PAIN FOR MOST INDEBTED SET TO WORSEN / THE FINANCIAL TIMES MARKET INSIGHT

Markets Insight

Pain for most indebted set to worsen

Henny Sender

Profligate US Treasury unlikely to suffer but many US companies will

©AFP

 

 

At the moment, the Federal Reserve’s favourite message appears to be either “not yet” or “almost there”.

 

The Fed’s almost zero interest rate policies evidently are to be with us at least a bit longer.

Moreover, the Fed seems far more sensitive, or even sympathetic, to the impact its policies have beyond the US than in the past. Yet the massive liquidity that not long ago was sloshing around the globe, courtesy of the major central banks, seems to be evaporating by the day.

The burden of servicing borrowed money, especially borrowed dollars, seems, equally, to be rising by the day. Deflation is deepening, making that burden even heavier in real terms.

Emerging markets currencies keep going down and outflows from emerging debt and stock markets are rising.

There is almost certainly worse to come. A world awash with dollars is rapidly being replaced by a dollar-scarce world. The rise in the dollar means tightening regardless of what the Fed does. The pain of deleveraging for the most indebted will become ever more severe.

 

Given the plunge in global markets, spooked by a combination of developments both in the real economy of China and its financial market and in European share markets, it is hard to imagine the Fed moving in September — even though the reasons are shifting.

 

Last week, the surge in the dollar and the consequent tightening were a reason to postpone action. But with the global equity sell-off on Monday and corporate debt markets coming under pressure, it is virtually inconceivable that the Fed will act.

It still is not clear how the pain for the most indebted will be distributed though.

Ironically, the US, long regarded as the most profligate of all borrowers thanks to the reserve status of the dollar, for the moment looks more immune than almost anywhere else.

The Treasury market has seen three of its most important buyers — China, Japan and Saudi Arabia — cease accumulating reserves and consequently with far less financial firepower, while the Fed itself is buying less. Yet yields are hardly registering any impact .

Many companies, though, will be less fortunate than the US Treasury. Expect downgrades and defaults to increase dramatically in coming months, as commodity prices fall and cash flows dry up for an ever widening circle of companies in the commodities food chain.

 

Most emerging markets will have an even harder time. Moreover, few are in control of their own fate.

 

Many of the most vulnerable are tied closely to China, and the country’s falling purchasing managers’ index, an indicator of economic health, is worse news for them than for the Chinese themselves.

 

China itself, as always, is a harder call. In the past few years, it has become evident that China’s real competitive advantage has been an abundance of capital rather than cheap labour.

New initiatives, including the Asian Infrastructure Bank, the New Development Bank and the oddly named “One belt, one road” infrastructure plan, are all about exporting capital to places such as Pakistan ($46bn soon coming its way) that can use it productively at a time when investment in China is losing its efficacy.

At the same time, though, lots of claims on what was once $4tn in Chinese reserves make that number seem less impressive than even just a few months ago. In the past four quarters, China has seen outflows of about $350bn and reserves have shrunk as export earnings have slowed.

At year-end, outstanding cross-border claims on Chinese residents totalled $1tn, according to the latest data from the Bank for International Settlements, making the mainland the eighth largest borrower worldwide. Fully 39 per cent of that debt is in dollars, and 78 per cent of total claims are short-term claims.

Moreover, many mainland companies borrowed dollars expecting the greenback to depreciate over time. Few expected that a renminbi that was appreciating ever more quickly (up 4 per cent in the three months before mid-August) would suddenly reverse course or that deflation would deepen every month, making the real debt burden ever more onerous.

Goldman Sachs analysts recently concluded a study of the debt profiles of the top 125 listed Chinese companies, (with a collective $270bn in foreign debt) and found no worrying concentrations. But many companies use offshore subsidiaries and off-balance sheet vehicles (not to mention questionable accounting).

While much of the capital outflow and the rise in the dollar can be accounted for by prudent hedging, jittery Chinese investors have less reason to keep their money in China than ever before. The capital outflows, whether from a need to diversify or to find a bolt-hole abroad, will only increase.

“The end of excess liquidity and the end of excess profits have engendered the end of excess returns in 2015,” the equity strategists at Bank of America Merrill Lynch noted in a report on August 19.

Excess pain, sadly, is likely to come up next.