One month ago, when we last looked at the Fed’s update of Treasuries held in custody, we noted something troubling: the number had dropped sharply, declining by over $22 billion in one week, one of the the biggest weekly declines since January 2015, pushing the total amount of custodial paper to $2.805 trillion, the lowest since 2012. One month later, we refresh this chart and find that in last week’s update, foreign central banks continued their relentless liquidation of US paper held in the Fed’s custody account, which tumbled by another $14 billion over the course of a week, pushing the total amount of custodial paper to $2.788 trillion, a new post-2012 low.
Today, to corroborate the disturbing weekly slide in the Fed’s custody data, we also got the latest monthly Treasury International Capital data for the month of September, which showed that the troubling trend presented one month ago, has accelerated to an unprecedented degree.
Recall that a month ago, we reported that in the latest 12 months we have observed a not so stealthy, actually make that a massive $343 billion in Treasury selling by foreign central banks in the period July 2015- August 2016, something unprecedented in size.
Fast forward to today when in the latest monthly update for the month of September, we find that what until a month ago was “merely” a record $346.4 billion in offshore central bank sales in the LTM period ending August 31 has – one month later – risen to a new all time high $374.7 billion, or well over a third of a trillion in Treasuries sold in the past 12 months.
The UN Conference on Trade and Development rang the alarm on the possibility of a global debt default contagion due to international economies’ over-reliance on deficit spending, low interest rates to stimulate economies.
The next economic crash may be the last warns trade economists at the United Nations cautioning that the next global recession could quickly get out of control plunging the world into an economic depression and resulting in a post-apocalyptic failing of major governments as the world’s bond market teeters on the precipice of a full-on meltdown.
“As capital begins to flow out, there is now a real danger of entering a third phase of the financial crisis which began in the United States housing market in late 2007 before spreading to the European sovereign bond market,” said the UN Conference on Trade and Development (UNCTAD).
In the wake of the 2008 economic collapse, countries around the world forced their economies afloat by flooding the market with cheap money by artificially lowering interest rates to near zero – an unprecedented rate point at which benchmark rates have remained for nearly 8 years now. “Alarm bells have been ringing over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion. Damaging deflationary spirals cannot be ruled out,” the report remarks. In the event of an economic slowdown, the experts caution, the massive debts held by bondholders may not be redeemed forcing whole economies into default. Large emerging economies including Brazil, Russia and South Africa may be the worst hit in the event of another economic slowdown as they are the most likely to face a credit crunch from lenders who are unwilling to renew their debt or buy more pushing borrowing costs to unprecedented levels.
Ratings agency S&P Global Ratings revised its outlook on Russia’s credit rating to ‘stable’ from ‘negative’ saying that external risks to the oil-producing nation have eased and the economy should return to growth in coming years.
Russia’s economy has come under pressure from the protracted slump in crude oil and as its the conflict in Ukraine earned Moscow sanctions from the US and EU.
However, as the economy adjusts to this environment, S&P Global Ratings said it expects a return to real GDP growth averaging 1.6 per cent in 2017-2019, following a 1 per cent contraction this year.
The decision comes as the central bank cut interest rates today, citing weak inflationary pressures for a 50 basis point easing of its key policy rate.
In a statement on Friday, S&P Global Ratings, said:
The stable outlook reflects our expectation that the Russian economy and policy making will continue to adjust to the lower oil price environment and the country will maintain its strong net external asset position and modest net general government debt burden in 2016-2019.
The agency expects that while fiscal pressures will remain, the government deficit will narrow in 2016-2019.
The agency maintained its long-term rating on the country at BB+, leaving it in junk territory.
There is a growing conviction in the markets that for the world’s hardest pressed central banks there is no alternative to a helicopter money drop.
A last-ditch effort to channel purchasing power directly to people likely to spend a monetary windfall strikes many as the natural next step, as the effectiveness of unconventional central bank measures dwindles. Yet the authors of the latest Geneva report, published annually by The International Center for Monetary and Banking Studies and the Centre for Economic Policy Research, beg to differ.*
They argue that there is room to push interest rates further below zero. They see the potential to expand both the scale and scope of central bank asset purchases. And they believe that it would be possible to loosen the constraint on traditional interest rate policy in today’s exceptionally low interest rate environment by increasing central banks’ inflation targets.
