Now that we’ve put geopolitics back in its box, with the ECB and the BoE meeting today and with the US payrolls report out tomorrow, it might not be unwise to do an economics check again.
By and large, key pointers remain positive albeit in many cases not quite as positive as they might be. In other words, the rebound is slowing, but as yet there are no indicators that they are set to revert to negative.
The week has so far brought a raft of second-tier indicators in the US, all of which bar one looked pretty positive. The fly in the ointment came yesterday in the form of the February Non-Manufacturing ISM which, as forecast, fell back from the 54.0 it registered in January – not to the predicted 53.5 – but to a slightly scary level of 51.6. This is still comfortably in positive, expansionary territory but it will rattle the employment bulls as it points to slowing jobs growth in the service sector.
That said, the extreme weather which the Eastern USA has been dealing with since the beginning of the year has surely rattled sentiment and I would suggest that many of the January and February economic indicators will subsequently prove to have been out of shape as a result. I do, however, see one pair of numbers which I continue to find worrying – Personal Spending is still growing faster than Personal Income.
Credit growth and AT1s
Equity investors love credit growth because it feeds into consumption and eventually into earnings and dividends. But as a debt professional and having lived so recently through the collapse of an overborrowed private sector, I cannot get excited about the emerging signs of the next round of consumer credit funded growth.
Why my concern? While credit is growing faster than the economy, banks are busily boosting their capital through CoCo issuance – now elegantly renamed AT1 – which neatly pushes the risks caused by overlending directly on to debt investors and away from equity holders, an ever increasing proportion of whom are senior bankers who are finding a significant share of their total compensation being paid in deferred stock. Not of course that such thoughts would ever have crossed anybody’s mind.
As I continue to rub shoulders with low people in high places, I dined last night with a senior staffer at one of the larger financial institutions. I very rarely now meet with senior people from the industry and the subject of CoCos doesn’t come up. The issue as far as I am concerned is simple – they are being pumped out 10 to the dozen but until the first one has defaulted, nobody will really be able to assess what they will do for holders or issuers or – and it is for the protection of these that they were created – taxpayers. All the stress tests which are carried out and applied prior to issuance and which are aimed at proving how robust these little blighters should be are constructed to prove how good they are, not how bad.
This week has brought another goodly spread of AT1 issuance and all of these new securities seem to break syndicate at between 1 point and 1½ points to the good even though the terms look to me to be progressively less compelling – not that I ever thought them to be that fantastic in the first place. More to the point, when a crisis does hit, the limited liquidity which secondary markets offer at the best of times will melt away to zero and mark-to-market losses will be cataclysmic.
Chinese repricing
On the subject of first defaults, the Chinese yuan bond market is facing its first default in the shape of Shanghai Chaori Solar Energy Science & Technology Co which, as the name says, makes (or made) solar panels. It is due to make an interest payment in its Rmb1bn 8.98% 3/17 bond tomorrow but has already declared that it is not in a position to do so. This is a new phenomenon for the domestic bond market which might quite easily lead to a total repricing of the market. We know what happens when previously unpriced risk swamps a sector – it killed Bear Stearns and subsequently Lehman Brothers – and although there is no reason to fear something quite so dramatic in China there might be a need to review some of the domestic bonds which have never been traded or priced with actual default risk in mind.
Dubious Greek checks
Finally, the Troika seems to be in disagreement with the Greek authorities – oh really? Recent stress tests which appear to show the Greek banks to be sound are apparently not rigorous enough for the IMF which has its doubts about their validity. It suggests that the tests are too optimistic and that they paint too rosy a picture of the state of the institutions in question. I wonder why I am not surprised?