2013 started with a roar as risk assets rallied off of late 2012 QE-to-infinity rhetoric from both the Federal Reserve and the Bank of Japan. As speculative juices continued to flow we witnessed a new all time high in NYSE margin debt (April) coupled with a new high in covenant lite levered loans (double the peak in 2007).
Predictably, along the path to QE addiction is a road paved with economic casualties. One example of the real economy hitting road blocks is the Caribbean sovereign debt debacle. According Bloomberg:
Jamaica and Belize, which restructured about $9.5 billion in local and global bonds this year for the second time since 2006, face a “high probability” that they will default again, Moody’s said in a May 20 report.
Among Caribbean island economies, only the Bahamas is expected to grow more than 1.5 percent this year compared with 4 percent for Latin America, Moody’s said in an earlier report. Without faster growth, repeat defaults may become common as Caribbean governments find it easier to cut bond payments than spending, said Arturo Porzecanski, a professor of international finance at American University in Washington.
Maybe the professional speculator accessing cheap financing from his prime broker to buy “distressed sovereign debt” should consider the following:
“These countries are exhibiting an increased unwillingness to pay,” according to Arturo Porzecanski, a professor of international finance at American University in Washington. “We may be seeing the birth of a region of serial defaulters.”
Takeaway: Like Cyprus and Greece the tipping point for many of these small, tourist dependent nations appears to be roughly 110% of debt-to-GDP. This begs the question, “How much longer can countries such as Spain, France, Japan and Portugal put off the day of reckoning?”
Under the You-Can’t-Make-This-Up category of sovereign debt insanity, the May 17th Grant’s Interest Rate Observer files this report:
Many these days are picking the poison of foreign places – Bolivia, for instance. Last fall, the scenic, private-property expropriating, contract-abrogating and formerly hyper-inflating South American nation issued its first international sovereign debt since 1920. And the Bolivian 4 7/8s of 2022 this year have rallied by 57 basis points, “the most among sovereign bonds with BB-minus ratings tracked by Bloomberg.” [according to Grant’s analyst Evan Lorenz]
The Great Bond Bull Market began in September, 1981 (over 31 years ago) with U.S. T-bond yields over 15%. Yields on the 10-year now stand just a shade below 2%.
Precisely 2 years ago, Jim Grant was quoted in an Associated Press interview:
I think it’s useful to imagine how things might look ten years hence. What will one’s children, heirs or successors think about a purchase today of ten-year Treasurys at 3.25 percent? They’ll look back and say, “What were they thinking?” The (federal deficit) was running at 10 percent of GDP, the Fed had pressed its interest rates to zero, it had tripled the size of its balance sheet, and they bought bonds? Treasurys are hugely uninteresting, as is similar government debt the world over.
Today the Bolivian government can borrow for 9 years at 4 1/2%. Have bond investors completely lost their minds?
Over the last week Cyprus has made front page news as the country teeters on the brink of insolvency. Knowing the powers at be have stricken the word from their playbook, or replaced it with “liquidity issue”, one must now consider the fate of the EU. How can this be when Cyprus is a tiny .2% of eurozone GDP? Consider this, according to the latest bank figures from the BIS, European banks had $38 billion of exposure to Cyprus! In addition, last week the ECB threatened to withdraw emergency lending access (ELA) to the Central Bank of Cyprus unless they move forward with the proposed bank bail-in restructuring.
Cyprus has proposed the idea of a bail in as a way to recapitalize their insolvent banking system whereby depositors above and below 100,000 euros will be given haircuts of 9.9% and 6.75% respectively.
Of course, this completely violates traditional bank restructuring laws where depositors are the last party in line to incur any losses. Which then begs the question, “why is the ECB trying to protect bondholders”?
Lets take a step back and review the moving parts in this game. First, Cyprus is a low tax haven for Russian oligarchs while total deposits from Russia are somewhere near $26 billion or 130% of Cypriot GDP. Total bank deposits are approximately $140 billion.
Over the last week the Central Bank of Cyprus has been posting sovereign debt at the ECB window, with undisclosed haircuts, in order to keep a lifeline open for the banks (which have been closed over this period of time). During the Greek crisis haircuts ranged from initial 25% to 50% as the situation worsened due to strings attached by the ECB.
Final comments: Why all of a sudden are the Cypriots being threatened by a complete removal of ELA by the ECB unless a bail-in is imposed on depositors? Could one reason be the $9.7 billion in German bank exposure to Cypriot banks? Or is there really no collateral, unlike Greece, so the ECB has no choice but to go after Russian oligarchs with a 10% money laundering fee? Either way, the tiny country of Cyprus has already set off Spanish and Italian bank runs as the EU periphery prepares for possible bail-in aka ECB theft operations. Now all we need to see is Mario Draghi making a statement, a la Ben Bernanke at the outset of the subprime bubble bursting, “Cyprus is only .2% of ECB and remains contained”.
The following sovereign debt issuers offer the least attractive combination of low yields and out-of-control finances, according to the Jan. 16th issue of The Economist:
- U.K. – 14.2% budget deficit, 4.05% 10-year government bond yield
- Spain – 11.8% deficit, 3.95% yield
- Greece – 13.0% deficit, 5.89% yield
- U.S. – 10.0% deficit, 3.78% yield
- Japan – 7.4% deficit, 1.32% yield
Note: We are currently short 30-year U.S. T-bonds and 10-year Japanese government bonds.