Macro and Credit - The Ninth Wave

"Every wave, regardless of how high and forceful it crests, must eventually collapse within itself." - Stefan Zweig (1881-1942)

While chuckling about the gullibility of some investors pundits who were somewhat surprised by the Bank of Japan' latest move in implementing Negative Interest Rate Policy (NIRP), given as per the SNB move in 2015, they should know by now that central bankers always lie, we reminded ourselves The Third Wave experiment when thinking about our title analogy. While you might be already wondering why our title is the Ninth Wave and not the Third Wave experiment, it is fairly easy to explain. 

The Third Wave experiment was conducted by school history teacher Ron Jones during the first week of April 1967 in Palo Alto in California in order to explain his students how the German population came to accept the actions of the Nazi regime during World War II. Jones started a movement called "The Third Wave" and told his students that the movement aimed to eliminate democracy (in our central banks case: "interest paid"). Jones experiment (in similar fashion to current central banks experiments with QEs and NIRP) on the fourth day of the experiment quickly decided to terminate the movement because it was slipping out of his control. The experiment was all about explaining the rise of fascism. In our current environment, our central bankers "deities" are indeed experimenting with some form of "fascism" with their intent in imposing "financial repression" and discipline to the markets, we think.

So why our title?
Jones based the name of his movement, "The Third Wave", on the supposed fact that the third in a series of waves is the strongest, an erroneous version of an actual sailing tradition that every ninth wave is the largest hence our chosen title.

But, back in November 2011 we discussed a particular type of rogue wave called the three sisters, that sank the Big Fitz - SS Edmund Fitzgerald, an analogy used by Grant Williams in one of John Mauldin's Outside the Box letter:

"In fact we could go further into the analogy relating to the "three sisters" rogue waves that sank SS Edmund Fitzgerald - Big Fitz, given we are witnessing three sisters rogue waves in our European crisis, namely: Wave number 1 - Financial crisis Wave number 2 - Sovereign crisis Wave number 3 - Currency crisis In relation to our previous post, the Peregrine soliton, being an analytic solution to the nonlinear Schrödinger equation (which was proposed by Howell Peregrine in 1983), it is "an attractive hypothesis to explain the formation of those waves which have a high amplitude and may appear from nowhere and disappear without a trace" - source Wikipedia." - Macronomics - 15th of November 2011

We voiced our concerns in June 2013 on the risk of a rapid surging US dollar would cause with the Tapering stance of the Fed on Emerging Markets in our conversation "Singin' in the Rain":

"Why are we feeling rather nervous?

If the Fed starts draining liquidity, some "big whales" might turn up belly up. Could it be Chinese banks defaulting? Emerging Markets countries defaulting as well due to lack of access to US dollars? It is a possibility we fathom." - Macronomics - June 2013

At the time we stated that we were in an early stage of a dollar surge.

Back in December 2014 in our conversation "The QE MacGuffin" we added:

"The situation we are seeing today with major depreciation in EM currencies is eerily similar to the situation of 1998, with both China and Japan at the center of the turmoil."

What is of interest of course is that indeed the Third Wave experiment analogy has been somewhat validated by Goldman Sachs in a recent research report as per below chart:

- source Goldman Sachs.

This ties up nicely with our "reverse osmosis" theory we mentioned again in our previous conversation "Under pressure"(This global macro hypothesis was first described in our August 2013 conversation "Osmotic pressure").

But if the sailing tradition that every ninth wave is the largest is true, then again, our chosen title is the correct one.
The Ninth Wave happens to be as well a splendid painting from 1850 by Russian Armenian marine painter Ivan Aivazovsky. Overall, our title refers to the nautical tradition that waves grow larger and larger in a series up to the largest wave, the ninth wave, at which point the series starts again. This of course goes with our earlier quote from Stefan Zweig. Zweig's quote does ring eerily familiar with the reckless abandon in which central bankers of the world are engineering the biggest bond bubble (or wave) ever seen, and the Ninth Wave might eventually turn out to be Wave 3 squared result but we ramble again...

In this week's conversation we will once again reiterate our advice to start playing "defense" in credit and move higher into the capital structure and in the ratings spectrum. We will also look at the debilitating global growth outlook as well.

Synopsis:

• Credit - Time to play defense on any "relief" rally
• US Investment Grade Credit - Why you want to "front-run" Mrs Watanabe
• Macro -  Growth outlook? It's weaker than you think
• Final chart - Why a flatter yield curve is not good for the financial sector

• Credit - Time to play defense on any "relief" rally

As we pointed out recently, half the High Yield universe by market value today trades at 310bps, while the other half is at 1050bps. While the distressed list has a disproportionate representation of commodities (33%), this dispersion doesn't bode well for US High Yield, given default and distress ratios are increasing, even outside commodities. 

We commented recently that the higher the "distressed glut", the lower will be the recovery rate. Also, the number of distressed bonds is rising in Europe and of course our favorite "CCC credit canary" issuance levels has plummeted. When it comes to issuance levels and US High yield, year-to-date issuance is down by -16.3% according to SIFMA.

While looking more into issuance levels, we looked at the data provided by Dealogic through the blog Credit Market Daily from Dr Suki Mann, former UBS European Credit Market Strategist. When one looks at High Yield corporate bond issuance, one can clearly see that the issuance levels, given market gyrations have fallen from the proverbial cliff in January:

- graph source creditmarketdaily.com 

As we repeatedly pointed out in our missives, like any behavioral psychologist, we tend to focus on the process rather than on the content. Whereas every pundits and their dog focus these days on the correlation of oil and the relationship with equities, and fathom on a potential rebound of both, we prefer to stick to what we are seeing which is the evident deterioration in the broader credit picture and the implication for equities. The "process" is playing out we think. While yes we can expect indeed a short-term "Keynesian" rebound, we do remain medium to long term "Austrian" bearish and cautious in the grand scheme of things.

For instance, we reacquainted ourselves with what is happening in the Securitization world as of late, reading through Bank of America Merrill Lynch latest Securitization Weekly. We particularly read with attention their latest note from the 29th of January:

"Overview – Things are bad, at risk of getting worse

The bounce in oil should provide some near term upside/relief in securitized products (SP) credit, but will it last? Financial stress receded this week, but it is unprecedented for the Fed to be tightening at current elevated levels. As cheap as SP credit has gotten, we think additional downside risks are too high; stay long duration in agency MBS.

Last week, we compared the price pattern of ABX, the subprime index, back in 2007- 2009 with oil in 2014-2016 (Chart 1).

