USD-denominated debt outside the US hits record – even junk
bonds.
China announced today that it would sell $2 billion in government bonds
denominated in US dollars. The offering will be China’s largest dollar-bond
sale ever. The last time China sold dollar-bonds was in 2004.
Investors around the globe are eager to hand China their US dollars, in
exchange for a somewhat higher yield. The 10-year US Treasury yield is
currently 2.34%. The 10-year yield on similar Chinese sovereign debt is
3.67%.
Credit downgrade, no problem. In September, Standard & Poor’s
downgraded China’s debt (to A+) for the first time in 19 years, on worries
that the borrowing binge in China will continue, and that this growing
mountain of debt will make it harder for China to handle a financial shock,
such as a banking crisis.
Moody’s had already downgraded China in May (to A1) for the first time in 30
years. “The downgrade reflects Moody’s expectation that China’s financial
strength will erode somewhat over the coming years, with economy-wide debt
continuing to rise as potential growth slows,” it said.
These downgrades put Standard & Poor’s and Moody’s on the same page
with Fitch, which had downgraded China in 2013.
But the Chinese Government doesn’t exactly need dollars. On October 9th,
it reported that foreign exchange reserves – including $1.15 trillion in US
Treasuries, according the US Treasury Department – rose to $3.11 trillion at
the end of September, an 11-month high, as its crackdown on capital flight is
bearing fruit (via Trading
Economics):
So why does China want these $2 billion in US dollars? For one,
they’re still cheap, given the low yield, which is expected to rise as the
Fed has started to unwind QE. And two, China might be interested in creating
a benchmark for dollar-bond trading in China that could help set prices for
Chinese corporate debt denominated in dollars. And there’s a lot of it.
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Other emerging market governments and companies have jumped on the same
dollar-bandwagon. Among them Tajikistan. It sold $500 million of 10-year
bonds in September, its first foreign currency bond sale ever. S&P rated
the bonds B-, six notches into junk, one of the lowest sovereign bond ratings
out there. Yet at a yield of 7.125%, there was strong demand from European
and US investors.
“Investors are very bullish on bonds from emerging markets and very keen
to diversify into new names,” Peter Charles, a Citibank managing director who
handled the bond sale, told the Wall Street Journal.
In June, even the Maldives, a minuscule nation of atolls in the Indian
Ocean, was able to sell $200 million in five-year bonds with a 7% coupon.
In total, emerging market governments and companies have issued $509 billion in dollar-denominated bonds so far
this year, a new record. Dollar-denominated junk bond issuance in the
developing world has hit a record $221 billion so far this year, up 60% from
the total for the entire year 2016, according to the Wall Street Journal:
Investors’ thirst for income is enabling governments and companies in some
of the world’s poorest countries to sell debt at lower and lower interest
rates.
Buyers reason that the debt pays a healthy yield and carries few immediate
risks. The global economy appears robust and emerging-market defaults are
low. Bankers say they expect emerging markets to sell tens of billions of
dollars in new junk bonds by year-end.
The euphoria is worrying some investors, who warn that frenzied buying of
risky assets sometimes presages market turning points. The average yield on
speculative-grade corporate bonds in emerging markets dropped to 5.53% late
last week, the lowest on record, according to J.P. Morgan. Two years ago,
that yield was over 9%.
In previous times of market stress and economic weakness, junk bonds and
emerging-market debt were among the asset classes that suffered sharp price
declines as investors dumped riskier holdings for safer ones. The recent
tightening in spreads raises questions about whether investors are getting
adequately paid for the risk they are taking on.
Total dollar-denominated debt owed by governments and non-bank
corporations outside the US has risen to a new record of $10.7 trillion,
according to the Bank for International Settlements’ last Quarterly Review,
cited by Krishen Rangasamy, Senior Economist at the National Bank of Canada, Economic
Analysis. In the Emerging Markets, dollar denominated debt amounted to
$3.4 trillion:
Dollar denominated debt owed by governments and non-bank corporations in
advanced economies with currencies other than the dollar has reached 26% of
their GDP, nearly three times the level of the year 2000.
Borrowing in foreign currencies increases the default risks. When the
dollar rises against the currency that the borrower uses – which is a
constant issue with many emerging market currencies that have much higher
inflation rates than the US – borrowers can find it impossible to service
their dollar-denominated debts. And when these economies or corporate cash
flows slow down, central banks in these countries cannot print dollars to
bail out their governments and largest companies. Financial crises have been
made of this material, including the Asian Financial Crisis and the Tequila
Crisis in Mexico.
But today, none of this matters. What matters are yield-chasing investors
that, after years of zero-interest-rate-policy brainwashing by central banks,
can no longer see any risks at all. And the dollar remains the foreign
currency of choice.
Betting against the dollar remains a favorite sport. Read… The
Hated Dollar Resurges. But Why?
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