May 22, 2018
Corporate Bonds Sink Fast in One of Worst Tumbles Since 2000
You need to rifle through 18 years of history to find selloffs that compare to the one corporate bond investors are now enduring. Debt of American companies just posted their third-worst 100-day returns since 2000, according to a JPMorgan Chase & Co. index, as tighter monetary conditions leave their mark on high-quality bonds with longer maturities. With negative returns likely to scare off retail investors, the outlook for the asset class looks grim, JPMorgan strategists said in a Friday note. But they find a silver lining: the highest yields in almost five years are likely to discourage new bond supply, which would at least help the technical picture. The selloff in corporate credit is now on par with the rout in emerging markets. A Bloomberg Barclays index of U.S. investment-grade credit is down 3.9 percent so far this year, while dollar bonds of developing nations have declined at about the same clip. The two markets are caught up in different problems. In developing economies, it’s a resurgent dollar and concerns over credit quality after a debt binge. While corporate America’s earnings trajectory looks healthy, rising benchmark rates threaten investment-grade debt with average duration of over seven years. Securities with longer duration typically gain more when rates drop, but suffer stiffer losses when they climb. “Duration risk is the main culprit,” Greg Venizelos, senior credit strategist at AXA Investment Managers, said in an interview. The firm is holding less investment-grade debt relative to benchmarks as the Federal Reserve ratchets up rates. Full-year losses are unlikely to be as dire as the past 100 days, according to JPMorgan strategists. They cite strong demand among pension funds and overseas investors for long-dated notes. Bond prices also tend to converge to par the closer to an issue’s maturity, a dynamic known as curve rolldown.
Europe’s Italian Problem Is Bigger Than Brexit
The new government finally taking shape in Italy is one of the weirdest coalitions you could imagine — and a pretty effective combination if your aim was to sabotage the European Union. Although predictions about where this Italian misadventure is heading are difficult, it could easily be worse than Brexit for the EU. The coalition partners — the left-populist Five Star Movement led by Luigi Di Maio and the right-populist League led by Matteo Salvini — are poles apart in most respects, but come together over immigration, disdain for politics as usual and dislike of the EU. With notable originality, the program they announced last week combines the high-spending ambitions of the left with the low-tax ambitions of the right. This implies a surge of public borrowing. The partners are undaunted by Italy’s current debt burden (130 percent of gross domestic product) and seem to be downright inspired by the EU’s rules on fiscal consolidation. Their program doesn’t just break those rules; it laughs at them. “It’s necessary to review the structure of European economic governance, which is asymmetric, and based on the dominance of the market compared to the broader social and economic dimension,” says the program. The new government wants the EU to reform the single market for goods, services, capital and labor, to avoid “prejudicial effects on the national interest.” It wants a rethink of policy on immigration. And it challenges the EU’s agreements on bank reform, which it blames for the financial stress borne by Italian families and small businesses. All this is toned down from an earlier version which called for the European Central Bank to cancel 250 billion euros of debt and talked about ditching the euro.
China Makes Massive Cut to Car Tariffs After Truce With Trump
China will cut the import duty on passenger cars to 15 percent, further opening up a market that’s been a chief target of the U.S. in its trade fight with the world’s second-largest economy. The Finance Ministry said Tuesday the levy will be lowered effective July 1 from the current 25 percent that has been in place for more than a decade, boosting shares of automakers from India to Europe. Bloomberg News reported last month that China was weighing proposals to reduce the car import levy to 10 percent or 15 percent. A reduction in the import duty follows a truce between President Donald Trump’s administration and Chinese officials as they seek to defuse tensions and avert an all-out trade war. While the levy reduction could be claimed in some quarters as a concession to Trump and will be a boon to U.S. carmakers such as Tesla Inc. and Ford Motor Co., the move will also end up benefiting European and Asian manufacturers from Daimler AG to Toyota Motor Corp. “This is, without a doubt, positive news,” said Juergen Pieper, Frankfurt-based head of automobiles research at Bankhaus Metzler. “You can’t completely disregard the fact that there are certain imbalances in China’s favor. This could be a signal that if one side is making concessions, it could lead to the Americans easing some of their pressure as well.” Shares of Jaguar Land Rover owner Tata Motors Ltd. and BMW AG posted their biggest intraday gains in more than a month on the news. The Finance Ministry in Beijing said later Tuesday that the step is intended to help reduce prices and aid competition.
China Couldn’t Keep Growing Like Mad Forever
China, not the U.S., is the world’s largest economy. Though the U.S. is still tops when measured at market-exchange rates, China is about 20 percent larger after adjusting for the lower cost of goods and services there. The latter metric is what really counts, both in terms of standards of living and, probably, in terms of military purchasing power. With four times as many people as the U.S., it makes sense that China would eventually have a larger economy; it’s unlikely that any industrialized country — including the U.S. — can maintain a fourfold productivity advantage over another forever. For China, just being bigger than the U.S. is a pretty low bar. But that leaves the question of just how dominant China will eventually be in the world economy. Chinese gross domestic product growth now is holding steady at about 6.5 percent. Supposing for the sake of illustration that the rest of the world grows at 3 percent, a 6.5 percent growth rate would mean that China would constitute a quarter of the world economy by 2029 — just 11 years from now — and 40 percent of the world economy by 2050. By the 2060s, within the lifetime of today’s teenagers, China would account for more economic activity than the rest of the human race combined. In comparison, the U.S. share of world GDP never reached 40 percent even at the end of World War II, and was usually less than 25 percent during the 20th century. In other words, China is almost certain to become more economically important than the U.S. was during the past century. But it’s very hard to maintain a 6.5 percent growth rate for four decades straight. As recently as 2011, in fact, China’s GDP grew almost 10 percent, a rate it had exceeded a number of times during the prior two decades. There are reasons to believe that a further slowdown is in the offing. Despite headlines proclaiming China’s remarkable advances in industry after industry, the country is bumping up against some fundamental constraints.