The snag is that those prescriptions are a pretty good description of what the Bank of Japan has done since 2013 as its contribution to Abenomics. When Haruhiko Kuroda took over as governor he introduced the most radical programme of quantitative and qualitative easing the world has seen, encompassing not just government bonds but equities via exchange traded funds and even real estate investment trusts.
The inflation target was raised to two per cent, to be achieved over two years. In January this year negative interest rates were introduced. The programme has been ramped up, with a big increase in the size of government bond purchases in 2014 and a commitment this July by the Bank of Japan to raise its annual purchases of ETFs from Y3.3tn to Y6tn ($58bn).
Earlier this week, the US national debt hit $19.5 trillion, for the first time ever. Since January 2016, it has increased by $500 billion, according to the US Treasury.
In 2009 when Barack Obama became president the debt was $10.63 billion. Currently, the debt ceiling has been suspended until mid-March which means the debt will rise further.
“The total national debt when Obama leaves office in January is expected to approach $20 trillion by then,” an article on Washington Examiner read. In August, the Congressional Budget Office reported that by the end of the fiscal year (September 2016), the debt-to-GDP ratio will increase by three percentage points, to 77 percent. This will be the highest ratio since 1950. During the next decade, the ratio will reach 86 percent, according to estimates. The debt is the sum total of annual budget deficits, plus interest. During his presidency, Barack Obama has repeatedly pledged to lower the deficit. However, during his presidency the deficit reached $1 trillion a year,and only in the last few years was it near $500 billion. “Figuring out how to handle the national debt will be among one of the first challenges for the new president and Congress to figure out. On March 15, the debt ceiling will be in effect again, and the new ceiling will be whatever level of the debt the US has incurred by that point,” the article read. As for the presidential candidates, neither Donald Trump nor Hillary Clinton has proposed concrete steps on controlling the debt. In April, Trump said he would settle the current debt within eight years, two presidential terms. However, many economists that Trump’s proposals, including reviewing agreements with creditors, will not be effective. “The reason neither major candidate is talking about the debt is that neither has a reasonable plan for dealing with it. Quite the contrary, because as bad as government debt is for the country, politicians just can’t get enough of it. Government borrowing enables today’s politicians to buy votes by promising goodies to today’s voters, while sticking tomorrow’s voters with the bill. Politicians and current voters collude in kicking the ball down the road, creating a ballooning problem for future generations,” an article on US News noted.
A pair of deficits are having a significant effect on the Indian economy. The massive and prolonged budget deficit has discouraged the government to spend enough to develop adequate infrastructure, making the country’s supply side of the economy so fragile. This has dissuaded foreign manufacturers from expanding into the country.
The deficit is significant because its proportion to the country’s gross domestic product is much higher than that for other Southeast Asian economies, such as Thailand and Indonesia.
The huge budget deficit can also increase the pressures both for inflation and expansion of the current account deficit, which are obstacles to keeping the country’s macroeconomic management healthy.
As of 2015, the budget deficit for the central government equaled 4% of the country’s GDP, and for local governments, the ratio came to 3%, making a combined government deficit ratio of 7%.
Deficits in municipalities are largely due to losses incurred at utilities. For those in poverty, local governments typically set electricity rates extremely low while charging businesses very high rates. As a result, however, companies are making attempts to use less electricity, and power companies have suffered losses.
The Bank of England’s new bond-buying programme ran into trouble on its second day of operations on Tuesday, as pension funds and insurance companies struggling with a deepening funding crisis refused to sell gilts to the central bank.
It started off well enough.
On the first day of the Bank of England’s resumption of Gilt QE after the central bank had put its monetization of bonds on hiatus in 2012, bondholders were perfectly happy to offload to Mark Carney bonds that matured in 3 to 7 years. In fact, in the first “POMO” in four years, there were 3.63 offers for every bid of the £1.17 billion in bonds the BOE wanted to buy.
However, earlier today, when the BOE tried to purchase another £1.17 billion in bonds, this time with a maturity monger than 15 years, something stunning happened: it suffered an unexpected failure which has rarely if ever happened in central bank history:only £1.118 billion worth of sellers showed up, meaning that the BOE’s second open market operation was uncovered by a ratio of 0.96. Simply stated, the Bank of England encountered an offerless market.
