Attack of the Killer BBBs
Although not recognized, the U.S. economy is in recession. Danielle DiMartino Booth wrote in today’s Daily Feather,
As one manufacturer after another warns that hopes for a second-half rebound is no longer in the cards, the trade war hit to the U.S. factory sector promises to increase the job cuts that have begun in industrials. You may have noted that yesterday’s data also revealed industrial production formally entered recession in this year’s first two quarters. (emphasis in the original)
In the critical transportation sector, Wolf Street, calls transportation “ugly.” Wolf Richter writes,
Freight shipments in the US across all modes of transportation – truck, rail, air, and barge – fell 5.3% in June compared to June last year, after having fallen 6.0% in May, the seventh month in a row of year-over-year declines, according to the Cass Freight Index for Shipments.
That index is now below where it was in 2014. Transportation was rockin a year ago but now the FTR Trucking Conditions Index is down below zero for the last three months. “Most of the weakness is in the industrial sector, so trucking activity related to consumer demand should be relatively stronger than the rest of the industry,” explained Avery Vise, FTR’s VP of trucking. But eventually, consumer demand will sour.
Real Vision’s Raoul Pal sees rising risk of a global recession — and that “a ‘doom loop’ could quickly take matters from bad to catastrophic.”
So what is the “doom loop”? In Pal’s words,
Phase One, the business cycle weakens, credit begins to widen, corporate cash flow worsens a tad and shares fall and volatility increases. I think that's where we've got to now. I think, Phase One, we accomplished, and it started really in about October. Phase Two, the business cycle weakens again, credit widens more, cash flow gets worse as do profits, tax receipts fall, and state pension funds stop buying debt. Big BBB stocks fall, and bonds fall even more sharply, equities fall hard. So, I think this is the next phase. And I think it's coming after the summer….
Okay, let's go into Phase Three. This is when things get ugly. The baby boomers start to panic to get out of equities permanently. This downgrades the BBBs to junk, the EU banks can't take the funding stress and the ECB and the government step in. Credit spreads explode, credit seize up entirely as pension funds are forced sellers on downgrades. Equities going to tailspin, there are no natural buyers. Credit widens dramatically, offered only, no bids, junk bond market overwhelmed. Pension funds get to trouble, defaulting on obligations. Big famous companies are being forced towards bankruptcy unnecessarily.
Mr. Pal points out that in addition to the largest amount of junk debt ever outstanding, $1 trillion, there is $4 trillion in BBB debt, which is just a notch above junk. Corporate debt totals $10 trillion and is 47 percent of GDP (according to Fed data).
Roughly $1 trillion in BBB debt is in just five companies plus the shale industry. The five are household names: AT&T, Ford, General Motors, General Electric, and Dell.
Jerome Powell’s January hawk-to-dove pivot is now understandable. He can’t afford for the bonds of Blue Chip names to tip into junk land where buyers will be few and far between.
Christophe Ollari says “We are now in the ultimate bubble, which is just inflating the financial asset to keep the financial condition as loose as possible…” He pointed out on Real Vision, the Federal Reserve “can’t afford a burst because they don’t have the meaningful tool to address the consequences of a massive downturn.”
Ollari sees a currency war in progress. He believes central bankers know their limitations and all they can do is lower rates or “out-dove the doves.” This, at a time when, “markets are extremely addicted to central bank answers.”
But, do the PHds running the central banks have the answers? Likely, no more than in 1974 when FA Hayek began his Nobel Prize acceptance speech, “We have indeed at the moment little cause for pride: as a profession we have made a mess of things.”
Hayek never lived to see the half of it. There is $14 trillion in sovereign debt with negative yields. The time value of money turned on its head. Why would anyone buy debt that required the creditor to make payments to the debtor? Because these sovereign bonds can be pledged as collateral or regulation requires the holding of these sovereigns.
Hayek concluded,
There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, “dizzy with success,'' to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.
Central Bankers were once the most trusted in government. However, in the last decade skepticism of their magical banking powers has led to the anarchy of Bitcoin and other crypto-currencies. Daniel Gros and Felix Roth wrote in 2009,
Central bankers all over the world should redouble their efforts to regain the trust of the people towards their institution. The recent criticism of the Federal Reserve in the US Congress might otherwise turn out to be harbinger of tougher times to come.
Ten years on, those tougher times have arrived.
