week to 2.91% - the high since January 2014.
UK yields have surged 105 bps over the past month.
Meanwhile, the yen (vs. $) dropped further to a 24-year low, as JGB yields rose two bps to within a hair of the BOJ’s 0.25% yield ceiling.
It’s another looming crisis that this week reached ever closer to the boiling point.
EM bonds remain under pressure, with notable yield surges in dollar-denominated EM debt.
Dollar yields were up 31 bps in Turkey to 10.40%, 23 bps in Saudi Arabia to 3.78%, 21 bps in Indonesia to 4.39%, 19 bps in Mexico to 5.49%, 16 bps in Peru to 5.16%, 15 bps in the Philippines to 4.11%, and 14 bps in Chile to 4.89%.
Ominously, dollar-denominated yields this week jumped to highs since at least 2009 in Chile, Peru, Panama and Mexico.
Key EM currencies suffered additional losses this week.
The South African rand declined 2.4%, the South Korean won 2.3%, the Brazilian real 2.1%, the Thai baht 1.9%, and the Colombian peso 1.8%.
Commodities are in the grips of global “Risk Off” dynamics.
The Bloomberg Commodities Index dropped 4.4% this week.
Crude sank 6.7% ($6.19), Gasoline 13.6%, Copper 7.7%, Nickel 5.3%, Tin 13.0%, Zinc 11.6%, Iron Ore 9.4%, Aluminum 5.7%, Coffee 3.9%, Cotton 11.2%, and Soybeans 5.9%.
I assume the global leveraged speculating community is running for cover.
The Shanghai Composite fell 1.5% to a one-month low, with the growth-oriented ChiNext Index sinking 4.1% to lows since mid-June.
The Beijing-induced developer bond rally lost momentum this week.
Chinese bank CDS surged higher, with China Construction Bank CDS jumping 11 to 101 bps, and Bank of China up 11 to 99 bps.
China sovereign CDS rose seven to a three-week high 75 bps.
September 2 - New York Post (Thomas Barrabi):
“Despite a summer rally, the US stock market is still an unprecedented ‘superbubble’ that will cause financial ‘tragedy’ for investors when it bursts, famed investor Jeremy Grantham predicted.
The co-founder of the asset-management firm GMO… said the current superbubble was entering its ‘final act’ due to deteriorating economic conditions.
A recent ‘bear-market rally’ that saw the S&P 500 recoup 58% of its losses from a June low follows the pattern of past stock-market crashes in 1929, 1973 and 2000...
‘The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing and stocks all critically overpriced and now rapidly losing momentum), commodity shock and Fed hawkishness,’ Grantham wrote...
‘Each cycle is different and unique - but every historical parallel suggests that the worst is yet to come.’”
Jeremy Grantham has enjoyed a long and distinguished career.
He accurately predicted bursting stock market Bubbles in Japan in the late-eighties, along with the U.S. equities Bubbles in the late-nineties and again in 2008.
Grantham will surely only solidify Wall Street legend status with his latest “superbubble” call.
For years, I’ve referred to the “Granddaddy of All Bubbles.”
“Super Bubble” has a more polished, conventional ring.
A “superbubble” word search in Grantham’s excellent six-page shareholder letter nets 27 hits.
“Bubble” receives an additional nine.
I also appreciate Grantham’s attention to critical issues that somehow don’t garner deserved attention.
Grantham:
“All that is to say: these long-term negative issues that I have kept at the back of my mind (and hopefully yours) for years – climate, human fertility, food, and other resources – are now becoming relevant short-term issues that bear on both inflation (upwards) and growth (downwards).
Indeed, collectively, they pose a potential risk to our long-term viability.”
With “Credit” and “debt” combining for zero word search hits, there is room to differentiate my Bubble analysis from Mr. Grantham’s.
Asset inflation and speculative Bubbles are always and everywhere monetary phenomena.
The U.S. stock market “superbubble” is a manifestation of history’s greatest global Credit Bubble.
Moreover, the post-2008 crisis “blow-off” finale saw unprecedented debt growth span the globe, with epic inflation at the very core of global finance – perceived safe central bank Credit and government debt.
