Political risk back in the spotlight as possible bond default shocks

Arguably the strongest contender to make the biggest waves in financial markets in the second half of this year are negative yields on bonds which have gradually evolved from merely a concerned thought into a desperate situation described only by the panic acquisitions of similar instruments containing positive returns regardless of the risk attached to it that could very well overshadow the scale of catastrophe when compared to the Financial Crisis of 2008/09.

Late in July I wrote a piece about the rapid transmission of funds from bonds markets in the developed world in favour of fixed income securities in emerging markets that offer the very least of a positive yield. The reason being the protracted use of monetary stimulant in the form of negative interest rate policy in countries such as Japan, Switzerland and the European Union in bid to purge economic stagnancy setting in.

At the time I concluded the absence of rationality from investors when considering all risks embedded in an instrument was an alarming notion to contemplate yet the onset of such a view has already infected the current market sentiment with disastrous consequences.

A twig of sensibility should be heeded in the latest reports coming out of Mongolia where newly elected government officials have stated their intentions to avoid default on its country's debt at all costs. This after the Mongolian bond market saw a surge in demand for its fixed income securities from positive yield seekers finding refuge from the financial storm.    

Yield-seekers get reality check as Mongolia sounds alarm on economic crisis @natashadoff https://t.co/8ZPwmBW7SL pic.twitter.com/5iVYZaqBjz

— Emerging Markets (@BloombergEM) August 11, 2016

However they hadn't counted on an outcome such as this to occur which meant it sent shockwaves throughout the Mongolian financial market once it was heard. But surely how can one blame the prudence of government especially in times when austerity is needed? It's nonsensical.

The matter goes straight to back to what's been said earlier; the irrational investors as opposed to the norm of rationality has blurred the outlook of financial markets to such an extent that not all risks have been considered leaving investors vulnerable to being caught in sudden price changing events.

Political risks stemming from emerging markets have grown in frequency due to their interconnectivity with big brother China in reference to trade relations. The contraction of the Chinese economy has not only hardened the view of its citizens but also those who have suffered gravely as a result of a slump in trade with communist reforming nation.

Besides this, the economic outlook has shifted vastly from prosperity to despair translating directly into potential political shockwaves occurring from the dissatisfaction of citizens on its governments which isn't fully being accounted for in terms of risk. Mongolia might be the first but certainly won't be the last offering an inkling of what can progress if the issue of negative interest rate policy isn't addressed with true reflection of its impacts on the rest of the world.

China can no longer rely on debt to fuel growth

It's hard to believe a year has flown past since matters relating to an implosion of Chinese equity markets took a firm grip of the world's future outlook and sent global financial markets into overdrive over the spillover effects of such an event.

Although the full risks have yet to contaminate the world economy it must be said that the Chinese government has orchestrated the fixed smooth over of concerns many economists cited as persistent problems that threaten to reappear at a later stage.

One of these risks is the consistent additions to an ever growing debt pile used to spur economic activity that's seemingly wearing thin in its appropriateness as a tool to stimulate growth. The current situation in which consumers and producers have burdened themselves up with debt is weighing heavily on their ability to transform income into a value chain.

The taxing demand interest repayments impose on the borrower is far outstripping any good that would come out of it due excessive obligations as a result of an overextension of credit.

Notwithstanding the fact that debt made in the past was done so with the perception of infinite growth at abnormally high rates which don't match present reality. The difficulty in achieving escalated economic expansion requires policymakers to reign in the debt in the short term to medium term and only recommence once satisfied enough has been done.

But considering how indebted China is, roughly 250% of GDP, this would be a mammoth task for any government to achieve in a short span of time. Herein lies where the next frontier of economic thought is going, the Growth Dilemma.

How does a nation abate the long term implications of an action that motivates a short term solution to a dire situation yet leaves its citizens poorer by laddening excessive obligations to their sustanence?  

China’s mounting debt is hurting its tradition of using spending and lending to spur growth. https://t.co/3m8dUpcTUy pic.twitter.com/gbNvnHEotP

— NYT Business (@nytimesbusiness) July 15, 2016

Is oil showing signs of fatigue after an impressive rally?

Although oil prices has impressed many this year with a spectacular comeback from decade lows to a phenomenal rally that equated to almost a doubling of price in less than six months, its no wonder a close eye has been stalking price action of late as it nears medium term resistance that some believe could offer a harsh reality check for oil bulls.

