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Debt, defaults, and devaluations: why this market crash is like nothing we’ve seen before

A pernicious cycle of collapsing commodities, corporate defaults, and currency wars loom over the global economy. Can anything stop it from unravelling?

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A global recession is on the way. This truism of economics holds at any point in which the world is not in the grips of a contraction.

The real question is always when and how deep the upcoming downturn will be.

“The crash will come, but it would be nice if it came two years from now”, Thomas Thygesen, head of economics at SEB told over 200 commodity investors and analysts in London last month.

His audience was rapt with unusual attention. They could be forgiven for thinking the slump had not already arrived.

Commodity prices have crashed by two thirds since their peaks in 2014. Oil has borne the brunt of the sell-off, suffering the worst price collapse in modern history. Brent crude has fallen from $115 a barrel in the summer of 2014, to just $27.70 in mid-January.

We are in a very unusual situation where market sentiment is of a different nature to anything we’ve seen before
Thomas Thygesen

Plenty of investors sitting in the blue-lit, cavernous surrounds of Bloomberg’s London HQ would have had their fingers burnt by the price capitulation.

• Mapped: How the world became awash with oil

“They tell you should start your presentations with a joke, but making jokes at a commodities seminar is hardly appropriate these days,” Thygesen told his nervous audience.

Major oil price falls have a number of historical precedents. Today’s glutted oil market is often compared to the crash of 1986, the last major episode over global over-supply. Back in the late 90s, a barrel of Brent crude fell to as low as $10 in the wake of the Asian financial crisis.

A perfect storm

But is the current oil price collapse really like anything the world economy has ever experienced?

For many market watchers, a confluence of factors – led by oil, but encompassing China, the emerging world, and financial markets – are all brewing to create a perfect storm in a global economy that has barely come to terms with the Great Recession.

“We are in a very unusual situation where market sentiment is of a different nature to anything we’ve seen before,” says Thygesen.

Unlike previous pre-recessionary eras, the current sell-off has seen commodity prices, equities and credit conditions all move in dangerous lockstep.

The S&P 500 trading pit is pictured from overhead at the Chicago Mercantile Exchange in Chicago, Illinois in this late 1980s handout photo. July 6 will mark the end of more than eight decades of open-outcry grain futures trading at the landmark Chicago Board of Trade Building, the art deco masterpiece housing the raucous trading pits that came to be seen as a symbol of turbulent capitalism reshaping the world. CME is closing the pits due to the rise of electronic trading. Now, the vast space once filled with thousands of arm-waving, hoarse-voiced traders, runners and clerks will be home to as-yet unknown new inhabitants lured, perhaps, by a super-fast, sophisticated telecommunications network, or the retro charm of 10 octagonal pits - with steps up the outside and then down into an arena-like space in the middle - where trading was conducted. REUTERS/CME Group/Handout via Reuters ATTENTION EDITORS - THIS PICTURE WAS PROVIDED BY A THIRD PARTY. REUTERS IS UNABLE TO INDEPENDENTLY VERIFY THE AUTHENTICITY, CONTENT, LOCATION OR DATE OF THIS IMAGE. FOR EDITORIAL USE ONLY. NOT FOR SALE FOR MARKETING OR ADVERTISING CAMPAIGNS. NO ARCHIVES. NO SALES. THIS PICTURE IS DISTRIBUTED EXACTLY AS RECEIVED BY REUTERS, AS A SERVICE TO CLIENTS. TPX IMAGES OF THE DAY

The S&P 500 trading pit is pictured from overhead at the Chicago Mercantile Exchange in Chicago, Illinois in this late 1980s handout photo. July 6 will mark the end of more than eight decades of open-outcry grain futures trading at the landmark Chicago Board of Trade Building, the art deco masterpiece housing the raucous trading pits that came to be seen as a symbol of turbulent capitalism reshaping the world. CME is closing the pits due to the rise of electronic trading. Now, the vast space once filled with thousands of arm-waving, hoarse-voiced traders, runners and clerks will be home to as-yet unknown new inhabitants lured, perhaps, by a super-fast, sophisticated telecommunications network, or the retro charm of 10 octagonal pits – with steps up the outside and then down into an arena-like space in the middle – where trading was conducted. REUTERS/CME Group/Handout via Reuters ATTENTION EDITORS – THIS PICTURE WAS PROVIDED BY A THIRD PARTY. REUTERS IS UNABLE TO INDEPENDENTLY VERIFY THE AUTHENTICITY, CONTENT, LOCATION OR DATE OF THIS IMAGE. FOR EDITORIAL USE ONLY. NOT FOR SALE FOR MARKETING OR ADVERTISING CAMPAIGNS. NO ARCHIVES. NO SALES. THIS PICTURE IS DISTRIBUTED EXACTLY AS RECEIVED BY REUTERS, AS A SERVICE TO CLIENTS. TPX IMAGES OF THE DAY