Our interest in oil stems from the correlation between securitized products credit prices and oil over the past year , as well as the correlation between oil and inflation breakevens, which underlies our recommendation to buy long duration agency MBS.

The ABX-oil comparison last week suggested to us that oil had the potential to decline down to the low 20s by March-April of this year. Naturally, oil rallied this week on that analysis, as news of some potential tightening of supply hit the market. Our experience with ABX tells us that these types of rallies are not unusual within the context of precipitous price declines and that fading the oil rally most likely makes sense. Given the correlations cited above, this suggests that selling or at least fully hedging riskier securitized products credit also makes. If oil goes lower, prices on mezzanine risk transfer, CMBS and CLOs are also likely to go lower, even though they are already at the cheapest levels in recent history.
To make matters worse, and to heighten the potential for some chaotic price declines, there is the matter of Fed policy. As we discuss next, given elevated levels of financial stress, we think the Fed’s decision to start tightening monetary policy in December created significant risks for financial markets. This week’s decision provided little indication to us that this risk will meaningfully alter policy decisions going forward. This suggests to us that downside risks for securitized products credit remain elevated, even after significant price declines in recent weeks and months.
This week’s rally in oil prices may be a precursor of some near term strength for mezzanine risk transfer, CLOs and CMBS, subject to the constraints mentioned above. We recommend either reducing or hedging exposures into such strength and moving up in quality to high quality, short spread duration sectors such as auto ABS. Meanwhile, we continue to recommend long duration agency MBS, with an added emphasis on prepayment protected stories with the 10yr yield dropping below 2.0%

Global financial stress on the rise

In Chart 5, we focus on the rise in financial stress since mid-2014, and show the 50-,
100- and 200-day moving averages.

The stress periods are seen as somewhat episodic, with stress rapidly elevating, and then subsiding, moving more or less back to the trend line defined by the 200-day moving average, which itself is steadily trending higher. The daily peak for the last two years was seen recently on January 20, and stress appears to now be subsiding, probably moving back to the 200-day moving average over the near term. Declining financial stress should be good for financial assets over the near term, including securitized products mezzanine credit. It probably will also give the Fed more comfort in hiking rates in March. This is where we see potential for additional downside in securitized products.

Consider the 2007-2009 experience for financial stress. Chart 6 shows a similar view to the ABX-oil view in Chart 1, benchmarking 2014-2016 versus 2007-2009.

The current cycle, where the January 20 peak was 0.65, appears benign relative to the super stressed levels of late 2008, when the GFSI hit a peak level of 3.01, almost 5x the current level. But just a week before the September 15, 2008 (the start of the global financial crisis), and for the prior year for that matter, the GFSI registered levels near 0.60, or right at about current levels. We have little reason to anticipate a shock to the financial system on the order of the financial disruptions during the GFC. But we think it is important to recognize that the pre-GFC financial stress is comparable to today’s levels, suggesting system vulnerability to shocks or policy errors.

It is in this context that we view the Fed’s tightening of monetary policy as very risky for financial assets. As Chart 7 shows, in 2007, with comparable levels of financial stress, the Fed was aggressively easing, not tightening; now, the Fed is tightening.

Tightening may be the correct policy for the Fed’s economic mandate, but that doesn’t mean financial assets will approve. Moreover, what makes matters more disconcerting for us this time is that, given the change in the political climate relative to the financial sector since 2008, it seems unlikely that there would be a strong (if any) policy response to financial system stress. The days of the Fed put, which arguably has been in effect since October 1987, appear to be over."

To get some sense of what might accompany higher levels of financial stress, we look at the relationship between oil and the GFSI over the past two years in Chart 8.

We actually show the inverse of oil, so oil in the 20-25 range corresponds to an inverse in the 0.4-0.5 range. Very roughly, Chart 8 suggests that if oil drops down to the 20-25 range, the GFSI could head up the 1.0 vicinity. This was the stress level last seen in 2011, which was “solved” by QE3. Would QE4 come in response to a return to comparable levels of financial stress? It’s possible, but given the recent track record, the Fed seems more likely to keep moving in the opposite direction of tightening. This scenario is not likely to be a good one for securitized products credit, in our view."- source Bank of America Merrill Lynch

While we agree with most of the points made by Bank of America Merrill Lynch made in their note, while we reading their interesting note a graph caught our attention, reminiscent of the heyday of 2007, namely the price action in both ABX prices and CMBX prices:

 - source Bank of America Merrill Lynch

Given all of the above, we strongly advocate selling "high beta" into strength and moving towards a more defensive position such as long duration and US high quality Investment Grade "domestically" exposed credit and/or very long dated US treasuries (30 years) or playing it via ETF ZROZ (for retail players).

If you want more compelling "arguments" validating our defensive stance we strongly recommend you read the latest note from Bahl & Gaynor - "It's not what you own that kills you… it's what you owe"

So, moving on to why US high quality Investment Grade credit is a good defensive play? Because of attractiveness from a relative value perspective versus Europe and as well from a flow perspective. The implementation of NIRP by the Bank of Japan will induced more foreign bonds buying by the Japanese Government Pension Investment Fund (GPIF) as well as Mrs Watanabe (analogy for the retail investors) through their Toshin funds. These external source of flows will induce more "financial repression" on European government yield curves, pushing most likely in the first place German Bund and French OATs more towards negative territory à la Swiss yield curve, now negative up to the 10 year tenor.

As per Bank of America Merrill Lynch Credit Market Strategist note from the 29th of January entitled "The great rotation into US credit", we agree with the points they are making:

"After the ECB meeting last week, and US data and BoJ this week, we think that the widening yield differential between US and foreign fixed income will re-ignite foreign demand, as US corporate bonds look increasingly relatively attractive (Figure 6).

Apart from the effects of US data strength, a lot of this relative re-pricing happened because actual and expected foreign monetary policy easing tends to widen yield differentials with US Treasuries (Figure 7).

Obviously it may take a little time before yield sensitive foreign investors transition from the initial stage of finding the new lower absolute yields unattractive, to appreciating that US corporate credit now looks much more attractive on a relative yield basis, and increase their buying (Figure 8).

Corporate yield differential between USD and EUR

While at the time of writing our index system had not updated for Friday’s market movements post the BoJ, as of yesterday (1/28) US and EUR 10-year corporate bonds yielded 4.10% and 1.94%, respectively, for a yield differential of 2.16% - up from 1.98% last week:

Post-BoJ Japanese corporate bond yields and spreads

Due to a favorable time zone our Japanese corporate bond index has in fact updated for the post-BoJ Friday session. We see that in reaction to BoJ negative interest rates, yields declined 6bps to 0.25% while spreads widened 1bp to 29bps (Figure 11).

