On risk, cartels and Pimco's latest recruit

6 min read

Back again after a few days up and down the European continent and all I find is much the same uncertainty and confusion I left behind. The markets’ disappointment with the ECB on Thursday tells us more, in my humble opinion, about the markets than it does about the ECB. The message which St Mario gave us was clearly that the age of central banks doing what’s good for markets rather than what they perceive to be good for the economy are over. This is a message which needs to be carried into next week when the FOMC sits down and contemplates its own action.

I was staggered by an article which appeared in the Financial Times over the weekend which alluded to the state of the corporate credit markets and the risks which await highly leveraged companies and those who have lent money to them when the living was easy. I’m not sure how long it has been since we first went on Fed tightening watch but I well recall Alan Greenspan warning markets ahead of the commencement of the 1994 tightening cycle that the move had been clearly signalled and that anybody who was to get caught with their pants down would have nobody to blame other than themselves. And yet, the markets sailed into February 4th FOMC meeting eyes wide shut and the bloodbath was horrid.

That said, 1994 caused pain in the still nascent structured products market where solid credits were sold with turbo-charged yield enhancement strap-ons.

Back then, speculative-grade credits (that’s still the official name for sub-investment grade or junk borrowers) struggled to borrow for more than three or five years and were the domain of highly specialised portfolio managers who, in the eyes of the general investing public, appeared to meet in midnight rituals where they brewed strange concoctions and performed weird sacrifices.

(May I please ask, rhetorically of course, who out there last looked at the ratings agencies’ default tables and knows what default probabilities are applied to what credit rating and over what time period?)

The piece points out that when the Fed starts tightening one trillion dollars of corporate debt is at risk of downgrade.

It quotes one Matthew Mish of UBS who suggests that: “A large portion of the lowest quality debt issuers will face ‘severe refinancing challenges’ by 2018 as cashflow generation remains weak.”

He goes on: “It is our humble belief that the consensus at the Fed does not fully understand the magnitude of the problems in corporate credit markets and the unintended consequences of their policy actions.

“The implication is that their actions will be reactive, not proactive – but only time will tell.”

Ermm, sorry, sir, I think it is yield-hungry lenders who have forgotten how to value risk and who still believe that the central banks are the investment community’s guardian angels and protectors of bonuses of last resort.

Meanwhile, OPEC did what OPEC does best and that was to agree on nothing. I know they’re still referred to as a cartel (defined as “a group of businesses or nations organised to manipulate prices by regulating the production and marketing of a specific product”) although it must be time to agree that OPEC fails in that on all fronts. WTI at US$37.71 and Brent Crude at US$40.95 clearly attests to that.

The only good thing which OPEC’s bad tempered half-yearly caucus has so far achieved is to help to bring an end the rather odious Chavenista rule in Venezuela, whereby, at this point in time, I would not put it past President Nicolas Maduro to find a way of wriggling out of the electoral drubbing.

Downward pressure on crude might well continue but I still think it is a mistake to use the seven-year low in the price as proof that the global economy is going nowhere.

The decline in oil is mainly due to a sharp upturn in technology and the senseless fight of the old-school producers against the upstarts.

OPEC look like a bunch of typewriter manufacturers trying to suppress the word-processor by making more units and selling them at a loss.

Finally, the big one! Pimco, now devoid of Bill Gross (who is I think is still suing for the US$250m bonus he missed by getting himself fired) has hired the invisible Scotsman (aka Gordon Brown) who abolished the boom and bust cycle and saved the world as a roving (not raving) ambassador and consultant on all things economic.

He joins the likes of Ben Bernanke and Jean-Claude Trichet on the panel of five. Have they gone raving (not roving) mad?

The former chancellor of the exchequer and prime minister went through the boom of the naughties hailing the banks as saviours of the world – he opened the new Lehman Brothers’ offices at Canary Wharf with a speech lauding the firm as a model to be admired and copied in the UK – while happily blowing the massive tax receipts on social spending programmes.

The Pimco panel also includes Ng Kok Song, founder and former chairman of the Government of Singapore Investment Corporation, a proto sovereign wealth fund. Now there is a man who knows the difference between investing and spending, something the invisible one never did, thus leaving this country with spending programmes it can no longer afford but which were sold to the electorate as “investing in the future”.

I might be tempted to pay to hear our former PM speak but more out of curiosity than for interest in what he has to say.

In passing, isn’t it curious that Pimco’s CIO of global fixed income, Andrew Balls, just happens to be the brother of the former PM’s chief attack dog, ex-shadow chancellor and defeated MP for Morley and Outwood, Ed Balls. No comment.

Anthony Peters