6 de octubre de 2015 / 11:31 / hace 2 años

Credit creation and the liquidity drain: why markets are falling

* Global asset prices under pressure

* QE impact waning

* Liquidity drains out of emerging markets

By Sudip Roy

LONDON, Oct 6 (IFR) - A tightening in global liquidity conditions is heaping pressure on credit and equity markets as the effects of central banks’ quantitative easing wane.

Financial markets have struggled to perform throughout much of the year but reversals have worsened over the past few months.

“September is shaping up to be the worst month of the year for performance, and the year-to-date picture is no rosier,” said analysts at Bank of America Merrill Lynch in a recent note.

“Events have, of course, been numerous this year, and September has been about auto scandals, but underneath the surface there are signs that the monetary policy backdrop in Europe is creating a bull market in fatigue and a bear market in credit performance.”

In the last quarter, nearly every leading stock market declined sharply. The S&P 500 is an outperformer, yet it had losses of 8.68%.

Credit, too, is in the mire. Emerging market sovereign spreads weakened by 45bp in September, according to JP Morgan’s EMBI Global index.

European high-yield spreads have fared worse, wider by 73bp in September, according to BAML, while European investment-grade spreads moved out by 21bp.

Global primary bond markets have fallen victim of investors’ morose mood.

European cable company Altice was forced to downsize an acquisition-related offering in late September, while chemical company Olin hiked the yield on a two-part deal by a massive 350bp following investor pushback

Two deals were pulled in US high-grade last week, while trades for Hewlett-Packard Enterprise and Enbridge Energy Partners, paid huge new issue concessions.

Things are not that much better in European markets. The Province of Ontario cancelled a 10-year euro benchmark on Monday after it could not get the size it wanted.

The fallout in the primary markets is being blamed on a number of reasons: an indecisive Federal Reserve, China’s weakening growth outlook, depressed commodity prices and ructions in the corporate market caused by VW and Glencore.


Some analysts believe there could be a deeper reason behind the malaise.

The big worry is that the main policy that has propped up asset prices since the financial crisis - quantitative easing - is now failing.

While the central banks in the US and UK are no longer buying bonds, the ECB and Bank of Japan are.

“The framework was working well until just after the ECB announced its QE and suddenly the whole thing has fallen apart,” said Matt King, global credit strategist at Citigroup in a recent presentation.

“Suddenly, when in theory US$300bn a quarter of QE should be causing a 10% tightening in high-yield spreads, we’ve had sustained weakness even before all of the recent worries around individual names.”

King argues the reason that central bank stimulus is no longer working is due to the world potentially reaching its “credit limit”. While credit can lead to economic growth and inflation, it can also lead to asset bubbles.

“Credit does not net out. It contributes to booms and busts depending on whether lots is being created or is being paid down,” said King.

Nowhere more so than in the emerging markets. Since 2000, about US$8trn of cumulative capital - FDI, bank loans and portfolio flows - has surged into the emerging markets on a net basis, estimates King. That money has, in turn, stimulated US$5trn of new private-sector credit a year.

Initially, this helped generate strong growth in the developing world, with these countries propping up the global economy following the financial crisis.

But now the stimulative effect on growth seems to be fading, with credit driving up asset prices instead. “The scale of this is deeply disturbing,” said King, pointing out that house prices in China, for example, have risen by 33 times over the past 15 years. Over the same period, US property prices have increased by just 2.5 times.

And money is no longer flowing into emerging markets but out. The Institute of International Finance reckons that emerging markets are on course for their first net capital outflow in almost 30 years.

That net outflow figure could reach US$541bn this year, according to the IIF, with gross private outflows likely to be more than US$1trn.


This is not only leading to negative consequences for growth, but also influencing emerging markets central bank policy, with potentially big consequences.

In order to prop up falling currencies, EM central banks are shrinking their reserves, which are typically held in government bonds in the developed market economies, according to Gavyn Davies, Fulcrum Asset Management chairman and former Goldman Sachs chief economist.

Fulcrum estimates that total EM central bank balance sheets “may have declined by about US$450bn in the three months since the crisis worsened in the summer, of which about US$170bn has come from China alone.”

This has offset the monetary easing undertaken by the ECB and Bank of Japan, “leaving global QE substantially in negative territory”.

Davies said it is difficult to prove that “this drain of central bank liquidity” has directly led to the rise in global bond yields in the last month. “Market interpretations of Fed policy have probably been just as important,” he said.

But he reckons this “EM reserve drain” could be maintained for a while. If so, it could have important effects on investors’ portfolios, as they reduce duration and sell risk assets.

A gloomy tone in global markets could, therefore, persist, with the riskier end of the credit spectrum, especially, remaining in the doldrums.

“The situation does make me pessimistic about emerging markets in particular. We still need to see how investors respond, but there are negative implications too for developed market equities, high-yield and to a lesser extent investment-grade,” said Citigroup’s King.

“This process of credit creation and risk of credit destruction lies way closer to the heart of what’s really driving markets than is commonly recognised by investors.” (Reporting by Sudip Roy; Editing by Julian Baker, Helene Durand)

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