In our experience Japanese investors have been heavy buyers of US corporate bonds since 2012 – initially mostly on a currency hedged basis but increasingly unhedged. Clearly we expect more buying, especially after the April 1st start of the new fiscal year in Japan. However, today’s -7.5bps move in the cross currency basis swap initial negates the additional yield advantage to US credit created by the BoJ’s action." - source Bank of America Merrill Lynch

If you want to somewhat "front-run" the GPIF and Mrs Watanabe, increasing allocation to US domestically exposed high quality Investment Grade credit makes sense as per Bank of America Merrill Lynch's note:

"US strength, global weakness. 

Our preliminary analysis of the 4Q earnings reporting season for US HG companies shows little evidence that the US economy is going into recession. Specifically for global high grade companies that derive more than 50% of revenue from abroad we are tracking -5% earnings growth for 4Q, a small deterioration from the actual reported number of -2% in 3Q. However, for domestic companies without foreign revenue earnings growth is tracking +8% in 4Q, which is strong even if down a bit from +10% in 3Q. In terms of topline growth we are tracking -5% for the global companies and +8% for their domestic counterparts – both numbers virtually unchanged from 3Q." - source Bank of America Merrill Lynch

Whereas we disagree with Bank of America Merrill Lynch is with their US economy views, we believe that the US economy is weaker than what meet the eyes and that their economists suffer from "optimism bias" we think (more on this in our third bullet point), but nonetheless high quality domestic issuers are definitely credit wise a more "defensive" play.

When it comes to following the flow and once again on why we focus on the process rather than the content, you have to "follow the flow" and when it comes to the implementation of NIRP, think clearly about the "implications".

• US Investment Grade Credit - Why you want to "front-run" Mrs Watanabe

Back in March 2015 in our conversation "Information cascade", we stressed the importance of following what the Japanese investors were doing in terms of flows:

"Go with the flow:
One should closely watch Japan's GPIF (Government Pension Investment Fund) and its $1.26 trillion firepower. Key investor types such as insurance companies, pension funds and toshin companies have been significant net buyers of foreign assets." - source Macronomics, March 2015

One should therefore not be surprised of the latest actions of the Bank of Japan in implementing NIRP which has already been implemented in various European countries and enforced as well by the ECB. As a reminder from last year conversation, this is the definition of "Information cascade":

"An information (or informational) cascade occurs when a person observes the actions of others and then—despite possible contradictions in his/her own private information signals—engages in the same acts. A cascade develops, then, when people “abandon their own information in favor of inferences based on earlier people’s actions”." - source Wikipedia

The Bank of Japan has merely engaged in the same acts as others. "Information cascade" is a trait of behavioral economics. You get our point when we state that we behave like behavioral psychologist when analyzing market trends and central banks "behavior".

When it comes to Mrs Watanabe, Toshin funds are significant players and you want to track what they are doing, particularly in regards to the so-called "Uridashi" funds. The Japanese levered "Uridashi" funds (also called "Double-Deckers") used to have the Brazilian Real as their preferred speculative currency. Created in 2009, these levered Japanese products now account for more than 15 percent of the world’s eighth-largest mutual-fund market and funds tied to the real accounted previously for 46 percent of double-decker funds in 2009 with close to a record 80% in 2010 and now down to only 22.8%.
As our global macro "reverse osmosis" theory has been playing out, so has been the allocation to the US dollar in selection-type Toshin as per Nomura JPY Flow Monitor report from the 15th of January 2016:

"We expect toshin momentum to remain strong in 2016, as suggested by the recent recovery. The maximum amount of risky asset investment under NISA per year has been raised since the beginning of the year. Risky asset investment via NISA tends to be especially strong in January, which will support toshin momentum in the near future. Risk sentiment among retail investors remains the key driver of toshin momentum too, and the latest Nomura Individual Investor Survey suggests a further recovery in retail investors’ appetite for risk assets. The survey also shows a strong preference for USD among foreign currencies, suggesting retail investors are likely to be dip buyers of USD assets via toshins.

The share of US assets in total foreign currency-denominated toshins continued to rise to 58.9% in December from 58.8% the previous month, the highest share since December 2001. US assets held via toshins declined to JPY17.1trn ($143bn), but non-US asset exposure declined more rapidly, especially exposure to EM assets. Interestingly, the share of EUR assets increased to 8.2% from 7.9% the previous month, while outstandings held in EUR-denominated assets inched up to JPY2.4trn ($20bn) from JPY2.3trn. November BoP data showed a recovery in Japanese investment in EUR-denominated securities, and the stabilisation in toshin companies’ exposure to EUR assets is worth monitoring, as it may show a gradual recovery in Japanese investors’ preference for EUR." - source Nomura.

Of course the woes of the Brazilian Real have been exacerbated by Mrs Watanabe and her growing dislike for her preferred carry trade since 2009...

Because GPIF and other large Japanese pension funds as well as retail investors such as Mrs Watanabe are likely to increase their portfolios into foreign assets, you can expect them to keep shifting their portfolios into foreign assets, meaning more support for US Investment Grade credit, more negative yields in the European Government bonds space with renewed buying thanks to a weaker "USD/JPY" courtesy of NIRP.

Whereas this is our assessment, when it comes to "front-running" the risk appetite of the Japanese crowd, although the "Ninth Wave" painting has warm tones in similar fashion than the upcoming "Japanese" allocation, which reduce the sea's apparent menacing overtones and tone of the market, the "macro" picture overall remains menacing as per our next bullet point.

• Macro -  Growth outlook? It's weaker than you think

We think that for "credibility" reasons, the Fed had no choice but to hike in December given the amount spent in its "Forward Guidance" strategy and in doing so has painted itself in a corner. We ended up 2015 stating that 2016 would provide ample opportunities in "risk-reversal" trades. The latest move by the Bank of Japan delivered yet another "sucker punch" to the long JPY crowd. Obviously, should the reverse decide to reverse course in 2016, there will be no doubt potential for significant rallies in "underloved" asset classes such as Emerging Market equities. But, for the time being, the macro picture is telling us, we think that regardless of how some pundits would like to spin it, not only is the credit cycle past "overtime" and getting weaker (hence our earlier recommendations in our conversation) but, don't forget that there is no shame in being long "cash". It is a valid strategy. Particularly given the messages sent by various markets as illustrated recently in Bank of America Merrill Lynch's GEMs Inquirer note from the 28th of January entitled "The Dark Messages of the Markets":

"Mkts consistent with a double digit contraction in EMs EPS

We respect the messages embedded in diverse markets. We highlighted the signals from Dr. Sotheby’s (BID), Dr. Haliburton (HAL), and Dr. Copper, all falling more than 50% from their recent highs – which could reflect weak demand from plutonomists (rich people), energy capex, and Chinese infrastructure – the key drivers of global growth in the past fifteen years.

