Financial and Economic News: October 11, 2023Oct 11, 2023
Treasury Yields Surge
First up on the FinWeekly radar this week, economists at Goldman Sachs raised concerns about the recent surge in US Treasury yields, but in the same breath, insisted that these trends weren't likely to be a predictor of a possible recession at this time. If you missed it, ten-year US Treasury yields have risen by about 70 basis points since September, reaching their highest level since before the global financial crisis in 2007, closing at 4.80% on Friday.
Now, we've seen a trend of higher-interest-rates over the last few months, but the key takeaway is this: it's unlikely that these risks are individually significant enough to cause a full blown recession, and the Federal Reserve's ability to implement interest-rate cuts could offset a lot of the negative impact in such scenarios. However, I want to keep things transparent here, so lets recap on what some of the potential dangers associated with the surge in Treasury yields:
For example, we could see reduced stock valuations, because higher yields on Treasuries make them more appealing compared to stocks. If equity-risk premiums fall to historic levels too, that's where the 1% reduction in GDP growth could be expected. Another issue for my business owners out there is the increased risk of business closures. A more challenging financing environment may result in as much as a 50% increase in business exit rates, which would also reduce the rate of opportunity for economic expansion. And last but not least, there are concerns about federal debt sustainability. If things aren't kept in tight check, we might be looking at a number of deficit-reduction measures which could negatively impact the economic forecast over the next few years.
Looking back at history, we've faced similar situations and come out just fine. So, there's some comfort in knowing we've weathered this type of storm before. Sure, a 0.5% dip in GDP growth is worth noting, but it's not a recession on the horizon. We've got resilience, and there's time to make smart moves and adjust our strategies to handle this.
So, while there are concerns, rest assured we've got tools and experience to navigate these choppy waters and keep our economic ship sailing steadily.
But don't just take it from me, Lorie Logan, the President of the Federal Reserve Bank of Dallas, has offered her own thoughts, saying that the recent upswing in long-term Treasury yields may actually be the remedy we need for the Fed to slow down on further interest rate hikes. In fact, she contends that elevated term premiums, which are basically compensation for investors taking on the risk associated with interest rate fluctuations in bonds, could potentially reduce the need for additional monetary tightening.
But there's a catch: See, if it's the strong economy pushing those long-term rates up, the Fed might still have to step in and tighten the money supply. Right now, the Fed is engaged in deliberations concerning the prospect of another federal funds rate hike later this year, even though we've seen a series of rate hikes recently. What we do know is, Fed Vice Chair Michael Barr thinks that the job market is getting a bit more balanced, helping steer inflation in the right direction.
So, exactly how can you prepare for these possible upcoming changes? Well, I always like to remind you to stay vigilant about your finances - what you've got, what you owe, and how you're spending. When it comes to your investments, spread the risk, and keep some savings in things that can beat inflation, like stocks or real estate. And last but not least, keep your long-term goals in mind and be ready to adjust your plans as things change – because you can almost guarantee that they will.
IMF Global Growth Forecast
Next up, the European Central Bank (ECB) President Christine Lagarde (Laa-Gaar-Dee) revealed this week that the International Monetary Fund (IMF) has revised down its global economic growth forecasts, with one notable exception: the United States. And while the IMF's latest projections have been adjusted downward, things are looking stable for the US. Currently, the IMF's outlook envisions global GDP expanding by 3% in both 2023 and 2024, with the US economy expected to grow by 1.8% in each of these years.
On a global scale, economic growth hasn't returned to its pre-pandemic levels, and while the US is exhibiting stronger momentum, other advanced economies-like China-are still falling short of expectations. Lagarde has reiterated that the ECB's goal is to avoid a recession while still addressing inflation, and emphasized that she is optimistic about the euro area's short-term outlook.
So, what factors might be behind the IMF's decision to lower global growth forecasts, and why does the outlook of the US still look so positive? Well, firstly, economic conditions vary from one country to another, and while the United States witnessed a relatively robust post-pandemic recovery, some other advanced economies are grappling with challenges in sustaining growth momentum. Remember, the United States implemented a significant fiscal stimulus package, which bolstered consumer spending and supported economic growth, but for other countries, divergent recovery paths, varying pandemic management approaches, supply chain disruptions, trade dynamics, and international relations all play a role in shaping the economic prospects of different countries.
