Your weekly economic update from the team at FXD Capital
The sheer and rapid collapse of Greensill Bank encapsulates all of the dynamics at play in credit markets over recent years. With an abundance of investor cash facing a brick wall of low yields, the answer has been creative and tenuous ways to solve the conundrum via regulatory arbitrage and speculation.
Valued at $7 billion just under a year ago, Greensill is now facing insolvency after its main creditor (Credit Suisse) and insurer froze commitments and renewals, respectively. Greensill alone has $5 billion of exposures linked to the GFG Alliance group of companies, a severe concentration, which, when under stress, has brought down the whole operation almost instantaneously.
Lenders like Greensill, who finance supply chain deals, have thrived due to the allure of alternative lending. Trade financing can be a lucrative business to get into for its lenders. Unencumbered by regulatory rules on retail deposits, an invoice financier can lend money to corporates secured by invoices/receivables at attractive rates. For many corporates who lack the clout, size, or steady track record to raise more conventional financing, it’s often the only option on hand for raising money. Similarly to how payday lenders thrive in some sectors of the consumer market, invoice financing businesses often have a captive market cornered. The nature of invoice financing is also a self-fulfilling prophecy, with it promising long-term refinancing relationships for lenders.
As such, for investors looking for debt-related returns: steady cash flows, backed by assets with a status higher on the credit hierarchy, interest has ballooned in the invoice financing sector. Greensill looks like a case where it grew too quickly; there was too much money at hand, and it was deployed haphazardly. Either Greensill’s own investors’ desires were sated too much, or it was forced to take on more cash than it required. Investors also piled into an asset they hoped would behave like a benign, prime fixed-income investment when, in reality, it was more like a hybrid venture-capital-meets-junk-bond kind of play.
Consequently, it came unstuck for the reasons a traditional credit lender (like a bank) would: Too much concentration risk in their book, too many corners cut on credit quality and not enough comfort horizon on their liability maturities. In the case of its relationship to Credit Suisse, it also highlights the impact of cross-selling. The group also provides personal services to management, which may have clouded its judgment.
Bonds and Inflation
Markets took a breather this week. Yields have begun to normalise to a point where they point towards higher inflation in the short term, narrowing in the long-run. For example, the two-year break even rate (derived from inflation-protected government bonds – “TIPS”) is now around 2.7%, while the ten-year rate is 2.3%. The two-year rate has not been higher than the 10-year mark since early 2019
Essentially, the market is pricing in an upward effect from recent stimuli and reopening effects, which will fade over time.
The settling of yields has temporarily assuaged concerns, and markets responded with gusto, rallying this week after taking stock of the “new normal”. 10-year yields have begun to stabilise around the
1.50% level after previously reaching highs of 1.6%. Technology stocks benefited most from the weekly respite, with Tesla alone gaining 20% on Wednesday.
The Brexit aftermath is starting to seep into data releases. Exports to the UK fell by 40% in January, with imports in the other direction dropping 28.8%. The data corroborates all the early January consternation about holdups at ports. The divergence between the figures is due to different customs protocols: EU goods can still enter the UK unencumbered for another six months, while exports out of the UK face strict controls.
The UK economy shrank in January by the quickest rate since the COVID-19 outbreak last spring. Since December, UK output fell 2.9% on the month, but despite the gloomy figures, beat the even more pessimistic forecasters of a Reuters poll who predicted a 4.9% contraction. Services bore the fall’s brunt, with the sector falling by 3.5%; conversely, construction performed the best, rising at a rate of 0.9%.
Compared to pre-COVID, the UK economy is now 9% smaller.
President Biden signed into legislation a $1.9 trillion stimulus package on Thursday. Every American earning $75,000 or less will receive a cheque for $1,400 to use at their discretion. The stimulus package has been a factor weighing over recent machinations in interest rates and inflation, with it seen as another sign of the economy heating up. A Deutsche Bank survey this week found that 37% of stimulus (“stimmies” in Reddit parlance) recipients plan to invest a “large chunk” of it into the stock market, “directly into equities”. Such activity will be inflation negative and perpetuate the divergence of market returns vs real economy ones.
Biden’s efforts are now most likely to move onto infrastructure investment plans. On the jobs front., initial weekly claims printed at 712,000, the lowest level since November.
The ECB pledged to accelerate the pace of its bond-buying efforts over the next three months to respond to increased borrowing costs. It announced that the €1.85 trillion pandemic emergency purchase programme (PEPP) would be “conducted at a significantly higher pace” in the months to come. There is an estimated €25 billion capacity of weekly purchases that could last until the end of the year.
The announcement was necessary, as, in recent weeks, the ECB had been buying fewer bonds via PEPP, which was untimely in the context of market conditions. Euro government bond yields have fallen across the board this week following the news and the overall macro sentiment.
The ECB deposit rate remains at -0.5%. Corresponding 2021 growth forecasts were raised from 3.9% to 4%, and inflation expectations were revised to 1.5% in 2021, falling to 1.4% by 2023.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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