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Crexit: Corporate Debt Set To Balloon

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Following the Brexit vote, jokes abounded of possible Departugal, Czechout, Italeave, Oustria, Byegium, and several other countries name-based puns.

Funny stuff, but the latest portmanteau is far from a laughing matter: read on for analysts’ fears of Crexit, the result of ballooning corporate debt and the risks it poses.

The current situation and how it could be managed

Corporate debt is the housing market crisis of its day.

The figure is projected to balloon over the next few years, due to various factors.

One of the most important of these is that Central Banks throughout the world are toying with zero or negative interest rates.

This provides cheap money to make the rounds, and the debt is piling up.

crexit 1

A report earlier this week has warned that this debt pileup has the potential to spark a new crisis from all that borrowed money circulating in the economy.

The figures are astronomical and growing all the time.

By the year 2020, several things will have occurred.

Britain’s socialist opposition leader will have proven his credentials or flunked like everyone predicted.

The Kyoto Protocols aimed at 2020 will have been achieved or failed.

Portugal will have lost or retained the European Championship.

And business debt will probably climb from the $51 trillion it is currently at to $75 trillion.

This is according to our friends at S&P Global Ratings, who tend to be right about this stuff.

They track the eponymously named 500 companies’ index which is a good barometer of the economy.

Of course, $51 trillion is already a huge amount.

But the thing about debt is it’s perfectly manageable as long as:

The quality of credit stays high

–    Interest rates remain low as they currently are (which is why the Fed raising was such a huge event)

–    Inflation remains low

–    Economic growth remains high so that investors don’t worry about not getting paid

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Assuming things don’t go so swimmingly

But should things not go exactly according to this plan, there is another scenario, from where we get our horribly unimaginative and lazy portmanteau, crexit.

Should interest rates rise, which they could, and economic conditions worsen, which they might, there could be a huge problem for corporate America when trying to manage its debt.

Interest rate rises will make it harder to borrow money.

Worsening economic conditions are a huge fear now that Britain is almost certain to leave the European Single market, in some way, shape or form.

A bad global economy, let alone a sad one, would scare investors into thinking they won’t get paid, and country’s credit ratings will be slashed, making it harder for them to borrow.

Mostly, bondholders would suffer because rolling bonds over would become increasingly difficult under increased inflation and an interest rate rise.

The economy worsening would hurt businesses’ ability to pay off the debt.

A combination of these two leads to all sorts of problems for all parties.

If it did occur, we could see a crexit.

A credit-exit.

This would be lenders withdrawing from credit markets due to fears of the economy and covering their costs.

If it occurred, it would lead to a drastic tightening of market conditions.

This has the potential to cause another financial meltdown, and the world simply cannot deal with that, economically, politically or socially.

Worst Case Scenario

In the report, S&P Global said that the nightmare scenario would be a series of high-risk, high-cost negative surprises that prove to be the spark for a new crisis of confidence.

Confidence in the world economy is already at an all-time low because of how long and profound the last recession was.

crexit 2

Add to that the slowing China economy and Britain’s decision to leave the European Union; you have salt in the wounds that now mean the world economy is at its most fragile.

Confidence is low, and it can’t afford to get any lower.

If events opposite to those listed in the bullet points, or any major economic events that no one can foresee happen, it will be destabilizing.

–    Investors will feel pushed to exit their risky positions where they fear that they are going to lose big money.

–    If swarm effect holds genuine and they all go in the same direction, this will see a collapse in credit growth.

–    And the last time that happened? 2008

What is inevitable and what is potential

Many, S&P included, believe that a ‘correction,’ industry speaks for a significant collapse and readjustment, to be almost inevitable.

They see it as inevitable at some point in the next decade, and the real million-dollar question is to what extent they will be right.

Not whether it will happen, but how much.

They worry that investors have been too hungry for yield and have ended up going on a frenzy of buying speculative, low-grade corporate debt.

China has been as guilty as the United States in this regard, the former having used the borrowing tool to spur growth in the face of a slowing economy.

Its growth is still astronomical compared to Western economies, but it is decreasing each year.

Remember in the housing crisis (see graph below) when it was found out that mortgage bonds were weak structurally and pyramids made up of speculative and non-existent deals made the whole thing come crashing down?

This is a little similar, except now its corporate debt rather than mortgages.

crexit 3

The blame for much of this lies at the feet of the world’s central banks.

Since the crisis, they have embarked on a policy of low-interest rates and cheap money as a spur to economic growth.

The problem with this is the notion that growth fueled by credit rather than innovation and investment is healthy is an entirely false one.

The global economy needs real growth, not one made out of printed bills.

Monetary policy by said central banks has increased the financial risk that the world faces, the opposite effect that it was meant to have.

After uncertainty about growth during the crisis, central banks wanted to give the economy a jolt to restore confidence and stability.

But it has done the opposite.

The problem is that corporate borrowing is shooting way ahead of global economic growth.

And who can blame them when credit is so cheap with interests rate set so low?

More debt? Don’t fret

Even in the face of this impending crisis with sky-high debt levels, central banks are too terrified to put the brakes on to their policy of low rates.

