The Global Markets Weekly – 12/11/15

Posted December 14, 2015 by rvillareal

Energy and Debt[private]

For policymaking as in life, timing is everything.  The Fed plans to start its first tightening cycle in over ten years, just as the debt markets are starting to fray.  In the credit markets, the traditional “canary in the coal mine” is the high yield or junk bond market.  Spreads have moved above 600 bps, close to what preceded the recessions in 1991, 2001, and 2007.  But not always, similar spreads were seen in 2011, when markets were queasy but no recession came.

Much of the trouble in junk bonds has come from the woes in the oil patch.  Oil prices have fallen two thirds to under $40 currently, leading to well-publicized cutbacks in the energy industry.  Unfortunately, the energy industry has become increasingly reliant on debt, with industry debt having risen from about $350B of total corporate debt market in 2005 to $850B in 2015.  Increasingly, energy firms have tapped the junk bond market, with their share of outstanding debt increasing from 4% of total junk in 2004 to 14% last year.  About half of the energy junk is considered in distress by at last one rating agency.  In fact, about one third of the 100 bond defaults this year has come from the energy industry.  And the pace of corporate bond defaults is the highest since 2009.

Investors have gotten caught over their skis.  One well-known distressed debt fund has suspended redemptions this week to avoid a fire sale of assets.  Policymakers have to be concerned that this phenomenon will become more prevalent as short-term financing costs rise with the funds rate.  While a money market mutual fund may not “break the buck,” funds  may have to sell assets rapidly to meet redemptions in a replay of the taper-tantrum of 2013 or the mini-tantrum of November 2015.

With the US economy still decelerating from a 2 3/4% pace in mid-2015 to something closer to 2% currently, defaults are likely to accelerate in early 2016.  Not a good reason to consider rapid-fire hikes in the funds rate.  As a result, many investors expect the Fed to miss the chance to hike a second time in the next meeting in late January.  Rather, they may wait for the dust to settle, considering March as a better date for the pressing the button again.

• U.S.:Investors consider it a no brainer that the Fed will hike rates (Wed).  There will be interest in what Yellen has to say regarding the likely pace of hiking as well as looking at the numerical forecasts to see if the median FOMC member has slowed either the pace of the projected tightening or how far they expect to go.
• Eurozone: Business (and consumer) surveys have continued to offer solid signs, albeit with services faring better than manufacturing, presumably due to the former being more sensitive to the (relatively more solid) domestic Eurozone economy. This is likely to continue with the December updates due this week.  A set of largely-stable readings are anticipated for both the PMI flashes due on Wednesday.
• UK: The BoE has said it will use its February Inflation Report to examine in more detail why wage growth may have disappointed, something that may be all the more vital for the central bank given the likelihood that average earnings data in the Labor Market Report due next Wednesday may slow further!
• Japan: The BOJ will stay put (Th), maintaining the same tone in the statement and press conference. Additional stimulus is likely to be introduced later than January, if necessary.
• Other central banks:  An underwhelming set of measure from the ECB recently increases the chances of no action both the Rigsbank in Sweden (Tu) and from Norway’s central bank (Th).

12-11 gmw[/private]