Additionally, other indicators including transport stocks, the Baltic Dry Index, high yield bond spreads, the KOSPI, cubicle makers, shipping companies, palladium prices, the stock-bond ratio, are all suggesting a severe earnings recession in Asia and emerging markets. How severe? For EMs, USD EPS growth could contract about 15% in 2016. Consensus is at plus 8.4% EPS growth for 2016 for emerging markets (and 6.5% for Asia ex-Japan). (We combine all these growth-sensitive market prices into one indicator to divine EPS growth). Its message is consistent with Nigel Tupper’s global earnings revisions index. From these levels, both have been associated with policy easing, not tightening. We remain suspicious of cheerful consensus growth forecasts, which display a persistent upward bias, and are likely to be revised down. The Wu-Xia synthetic Federal funds rate (Bloomberg: WUXIFFRT Index) LEADS EM equities by 18 mths, and has been tightening since mid-2014, and the Fed forecasts further tightening by 100bps this year.

Valuations not close to cheap in Asia/EMs

Asia ex-Japan is trading at an EV/Net income of 19.9x, compared with an average of 21.7x over past 21 years. This is 0.2 standard deviations below the mean. At market lows, it normally gets to levels around 13x. We would caution against getting too excited by the 1.2x PB in ex-Japan Asia (and EMs) – the ROEs in both region are under pressure, and flattered by a rise in corporate leverage. We need to see a stand-still (or a reversal) of US monetary tightening for us to re-assess our negative views. And/or, much better value." - source Bank of America Merrill Lynch

The question therefore you need to ask yourself is if the FED is going to eventually "blink" during the course of 2016. Because, as put bluntly in Bank of America Merrill Lynch's note, all the Doctors put together do not point towards a "bullish" outcome for growth:

- source Bank of America Merrill Lynch

Financial conditions since mid 2014, that's what credit is telling you, that's what oil prices are telling you and that's what the 3 doctors have been telling you. The damage has been done and while we can understand why the FED has decided to defend its "credibility", we all know looking at the lofty valuations touched, that they should have tightened much earlier one rather than boosting further up "asset prices" for the "plutonomists" to paraphrase Bank of America Merrill Lynch.

In our conversation of November 2013 entitled "Squaring the Circle", we also argued that the performance of Sotheby’s, the world’s biggest publicly traded auction house was indeed a good leading indicator and has led many global market crises by three-to-six months. It has proved a timely indicator of potential global stock markets reversal. Whenever its price reached 50 or so with sky high valuations, a reversal has never been far away. 

Finally, when it comes to our positioning relative to the US recessionary crowd, we believe that a flattening of the US yield curve is never a good sign, particularly for the US financial sector which has been vaunted by some as a "compelling" buy. We will dispel this belief in our final chart.

• Final chart - Why a flatter yield curve is not good for the financial sector

We have been fairly vocal on our take on the direction that US long bonds would take given our deflationary incline. We have in fact hinted on numerous occasions that we had  been increasing our long duration exposure in conjunction with playing the rebound in gold miners (yes, disclosure we are as well, long ABX aka Barrick Gold). 

But if the 3 Doctors listed above don't tell you enough about the state of affairs, then, maybe the state of the US yield curve might tell you a little bit more. To that effect, we would like to point out the shape of the yield curve for our final chart extracted from Bank of America Merrill Lynch latest Securitization Weekly from the 29th of January:

"This week gave some indications of what this somewhat bleak view of ours might mean for rates and the yield curve (Chart 9): as of writing, the 10yr stands at 1.94, the lowest level since April 2015, and the 2yr-10yr spread of 115 bps is the lowest since early 2008. 

This is consistent with what we are looking for this year and why we have persistently recommended a long duration exposure in agency MBS, down in coupon (DIC) in passthroughs and Zs in CMOs. Following on the above discussion, we still see things as follows: the Fed likely will continue to push up short rates and thereby lower growth expectations, anchoring the back end of yields, and flatten the yield curve even more. The only change from this week is that, with new lows in treasury yields, we emphasize the need to own relatively stable long duration assets." - source Bank of America Merrill Lynch

Yes indeed, flatter is not good. And if, like us, you think that US Financials are the second derivative of an economy, meaning that putting on the "beta play" would only be justified by an acceleration of the growth outlook (loan growth) then, we think, there is nothing compelling in playing the "supposedly" value play in US Financials (When it comes to Europe, you already know our stance, stay out of it).

To complete our rebuttal of the "attractiveness" of US Financials, we would like to point out towards  Reorient Group strategist David Goldman's take in their note from the 21st of January entitled "Where to Hide?":

"Underperformance by the banking sector always is a bad sign for markets and the economy; it suggests that the credit mechanism is clogged, with knock-on effects for the rest of the economy. As we observed in our Jan. 18 Week Ahead report, the deterioration of credit conditions and the flattening of the yield curve have left the banks with sharply reduced earning potential. The banks invest more in Treasury securities than in business loans, and the flattening yield curve crushes the differential between their cost of funds and the yield they earn on Treasuries.

Banks’ net interest margin is already at the lowest level in history.

- source Reorient Group

So, before you decide to jump again on the "beta" wagon, think very clearly on how US Financials can be "profitable" in such a deflationary environment and a significant flattening of the yield curve.
There might be at least some solace in US Financials versus European Financials (in particular Deutsche Bank and Italian banks woes), but apart from that, we don't see any "screaming buy" in the former and "zero interest" in the latter.

"Growth is the only evidence of life." - John Henry Newman, British clergyman

Stay tuned!

Credit - Osmotic pressure

"We want a story that starts out with an earthquake and works its way up to a climax." - Samuel Goldwyn 

Looking at the continued sell-off in Emerging Markets currencies with the Indian Rupee touching a record low level of 65.56 before bouncing back by 2.1%, on Friday the biggest move since June 2012 and the Brazilian Real which continued its slide before bouncing back as well 3.7% to 2.3488 following a 60 billion US dollar central bank pledge, made us venture towards our distant memories, in similar fashion like our previous posts made us revisit our musical souvenirs from the 80's.