Grantham:
“Why are the historic superbubbles always followed by major economic setbacks?
Perhaps because they occurred after a very extended build-up of market and economic forces – with a major surge of optimism thrown in at the end.”
Super Credit Bubbles are followed by acute instability and economic upheaval.
Invariably, a crisis of confidence in Credit and the Credit system plays a profound role.
Why was the post-mortgage finance Bubble economic downturn much deeper than the post-tech Bubble recession?
Because Credit system impairment was significantly more severe.
Importantly, a crisis of confidence in risky mortgage Credit poisoned the liabilities of highly levered financial institutions, fostering disruption and a dramatic slowdown in Credit growth (an actual contraction of mortgage Credit).
The Great Depression was more the fallout from a crisis of confidence in debt and banking systems than a direct consequence of the 1929 stock market crash.
Supercycles – such as the one that gained momentum coming out of the First World War, only to succumb to “blow-off” extreme excesses during the “Roaring Twenties” – see an unsustainable buildup of speculative Credit (leverage) in asset markets (i.e. bonds, stocks, real estate…).
As was certainly the case in October 1929, the bursting of a speculative Bubble in the securities markets can be the catalyst for a destabilizing contraction of speculative Credit.
Market deleveraging then leads to illiquidity, general risk aversion, and an abrupt slowdown – or even contraction – of system Credit.
Super Credit Bubbles inevitably end in crisis.
Boom periods ensure Credit excesses that fuel resource misallocation and mal-investment.
Government and central bank market intervention and reflationary measures – as we’ve witnessed repeatedly – can thwart Credit impairment and tightening, but at the great cost of spurring only greater excess along with an extended cycle.
Repeat this boom-bust-government reflation cycle a few times, and you’re witnessing a Supercycle.
Supercycles culminate with a terminal confluence of reckless policymaking, dysfunctional markets and egregious financial excess.
The heart of the matter: an untenable mountain of debt is supported by a deeply maladjusted economic structure.
The amount of perceived wealth tied up in speculative asset Bubbles becomes completely divorced from underlying wealth producing capacity within the real economy.
The unavoidable bursting of speculative Bubbles unleashes forces that expose deep-seated system Credit, market and economic fragilities, along with policy impotency.
Each Supercycle has unique characteristics – shaped by technological innovation and innovations in financial, policymaking, market and economic structure.
At some point, Bubble excess turns overtly perilous.
Policymakers either no longer retain the capacity to prolong the Bubble, or view the costs of further extending the cycle as too prohibitive (i.e. Japan 1989).
I could not agree more with Jeremy Grantham.
The worst is yet to come.
While speculative market Bubbles have been pierced, the long and arduous process of structural economic adjustment has yet to commence.
Credit Bubbles have begun to burst at the “Periphery,” yet the adjustment to the New Cycle begins in earnest when Credit growth falters at the “Core.”
With my analytical Bubble focus on Credit, a brief data overview:
I’ll refer to data from the IIF’s May Global Debt Monitor:
“Total global debt rose by $3.3 trillion in Q1 2022 to a new record of over $305 trillion – mostly due to the U.S. and China.”
Comparing Q1 2022 to pre-Covid Q3 2019 (10 quarters), total global debt surged $52.9 TN, or 20.9%.
Over this period, emerging market (EM) debt expanded $26.2 TN, or 36.1%, led by a 47% surge in EM government debt and a 32.6% increase in EM non-financial corporate debt.
Additional detail behind the ongoing historic expansion of U.S. and Chinese Super Credit Bubbles:
U.S. Non-Financial Debt (NFD) growth averaged $530 billion during the nineties.
This annual average inflated to $1.892 TN for the mortgage finance Bubble period 2000-2007, with a 2004 peak of $2.90 TN.
Pandemic year 2020 saw NFD growth spike to $6.752 TN, with last year’s expansion slowing to a still enormous $3.797 TN.
NFD then expanded a nominal $1.659 TN during 2022’s first quarter, a blistering 10.2% growth rate.
Household Mortgage borrowings expanded at the fastest pace (8.62%) since 2006, while Consumer Credit (non-mortgage) grew at the strongest rate (8.73%) since 2001.