Interest rates are low from Tokyo to Texas, from London to Lagos, Moscow to Medellin (okay maybe not exactly in all those places but you get the picture).

crexit 4

The low-interest rates have caused a boom in not only corporate debt but government debt too.

$12 trillion of government bonds now carry negative yields.

That means investors aren’t getting anything back from buying government bonds.

Debt flow is predicted to grow by over $60 trillion by 2020.

–    Two-thirds of this are expected to be in refinancing (so just managing current debt).

–    The remaining one-third will be in a brand spanking new debt. Shiny, shimmering debt.

–    This will include bonds, loans, and any other financial instruments.

–    This projection has increased from that of under $60 trillion that was given by S&P some time ago.

Best case scenario

While the debt market is reaching its upper limits, S&P and others are hoping for an orderly drawdown.

A gradual scaling back of current policy of low-interest rates and cheap money for more sound future finances.

This is the best case scenario, but it will be difficult to become a reality.

Firstly, things like Brexit will unnerve world leaders.

The most important political events such as the high vote throw a spanner in the works and a change to the status quo of the last 40 years is bound to cause some paranoid visions of what its result will be.

Nervous leaders are prone to pulling back from giving cheap credit to higher-risk borrowers.

Debt is piling up in China’s somewhat opaque but robustly expanding corporate sector, and there is also growing debt in the United States’ leveraged finance sector.

The risk is in credit quality.

‘Highly leveraged’ is a term applied to around half of companies that are outside the financial sector.

This category is the lowest one available for risk, and about 5% of this category group have negative earnings or negative cash flows.

In 2016 so far, there have been 100 debt defaults.

This is the most for this period in the year since the financial crisis.

Worrying signs.

S&P and other firms are worried that investors who have tried to play a long game and bought bonds with long-term caveats are at risk.

They have done so to chase high yield, but the risk is that they will lose money and pull out of the market to play it safe.

Unfettered funding of debt has created conditions for elevated prices of financial assets.

Low-interest rates have added to this factor and increased the effect.

Investors are searching for yield, and financial assets are seeing augmented prices because of it.

Market volatility could increase over the next few years because of this.

Small secondary-market cash flow and liquidity will lead to credit spreads for even riskier securities and longer contracted assets being the most exposed.

China will be responsible for most credit flow growth.

The nation is predicted to add almost $30 trillion to global demand, while the US and Europe will add $14 and $9 trillion respectively.

 

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Trump Says Economy ‘Roaring Back’ in June As 4.8 Million Jobs Added

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Trump Says Economy ‘Roaring Back’ in June As 4.8 Million Jobs Added

The economy added back 4.8 million jobs last month, according to the government’s June jobs report released yesterday. That handily beat the 3.7 million jobs forecasted by economists and dropped the unemployment rate down to 11.1%.

After the report was released, President Trump said the economy was “extremely strong” and “roaring back” after the country has regained more than 7.5 million jobs in the last two months. Trump added that the economy will keep growing unless voters elected Democrat Joe Biden in November. He said Biden would raise taxes and hurt the economy and the stock market would “drop down to nothing.”

Jobs Added

Of the jobs added back in June, bars and restaurants hired – or rehired – 1.48 million workers. This comes as many reopened for outdoor dining in the early phases of the reopening. They brought back a similar number of workers in May. It happened after shedding more than 6 million jobs due to the pandemic.

The retail sector regained 740,000 jobs, healthcare added back 358,000 workers, and manufacturing saw 356,000 jobs added.

The energy sector continues to be battered by low oil prices amidst the economic slowdown. Additionally, that industry shed an additional 10,000 jobs last month.

The return of lower-paying jobs like those found in the restaurant and hospitality industry dragged down the average hourly wages for the second straight month.

Many are cautioning against reading too much into reports like average hourly wages while the economy is in such turmoil.

Stephen Stanley, chief economist of Amherst Pierpont Securities, says, “The wage figures will be pretty much useless for a long while until the labor market gets back to some semblance of normality.”

Andrew Chamberlain, chief economist of the job site Glassdoor, also gave an explanation. He added, “Today’s positive jobs report does provide a powerful signal of how swiftly U.S. job growth can bounce back and how rapidly businesses can reopen once the nation finally brings the coronavirus under control — a reason for optimism in coming months.”

Looking Forward

Unfortunately for many of the workers recently rehired to work in bars and restaurants, the recent spike in new coronavirus cases could lead to those jobs quickly being lost for a second time. Bars in many states are being shut down again in an effort to curb the growing number of cases.

The unemployment rate fell for the second straight month. However, the Bureau of Labor Statistics is trying to fix a reporting error that, if corrected, would increase the unemployment rate by 1%.

The problem is how households respond to the monthly survey that is used to calculate the unemployment rate. The jobless rate would have been 1 point higher if not for continued problems in how respondents answer the question about their employment status.

What many consider the “real” unemployment rate, which is the U6 rate, includes workers who can only find part-time jobs. It also includes those who’ve become too discouraged to look for jobs because so few are available. Using that measurement, the unemployment rate stands at 18% in June, down from 21.2% in May.