Emerging Currencies "tapering" in true MMA fashion since Bernanke started mentioning "tapering" its QE programme, graph source Thomson Reuters Datastream / Fathom Consulting / Macronomics:

So why "Osmotic pressure" as our chosen title you might rightly ask?

This time around, our chosen title is directly linked to capital flows we are seeing, with the outflows from Emerging Markets towards Developed Markets. 

As the Osmosis definition goes:

"When an animal cell is placed in a hypotonic surrounding (or higher water concentration), the water molecules will move into the cell causing the cell to swell. If osmosis continues and becomes excessive the cell will eventually burst. In a plant cell, excessive osmosis is prevented due to the osmotic pressure exerted by the cell wall thereby stabilizing the cell. In fact, osmotic pressure is the main cause of support in plants. However, if a plant cell is placed in a hypertonic surrounding, the cell wall cannot prevent the cell from losing water. It results in cell shrinking (or cell becoming flaccid)." - source Biology Online.

Nota bene: Hypertonic

"Hypertonic refers to a greater concentration. In biology, a hypertonic solution is one with a higher concentration of solutes on the outside of the cell. When a cell is immersed into a hypertonic solution, the tendency is for water to flow out of the cell in order to balance the concentration of the solutes." - source Wikipedia

So the reasoning behind our chosen title is linked to our past "biology" classes of course, given since 2009, the effect of ZIRP has led to a "lower concentration of interest rates levels" in developed markets (negative interest rates). In an attempt to achieve higher yields, hot money rushed into Emerging Markets causing "swelling of returns" as the yield famine led investors seeking higher return, benefiting to that effect the nice high carry trade involved thanks to low bond volatility.

We did send a warning in June in our conversation "The Daisy Cutter":

"If you think rising yields are only putting global trade at risk, think as well how it will ripple through in various sectors and countries." - source Macronomics 

This is what we envisaged in our conversation "Singin' in the Rain" as well:

"If the dollar goes even more in short supply courtesy of Bernanke's "Tap dancing" with his "Singin' in the Rain", could it mean we will have wave number 3 namely a currency crisis on our hands? We wonder..."

The mechanical resonance of bond volatility in the bond market started the biological process of the buildup in the "Osmotic pressure" we think and bond volatility has yet to recede. 

The volatility in the fixed income space has remained elevated as displayed by the recent evolution of the Merrill Lynch's MOVE index rising from early May from 48 bps  towards the 100 bps level again, whereas the VIX, the measure of volatility for equities is finally reacting - graph source Bloomberg:

MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.

CVIX index = DB currency implied volatility index: 3 month implied volatility of 9 major currency pairs.

Of course, what we have been tracking with interest is the ratio between the ML MOVE index and the VIX which remains elevated from an historical point of view if we look back since October 2000 - graph source Bloomberg:

With VIX picking up, no wonder the ratio between the MOVE index and VIX has fallen from last week 7.06 level towards 6.10 as the contagion in the equities space is finally picking up. Hence, last week our "Fears for Tears" concerns for our equities friend as the "tapering" noise increases as we move towards September.

As a reminder, we started pondering about the potential end of the goldilocks period of "low rates volatility / stable carry trade environment in June:

"As pointed out by Bank of America Merrill Lynch's note stable carry thrives in low rates volatility environment, the recent spike in US bonds volatility has had some devastating effect in high yielding assets:

"Carry trades love low risk-free interest rates, but they love low interest rate volatility even more. This is why over the past three years, billions of dollars have poured into high yielding assets like risky corporate bonds, emerging market currencies, and dividend paying stocks, driving their risk premiums to abnormally low levels."

So what we are witnessing right now is indeed "reverse osmosis" in Emerging Markets, and the osmotic pressure which has been building up is no doubt leading to an "hypertonic solution" when it comes to capital outflows in Emerging Markets.

Let us explain:

In a normal "macro" osmosis process, the investors naturally move from an area of low solvency concentration (High Default Perceived Potential), through capital flows, to an area of high solvency concentration (Low Default Perceived Potential). The movement of the investor is driven to reduce the pressure from negative interest rates on returns by pouring capital on high yielding assets courtesy of low rates volatility and putting on significant carry trades, generating osmotic pressure and "positive asset correlations" in the process. Applying an external pressure to reverse the natural flow of capital with US rates moving back into positive real interest rates territory, thus, is reverse "macro" osmosis we think. Positive US real rates therefore lead to a hypertonic surrounding in our "macro" reverse osmosis process, therefore preventing Emerging Markets in stemming capital outflows at the moment.

So in this week's conversation, as we moved towards the "interesting" month of September we will revisit some of our thoughts from our conversation "Singin' in the Rain" and look at the risk and opportunities lying ahead.

As a reminder from our June conversation:

"We got seriously wrong-footed by the market's reaction to the "tapering QE" scenario and we still think at some point the Fed will maybe redirect its buying towards MBS, given that rising rates could seriously dent any hope of a "housing recovery" should the move continue at a rapid pace like it has this week."

The "housing recovery is indeed at risk - graph source Thomson Reuters Datastream / Fathom Consulting:

As indicated by Prashant Gopal on the 22nd of August in Bloomberg in his article "U.S. Mortgage Rates Jump to Two-Year High With 30-Year at 4.58%": 

"The average rate for a 30-year fixed mortgage rose to 4.58 percent this week from 4.4 percent, Freddie Mac said in a statement today. The average 15-year rate climbed to 3.6 percent from 3.44 percent, the McLean, Virginia-based mortgage-finance company said. Both were the highest since July 2011.

Homebuyers are rushing to take advantage of historically low borrowing costs before they increase any more. Existing-home sales in July jumped 6.5 percent to the second-highest level in six years, the National Association of Realtors reported yesterday. Those transactions largely reflect closings of contracts signed a month or two earlier, when mortgage rates were just beginning to edge up." - source Bloomberg

From the same article:

"The Mortgage Bankers Association’s index of applications to lower monthly payments fell 7.7 percent in the week ended Aug. 16, the 10th straight decline. A measure of purchases rose 1.2 percent, the trade group said yesterday.

