Author: Barclay Butler

As a decade of easy money and low interest rates came to an end, and with fears of a credit crisis seemingly receding, experts are advising that globally a wave of corporate bankruptcies may well come to pass. Top corporate debt experts are ringing the doom bells as they say apart from the early days of the pandemic, large corporate bankruptcies amounting to USD500 billion are accumulating at a pace second only to the global financial crisis in 2008.

Such experts suggest that the amount of corporate debt will continue to grow, straining credit markets that have been recovering from some of the biggest losses seen in twenty years and could threaten to slow economic growth. Many commentators just see the tip of the iceberg, as empty offices sprawl from Hong Kong to San Francisco, where many workers now work remotely from home. However, the underlying problem is debt built up throughout an era of cheap money, now costing much more to service as central bank’s monetary policy dictates increases in interest rates.

For example, in the United States from 2008 to 2021 the size of leveraged loans and high yield bonds, (owned by lesser creditworthy and riskier businesses) more than doubled to circa USD3 trillion. One interesting figure that has also been released for the time span 2008 – 2021 is that debts belonging to non-financial Chinese companies soared relative to the size of the Chinese economy. 

Elsewhere in Europe, in 2021 junk bond sales increased by circa 40%, a number of which are coming due for payment adding to the already outstanding debt of USD 785 billion that will have to be paid. In London, HSBC has its headquarters in Canary Wharf along with a number of other large financial institutions, where the once completely derelict site became a major financial centre. HSBC has already announced they are vacating the site in 2026 and prior to the Covid-19 pandemic banks were already scaling back on their working space. As a result, and not forgetting the impact Brexit had on office working spaces, two buildings in Canary Wharf owned by a Chinese property developer were seized by receivers due to non-payment of loans. 

In the world of private equity some of the companies they bought now have a debt level in excess of USD70 billion and are trading at distressed levels. For many years private equity enjoyed low interest rates and easy credit, and their business plan was to buy a company, then borrow money and then cut costs, thereby making a profit. Sadly, these companies were often left laden with debt, and more often than not with floating rate loans on the books. Like many companies throughout the world some private equity firms thought near zero interest rates would last forever, so they never bother to protect their companies with lost cost hedges. Today, with higher interest rates these companies are close to receivership.

As all these debts grow and more companies become distressed, other sectors such as advertising companies are affected, as this is the first area where companies reduce their budgets. Another sector feeling the pinch is real estate, where most of the distressed debt is related to the property problems in China, where companies such as Dalian Wanda Group have seen their debt price collapse and China Evergrande Group who have had to restructure their debt.

The collective global economy will have to hold their breath to see if central bank policies will allow for a reduction in interest rates as inflation is hopefully brought under control. However, with Russia having pulled out of the Black Sea Grain Initiative (implemented in July 2022), this may or may not negatively impact inflation, we will have to wait and see.

As inflation in the United States begins to cool, it is accelerating a decline in the US Dollar, which in turn is benefitting risk assets* across the globe. In September 2022, the US Dollar surged to a record high on the back of increasing interest rates, today against a basket of currencies the US Dollar is down circa 13%, its lowest levels for 15 months.

*Risk Assets as the words imply are those assets that carry a certain amount of risk and are quite susceptible to price volatility. Such assets are generally recognised as emerging markets, currencies, equities, commodities and high-yield bonds.

The global financial system is underpinned to a great extent by the US Dollar, so as the US Dollar declines, so US Treasury yields ease, making the US Dollar less attractive. However, on the other side of the coin, this gave a boost to foreign currency across the board such as the Mexican Peso and the Japanese Yen.

From a corporate standpoint, some US companies will benefit from a weaker dollar as this will allow multinationals to convert overseas profits back to dollars more cheaply, whilst at the same time making exports more competitive in overseas markets. For example, in the US technology sector, where some companies are enjoying high growth and have recently led the markets higher, they have, according to experts, generated circa 50% of their revenue from overseas markets.