Part of the reason we've seen a spike in price is due to the fact that US shale gas producers responded hastily when reasonable thought proved harmful in believing a rebound in price was nearer than fully understood in the dynamics leading down the value.  Needless to say the added economic deterioration in a number of OPEC member nations helped spur on a resurgence that's outshone returns of yesteryear.

We now have a scenario where oil prices are lofty enough to fulfill breakeven or even profit-making criteria for US suppliers to justify opening taps up again which is proving to be the case as found in the article below posted by the Economist.

 I've been saying this for a number of weeks combined with the price stalling at critical levels it could suggest that this sentiment is gaining traction amongst oil traders with a relative balance between buyers and sellers in the weeks gone past from a state where buyers far outstripped sellers driving up prices.  

Oil costing $50 a barrel is leaving American frackers hopeful https://t.co/gFQZbmWBPZ pic.twitter.com/2GdGAT19PW

— The Economist (@TheEconomist) June 23, 2016

As this is said further evidence shows that finance institutions that were once happy to accept the Cinderella prospects fed to them from producers seeking funding are stepping away from the market of lending to this sector with largely exposed European bankers opting to strave off capital hungry borrowers by refusing to issue new debt or alternatively finding buyers for these loans that have taken on additional risk.

What does this tell us?

It says European banks don't foresee the same optimal outcome that featured in the reason to grant long term borrowings to oil producers but instead of holding ground and patiently wait for the usual cycle to correct itself, this theory no longer stands as these institutions see harsher consequences if they were to hold these debt instruments for anytime longer otherwise why would they be selling?

To go further it also adds momentum to those who believe US shale producers will restart operations and possibly cause prices to slump again. The fact that European banks are doing this now paints the extreme optimism given to the situation.

Where does it leave us?

Quite simply the oil market will be left in a volatile oil market that will continue to exhibit wild movements in price until stability is found but even this is uncertain as of now. The flexibility of shale gas producers mean suppliers are able to shift between markets in search of profitable returns making equilibrium dependent on the surplus/deficit of either chosen produce.

Europe's banks dumping loans as they pare exposure to oil industry https://t.co/evIcU5EvkQ via @business @LCasiraghi pic.twitter.com/pVxui2BTLz

— Shelley Smith (@SLSmth) June 23, 2016

Japan's delay of a sales tax hike merely spells doom

In an expected move Japanese Prime Minister Shinzo Abe delayed the implementation of a sales tax hike following the failure of the once prospective Abenomics that's seen Japanese debt balloon outwards placing its citizens with grim prospects of the future. The move will bring short term gain to an economy that's been battling deflationary pressures together with contractionary expectations related to the health of economic activity in the country.

Abe didn't deviate much from what he had said last week when Japan hosted the other 6 remaining members who make up the economic council of G7(otherwise known as Group of 7). He reiterated the risk the global economy faces due to the slowdown in activity in emerging market nations saying China had influenced most of the current downtrend being experienced adding that the adverse effects felt by most nations around the world had taken the wind out of the sails of a planned economic recovery that had been underway for some time.

As much as these economic conventions help guide investors on the course of direction the world economy is headed in, very often they're used to test alliances with the case of Japan's ties to China standing on shaky ground having centuries old rivalry with its Asian neighbour.

Trying to point out China's failings while ignoring their own dilemma of an increasing debt horde is quite rich when coming from the likes of Japan.

S&P says #Japan sales tax hike delay makes 'some sense' (as debt to GDP has grown to 240%). https://t.co/fdwLDUssIQ pic.twitter.com/2ScgLFnVv5

— Holger Zschaepitz (@Schuldensuehner) June 1, 2016

Credit rating agencies have already started circling with a handful of critics painting a woeful picture of the outlook of the Japanese economy if it doesn't properly arrest its debt problems that sits at the highest levels to GDP amongst all countries in the world. Furthermore the situation only becomes bleaker when you weigh up the poor take up of prime minister Abe's stimulant fiscal measures that produced the tiniest amount of excitement at the beginnings of its undertakings that subsequently fell by the wayside in recent years.

Refusal to concede defeat, Abe's lack of sensibility has prompted Bank of Japan Governor Haruhiko Kuroda to rush in and "save the day" as some might term it, when in fact the policies churned out from the monetary body is in direct conflict with the goals of the economy and its people.