The 30-year fixed mortgage rate is well below its average of about 6.3 percent for the past 20 years, according to data compiled by Bloomberg. The 20-year average for a 15-year loan is about 5.83 percent." - source Bloomberg

Yes but, there is indeed a "convexity issue at play" given the US average Maturity of Fixed Rate Mortgages has been steadily increasing in the last decades - graph source Thomson Reuters Datastream / Fathom Consulting:

 And as our very wise credit friend former head of credit research said on the subject of convexity in June in our conversation "Singin' in the Rain":

"Convexity is a bigger issue in all the pensions + fixed income funds. That's one reason mortgages have been whacked. the Fed will basically have to do a ECB - stop buying USTs and start buying RMBS. But pensions (or Fannie / Freddie) do not hedge MBS with USTs - they do it with LIBOR"

At the time we argued:

"The Fed is likely to step in and actually increase QE to try and hold rates down, because mortgage rates have spiked substantially over the last month from a low of around 3.5% to around 4.3%, we have to agree with our friend that a "new dance" routine from the Fed might be coming." 

Central Banks Assets - graph source Thomson Reuters Datastream / Fathom Consulting:

Why the Fed might indeed increase QE? 

Point number 1:

Because the Fed is facing a raft of sellers and the economy is not as strong as it seems.

For instance, China’s holdings in May were $1.297 trillion, less than the $1.316 trillion reported by the Treasury last month. China’s stake dropped by $21.5 billion in June, or 1.7 percent according to Bloomberg as per Treasury Department data released on the 14th of August. On top of that US Commercial Banks as well have been selling as indicated by Bloomberg Chart of the Day from the 19th of August - graph source Bloomberg:

"U.S. commercial banks are dumping Treasuries at the fastest pace in a decade and boosting loans, helping make the debt securities the world’s worst performers as the economy gains momentum.

The CHART OF THE DAY shows banks’ holdings of U.S. Treasury and agency debt tumbled $34.7 billion to $1.81 trillion in July, the biggest monthly decline in 10 years, according to the Federal Reserve. The level dropped to $1.79 trillion in the first week of August, Fed data showed on Aug. 16. Also tracked are 30-year bond yields climbing to a two-year high. The lower panel records commercial and industrial loans as they surged to $1.57 trillion, the highest since 2008.

Bank sales of Treasuries accelerated after Federal Reserve Chairman Ben S. Bernanke said on June 19 policy makers may reduce the bond-buying program they use to support the economy. Concern the Fed will trim its $85 billion a month of Treasury and mortgage purchases helped send notes and bonds due in a decade or longer down 11 percent in the past 12 months. It was the biggest loss of 174 debt indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies." - source Bloomberg.

Point number 2:

Our "omnipotent" magicians are desperately trying to "bend" the velocity curve and anchor higher inflation expectations. On that note we read with interest Professor Rogoff comments in Bloomberg article by Aki Ito and Michelle Jamrisko on the 12th of August - "Rogoff Saying This Time Different Calls for Reflation":

"Rogoff is espousing aggressive monetary stimulus, even at the cost of moderate price increases. At a time of weak global inflation, higher prices may even help the U.S. economy by lowering real interest rates and reducing debt burdens, he said.

“In more normal times, you’re looking for the central banker to be an anchor against high inflation expectations and to assure investors that inflation will stay low and stable to keep interest rates down,” Rogoff, co-author with Carmen Reinhart of the 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” said in an interview. Now “we’re in this situation where many of the central banks of the world need to convince the public of their tolerance for inflation, not their intolerance.”

G-7 Inflation

Central banks across the developed world are struggling with inflation that’s too low. Consumer price increases in all but one of the Group of Seven economies are currently running under 2 percent, which has become the standard goal in recent years for monetary authorities. Two years ago, deflationary Japan was the only country struggling with below-target inflation."  - source Bloomberg.

The only issue is once the "Inflation Genie" is Out of the Bottle" as warned by Fed's Bullard in 2012, it is hard to get it back under control:

“There’s some risk that you lock in this policy for too long a period,” he stated.  ”Once inflation gets out of control, it takes a long, long time to fix it”

While the recent jump in interest rates, has created an "hypertonic surrounding" in the reverse osmosis plaguing Emerging Markets, it has had some positive effect somewhat for the insurance sector as well as the Auto Industry given that it has provided some relief in terms of "reserve adequacy" for insurers and a relief on "reinvestment rates" to plug the growing gap in pensions liabilities hindering the allocation of capital for the Car industry giants.

As a reminder from our conversation "Cloud Nine": 

"If we look at GM and FORD which went into chapter 11 due to the massive burden built due to UAW's size of "unfunded liabilities", they are still suffering from some of the largest pension obligations among US corporations. Both said this week they see a significant improvement in their pension plans liabilities because of rising interest rates used to calculate the future cost of payments. When interest rates rise, the cost of these "promissory notes" fall, which alleviates therefore these pension shortfalls. So, over the long term (we know Keynes said in the long run we are all dead...), it will enable these companies to "reallocate" more spending on their core business and less on retirees. Charles Plosser, the head of Philadelpha Federal Reserve Bank, argued that the Fed should have increased short-term interest rates to 2.5% in 2011 during QE2."

But, of course, what matters is indeed the "velocity" of the movement, and the intensity. So far we have avoided a major sell-off in credit. 

As indicated by Megan Hickey and Zachary Tracer in their Bloomberg article from the 1st of August commenting on US insurer's Metlife's results entitled "Metlife Says $10.9 billion of Bond Gain Erased, More Than Crisis", what matters is the pace of the rise in interest rates:

"MetLife Inc., the largest U.S. life insurer, saw $10.9 billion in bond gains wiped out in the three months ended June 30 as interest rates rose, exceeding the decline in any quarter of the financial crisis.

Net unrealized gains narrowed to $20.9 billion on the portfolio of available-for-sale fixed-maturity securities, from $31.8 billion three months earlier. The tumble helped cut MetLife’s bond holdings about 4.8 percent to $356.5 billion." - source Bloomberg

They also added the following comments from a Fitch Ratings analyst:

"Losses tied to deterioration in the creditworthiness of issuers are more worrisome than the more recent fluctuations related to interest rate movements, said Douglas Meyer, an analyst at Fitch Ratings. He said higher rates can help increase investment income at insurers and improve profitability on some products.

“The jump in interest rates, the way we look at it, it has a positive impact on the industry,” he said. “This will provide relief in terms of reserve adequacy, it will provide relief on reinvestment rates.”

An extreme spike in rates of more than 5 percentage points could hurt insurers, he said. Clients might redeem products that offered lower yields, forcing insurers to sell securities at a loss to meet withdrawal demands, he said." - source Bloomberg.