This year’s dramatic fall in yields on bonds issued by investment grade sovereigns has again raised the risk that a sudden interest rate rise could impose large market losses on fixed-income investors around the world, Fitch Ratings says. A hypothetical rapid reversion of rates to 2011 levels for $37.7 trillion worth of investment-grade sovereign bonds could drive market losses of as much as $3.8 trillion, according to our analysis.
Unconventional monetary policies in Japan, Europe and the US, together with a surge in investor demand for safe assets, pushed sovereign yields to new lows in 2016, with $11.5 trillion in sovereign securities trading at a negative yield as of July 15. This figure fell slightly from the June 27 total of $11.7 trillion as a result of changes in dollar-yen exchange rates and a slight uptick in yields for long-term Japanese government securities.
Global bond investors have seen significant gains this year, particularly on longer-term fixed-rate securities where prices are most sensitive to changes in interest rates.
As rates hit record lows, investors face growing interest rate risk. A hypothetical rapid rate rise scenario sheds light on the potential market risk faced by investors with high-quality sovereign bonds in their portfolios.
Global composite yield curves, derived by Fitch from median yields of the 34 IG-rated countries (with at least $50 billion of outstanding debt) in July 2016 and July 2011, fell across all maturities over the past five years. Median yields on 10-year securities are 270 basis points lower than they were in July 2011. At the shorter end of the curve, median yields on 1-year securities have fallen by 176 bps.
There are four events this week that will command the attention of global investors.
1. The Reserve of Bank of Australia is first. It is a close call, though the median in the Bloomberg survey favors a cut, including most of the banks in Australia that participate in the poll.
The case for it is that price pressures are weakening, and credit growth is slowing. The currency has begun appreciating again, and the Federal Reserve cannot be counted on to lift US rates until the end of the year, at the earliest.
The argument against the RBA moving is that there is no urgency to exit the “watch and wait” mode. A rate cut would not necessarily weaken the currency as Australia would still offer highest policy rate (after New Zealand) among the high income countries. It is also not clear that the record low interest rates are a constraint on credit growth. Better keep the powder dry and see how events evolve, though it can be fairly confident that New Zealand will cut interest rates later in August.
2, Investors are more confident of the outcome of the Bank of England’s meeting than the RBA meeting. After the recent dismal survey readings, indicative prices suggest that a 25 bp rate cut is fully discounted. A newswire survey found 95% of the sample anticipated a rate cut, and of those, 95% expect a 25 bp cut in the base rate.
There are two other measures that the BOE is expected to consider. A little more than 80% of those who expect the BOE to do more than cut rates expect the funding for lending scheme to be extended. Participants are nearly evenly split on the prospects for a new round of asset purchases. About half of those that expect a new round of QE expected it to be between GBP25 and GBP50 bln. Outside of that ranges the response were heavily in favor of a larger than a smaller Gilt buying program.
Sterling eased to the lower end of a $1.30-$1.35 trading range as the market priced in the easing of monetary policy. It may firm back toward the upper of the range as the soft US dollar environment we anticipate, coupled with “sell rumor, buy fact” type of activity. In the futures market, speculators have a near record short gross sterling position and have a record net short position.
Even though the country reached 43 per cent of its fiscal deficit target in the first two months of 2016-17 itself, Singaporean brokerage DBS on July 29 said it does not see a slippage for the full year.
“For this year, we don’t see a fiscal slippage, even as quality of adjustment is questionable,” it said in a note released after official data said that fiscal deficit reached 43 per cent of the yearly target in May.
In the past, there have been voices, including from the central bank, which have suggested looking at the “quality” of the deficit, or whether the borrowings are used for more productive purposes.
Conceding that the 43 per cent number looks “precarious”, the brokerage said the start of a new fiscal year experiences slower revenue collections on the direct taxation front but there is front-loading of expenditure.
It said over the course of the year, revenues will get a leg up through the expected higher indirect tax collections, but underlined that non-tax receipts targets through spectrum sales and divestment at 1 per cent of GDP are “ambitious”.