Cruising for a Bruising
The BIS has published its annual report, which as usual contains numerous quite candid observations about the global credit and asset bubble. The entire report is 246 pages long, so it takes a while to go through it all. Here is a comment from the report that doesn't really tell us anything new, but represents a good summary of what the brewing problem consists of:
“Highly accommodative monetary policies in the advanced economies played a key role in lifting the valuations of risk assets throughout 2013 and the first half of 2014. Low interest rates and subdued volatility encouraged market participants to take positions in the riskier part of the investment spectrum. Corporate and sovereign spreads in advanced economies drifted to post-crisis lows, even in countries mired in recession. Buoyant issuance of lower-rated debt met with strong demand, and equity markets reached new highs. Some asset valuations showed signs of decoupling from fundamentals, and volatility in many asset classes approached historical lows.”
Central banks got what they wanted – investors are acting as if there were no longer any risk. This is seemingly confirmed by certain data points like ultra-low default rates in junk bonds, but it must be remembered that these low default rates are themselves a direct result of yield chasing and the tsunami of central-bank created money that is crashing ashore in various asset markets. If any Tom, Dick and Harry regardless of his creditworthiness can get refinancing at absurdly low rates anytime he wants, then why should he default?
The problem is of course than many of the bubble activities that are receiving funding today at ridiculous rates would likely never get funded in an unhampered market economy, or would only be able to compete for funding at prohibitively high interest rates.
The entire situation is therefore solely a result of ultra-loose monetary policies. Has the perpetuum mobile finally been invented by our esteemed central planners? We rather doubt it – something, somewhere, will go wrong. The longer it takes for this to happen, the worse the denouement will be.
The BIS report contains a wealth of interesting charts documenting the current echo bubble era. One can make an educated guess as to where lightning will likely strike next, and our assessment on this point remains the same: it is likely corporate debt where trouble will rear its head.
As to what might trigger it: two possible scenarios come to mind. One is that economic growth just continues to underwhelm and eventually weakens enough to create worries in credit and asset bubble land. Another possible scenario would be that prices actually to begin to increase too fast for the liking of the planners, which might end up disturbing the happy consensus that interest rates will remain low for as far as the eye can see (of course, whether interest rates are “high” or “low” is a relative question. Rising rates may still be extremely low if prices rise even faster). Regardless though of which direction the problems will eventually come from, it is absolutely certain that massive capital misallocation has been fostered by loose monetary policy and that there will be a price to pay.
A Selection of Charts
1. Central Bank Data
Below is a selection of charts from the BIS report – first up, a look at the founts of the above discussed echo bubble activities – the central banks.
Policy rates, central bank assets and 3 month & 10 year interest rates on government debt.
Nominal vs. real policy rates, disaggregated by type of economy, plus CB assets worldwide.
The same data again, focused on major developed currency areas.
2. Market Data
Next come a few charts showing what is happening in the markets, in terms of credit spreads, capital gains, volatility bond issuance and bank lending. Obviously, spreads have been crushed and asset prices have increased quite a lot. There is no margin for error.
Corporate bond issue has soared, as has the extension of leveraged loans. In so many words: “nothing can go wrong”.
High yield spreads, default rates and real GDP growth in the euro area and the US. Low default rates and low spreads always go hand in hand, but both are artificial creations – a direct result of massive monetary pumping. Since 2008, the US true money supply has increased by 95%, that of the euro area by 47%. No wonder the markets are partying as if there were no risk. However, risk has probably rarely been higher …
Volatility in equities, bonds and foreign exchange mirrors the happy “there is no risk” consensus.
3. Economic Growth, Credit Growth, Debt Service and NPLs
Next up a few charts looking at economic growth, credit growth, debt service costs and a few more examples of yield chasing.
(click to enlarge)Output growth, PMI reports and global trade growth. Global trade certainly looks green around the gills. Advance economy PMIs are looking good, but this is likely also a result of the increase in bubble activities: companies are happy over growing accounting profits, but a good portion of them will likely turn out to have been an inflationary illusion down the road.
Credit growth remains brisk, and while households are deleveraging, governments and corporations are accumulating debt as if it were the greatest thing since sliced bread.
Cross border credit growth has soared, but mainly via the issuance of bonds – bank lending remains fairly anemic.
Actual debt service ratios, historical averages and projected debt service ratios if interest rates should rise. The last time interest rates rose, soaring debt service costs and a massive bust were soon at hand.
Flows into emerging market debt (and "frontier market" debt for that matter) are soaring as investors chase yields wherever they can be found.
Non-performing bank loan trends have decoupled – while they are still soaring in peripheral Europe, they have been declining in the US for some time. This is partly due to the fact that credit in Europe has been far more dependent on bank lending than bond issuance prior to the crisis. Partly it is also a result of the fact that it is easier for the Fed to bail out the banking system and provide artificial stimulus than it is for the ECB. Hence more malinvested capital and unsound credit is actually being liquidated in Europe.
Trends in NPLs all over the world – Italy and Spain are the current NPL leaders in the developed world, Hungary leads emerging Europe. Wee have a feeling that the extremely low NPL ratios in China won't last.
4. Inflation, Productivity, Population
And lastly, a look at officially reported “inflation” rates (meaning: rising prices – that there has been massive money supply inflation is beyond doubt) and productivity and population data. Inflation rates seem to be turning up lately, while productivity and population trends are quite sobering.
CPI inflation rates across the world, including "core" inflation, compared to commodity prices. Inflation is widely considered "dead", but does seem to be perking up lately anyway.
Developed nations productivity and population trends, the latter with projections. None of this looks particularly comforting.
It will be interesting to see what kind of pin will prick the balloon in the end. One thing is clear, an extremely stretched and imbalanced situation has been created, with exploding debt growth conspicuously unsupported by real economic growth (however it is measured).
In light of the above deliberations, here is another noteworthy quote from the BIS report that certainly mirrors our thinking on the matter:
"The prospects for a bumpy exit together with other factors suggest that the predominant risk is that central banks will find themselves behind the curve, exiting too late or too slowly”
We would argue that this is already happening – and if it isn't, it is going to. In our opinion this is one more reason to buy all dips in gold. Of course the people manning the BIS primarily want governments and their agencies to implement a “better plan”, but there is no better plan, simply because there cannot be one. Central panning is inherently contradictory, it cannot possibly work. The only lasting solution would be to adopt an unhampered market economy, but even that would initially be quite painful and is certainly considered politically unpalatable for a wide variety of reasons (few of which have anything to do with actually enhancing society's welfare).
Charts by: BIS (Bank for International Settlement)