Now, obviously this isn't all set in stone and we're not out of the woods just yet. It's important to acknowledge that economic forecasts are inherently uncertain, subject to unexpected events and global developments. Fortunately we're here to keep tabs on the IMF's evolving assessment of the economic landscape.
ECB Calls Out Euro-Governments
On the flip-side of this developing story, Euro-area governments appear to be holding back on adopting budgetary policies that align with the European Central Bank's (ECB) efforts to control inflation. Understandably, the alignment of fiscal and monetary policies is crucial for controlling inflation effectively, but right now this coordination is seriously lacking.
The ECB's tightening measures have had an adverse impact on economic growth, with GDP expanding by only 0.1% in each of the first two quarters of the year, and now EU rules, which are designed to prevent excessive borrowing, have been suspended since 2020 to allow governments to support their economies.
In the meantime though, many Euro-area governments are not aligning their budgetary policies with the European Central Bank's (ECB) efforts to control rising inflation. The ECB is concerned that these governments are not cooperating to stabilize the Euro-area economy, despite the ECB's efforts to raise interest rates to curb inflation. This lack of coordination between fiscal and monetary policies is seen as a challenge in managing inflation effectively. What's more, the ECB's tightening of monetary policy has had a negative impact on economic growth, potentially even raising the possibility of a recession in the Euro region. And the suspension of EU borrowing limits since 2020 to support economies during the crises only further complicates efforts to establish a unified fiscal strategy. Overall, this situation reflects a disconnect between the ECB's monetary policies and the fiscal policies of Euro-area governments, but it's good to keep an eye on how these things connect.
Next up on my radar: over an eventful weekend of negotiations, Caius Capital, along with other creditors made a huge financial maneuver aimed at bolstering the financial stability of Metro Bank. This strategic move involved a substantial £175 million ($214 million) bond sale, in an effort to fortify Metro Bank's financial position. In particular, the majority of creditors opted to exchange their existing 2025 bonds with new ones maturing in 2028, allowing them to sidestep possible losses on their holdings.
But why this restructuring? In a nutshell, this financial restructuring was a rescue deal for Metro Bank, after alarm bells were raised following a prolonged period during which its bonds had been trading at a significant discount. As for the investors, Caius Capital actually wound up with some pretty substantial gains, since the bonds they acquired were trading lower than normal, but surged after the deal closed from 57 pence to 88 pence. Unfortunately for holders of Metro Bank's subordinated bonds, they had to contend with less favorable terms, including the issuance of new bonds maturing in 2034, along with a 40% reduction in the value of their existing bonds.
As for the big picture: the successful execution of this debt restructuring marks a noteworthy event within the realm of the UK financial sector, and this deal signifies a pivotal step toward restoring the financial equilibrium of the bank. And yet, the necessity of such an exceptional debt restructuring within the UK financial sector emphasizes the seriousness of the challenges Metro Bank faced, and the importance of ensuring investor trust, because nobody wants to hold onto a risky investment in uncertain times, it's that simple.
Country Garden In Trouble (Again)
And last but not least, Country Garden, a major player in China's property development sector, finds itself at a critical financial crossroads. If you haven't been keeping up, recent failures to meet significant dollar interest payments have raised concerns about the company's financial stability, leaving investors apprehensive about potential losses.
As one of China's most heavily indebted developers, with a total debt load of approximately $187 billion, Country Garden's woes shed light on the challenges plaguing China's property market in general. Since 2021, the sector has been grappling with difficulties including multiple defaults and numerous incomplete projects, despite government efforts to stimulate demand.
The company's recent announcement that it may struggle to meet offshore payment obligations is only making things worse. The low trading prices of its dollar bonds, currently at 5 to 7 cents on the dollar, means it's clear that investors are skeptical about recovery, but as for the wider market, the risk of defaults and debt restructuring, accompanied by possible financial contagion, emphasizes the need for substantial government support and possible policy interventions.
And to make a bad thing worse, the upcoming coupon payments, including a $40 million interest payment on a 2024 bond and a $15.4 million payment on a 2025 note, are also surrounded by uncertainty. As always, my advice is to remain vigilant and well-informed about China's evolving property market and its financial implications.
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