Although a 75pc oil price collapse should represent an unmitigated positive for the world’s fuel thirsty consumers, the sheer scale of the price rout is already imperiling the finances of producer nations from Nigeria to Azerbaijan, and is now threatening to unleash a wave of bankruptcies across corporate America.

It is the prospect of this vicious feedback loop – where low oil prices create financial tail risks that spill over into the real economy – which could now propel the world into a “full blown crisis” adds Thygesen.

So will it materialise?

The world economy is throwing up reasons to worry, as the globe’s largest emerging markets have shown signs of deterioration over the last six months, says Olivier Blanchard, the former long-serving chief economist of the International Monetary Fund.

My biggest fear is precisely that the dramatic shift in mood becomes self-fulfilling
Olivier Blanchard

“China’s growth is probably less than officially reported. Russia and Brazil are doing very badly. South Africa is flirting with recession. Even India may not be doing as well as was forecast,” says Blanchard, who left the Fund after seven years late last year.

As it stands however, he says market ructions still represent a classic case of “herd” behaviour.

“Investors worry that other investors know something bad, and so just sell, although they themselves have no new information.”

Blanchard spent seven years firefighting the worst financial crisis in history at the IMF

But a tipping point may well be approaching. According to Blanchard’s calculations, a 20pc decline in stock markets that persists for more than six months, will translate into a decline in consumption of between 0.5pc to 1.0pc.

“This would be a serious shock. My biggest fear is precisely that the dramatic shift in mood becomes self-fulfilling”.

The first domino to fall

For now, oil-induced financial stress is concentrated in the energy sector.

With Brent set to languish around $30-35 barrel for the rest of the year, prices will persist below the $40-60 barrel break-even point that renders the bulk of US oil and gas companies profitable.

Spreads on high yield US energy corporates have soared to unprecedented highs. “They make Lehman look like a walk in the park” says Thygesen.

More than a third of the entire US high yield bond index is now vulnerable to crude prices remaining low or falling even further, according to calculations from Oxford Economics.

As a result, 2016 is set to see the first wave of corporate bankruptcies in the oil and gas sector. Highly leveraged US shale companies will be the first be picked off. Should escalating defaults have a further depressant effect on oil prices, it could unleash a tidal wave of corporate bankruptcies in the world’s largest economy.

Conditions that usually pave the way for mounting defaults are currently met in the US
Oxford Economics

Indebtedness is not just the scourge of the US. Globally, the oil and gas industry has issued $1.4 trillion of bonds and taken out a further $1.6 trillion in syndicated loans, driving the sector’s combined debt to $3 trillion, according to the Bank of International Settlements. They warn of an “illusion of sustainability” that could quickly turn toxic as the credit cycle unravels.

The question exercising the minds of economists and investors is the extent to which this contagion could metastasize beyond the energy sector, as banks cut off credit access, loans turn bad, and financial conditions enter a critical tightening phase.

“Conditions that usually pave the way for mounting defaults – such as growing bad debt, tightening monetary conditions, tightening of corporate credit standards and volatility spikes – are currently met in the US”, says Bronka Rzepkowski at Oxford Economics.

Such levels of financial distress, more often than not, portend a global recession.

In every instance of the US high yield spread rising above its long-term average, a recession or financial crisis has been nigh, says Rzepkowski, who cites 2011 as the only time the markets sent out a false signal, lulled by the Federal Reserve’s mega quantitative easing programme.

US shale break-even prices remain closer to $60 a barrel

We are not there yet, but worryingly for market watchers, a series of other indicators are also flashing red.

Global equity markets have endured their worst start to a year since the dotcom crash. To paraphrase Nobel prize-winning US economist Paul Samuelson, Wall Street has predicted nine out of the last five recessions, but the current turbulence has an ominous precedent.

