In Bonds There Is Truth

Authored by Bill Blain via MorningPorridge.com,

How Bad Is Bad?

“In the face of pain there are no heroes.”

The news on the virus front lines does sounds better. Although the media fluster about new “second wave” outbreaks in Asia, Europe and the States, the scientists say it will be winter before the real second wave emerges – the key lesson of the Spanish Flu – giving us time to prepare, maintain distancing, improve logistics and build up stocks, innovate treatments and maybe even crack the vaccine (and subsequent vaccine wars..). Tumbling infections mean London could be “free” of the virus in weeks – apparently. 

Even more importantly, it’s time for hapless governments to ensure testing regimes are in place, contact tracking apps work and demonstrate they have a plan. If a second wave doesn’t come later this year – fantastic. But if it does… lets be ready. 

Otherwise, the economic news is unremittingly bad. 

Where to start in terms of just how unlikely the V-Shaped recovery is likely to be? Its not even worth commenting on yesterday’s late stock rally – fueled by bank rumors, and FOMO. Its mad that stocks remain so high when the news is so bleak. But it makes curious investment sense in a world where investors believe Governments and Central Banks have little choice but to bail out battered businesses, pay for jobs, and push prices higher though monetary stimulus. 

Yesterday it was Transport for London that warned it was going bust. If I never see the inside of the Drain (Bank to Waterloo) again, it will be too soon…

But Governments have little choice but to spend, spend and spend more. Whole sectors of the economy need long-term Intensive Care and structural investment. Plans are needed to support the sectors most impacted by the crisis: aviation & aerospace, hospitality and tourism. Legions of SMEs and jobs that rely on subcontracting for aerospace firms could go, meaning the implications for jobs and long-term skills will be devastating. The French are preparing to pump billions into life-support for their tourism industry. The Italians, Spanish and Greeks would do the same – if Germany would let them. 

A different kind of aid is required across the economy for the sectors hit by the Cascade Effect. Cascading Default Risk is best illustrated in property, where one tenant skipping rents becomes many, meaning landlords default. Property companies tumble and the banks and asset managers that finance or own property suddenly find their property is secured on non-paying assets. Some form of debt foregiveness will be required – which means more state intervention and market distortion. Commercial property is in the firing line, with US Colony Capital defaulting on $3 bln of loans – which includes health care units, which tells you something about the real priorities in US health provision. 

We also need grown up politics. Here in the UK, I’m hopeful for Sir Keir Starmer, the new Labour leader, but when the Corbynite rump, a festering nest of rejected polices and irrelevant slogans, demand unions are given the right to decide when workers return, or that all tenants should simply stop paying rents, it’s clear their social consciences are untroubled by consequences. 

Rent strikes will benefit a few ne’er-do-wells in the short-term, but ensure defaults on buy-to-lets and a tumble in property prices, and crushing consumer confidence as the middle classes have always considered their homes to be rock-solid bastions of wealth preservation. Local authorities won’t be able to replace private landlords, thus ensuring a long-term rise in homelessness – unless you simply nationalise the whole housing stock as the clock strikes 13 on that bright cold morning in April.

As for the teachers? Too dangerous for them to return to their jobs… We won’t be out the balconies clapping and cheering them at 8pm. The science says they should socially distance in the staff rooms, and kids aren’t the danger. The unions say no. The bottom line is that getting the country’s productivity levels up in the short and long term requires kids back at school. End of.

Then there is the third area where intervention may still be needed – corporate debtRemember: in Bonds there is Truth! There are a number of very worrying trends underway. Most folk will now be aware of the growing concerns about the risks embedded within CLOS. When the rating agencies expect 15% junk defaults, it’s clear these losses will be magnified in the CLO sector. Junk is now a $2 trillion market (bonds and loans). (Good primer on CLO issues is their piece earlier this week in FT: CLOs: Ground Zero for the next stage of the financial crisis.)

As defaults will rise and corporates will need more cash to survive through the coming recession, we are seeing rates rise dramatically. The double digit coupons we’ve seen on recent airline, aircraft maker, and cruise company deals – demonstrate investors are now demanding, and getting proper risk returns. 

That’s maybe good news from investors – in the short-term. Long-term the implications are real rising interest rates will accelerate the corporate clear out as Zombies either get permanent government money or fold. (Interesting piece this morning from Gillian Tett in the FT about how US Bankruptcy courts won’t be able to cope.) 

We’re also seeing banks hike their leverage rates, what they charge hedge funds for funds. Banks don’t hold risks, they simply fund them and transfer the risk to others. That’s going to be another cascade effect – despite banks being given zero funding from central banks, they are hiking risk lending rates to funds who now do the bulk of business funding via bonds or direct lending. Everyone from SME lenders to distressed asset players is having to raise their return targets to reflect the higher bank rates being charged. The result is less deals get funded, and less business in total gets done. It’s another area Governments might look at..

And we haven’t even talked about Geopolitics yet! Its getting fraxious as nation’s self-interest trumps even Trump. Vaccine wars? 

The prospects for a simple Brexit agreement with the UK actually look better than ever. All the papers think agreement is doomed; there isn’t enough time, Boris is not focused, and it’s going to be a disaster. Relax. Whatever the EU wants, Germany knows which side it’s bread is buttered. If Brits stop buying German cars.. the German courts will be on our side. 

It’s rich the EU is starting legal action against the UK because we’ve closed our borders. We’re only letting in the Irish, and for some reason, the French (maybe because they are unlikely to want to visit anyway, but London is one of the largest French cities!) Its time the UK does a Germany and simply makes clear our national self-interest trumps EU rules every time. The EU judges also decided the UK broke the law by exempting Commodity Derivatives from VAT – without begging permission first. There were fears they might have demanded back-taxes on trillions of trades! 

The Germans and their Constitutional Court have put Europe on collision course. But, it’s the same here in the UK where the SNP are determined not to squander any opportunity to make a bad situation worse. 

The big one is of course China vs US, but we don’t have to worry about that one today, because Donald isn’t minded to speak to Xi right now. But we do have to worry tomorrow about trade wars, real wars, cyber wars and vaccine wars. I suspect this is not going to end well..

The bottom line is what the Virus has triggered is not just a random reversible recession caused by global lockdown, but it’s been the catalyst for the most fundamental tipping of the Global Economic Apple-cart ever. It’s going to take decades to put all the pieces back on the table again…  

Meanwhile. 

Just how bad are things going to get for the airline business? Some airlines optimistically hope to resume 50% of services from the summer. She-who-is-Mrs-Blain and I won’t be off to Rome for a city break this year. 2 weeks in quarantine when we arrive and another 2 weeks when we come home? I don’t think so. 

Much as I love planes, I hate airports and flights. Nothing is so calculated as to frazzle me. It’s going to get worse. Do you want to be able to take less hand luggage, queue to get your temperature taken, queue for longer to dump your baggage – which will cost extra – take longer to get on board, wear a facemask the whole flight, ask permission to go to make an escorted trip to the toilet, and sit in fear of anyone coughing? 

Boeing’s CEO says a US domestic carrier is likely to fold this year. No Sh*t Sherlock – that’s what Chapter 11 was invented for. Ryan Air chief Mick O’Leary is suing a sheaf of European givernments following bailouts of domestic airlines. The American’s have bailed airlines out to the tune of $50 bln (wages and support). The Europeans won’t be far behind in terms of money. Whatever governments do, I reckon by the end of the summer 50% of jobs in aviation will have gone. 

Yet, US airlines and Boeing were still able to raise over $35 bln from the markets in April!  

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