We quoted our fellow blogger and friend Martin Sibileau back in June in "Singin' in the Rain" on the risk ahead for credit:

"If Ben triggers a sell off in credit with the insinuation of tapering, the dealers on the other side, making the bid for the investors, will be forced to do the rate hedge their investors did not do, because they must be interest rate neutral! That means selling US Tsys for an average of 85% and 50% of positions in HY and IG respectively! In other words, the potential sell-off tomorrow may trigger a surprising self-feeding convexity. How are precious metals to react in such scenario?" - Martin Sibileau

And as we discussed above, "macro" osmosis has led to "positive correlations". When it comes for risks ahead, we share CITI's Matt King views from his European Credit Weekly, namely that after a pleasant summer for credit, it might be time indeed to continue to reduce exposure to neutral:

"Dominoes

One of my favourite games as a child was always dominoes. No, not the rather tedious business of laying tiles end to end and trying to match up their spots.

Rather, the much more thrilling challenge of creating long and winding lines before knocking them over, and being amazed at the far-reaching devastation which could be caused with a single flick of the finger.

European credit feels at present to us like the last asset in a similarly long chain – seemingly remote from the problem of higher UST yields, almost immune to date to the outflows starting to occur elsewhere, and yet nevertheless with an intricate linkage to other assets which belies its apparent distance.

Ironically, our best guess has been and remains that the domino run will not quite get started in the first place – or, at a minimum, that some benign and omnipotent central banker will reach in to remove a domino or two and stop any run before it reaches us. Our house forecasts show the UST backup abating, show credit spreads remaining tight, and the EM sell-off remaining contained to mid-2014.

Moreover, it is striking just how well spreads have generally performed in the face of the backup in UST yields to date. EM hard currency mutual funds, for example, have lost nearly one-third of the last three years’ cumulative inflows (Figure 2), against which the backup in EM spreads, while notable, is hardly cataclysmic. 

The outflows from credit funds have been tiny by comparison, and in Europe have been almost negligible. Unless outflows pick up very significantly, there is every reason to think € spreads remain resilient." 

Besides, in many respects the risks as we head into September seem rather obvious. Tapering has been extremely well flagged. The Fed minutes suggest it will happen this year, but did not seem overly attached to our view of a September start.

German elections have been talked about a great deal, but seem ever less likely to bring about a significant change in the political landscape. Conscious corporate releveraging seems largely confined to the US. Supply is likely to pick up significantly, but is likely to have been widely anticipated. Above all, we have little sense of any build-up in complacent longs during the summer in the way we earlier feared, as is vouched for by the lack of outperformance of most high-beta names.

And yet despite all this, we still recommend reducing any remaining longs in € credit to neutral." - source CITI

CITI's Matt King also added:

"When playing dominoes, it usually takes a few goes before the run really gets started (unless, of course, you didn’t mean for it to start, in which case there’s no stopping it). Our best guess is likewise that, despite the somewhat precarious lineup, not a great deal happens over the next few weeks, and that spreads trade more or less sideways.

But that’s a bit like leaving the room and hoping that when you come back later you’ll still find all the dominoes standing just as you left them. As those with younger brothers will know, you ought to be okay – but at this point we just don’t think you’re being paid for it." - source CITI

The issue for us is that from a "macro" perspective, if the reverse "osmosis" has truly started and with "positive correlations" still in place, there is indeed not only heightened risk from the continuation of the sell-off in Emerging Markets which could affect Developed Markets in the process, but, exogenous factors with political tensions and agendas could indeed roil further risky asset classes.

The $3.9 trillion of cash that flowed into emerging markets over the past four years has started to reverse, indicative of the "Osmotic Pressure" and "reverse osmosis" process taking place.

As we posited back in June for Emerging Markets:

"Why are we feeling rather nervous?

If the Fed starts draining liquidity, some "big whales" might turn up belly up. Could it be Chinese banks defaulting? Emerging Markets countries defaulting as well due to lack of access to US dollars?" - source Macronomics, June 2013, "Singin' in the Rain"

Moving back to our friend Martin Sibileau's June question on "precious metals":

"In other words, the potential sell-off tomorrow may trigger a surprising self-feeding convexity. How are precious metals to react in such scenario?"

At the time we argued that precious metal had further to fall and they did.

But, as we move towards September and what has already started is a bounce back. In similar fashion to what we confided in our January conversation "If at first you don't succeed...", we have once again put in practice the effect of our magicians ("omnipotent" central bankers practicing their "secret illusions") by starting being long gold miners via ETF GDX and some selected miners as well.

The S&P 500, the US 10 year breakeven, please note we have added Gold into our previous Chart,  graph source Bloomberg:

Once again we have broken our Magician's Oath:

"As a magician I promise never to reveal the secret of any illusion to a non-magician, unless that one swears to uphold the Magician's Oath in turn. I promise never to perform any illusion for any non-magician without first practicing the effect until I can perform it well enough to maintain the illusion of magic."

What is the rationale behind our call? We once again come back to our June conversation "Singin' in the Rain" where we quoted David Goldman's article about Gold and Treasuries and bonds in general which he wrote in August 2011 (the former global head of fixed income research for Bank of America):

"Why should gold and Treasury bonds go up together? Gold is an inflation signal and bonds are a deflation hedge. At first glance it seems very strange for both of them to rise together. Why should this be happening?

 The answer is simple: bonds are an option on the short-term interest rate, and gold is a perpetual put option on the dollar. Both rise with volatility.

 It’s like the old joke about the thermos bottle: “How does it know if it’s hot or cold?” If the policy compass is spinning and there’s no way to predict how governments will react, you don’t know whether to hedge for inflation or deflation, so you hedge for both. By put-call parity, if there is huge volatility in the policy responses of governments, the option-value of both gold and bonds goes up."

Our thermos bottle is lately behaving accordingly because the YTD movements in 5 year forward breakeven rates is falling again, which is indicative of the strength of the deflationary forces at play - source Bloomberg:

The 5 year forward breakeven was at 2.56% on the 21st of August but it has been breaking lower as per the most recent reading - graph source Thomson Reuters Datastream / Fathom Consulting:

QE and the US Dollar - graph source Thomson Reuters Datastream / Fathom Consulting:

Dollar index versus Gold - graph source Bloomberg:

So far we have bought the put leg of the put-call parity strategy and we are indeed thinking of adding the call leg shortly. That's all for magic tricks. We enjoy your company, dear readers, but we should not be breaking our Magician Oath too often as you haven't sworn to uphold the Magician's Oath in turn yet...