Over the last 45 years, the S&P500 has suffered a loss of more than 12.5pc on 13 occasions. Six of these have given way to a recession in the US, providing a more than 50pc probability that a global downturn is just around the corner.

In Europe, stocks have now fallen by 10pc in the last six months.

“Of the 14 previous occasions equities have had a similar decline, seven have been associated with recession, with lacklustre returns thereafter,” says Dennis Jose at Barclays.

He notes investors have begun to pile into “defensive” stocks, such as healthcare and consumer industries.

“The weighting in defensives has increased to the highest levels seen since 1980 suggesting that investors may have already embraced the risk of a recession.”

Dollar danger

Macroeconomic indicators from the world’s largest economy are also beginning to turn sour. The US has already fallen prey to a manufacturing collapse. Service sector data for December showed the slowdown is spreading to the dominant driver of economic growth.

“The shine has come off the US”, says David Folkerts-Landau, chief economist at Deutsche Bank.

He notes the economy is “firing on one cylinder” with consumers the sole bright spot in an environment of still weak capital investment, and a crippling exchange rate that is hurting exporters and squeezing corporate profits.

“It is not a very healthy situation,” says Folkerts-Landau, who forecasts US growth will fall below 2pc this year. “That is a precarious number.”

A crucial part of the story has been the relentless appreciation of the US dollar. The greenback has risen by more than 22pc on a trade weighted basis since mid-2014.

The effects have been felt far beyond the US. The soaring dollar has put record pressure on China’s exchange rate peg, forcing Beijing to burn through its reserves with interventions amounting to $140bn-a-month in December to protect the renminbi.

Meanwhile, China’s capital outflows have accelerated to $676bn, according to the Institute of International Finance.

This policy bind – known as the “Impossible Trinity” of managing a fixed exchange rate, maintaining independent monetary policy, and a open capital account – means a devaluation of some magnitude is all but inevitable.

• Has China lost control of its currency?

“It will definitely be in the double digits”, says Folkerts-Landau. “We will be lucky if the depreciation will be in the lower double-digits by the end of the year.”

“Once you anticipate that, and you are sitting in Indonesia or Latin America, it has an immediate impact on how you think about the world”.

A weaker renminbi would unleash a new wave of deflation in an already fragile global environment, and hasten the pressure on emerging market exchange rates as the world’s currency wars would renew apace.

Federal reverse?

What, if anything, could halt this pernicious cycle of events from unfolding?

In the short-term, analysts are unanimous: all eyes are on the US Federal Reserve. The central bank’s first rate hike in seven years last December has come to look frighteningly premature in the space of just eight weeks.

I have no doubt that the Fed would expand QE
Olivier Blanchard

Events have forced the Fed’s policymakers to take to the airwaves and soothe fears that another four rate hikes are on the way this year. It is a welcome sign for jittery markets, but may not be enough to convince them that the Fed will be nimble enough to reverse course and begin easing should financial conditions worsen.

Others, like Blanchard, are more sanguine about the ability of central banks to ride to the rescue again.

“I have no doubt that, if there was such a decrease in consumption, or if the strong dollar proved to affect net exports more than is forecast, or any other adverse event for that matter, the Fed would wait to do further increases” he says.

“And if things got really bad, I have no doubt that the Fed would expand QE.”

Oil prices meanwhile are widely expected to rebound from their depths by the second half of the year, as dwindling investment and the buckling of the vulnerable shale players begins to bite on production levels.

This in itself presents its own set of challenges. The lower oil prices fall, the faster buyers are expected to flood back in, with violent upward movements already in evidence over the last ten days.

In the longer term, even the postponement of the next global recession will do little to assuage fears that world could find itself defenceless against another round of mania, panics or crashes.

Two of the world’s three major central banks have slashed interest rates in to negative territory. Monetary tools will need to be deployed more creatively, perhaps going as far as injecting stimulus directly into the veins of the economy.

Should the world manage to ride out the perfect storm of 2016, next time round, answers will be difficult to find.

http://www.telegraph.co.uk/finance/economics/12138466/when-is-the-next-financial-crash-coming-oil-prices-markets-recession.html

 

U.S. jobs growth slows to 151,000, but jobless rate hits 8-year lo

Unemployment falls to 4.9%, wages surge in mixed labor report

Retail and leisure jobs were the source of January employment growth.