In the currency world, throughout the foreign exchange markets, as the US Dollar declines technical levels are being broken, and across the globe those currencies that are risk-sensitive are ticking up. Certain foreign exchange strategies will benefit from a falling US Dollar such as a Dollar Funded Carry Trade*. Experts in the dollar funded carry trade market expect these trades to thrive against a bleak outlook for the US Dollar. 

*A Dollar Funded Carry Trade is where a higher yielding currency is bought against the sale of US Dollars, allowing the participant to pocket the difference.

The fall in the US Dollar will be a boon to some central banks and their monetary policies as they can withdraw support for their own currencies. In Japan for example, the US Dollar has fallen by 3% in the week ending 14th July and has dented expectations that as an import reliant economy, the government would have to intervene in the currency markets.

Figures from the S&P Goldman Sachs Commodity Index (S&P GSCI) have ticked up 4.6% this month reflecting the declining dollar reflecting raw materials being more attractive to foreign buyers. Emerging Markets are also benefitting from a fall in the US Dollar, making any debt corporate or sovereign easier and cheaper to service. This has been reflected in a 2.4% increase this year in the MSCI Emerging Market Currency Index.

The outlook for the US Dollar is essentially very bearish with many experts predicting the currency will fall to levels before the Federal Reserve started hiking interest rates and may go even weaker. But bears beware, a sudden unexpected increase in inflation could change strategies across the globe.

Whilst the United Kingdom still struggles to keep inflation in check, inflation surprisingly fell to 5.5% in the Eurozone, down from 6.1% in May, which is the lowest since January 2022. However, before policymakers could start popping champagne corks, the mood was tempered as figures showed a small uptick in core consumer price growth, with core inflation (excludes food and energy) having increased from 5.3% in May to 5.4% in June. This was clearly a disappointment for the ECB (European Central Bank), as until the underlying price pressures fall to the target of 2%, the ECB has confirmed they will keep raising interest rates.

Meanwhile, in the United Kingdom, contrasting figures with the Eurozone show inflation at the end of May at 8.7%, and with the Bank of England raising interest rates by 50 basis points on 21st June, there are fears that in order to keep battling inflation, a subsequent rise of the same amount is in the offing. Furthermore, recently released figures show that amongst the G7 countries, the United Kingdom’s growth rate for Q1 was the slowest (apart from Germany) and as of May, the annual inflation rate of 8.7% was the highest.

Experts point to emerging differences between the United Kingdom and the Eurozone, where the ongoing shortages of labour, plus the energy price crisis, make for a toxic combination resulting in inflation being more stubborn to shift than the Eurozone and other G7 countries. 

Regarding labour shortages, there are a record number of job vacancies, and the United Kingdom is facing additional inflationary pressure as companies across the land increase salaries/wages in attempts to fill these vacancies. Post-Brexit immigration laws are cited as one reason for a declining labour market, whilst post the Covid-19 pandemic, there are record levels of long-term sickness amongst adults of the working age.

Expert analysts also point to the United Kingdom’s governments Energy Price Guarantee (EPG), where for a typical household, electricity and gas bills have been capped at £2,500 pa (1st October 2022 – 1st July 2023). However, similar caps were not introduced in the Eurozone, therefore the recent decline in global wholesale electricity and gas prices are better reflected in their current inflation rate.

Furthermore, economists suggest another divergence between the Eurozone and the United Kingdom is that the UK’s economy is more service based than manufacturing based as opposed to those economies in the Eurozone. This leads to a more balanced economy which is reflected in the fact that inflation across the Eurozone is declining (apart from Germany and Croatia) whereas the United Kingdom is struggling on the inflation front. 

Figures for the end of July will show if this divergence is continuing, however, within the ECB’s rate setting council members have acknowledged that criticism by members of the UK press regarding the Bank of England’s handling of inflation, has served as a cautionary warning to the wise.