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Trump Favors Larger Stimulus Checks, Says ‘Tremendous’ Market Crash if Biden Wins

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Trump Favors Larger Stimulus Checks, Says ‘Tremendous’ Market Crash if Biden Wins

In a wide-ranging interview with Fox Business News, President Trump mentioned his support for another round of stimulus checks and says should Joe Biden win the election in November, we should expect the stock market to crash “a tremendous amount.”

On Stimulus Checks

Speaking with Blake Burman, the president says he is in favor of another round of stimulus checks, but wants to make sure that there is a financial incentive for Americans to return to work.

“I support it, but it has to be done properly. I support actually larger numbers than the Democrats, but it’s got to be done properly. We had something where it gave you a disincentive to work last time. And it was still money going to people, and helping people, so I was all for that. But we want to create a very great incentive to work.”

Trump also mentioned he wants the checks to arrive quickly and spent quickly, without the Democrats adding complications.

“I want the money getting to people to be larger so they can spend it, I want the money to get there quickly and in a non-complicated fashion. And they wanted to make it too complicated, also it was an incentive not to go to work,” said Trump.

Returning to work is what hard-working Americans are looking forward to, says Trump, and he wants there to be a financial incentive to do so.

“You’d make more money if you don’t go to work. That’s not what the country is all about. And people didn’t want that. They wanted to go to work but it didn’t make sense because they make more money if they didn’t… we want people to get out and we want to create a tremendous incentive for people to want to go back to work.”

On Biden and Taxes

When asked about Joe Biden’s recently announced plans to raise corporate taxes if he becomes President, Trump said “You’re going to crash the market. 401(k)s will be down the tubes, the wealth of the country will be down.”

He added “That will kill the market. It will kill everything we are doing, it will kill jobs, and it will be very bad. Frankly, the stock market is doing well, but it’s an overhang. If he got elected, and they say this, that’s an overhang over the market, because the market would crash. Would absolutely crash.”

When asked what he means by crash, Trump responded, “Markets would go down by tremendous amounts. He’d raise taxes, he’d raise regulations. Look, one of the biggest things I’ve done is I’ve cut regulations more than any President in history. We still have regulations, but they’re much less. His people, the people around him (Biden) are radical left. They’re going to raise taxes, they’re going to raise regulations, and they’re going to put everyone out of business. It would be a disaster.”

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Fed to Keep Rates At Zero, Worried About Market Crash Later This Year

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Fed Will Keep Rates At Zero, Worried About Market Crash Later This Year

The Federal Reserve will keep rates at near zero percent for the foreseeable future. Also, a few members feel worried about a second wave of the coronavirus crashing the markets later this year. These are according to the minutes of the June 9-10 meeting.

Near-Zero Rates

Federal Open Market Committee members voted to keep the benchmark short-term borrowing rate in a range of 0%-0.25%. They also said that, until the economy “had weathered recent events,” they would keep it there. Without providing specifics, the notes also mention that “a number” of members believe there is a high probability of additional “waves of outbreaks” of the coronavirus.

This worry over additional outbreak waves and the economic damage it could bring led the FOMC committee to downgrade their economic outlook from the April meeting. The said meeting had predicted a more benign baseline forecast.

The members also indicated that they will begin providing the markets with stronger guidance about future interest rate moves. However, Fed watchers don’t expect the committee to begin providing this guidance any earlier than the September meeting.

“In particular, most participants commented that the Committee should communicate a more explicit form of forward guidance for the path of the federal funds rate and provide more clarity regarding purchases of Treasury securities and agency [mortgage-backed securities] as more information about the trajectory of the economy becomes available,” the minutes said.

Milestones and Metrics

The committee also discussed what milestones they will use to determine an appropriate time to start raising interest rates. When they did, the metrics proposed has split the committee.

In 2012 for example, the Fed said it would keep rates at zero until the unemployment rate fell below 6.5%. Alternatively, they also said it would keep zero rates until the inflation goes above 2.5%.

In June’s meeting, a “number” of members said any interest rate increases should be tied to the Fed’s 2% inflation target. Meanwhile, a “couple” favored using the unemployment rate. A “few” members suggested the committee set a specific date.

The FOMC also released its expectations for GDP over the next few years. The median GDP projection for 2020 was a contraction of 6.5%. A 5% increase in 2021 and a 3.5% in 2022 will follow this. However, they acknowledged “that there remained an extraordinary amount of uncertainty and considerable risks to the economic outlook.”

Trump on Powell

Meanwhile, there’s a bit of good news for Federal Reserve chairman Jay Powell. It appears he has slowly won over his most vocal critic, President Trump.

During an interview on Fox Business News, Trump said Powell has “stepped up to the plate” and he’s happy with Powell and Treasury Secretary Steve Mnuchin for the work they’ve done to help the economy recover.

“I would say that I was not happy with him at the beginning, and I’m getting more and more happy with him, I think he’s stepped up to the plate. He’s done a good job, he’s had to liquify a little bit, let us liquify, put out the money that you needed, and I would say over the last period of 6 months he’s really stepped up to the plate.

“I can tell you I’m very happy with his performance, and Steve Mnuchin, I think they’ve both done a very good job, they’re working together very closely.”

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