China’s metric for system Credit - Aggregate Financing – expanded $5.1 TN over the past year (through July).
While Credit growth slowed slightly from 2020’s historic deluge ($5.2 TN), it still dwarfs 2019’s $3.8 TN and 2018’s $3.3 TN.
As a macro analyst of Credit, it is both remarkable and ominous that China today confronts such instability even in the face of ongoing massive Credit inflation.
Understandably, Beijing is reluctant to push system Credit to only more perilous extremes.
Policy discussions are not framed around Credit, and Central bankers certainly don’t discuss the necessity of significantly slowing debt growth to restrain inflationary forces.
But that’s the reality.
August 29 – Reuters (Balazs Koranyi and Howard Schneider):
“The message from the world's top finance chiefs is loud and clear: rampant inflation is here to stay and taming it will take an extraordinary effort, most likely a recession with job losses and shockwaves through emerging markets.
That price is still worth paying, however.
Central banks spent decades building their credibility on inflation fighting skills and losing this battle could shake the foundations of modern monetary policy.
‘Regaining and preserving trust requires us to bring inflation back to target quickly,’ European Central Bank board member Isabel Schnabel said.
‘The longer inflation stays high, the greater the risk that the public will lose confidence in our determination and ability to preserve purchasing power.’
Banks should also keep going even if growth suffers and people start to lose their jobs.
‘Even if we enter a recession, we have basically little choice but to continue our policy path,’ Schnabel said.
‘If there were a deanchoring of inflation expectations, the effect on the economy would be even worse.’”
And for those hoping for some back-peddling after the market’s poor reception of Powell’s hawkish Jackson Hole talk, there was none.
August 29 - Bloomberg (Joe Weisenthal, Tracy Alloway and Jonnelle Marte):
“Sharp stock-market losses show investors have got the message that Jerome Powell and his colleagues are serious about tackling inflation,” said Minneapolis Fed President Neel Kashkari.
‘I was actually happy to see how Chair Powell's Jackson hole speech was received…
People now understand the seriousness of our commitment to getting inflation back down to 2%.’”
The global central bank community is now in alignment.
Their job is today so challenging specifically because they for much too long irresponsibly accommodated unbridled Credit growth.
And certainly “globalization” played a major role in years of relatively quiescent consumer price inflation, despite massive monetary and asset inflation.
It’s now payback time.
Inflation has become a global phenomenon.
Global Credit excess, supply chain issues, and climate change are beyond the scope of individual central banks.
Moreover, faltering global Bubbles certainly exacerbate acute geopolitical risks.
Unfolding energy and food crises are compounding inflation risk and policy challenges.
Hopeful talk of Goldilocks returned after Friday’s report of stronger-than-expected labor force growth, along with weaker-than-expected Average Hourly Earnings.
I can’t help but think that there’s currently too much focus on economic data.
Credit growth must slow, and there is at this point sufficient momentum in general price inflation and lending to sustain the Credit boom.
Central banks have signaled they are not backing down because of recession risk.
Following the eurozone’s 9.1% inflation report, the emboldened ECB hawks are ready to make their case next week for a big hike.
Increasingly fragile global markets are on a collision course with concerted aggressive monetary tightening.
And Fed QT (quantitative tightening) jumps to $95 billion this month.
With $2.17 TN of reverse repos currently held at the Fed, the conventional view holds that this “excess cash” allows for a seamless shrinking of the Fed’s balance sheet.
Probably the more germane discussion would center around the impact of Fed liquidity withdrawals in a backdrop of de-risking/deleveraging and waning market liquidity.
Moreover, it’s worth pondering potential market function issues for the global derivatives marketplace in the event of a serious bout of de-risking/deleveraging in conjunction with QT and central bank liquidity support (i.e. “Fed put”) ambiguity.
Market liquidity and dislocation concerns make selling market protection an only riskier proposition.
Summing it up, there’s a strong case that global markets are at the cusp of succumbing to Crisis Dynamics, which will be especially difficult to shake this time around.
The Super Credit Bubble is at the brink.
Quoting Grantham:
“If history repeats, the play will once again be a Tragedy.
We must hope this time for a minor one.”
I’m holding out hope, but nothing I see points to “a minor one.”
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