The market never lies and none can be truer when observing the abnormal strength of the Yen versus the US Dollar leaving many theorist scratching around for answer after the BOJ dropped interest rates below zero and announcing more stimulus measures to an already extended program.

Supranational monetary organisation the International Monetary Fund have recently warned developed nations that the limits of monetary stimulus are wearing thin and stressed the need for governments to begin "structural reforms" of their economies if they want to avoid riding into economic catastrophe further down the line.

But again the powers that be continue to steer their economies in the opposing direction of rationality with Japan being a basket case leading the forefront of technological advancement in an economy yet failing to take into account the impact such changes bring onto the decision making process of its citizens.

Looking at reasons for why conventional economic policies aren't working isn't enough and should instead be viewed as a need to push past old beliefs by exploring the possibilities of exceeding the bounds of theories that have laid around for decades and renew the study of economics as it was intended in the formative years of Adam Smith.

The cats out the bag for the IMF's plan on the Greek debt crisis

An explosive leaked transcript from a conversation between IMF officials pertaining to the manner in which the monetary body intends on dealing with the Greek debt crisis has rocked the already shaky relationship between the desperate European nation plagued by economic calamity and one of  the three lenders of saving grace, the so called Troika, installed to prevent a spillover of defaulting debt due to non-payment because of inadequate means of doing so.

In the transcript that was released by WikiLeaks on Friday, the conversation suggests that the IMF may try to pressure the European Commission to provide a larger proportion of the debt relief as well as force the Greek government to scrap pension increases that's been at the heart of the stalemate between creditors and Athens. The IMF intends on doing this by threatening to exit from the Troika which could spell disaster going forward however this seems to be a scare tactic that was discussed amongst the three IMF officials who believe such a threat would awaken the European Union from its unrealistic ideals it thinks would be satisfactory to secure stability in the region once again.

This latest developments set off what is expected to be yet another round of back and forth disagreements between Greece and its creditors in an attempt to prevent a crisis. We saw the negative blow to confidence in the global economy when Greece's prime minister Alexis Tsipras fought for weeks over the conditions attached to the renew bailout deal that was eventually agreed upon at a much later date than would've been necessary.

The fight will continue as the deadline to reach a new deal draws closer with July being the cut off, but this time we can look forward to an even bigger resistance from Tsipras with these revelations giving him all the ammo needed to take aim at his nation's creditors. This could be devastating for financial markets as it would bring a new wave of volatility and uncertainty into the mix under tough conditions already being felt.  

#Greece demands IMF explanation over leaked debt transcript https://t.co/EPKuq2wDsd

— Pedro da Costa (@pdacosta) April 2, 2016

One of the possibly reason's why creditors need to see a resolution soon could be because the referendum vote in the UK over whether to stay in the EU or not taking place on the 23rd June 2016. Many believe that the run up to these elections might interfere with the priority of reaching a conclusive agreement in Greece that wouldn't leave much time for policymakers to draw enough attention to the criticalness of such resolution after proceedings from the elections have wrapped up.

Although it can be argued that the Troika has had more than enough time to iron out its differences with Greece, the previous negotiations have left a bitter taste in their mouth with many leaders taking deep political hits to their credibility. In attempting to devise a plan being fully aware of Tsipras resilient and tempered personality, the IMF has tried to avoid a renewed crisis and in fairness who could blame them.

However Greece's 11th hour crucial decision-making antics have pushed the extremities too far that the European Union has been found complacent in its concessions to allow these political point scoring games to continue for as long as they have.

It could be said that the IMF sees the Greek debt crisis as a perpetual disadvantage for the EU moving forward with the latest revelations indicating their unhappiness at the lack of proper restructuring taking place which puts Europe at risk of economic catastrophe. We've heard that the benefits of an expanded monetary program has reached the end of its time and the need to restructure, in referring particularly to developed economies, is catching up with politicians who have for too long made promises that lack the continuity of more than a generation.