By

JeffryBartash

Reporter

WASHINGTON (MarketWatch) — The pace of hiring in the U.S. tapered off in January, but wages rose sharply and the unemployment rate dipped below 5% for the first time since 2008 in a mixed report that adds little clarity about the health of the economy.

The U.S. generated 151,000 nonfarm jobs in the first month of 2016, the Labor Department said Friday. Economists polled by MarketWatch had expected hiring to slow to 180,000 after big gains at the end of last year.

The smaller-than-expected increase could add to growing worries about a weakening U.S. economy and even the possibility of recession. U.S. stocks fell in early Friday trading.

Read: Recession not happening in the U.S., CEOs signal

Yet the January jobs report also offered some good news to suggest the labor market remains healthy enough to keep the economy moving.

The unemployment rate, for example, fell a tick to 4.9% the lowest reading in eight years.

The U.S. is still creating more than enough jobs to keep up with increases in the size of the labor force. Over the past three months, for example, the economy has gained an average of 231,000 new jobs. That’s well above average.

In another sign of a robust labor market, the average wage paid to workers jumped 0.5% in January to $25.39 an hour. Wage growth accelerated toward the end of 2015, and it’s climbed 2.5% in the past 12 months, just a hair below the post-recession high set in December.

Economists predict wages will rise even faster in 2016 as it gets harder for companies to find good help. At the same time, they expect hiring to slow as the pool of available labor shrinks.

In any case, the latest snapshot of labor-market trends did little to clear up questions about where the economy is going. A raft of reports in early 2016 suggests growth remains sluggish following a slowdown in the fourth quarter.

“The January employment report is clearly a half glass of water,” said Steve Blitz, chief economist of ITG Investment Research.

The mixed picture won’t give the Federal Reserve much to chew over, either. Economists predict the central bank will wait until at least early summer before raising interest rates again.

Inside the report

The retail industry added the most new jobs in January, taking on 58,000 new employees. Restaurants hired 47,000 workers and health-care companies boosted payrolls by 37,000.

In a surprise, manufacturers also created the most new jobs in a year, with payrolls rising by 29,000. Makers of food products led the way. Yet the increase in hiring in January is unlikely to be sustained as manufacturers struggle with falling exports in key overseas markets.

The financial industry beefed up staff by 18,000, continuing a steady trend of hiring after years of little employment growth.

Yet the ranks of professionals only increased by 9,000, largely because of a big drop in temps. These types of jobs have grown the rapidly during the economic recovery.

As expected, the transportation sector cut 20,000 jobs, mostly couriers used during the holidays to deliver packages. The energy industry, coping with cheap oil, also eliminated more jobs.

The pace of job creation at the end of 2015 was little changed after the government incorporated annual revisions in the employment report.

Some 262,000 new jobs were created in December instead of 292,000. But November’s gain was raised to 280,000 from 252,000.

Startup funding slowdown hits harder in Silicon Valley than S.F

The chill that descended on fourth quarter startup funding affected Silicon Valley more than San Francisco, according to research done for TechFlash Silicon Valley by PitchBook Data.

The overall number of deals and total of dollars that poured into Bay Area venture-backed businesses reflected the dropoff from the feverish activity of recent years that PitchBook and others reported earlier this month.

But it played out unevenly in the region.

There were 176 funding deals done in Silicon Valley in the last three months of 2015, down 35 percent compared to last year’s fourth quarter.


Get the free daily TechFlash Silicon Valley newsletter.


San Francisco had 185 deals in the fourth quarter, down by about 30 percent from last year.

Helped by a huge Q4 $1.6 billion in funding raised by Airbnb, the amount raised by San Francisco-based VC-backed companies jumped by about 29 percent year-to-year to $5.2 billion.

The dollars raised in Silicon Valley in the period dropped by about 13 percent to around $3 billion.

 

Investors around the world are ditching the markets

Not to alarm you — and please don’t call your wealth manager immediately after reading this — but the entire world is going to cash.

Bank of America Merrill Lynch (BAML) sent around a report tracking global fund flows, and since the second half of last year, cash has been the most popular asset in the world.