On a final note, in true Pareto efficient economic allocation, while some pundits wager about simultaneous developments having contributed to the weakness in Emerging Market equities, for us Emerging Markets have been simply the victims of currency wars ("Have Emerging Equities been the victims of currency wars?"), "Abenomics", and of course "reverse osmosis" courtesy of positive real interest rates in the US. It is therefore not a surprise to see that the biggest beneficiary of "reflationary"policies have indeed been the Japanese as displayed in Bloomberg's Chart of the Day from the 22nd of August displaying the Earnings Per Share for 6 regions:

"Prime Minister Shinzo Abe’s policies to lower the yen and end deflation are already paying off for corporate earnings, with Japanese companies’ profits outpacing the rest of the world.

The CHART OF THE DAY shows earnings per share in six regions tracked by Bloomberg rebased to 100 at the end of June 2011. Profits for the Topix climbed the most, rising 32 percent as companies in Japan’s equity benchmark recovered from the March 2011 earthquake that damaged large parts of the country’s north east. The lower panel of the chart shows the yen’s decline against nine other world currencies.

“Japan has been through a full earnings cycle over the past two years,” said Mert Genc, a London-based strategist at Citigroup Inc., which composed the graph. “First, largely as a result of the earthquake, earnings halved. But then they doubled again, with the latest boost coming from weakness in the yen and improving economic performance.”

Japanese exports jumped by the most since 2010 in July, showing the economy has benefited from the yen’s 22 percent slide against the dollar since the end of 2011. Earnings in the U.S. have climbed 16 percent since June 2011 as the Federal Reserve’s bond-purchasing program helped to stimulate growth. Profits in the U.K., the euro area, emerging markets and Australia have declined in the same period.

Analysts estimate earnings in the Topix will grow 11 percent in 2014, according to Bloomberg data, in line with the average for the other regions in the chart of the day." - source Bloomberg.

The MSCI Emerging Markets Index has declined 12 percent this year, compared with a 12 percent gain for the MSCI World Index of companies in advanced economies.

"Remember, the storm is a good opportunity for the pine and the cypress to show their strength and their stability." - Ho Chi Minh 

Stay tuned!

The surge in the Brazilian real versus the US dollar marks the return of the "Double-Decker" funds.

"If you ain't just a little scared when you enter a casino, you are either very rich or you haven't studied the games enough." — VP Pappy

As we indicated in October 2011, in our conversation "Misery loves company", the reason behind the large depreciation of the Brazilian Real that specific year was because of the great unwind of the Japanese "Double-Decker" funds. These funds bundle high-return assets with high-yielding currencies. "Double Deckers" were insignificant at the end of 2008, but the Japanese being veterans of ultralow interest, have recently piled in again.

These funds represented 126 billion USD in asset in 2011. Following the great unwind we discussed back in 2011, these funds have recently surged back to 106.4 billion USD last month from November according to a Bloomberg article from Jun Yang from the 25th of January - Double-Decker Funds Grow Most in 10 Months in December on Real:
"The total net asset value of the so-called double-decker funds -- designed to first invest in high-yielding assets like junk bonds and then buy into currencies to further increase returns -- rose 7.9 percent to 9.63 trillion yen ($106.4 billion) last month from November, the steepest increase since February, according to data compiled by Thomson-Reuters unit Lipper. Created in 2009, the products now account for more than 15 percent of the world’s eighth-largest mutual-fund market. The Brazilian real was among the 10 best-performing currencies against the yen last month, gaining 9.5 percent as the central bank intervened to stem the currency’s decline against the U.S. dollar. Products tied to the real accounted for 46 percent of double-decker fund assets last month, as Japanese individuals looked to beat the country’s low interest rates by looking overseas for higher-return investments. The gain in the real helped boost demand for the funds, Shoko Shinoda, a Tokyo-based analyst at Lipper, said by phone. Net sales jumped 31 percent in December from the previous month, according to the research company’s data." - source Bloomberg

The surge in the Brazilian Real versus the US Dollar, with the Japanese investors once again playing their favorite high-yielding currency - source Bloomberg:

In blue the Brazilian real versus the US dollar, in red the Australian dollar versus the US dollar, as one can see the correlation between the Australian currency and the Brazilian real broke down spectacularly in 2011!

From the same Bloomberg article:
"Double-decker products use non-deliverable forward contracts for foreign exchange to leverage returns and pay monthly dividends, catering to Japanese individual investors who want a regular income, such as retirees. The real has been preferred by Japanese funds to other emerging-market currencies because it’s more actively traded in the global foreign-exchange market, Shinoda said. Nomura Asset Management Co.’s real-linked “U.S. High Yield Bond Fund,” is a double-decker fund investing in U.S. dollar- denominated industrial bonds. Its net asset value increased 6.8 percent in December, after falling 1.4 percent a month earlier, according to data compiled by Bloomberg. Total returns on the fund were 21.8 percent in 2012, compared with a 5.4 percent loss the previous year, the data show. The real’s drop over the past two years, amid a series of interest-rate cuts in Brazil, and subsequent fluctuations in returns on double-decker funds, have prompted Japan’s financial regulator to require more disclosure about the products’ risks, making sales more difficult, said Sadayuki Horie, a Tokyo-based researcher at Nomura Research Institute." - source Bloomberg

At the same time Brazilian companies have sold the most junk bond on recort since May 2011 last Month according to Boris Korby from Bloomberg in his article - Junk Bond Frenzy Poised to Spill Into February: Brazil Credit from the 1st of February:
"Brazilian companies led by Banco do Brasil SA sold the most junk debt since May 2011 last month as unprecedented global demand for high-risk securities enabled the neediest borrowers to chop their financing costs. State-owned Banco do Brasil sold $2 billion of junior subordinated perpetual bonds rated BB by Standard &Poor’s in the nation’s second-largest high-yield sale on record, pacing $4.25 billion of speculative-grade offerings in January. Junk- bond issuance accounted for 81 percent of Brazil’s corporate debt sales, versus 34 percent globally and 18 percent in the country last year, data compiled by Bloomberg show. 
With U.S. Treasury yields touching a nine-month high, debt investors are turning to the riskiest emerging-market bonds as they face diminishing returns on their safest holdings. That’s allowed junk-rated companies in developing nations to cut their borrowing costs to a record 6.56 percent last month." - source Bloomberg

According to Bloomberg, the amount of Brazilian junk bonds sold was second only to China among emerging markets last month. High-yield issuance in China reached at least $5.3 billion, data compiled by Bloomberg show.

The heat is on...

"The gambling known as business looks with austere disfavor upon the business known as gambling." - Ambrose Bierce

Stay tuned!