If the EU continues to follow such a path that leads to no ends we could well begin to see the end of the EU itself. And so I leave you with a quote:

"The recipe for perpetual ignorance is: Be satisfied with your opinions and content with your knowledge." ~ Elbert Hubbard  

#IMF predicts #Greece's default will coincide with UK's EU referendum. https://t.co/Ic0VnAXSvC pic.twitter.com/Za28kCGaGU

— Holger Zschaepitz (@Schuldensuehner) April 2, 2016

What Credit Suisse losses say about the fate of the banking sector

After 9 months as the new head of Credit Suisse, Tidjane Thiam has made a frightening concession surrounding his oversight of the company by indicating that traders within the firm had ramped up their positions of illiquid and distressed debt holdings without the knowledge of their seniors going as far to say that even he had no knowledge that such activity was happening right under his nose.

This comes as the banking firm looks set to report another quarter of losses following a dismal previous quarter where Thiam announced a major restructuring program that aimed to trim off fat and focus the company in the direction of wealth management.

Following these new revelations Thiam looks set to deepen his restructuring program by cutting more costs one of which proposes an additional 2000 jobs cuts on top of the planned 4000 taking the the tally to 6000. One does get a sense of eeriness when a CEO of a major financial institution makes such statements that you begin to wonder if banks may be headed for troubled times.

The reason for such thinking is supported by the fact that the dawn of negative interest rates has beckoned on many in the financial system to re-think or adjust their strategies so as to align the current interest rate environment with that of a profitable financial institution business model. However having never experienced a situation where interest rates are below zero there's no common theory to apply their minds too that would aid these financial houses of the appropriate measures needed to be taken.

What Thiam has revealed is precisely what we will see coming through from other major banking firms as the months pass and the effects of negative interest rates take their full toll on the economy.

Credit Suisse CEO says traders ramped up distressed debt holdings without his knowledge https://t.co/KUbTFzvudq pic.twitter.com/LPxhRzTYMw

— Bloomberg TV (@BloombergTV) March 24, 2016

Conventional thinking would suggest that for a bank to make money it needs to make loans available to those who require the funds. In return the bank receives interest which contributes to the profitability of the business. However banks are now burdened with the reality of receiving no interest for loans made available but instead pay the borrower to loan the money.

This can't be the case as the majority of  banks profits come from interest earned on loans which would decimate banks earnings. Banks have so far resisted this practice as it would mean that they would be entitled to charge depositors interest for having their money in the bank. This would lead to many depositors removing their savings from the bank thus shrinking the size of the potential loans that could be made available.

We can see from the above paragraphs that the landscape of banking has dramatically changed due to the onset of negative interest rates but it hasn't stopped shareholders of these companies expecting profitability. It's this exact point why we've seen a drive by management to attempt to seek out profits over and above what is considered the norm resulting in the business taking on more risk than would be necessary.

But as the global economy becomes a curveball of uncertainties nobody really knows when we'll see healthier economic times creating a financial storm of volatile proportions with just the right mix of fearfulness that triggers off the most violent financial market moves causing deep declines in asset valuations.

 Perhaps they could turn to the mainstay of good returns found in emerging markets but even their risk profiles have markedly increased over the past year following a bleak Chinese outlook that's left many uninspired, dejected and more so burdened by huge debt piles that require faster growth to pay them off yet not finding any joy in it.

It feels as if the financial market space is becoming claustrophobic with avenues of return wearing thin as the benchmark rate of return in the economy drops below zero and further downwards. This circus will only end when policymakers realise what the error of their judgement is causing and feel the urgency of shifting the extremity away from the edge and bring normality back into existence. Until then the world financial system will walk a tightrope in the hope that logic eventually prevails but hopefully by then it isn't too late.

Resurgence in commodities are only short term in nature

Colossal; the best way one would be able to describe the movements that's been witnessed in mining counters over the past year with the present bounce making no exceptions when pulling off hair raising moves that would frighten even the most experienced trader. The perception around this relief rally is that it was a response to a rather dramatic selldown and should only to temporary.

I found this chart tweeted by the World Economic Forum which shows the net exports/imports of various nations around the world in terms of commodities as a percentage of GDP. The resource abundant countries make up the usual supply force that determine the amount of quantities available to the market however the most interesting shades on the geographical chart are those that are resource dependent or otherwise the part of the market that stimulates demand for quantities.

The most distinctive areas that we are able to identify are countries such as the United States of America, Japan, Europe and China. I have mentioned these countries specifically for a reason because if we think about the economic commentary that's dominating the news flow currently we'd find that all these countries are suffering from economic inaptness.

