Bonds & Interest Rates

China Braces for $1.3 Trillion Maturity Wall as Defaults Surge


China’s corporate bond tab currently stands at a mind-numbing $1.3 trillion of domestic debt payable in the next 12 months. That’s 30% more than what U.S. companies owe, 63% more than in all of Europe and enough money to buy Tesla—twice. What’s more, it’s all coming due at a time when Chinese borrowers are defaulting on onshore debt at a record-breaking pace. This could get messy.

(Bloomberg) — Even by the standards of a record-breaking global credit binge, China’s corporate bond tab stands out: $1.3 trillion of domestic debt payable in the next 12 months.

That’s 30% more than what U.S. companies owe, 63% more than in all of Europe and enough money to buy Tesla Inc. twice over. What’s more, it’s all coming due at a time when Chinese borrowers are defaulting on onshore debt at an unprecedented pace.

The combination has investors bracing for another turbulent stretch for the world’s second-largest credit market. It’s also underscoring the challenge for Chinese authorities as they work toward two conflicting goals: reducing moral hazard by allowing more defaults, and turning the domestic bond market into a more reliable source of long-term funding.

While average corporate bond maturities have increased in the U.S., Europe and Japan in recent years, they’re getting shorter in China as defaults prompt investors to reduce risk. Domestic Chinese bonds issued in the first quarter had an average tenor of 3.02 years, down from 3.22 years for all of last year and on course for the shortest annual average since Fitch Ratings began compiling the data in 2016.

“As credit risk increases, everyone wants to limit their exposure by investing in shorter maturities only,” said Iris Pang, chief economist for Greater China at ING Bank NV. “Issuers also want to sell shorter-dated bonds because as defaults rise, longer-dated bonds have even higher borrowing costs.”

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Inflation Jitters

While the combination of a massive fiscal stimulus and coronavirus vaccination campaign appears to put the US economy on track of a powerful recovery, several economic indicators issued recently have thrown the market into confusion, which may serve as an early warning that America’s re-opening may enter an unchartered territory.

Judging from recent statistics, there will be no shortage of surprises and cliffhanging moments in the coming months. The disappointing jobs report for April, which fell well short of economists’ estimates of adding 1 million new jobs, already had many wondering whether generous unemployment benefits issued by the Biden administration has led to hesitancy about taking a job.

Then came the big inflation scare… Click for the complete article

Fed says Inflation is “Temporary”

Oh really? We wonder, we really do. ~ Ed

The U.S. economy is going to temporarily see “a little higher” inflation this year as the recovery strengthens and supply constraints push up prices in some sectors, but the Federal Reserve is committed to limiting any overshoot, Fed Chair Jerome Powell said in an April 8 letter to Senator Rick Scott.

“We do not seek inflation that substantially exceeds 2 percent, nor do we seek inflation above 2 percent for a prolonged period,” Powell said in a five-page response to a March 24 letter in which the Florida Republican raised concerns about rising inflation and the U.S. central bank’s bond-buying program… Click for the complete article

The Problem With Rosy Economic Forecasts

“I have little doubt that with excess savings, new stimulus, huge deficit spending, more QE, a new potential infrastructure bill, a successful vaccine, and euphoria around the end of the pandemic, the U.S. economy will likely boom. This boom could easily run into 2023 because all the spending could extend well into 2023.” – Jamie Dimon, CEO JP Morgan Chase

There are many problems with this view looking forward.

To begin with, the vast majority of American’s do not have excess savings. If they did, then repeated stimulus payments wouldn’t be needed to support economic growth. The reality is “savings” get skewed by the top 20% of income earners, notably the 0.01% like Jamie Dimon.

The top 5%, of income earners skew the measure. Those in the top 20% have seen substantially larger median wage growth versus the bottom 80%. (Note: all data used below is from the Census Bureau and the IRS.)”

Since the top income earners have more than enough income to maintain their living standards, the balance falls into savings. This disparity in incomes generates the “skew” to the savings rate and obfuscates the ability to “maintain a certain standard of living.”

More Stimulus Not The Answer

Such remains problematic for many Americans and consistently forces them further into debt.

“The debt surge is partly by design. A byproduct of low borrowing costs the Federal Reserve engineered after the financial crisis to get the economy moving. It has reshaped both borrowers and lenders. Consumers increasingly need it. Companies increasingly can’t sell their goods without it. And the economy, which counts on consumer spending for more than two-thirds of GDP, would struggle without a plentiful supply of credit.” – WSJ

I often show the “gap” between the “standard of living” and real disposable incomes. In 1990, incomes alone were no longer able to meet the standard of living. Therefore, consumers turned to debt to fill the “gap.”… CLICK for the complete article

Good to Know (make that a must to know) – Yield Curve Control

Yield Curve Control

You’ll be hearing a lot about this if interest rates continue to edge up. Basically it means that the central banks create money to buy the government bonds needed to finance the deficit spending – and they buy them at low interest rates (yield). The Bank of Canada has bought over $300 billion in Gov bonds during the pandemic.
Many analysts think they’ll be forced to buy even more because inflation fears will precipitate more selling. After all, who wants to be stuck with a 10 year government of Canada bond that pays 1.5% if inflation is at 2% or more, which guarantees losing purchasing power.
During the pandemic interest rates would have been 3x higher or more because of the increased risk due to the pandemic fallout but 5% or 6% interest would push the government’s interest expense through the roof – plus cause massive losses in the bond market (remember bond prices drop when rates rise).
So the Bank of Canada stepped in – created hundreds of billions out of thin air and said we’ll buy the bonds thereby lending the government the money at record low rates.
But now rates on a 10 yr. Gov of Canada bond have moved from 0.46% in August to 1.5% in March. That’s a big difference when it comes to the cost of new borrowing.
So the big question is – how high will the Federal Reserve or the Bank of Canada let rates rise before they step in and create even more money and buy all the government bonds being sold in order to keep the interest rates down. In other words, CONTROL THE YIELD.