Over that period, about $7 billion went into the stock market. Fixed-income funds saw $46 billion in outflows, which BAML thinks is mostly due to redemptions from the credit markets, as opposed to, say, the government bond market.

Over the same period, $208 billion went into cash. When we say “cash” we mean the cold, hard stuff, and anything that can easily be converted into it. That includes money-market mutual funds and bank deposits that carry interest. It basically means investors are taking their money out of the markets and sitting it out.

BAML said investors are effectively selling inflation and buying deflation, or the continued decline in the value of asset prices.

The week ending January 27 saw the largest outflows from Treasury Inflation-Protected Securities — which are supposed to provide protection from inflation — in 33 weeks. It also marked the 13th straight week of outflows from bank loan funds and the seventh straight week of outflows from financials.

“All votes of no-confidence in the economy,” BAML said in the note.

In contrast, there have been four straight weeks of “robust inflows” into super safe government and Treasury bonds, and 19 weeks of inflows into muni bonds.

Here are the charts:

There have been huge inflows into money-market funds, while bond funds have seen outflows.

There have been huge inflows into money-market funds, while bond funds have seen outflows.

BAML

Super-secure government and Treasury funds have seen four straight weeks of inflows, according to BAML.

Super-secure government and Treasury funds have seen four straight weeks of inflows, according to BAML.

BAML

 

The Fed just put global financial markets on notice

Federal Reserve Chair Janet YellenREUTERS/Joshua RobertsFederal Reserve Chair Janet Yellen.

The Fed didn’t budge.

On Wednesday, the Federal Reserve kept its benchmark interest rates pegged at 0.25% to 0.50% — as was expected.

So, effectively, not much has changed.

But the Fed made a key change to make clear that it would be “closely monitoring” developments in global financial markets.

Here’s the key sentence (emphasis added):

The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.

The Fed also said that it would keep an eye on international developments as it examines the possibility for raising rates in the future (emphasis added):

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

When it comes to the Fed’s decisions, generally, its main concern is the US economy. So, often we don’t hear much about its thoughts on what’s going on overseas except for a few mentions in the minutes from each meeting, released three weeks after the initial statement.

But it looks like the Fed is once again eyeing what’s happening abroad as it is materially affecting businesses that make up the US economy.

“Although one could argue they are always monitoring global economic and financial conditions, the phrase ‘closely monitoring’ has traditionally been associated with a Fed that is quite concerned about current events. Combining this phrase with the removal of the phrase which noted that risks are ‘balanced’ highlights the uncertainty within the Committee,” according to UBS economist Drew T. Matus.

“These add up to a FOMC that, while still not willing to remove the option of going in March, is acknowledging conditions that may prevent them from doing so. Indeed, this statement could be read as making the FOMC that much more data dependent heading into the March meeting,” he continued.

Notably, the Fed previously included language about “monitoring developments abroad” in September after a rocky summer — although they subsequently took it out in December.

So now, given that the markets were quite volatile in January and various big US businesses such as Apple pointed in “softness” abroad, it’s not entirely surprising that the Fed again included such a reference.

Still, it’s worth acknowledging that this time around, the Fed’s tone was less intense.

“Note how much more benign the statement [this time] sounds than the warning that was included in the September 17, 2015 policy statement,” observed Credit Suisse’s Dana Saporta.

memorial

Apple’s new 4-inch iPhone will be named ‘5se’ and pack updated hardware and Live Photos

Tim CookREUTERS/Stephen LamApple CEO Tim Cook.

Apple is coming out with a new iPhone called the “5se” that has a 4-inch screen and a number of new features, like curved edges and the Live Photos feature, 9to5Mac’s Mark Gurman reported on Friday.

The new phone, scheduled for release in April, is basically the same size as the old 5S, but comes with updated internal components and features that were previously only available on the newer 6-series iPhones.

Gurman reported that the “se” is supposed to mean the “special” and “enhanced” edition of the old 5S phone.

Despite the popularity of the iPhone 6 series, there has been some demand for a smaller version of the iPhone, like the 5S. Gurman says that Apple is hoping the new 5se will cause those 5S users to upgrade their old phones.

According to Gurman, the 5se also comes with similar curved edges like the 6S or 6S Plus, and features that include Live Photos and Apple Pay. It also comes with an 8-megapixel camera and the same color options as the 6S.

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