Japan and Europe have both implemented negative interest rates that has the world flummoxed about whether these extents to monetary stimulus is either a hinderance or a necessity to the financial system. The inability to abate a deflationary price environment has meant that central bankers are pressured to pick up demand or face dealing with an inactive economy that refuses to budge.

China has gotten stuck in a transitory state between transferring between that of an industrial based economy to a consumer services oriented economy. Investors are hopeful that government may indicate that it intends on lending a helping hand to the economy that has stumbled along but the role of government is slowly diminishing as increasing debt piles continues to prevent them from executing radical infrastructure programs that would boost the economy.

The US looks like the only nations that has the capability to steer the world economy in the right direction however if we look at economic indicators being reported they would suggest less than needed activity showing that it may not be the saving grace the world's looking for.      

Could the commodity crisis be an opportunity for #Africa? https://t.co/68Fwchtviw #commodities pic.twitter.com/wtN0GRhlM2

— World Economic Forum (@wef) March 8, 2016

All these nations have pertinent issues that trouble their outlook but more so the fact that each one has been place in a trend of slowing economic activity at the same time makes for a bigger implication for the global outlook as a whole.

We've seen commodity stocks radically improving after last years onslaught brought on by supply glut fears however the rally that has evolved does not feel as if there is a steady trend of long term buyers entering the fray but rather that of a short squeeze. It would be dangerous to think that we've seen the end of a disastrous time for commodity stocks because there remains issues yet to be resolved.

Iron ore prices spiked 19% on Monday 7th March 2016 to record the largest one day jump ever but Australia's steel trade port was shut down due to a hurricane that halted operations together with a bolstering demand for steel following the end of holidays in China have all played a part in helping prop up prices in the short term however a supply glut looks likely to remain in place for the next 2-3 years if demand doesn't pick up significantly.

Oil remains a key component in deciphering any direction. With OPEC on its knees and shale gas producers drowning in debt, its quite evident we are far from the resolution required to allow prices to begin its ascent.

Then there's the big issue of debt that seems to be haunting many mining producers. Although fears may have faded for the time being, the increase in commodity prices we've seen so far this year isn't sufficient to generate cash flow to pay away these liabilities quickly enough to chase away credit ratings agencies from downgrading them further. While the market has become intoxicated with optimism they've forgotten these issues that haven't gone away.

Before we see a return of investors in the mining sector companies will need to show steady demand for its products and with supply gluts on the scale we've seen so far as well as the lack of response to stimulus measures from the four nations I mentioned above I don't envision seeing this happening anytime soon.

Moody's slashes China's outlook from stable to negative

Moody's rating agency has slashed China's outlook from stable to negative as it cites growing debt piles as a concern that could possibly send the Asian economy into turmoil if more isn't done to prevent it. The rating agency says that the government's reliance on fuelling demand with credit growth as well as the dependency by state owned enterprise to plug seeping holes could haunt them in the future if they aren't careful.

We've seen an outpouring of supportive statements from policymakers particular those involving the matters of the economy in an effort to get reforms back on track after volatility spread an ugly mess throughout the financial system late last year.

Part of government's promises was to overhaul the system whereby their currency is traded more freely however this has been mired with uncertainty as a recent devaluation cause a tremendous wave of doubt rippling through the global economy which was subsequently placed on hold so as to not cause further harm.

The PBOC has resorted to drawing down foreign currency reserves to protect the currency from external pressures that would require it to devalue more than what would be desired pushing authorities into a corner over what decision needs to be made.

I think China will be unable to sustain the rate of drawdown it is currently experiencing in its foreign accounts although there may be a hefty sum on hand it certainly won't last if the situation were to spin out of control, a scenario Moody's sees as possible. China's alignment to global standards in terms of financial markets means that it cannot meddle the way it is use to deeming their efforts worthless if not worrisome.

Hinderance of a financial market by any institution equates to the same outcome, a distortion that skews the picture away from reality that eventually ends up in tatters. Chinese authorities recent effort to bolster confidence in its ability to reform did show signs of integrity however that is not the end of the line of communication with more transparency is needed in relation to the timeframe with which policymakers intend on implementing a change to a more open market platform.

#China's credit rating outlook cut to negative over debt concerns https://t.co/nIMSNKj3o0 pic.twitter.com/0SsN8DHBTn

— CNNMoney (@CNNMoney) March 2, 2016