Date: November 19, 2018
Corporate America’s Debt Boom Looks Like a Bust for the Economy
Despite strong incentives in the Republican tax plan for American executives to expand, invest and ultimately boost the U.S. economy’s growth potential, a lot of the debt companies are issuing appears to be motivated by something else. Non-financial corporate debt stands at 45.6 percent of gross domestic product, near the highest in post-war record keeping. Despite that, non-residential investment — a broad category in the national accounts that includes everything from office buildings to software — has only been bouncing around the 13 percent of GDP range since 2012. “You would think that companies want to add to productivity capacity but we really haven’t seen it,’’ said Priya Misra, head of global rates strategy at TD Securities USA. “If they view the economy as in the late stages of the expansion, then there isn’t a lot of confidence about the outlook and it is easier to buy back stock.’’ It’s difficult to trace the uses of money raised from debt through the various accounts in the economy. But one worry is that rising corporate borrowing isn’t sustainable if the trend is more about transferring cash to owners rather than investing in assets or innovations that can produce more cash to pay future bills. “When we think about business cycles and what ends them, you can always follow the leverage,’’ said Ellen Zentner, chief U.S. economist at Morgan Stanley & Co. “It is not a household issue this time, it is going to be corporate.’’ One corner of the corporate debt markets that’s ringing alarms is leveraged lending, or credits to highly indebted companies.
Citigroup Sees U.S. Dollar Topping Out in 2019
The dollar will weaken next year as the economic boost from fiscal policy wanes and rising interest rates start to hurt, according to Citigroup Inc. The greenback will fall around 2 percent against the Group-of-10 peers over six to 12 months after climbing 1 percent in the next three months, analysts including London-based Jeremy Hale wrote in a note. Absolute growth and relative cyclical outperformance in the U.S. will slow and the yield advantage enjoyed by the dollar will be less sustainable, they said. “More medium term, our view is that the fiscal support to growth eventually fades in the U.S. and tighter monetary policy starts to bite,” the analysts wrote. “A lower dollar becomes the most likely source of equilibrium in portfolio balance terms.” The U.S. currency has rallied against all G-10 peers this year, buoyed by three Federal Reserve rate hikes while robust corporate earnings sent major benchmark stock indexes to record highs. Citigroup’s call for the dollar to top out next year echos those by other Wall Street investment banks including Morgan Stanley and Goldman Sachs Group Inc. “We see several changes to the global economic backdrop which, combined with a few negative medium-run factors, point to more downside than upside to the broad dollar in 2019,” Goldman Sachs analysts including Zach Pandl wrote in a note dated Nov. 18. “Slower U.S. growth tends to result in lower dollar returns (especially against G-10, but to some extent versus EM as well) even when U.S. interest rates are rising faster than expected.” The Bloomberg Dollar Spot Index has gained more than 7 percent from a low in April, while hedge funds have raised their net long positions this month to the highest since January 2017.
Draghi Sees Euro-Area Growth Lasting Despite Trade Risks
Mario Draghi expects the euro area to continue growing in coming years even amid risks from protectionism that need to be monitored “very carefully.” The European Central Bank president’s remarks in Frankfurt come after the region’s expansion slowed to 0.2 percent in the third quarter, the weakest pace in more than four years. The ECB will decide at its final policy meeting of the year on Dec. 13 whether to end its bond-buying program as planned, a key step toward slowly normalizing policy. Draghi confirmed that the recent slowdown is mostly due to temporary factors, such as new emissions-testing procedures that slowed car production in Germany and trade growth stabilizing at a lower, but still solid, pace. As a consequence, his assessment was that risks to the economy are still “broadly balanced” — a code word that the ECB uses to signal it sees no significant deterioration in its outlook for now. Employment and consumption remains strong, and interest rates on loans remain low thanks to continued support from the central bank. Underlying inflation still lacks a “convincing upward trend” but Draghi said he’s confident that wages will eventually feed into higher prices. He reaffirmed his expectation that the ECB — “subject to incoming data” — will end new bond buying in December.
Short-Dated Bond Spree by China Builders Flashes ‘Systemic Risk’
China’s property developers are rushing to sell short-term dollar bonds ahead of record debt maturities next year, a move that analysts say would add to more refinancing pressure down the road. Three issuers came to the market on Monday alone. Times China Holdings Ltd. is in the process of book building for a two-year bond with initial price guidance at 11 percent, while Greenland Holding Group Company Ltd. is taking bids for 1.5-year notes at low 9 percent area, people familiar with the matter said. A unit of China Evergrande Group is marketing a tap of existing notes due in 2020. Chinese developers have been caught in a tightening funding squeeze due to a deleveraging push by policy makers over the past two years. To make things worse, the sector is facing a record $62 billion of bonds due in both onshore and offshore markets in 2019, according to Bloomberg-compiled data. In this backdrop developers have had to offer higher premiums to investors even to sell shorter maturity dollar bonds. The growing reliance on short-dated issuance increases “systemic risk in the form of larger maturity walls that will need to be refinanced,” according to Paul Lukaszewski, head of Asian corporate debt & emerging market credit research at Aberdeen Standard Investments. “If the trend toward shorter dated issuance continues, we would not be surprised to see Chinese regulators intervene again much like we saw earlier this year with regards to 364-day issuance,” he said. China’s developers are paying the highest coupons among dollar issuers in Asia. The domestic unit of China Evergrande last month sold a five-year note at a coupon rate of 13.75 percent, the third highest for an Asian junk bond issued this year. Notes from Chinese property developers offer investors lower credit protection. The score according to Moody’s investor services hit the weakest last quarter.