Credit Markets Are Bracing for Something Bad
(Bloomberg Opinion) -- More so than any other market, credit is all about confidence. Yes, fundamentals such as revenue, cash flow and leverage matter, but as was seen with Lehman Brothers Holdings Inc., Enron Corp. and WorldCom Inc., when a borrower loses the confidence of its lenders, things can go downhill pretty quickly. And right now, some pretty influential people in the credit market are sounding less than confident.
The extra yield investors demand to own investment-grade corporate bonds instead of U.S. Treasuries expanded on Tuesday by the most since May as legendary Guggenheim Investment Management Chief Investment Officer Scott Minerd tweeted that “the slide and collapse in investment-grade credit has begun.” Minerd, whose Guggenheim Total Return Bond Fund gets a five-star rating from Morningstar, joins other bond-market titans who have also warned about excesses in the credit markets, including Marc Lasry of Avenue Capital and Howard Marks of Oaktree Capital. The impetus for Minerd’s tweet was the big drop in the bonds of General Electric, whose $165 billion of debt makes it one of the market’s biggest borrowers. CEO Larry Culp tried to reassure investors by going on CNBC Monday and expressing a “sense of urgency” in cutting debt and selling assets. Instead, GE’s bonds extended their decline as debt investors detected a “sense of panic” in Culp’s message, further denting their confidence. “The sell-off in GE is not an isolated event,” Minerd tweeted. “More investment grade credits to follow.”
To be sure, investment-grade yield spreads at about 1.09 percentage points are only the widest in four months and are still far lower than the 2.24 percentage points reached in early 2016 after oil prices collapsed and energy companies had trouble meeting their debt payments. Nevertheless, it hasn’t been a good year for credit, with the Bloomberg Barclays U.S. Corporate Bond Index losing more than 3.5 percent and on track for its worst year since 2008. Not only are interest rates rising — investors also seem to be getting worried about a “crowding out” effect, with companies having to compete even more for investors’ attention as the U.S. government ramps up its borrowing to unprecedented levels to pay for a soon-to-be $1 trillion budget deficit. And balance sheets are already showing some bloat: The Institute of International Finance puts the corporate debt-to-GDP ratio at about 72 percent, which is just below its all-time high in early 2008.
CRUDE CRUSHED, AGAIN
The oil market isn’t doing much to bolster confidence these days, either. Crude tumbled as much as 7.14 percent on Wednesday in its biggest decline since 2015. Oil prices have fallen for 12 straight days in an unprecedented run of losses, bringing its decline since early October to more than $20 a barrel, or about 27 percent. “Today’s move is just capitulation,” Nick Gentile, managing partner of commodity trading adviser NickJen Capital Management & Consulting, told Bloomberg News. Oil is facing pressure on both sides, in that there is a glut of supply at the same time that the outlook for demand is darkening. Producers can typically adjust supply as needed, but they have no control over demand. Declining demand is concerning not just for oil, but most all commodities and global markets in general. As Bianco Research noted in a report, the percentage of economies growing above their one-year average has tumbled to “a paltry” 30 percent. Some 44 percent of the respondents to Bank of America Merrill Lynch’s monthly fund-manager survey expect global growth to slow in the next year, the worst outlook since November 2008. The central macro scenario of Amundi Asset Management, one of Europe’s biggest money managers, is a “multi-speed slowdown” that risks becoming synchronized, according to Bloomberg News’s Eddie van der Walt and Cecile Gutscher. The firm says the year will end with a disjointed global economy and increased downside risks.
BOND TRADERS UNFAZED
The big decline in oil is likely to put downward pressure on inflation data in coming months, but bond traders aren’t ready to start betting that it could cause the Federal Reserve to slow the pace of planned interest-rate increases. In fact, the yield on the benchmark 10-year Treasury note is little changed at about 3.14 percent from the start of crude’s slide. Also, money-market traders are pricing in about 46 basis points of Fed rate increases in 2019, up from about 40 at one point last month, according to Bloomberg News’s Liz McCormick. “The world is a lot more efficient in how it uses oil these days, so changes in oil prices are a lot less significant to what happens to global growth,” Jim Leaviss, the head of retail fixed interest at M&G Investments, told Bloomberg News. The drop in oil and resulting decline in gasoline prices could also give consumers a boost heading into the holiday sales season, which should support the economy. “The U.S. consumer already has the tailwinds of low unemployment and recent wage gains to be thankful for next week,” DataTrek Research co-founder Nicholas Colas wrote in a research note Tuesday. “Lower gas prices might be what they need to make the start of Holiday 2018 better than the retail pundits expect.”
Oil’s plunge also has major implications for emerging markets, but to differing degrees. In general, Latin American equities tend to underperform their Asia-Pacific peers after oil prices fall, according to Bianco Research. The drop in oil is most bearish for Colombia, Mexico, Malaysia and Brazil, while it’s less of a challenge for Argentina and Chile, the firm noted. In the Asia-Pacific region, India and Thailand are among the least sensitive to a downturn in crude, while Indonesia might actually benefit from falling oil prices. In the foreign-exchange market, this year’s worst-performing emerging Asian currency, the Indian rupee, is finally catching a break against its regional peers thanks to the slide in oil, according to Bloomberg News’s Cormac Mullen. India, a major importer of the commodity, has seen its currency appreciate more than 2 percentage points in the last month against that of Malaysia, a net energy exporter. Still, the respite could be short-lived as the rupee will remain under pressure, with traders turning their focus back to the nation’s twin deficits, RBC Capital Markets strategists including Sue Trinh wrote in a note this week. “The oil story is a double-edged sword for EM,” Sacha Tihanyi, an emerging-markets strategist at TD Securities, told Bloomberg News. “For oil-importer countries facing current-account balance stresses like India and Indonesia, this is helping to take some of the dollar demand pressure off of them. But a severe drop in oil is not constructive for EM.”
The currency market is confident that the U.K. is on the verge of an agreement with the European Union on a Brexit divorce deal, removing a cloud of uncertainty hanging over Britain’s currency. The Bloomberg Pound Index surged as much as 1.24 percent Tuesday as sterling rose to its strongest level since April against the euro. Negotiators from both sides have settled on a draft after working through the night this week in Brussels, according to Bloomberg News, citing people familiar with the situation. Prime Minister Theresa May’s cabinet ministers are due to meet Wednesday to sign off on the pact, though EU officials cautioned that the deal isn’t done until it gets political sign-off in London. “What remains to be seen is whether the U.K. cabinet will agree to the proposed text,” Valentin Marinov, head of FX research at Credit Agricole, told Bloomberg News. Yields on U.K. 10-year government bonds rose six basis points to 1.52 percent, a sign traders may be raising bets on an interest-rate increase by the central bank should a Brexit deal be concluded. “It is important to note that this withdrawal deal does not fully address how the two economies will trade with each other after Brexit, and is likely to do so only in vague and high-level terms,” the strategist at Wells Fargo & Co. wrote in a research note. That should limit the potential longer-term upside for the U.K. economy and pound, they wrote.
The recent turmoil has some economists whispering about how maybe the Fed should skip its planned interest-rate increase in December. Although Fed officials have made clear the drop in equities is nowhere near bad enough to get them to pause, expect those whispers to get louder if the data continues to show inflation is in check. That’s why Wednesday’s Consumer Price Index report for October is so important. The median estimate of economists surveyed by Bloomberg is that core consumer prices, which strip out food and energy, rose 2.2 percent from a year earlier, the third consecutive month it has risen by that amount. Bloomberg Economics expects that firmer readings in shelter and used motor vehicle prices will add upward pressure on core CPI.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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