Default Rate

Anyone who was hoping the market would rebound on last-minute news that the US government has gotten funding for another 9 months, will be disappointed this morning, when futures are finally starting to notice the relentless decline in crude, and with Brent down another 1% as of this writing following yet another cut in the forecast of Global oil demand by the IEA (the 4th in the last 5 months) and with Chinese industrial production also missing estimates (recall that the Chinese slow-motion hard landing has been said by many to be the primary catalyst for the crude collapse) which however pushed Chinese stocks higher on hopes of even more stimulus, the S&P is trading lower by some 14 points, the 10 Year is in the red zone at 2.12%, and the USDJPY is close to session lows. In short: Kevin Henry's "ETF" desk at the NY Fed will have its work cut out to generate one of the now traditional pre-weekend feel good, boost confidence stock market ramps.

Are much lower oil prices good news for the U.S. economy?  Only if you like collapsing capital expenditures, rising unemployment and a potential financial implosion on Wall Street.

"... If the unemployment rate were to edge up after reaching a trough in two years and the gap between U-6 and unemployment remains as wide as it is today – in excess of historical norms – the size of the program would be expected to reach roughly $3.3 trillion in 2024, $1.7 trillion more than in the base case." - TBAC

Another day full of global macroeconomic disappointments is certain to send the S&P500 to all time-higherest records as 100,000 or so E-mini contracts exchange hands between central banks and Citadel's algos.

But, but, but... all the clever talking heads said they wil have to cut...

*OPEC KEEPS OIL PRODUCTION TARGET UNCHANGED AT 30M B/D: DELEGATE

WTI ($70 handle) and Brent Crude (under $75 for first time sicne Sept 2010) are collapsing... as will US Shale oil company stocks and bonds (and thus all of high yield credit) tomorrow. The Saudis are "very happy" with the decision, Venzuela 'stormed out, red faced, furious.' Commentary from various OPEC members appears focused on the need for non-OPEC (cough US Shale cough) nations to "share the burden" and cut production (just as the Saudis warned yesterday).

While OPEC has been mostly irrelevant in the past 5 years as a result of Saudi Arabia's recurring cartel-busting moves, which have seen the oil exporter frequently align with the US instead of with its OPEC "peers", and thanks to central banks flooding the market with liquidity helping crude prices remain high regardless of where actual global spot or future demand was, this Thanksgiving traders will be periodically resurfacing from a Tryptophan coma and refreshing their favorite headline news service for updates from Vienna, where a failure by OPEC to implement a significant output cut could send oil prices could plunging to $60 a barrel according to Reuters citing "market players" say.

Suddenly it is not just the shale companies that are starting to look impaired as a result of tumbling energy prices. According to a Deutsche Bank analysis looking at what the "tipping point" for highly levered companies is in "oil price terms", things start to get really ugly should crude drop another $15 or so per barrell. Its conclusion: "we would expect to see 1/3rd of US energy Bs/CCCs to restructure, which would imply a 15% default rate for overall US HY energy, and a 2.5% contribution to the broad US HY default rate.... A shock of that magnitude could be sufficient to trigger a  broader HY market default cycle, if materialized. "

Marty Fridson, CIO at Lehmann Livian Fridson Advisors, has been a leading figure in the high-yield bond market since it was known as the "junk bond" market — and he sees as much as $1.6 trillion in high-yield defaults coming in a surge he expects to begin soon... “And this is not based on an apocalyptic forecast,” he warns.

A quick anecdote that should quickly confirm just how broken everything is: earlier today MarkIt reported European manufacturing data that was atrocious, with both German and European PMIs tumbling to levels not seen since mid-2013, and with Europe's growth dynamo now in a contraction phase clearly signalling what has been long overdue: a European triple dip recession. So what happens? Moments later Germany sells €4.1 billion in 10 Year paper at a record low yield below 1%.... even as the Bundesbank had to retain a whopping 17.84% of the auction, the highest since June, with only €4.663 Bn in bids for the €5 Bn target, the first miss since May 21. So hurray for the central banks, boo for the economy, and as for that mythical creature, once known as bond vigilantes, our condolences: good luck figuring out what the hell just happened, and good luck recalling what a free market is.

It was all up to the Japanese banana market to fix things overnight: after the biggest tumble in US equities in months, and Asian markets poised for their third consecutive weekly drop, the longest streak since February, Japan reported CPI numbers that despite still surging (for example, in August TV prices soared 9.5%, but "down" from 11.8% the month before), when "adjusting" for the effects of the April tax hike, missed across the board. As a result the USDJPY was at the lows and threatening to break the recent parabolic surge higher which has helped move global equities higher in the past few weeks when the usual spate of GPIF-related headlines, because apparently the fact that Japan will and already has begun sacrificing the retirement funds of its citizens just to keep Abe's deranged monetary dream alive for a few more months has not been fully priced in yet, sent the USDJPY soaring yet again.

How do we know when an asset class is in a bubble? When everyone who stands to benefit from the continuation of the expansion declares it can't be a bubble.

Low volatility is being driven, in BofAML's view, by both fundamental and technical factors. Fundamentally, the volatility of real economic activity and inflation has fallen to near 20 year lows in what some are calling the Great Moderation 2.0. However, the recent further collapse in volatility is also explained by a feedback loop fueled by low conviction, low liquidity, low yields and low fear. Central bank policy has been the largest explanatory factor of both the fundamentals and technicals... and that has BofAML concerned about the risks of short-term volatility spikes exacerbated by market illiquidity.

As every 'real' corporate bond manager knows (as opposed to playing one on television), forecasting from historical defaults is a fool's errand as the process is entirely cyclical and non-stationary. The fact that default rates have been low for 4 years (thanks to an overwhelming flood of liquidity-driven demand for yield) is of absolutely no use when pricing discounted cashflows into the future. However, as Fitch warns, a jump in US high-yield default rates looms. There have been 10 LBO related bond defaults thus far in 2014, compared with nine for all of 2013. While most sectors remain relatively clam, the utilities and chemicals sectors are seeing huge spikes in defaults... which explains why the market is starting to price that in.

With the Fed tapering and both China “I don't think the markets are discounting what’s really happening in China,” and Japan’s currencies likely to weaken, the net impact on the U.S. will be deflationary, Kyle Bass warned in a recent presentation. That trend will be accelerated by the improvement in the balance of trade for the U.S., which had its current account deficit shrink due to increased hydrocarbon production. Bass warns, the crucial moment will come when the U.S. reports a sub-6% unemployment rate, meeting the target it has set for normalizing its monetary policy by ending QE and raising rates. He predicted that will come in July. That will be the Fed’s “worst nightmare,” he said. Raising rates would stifle growth and recreate unemployment problems, which would be disastrous politically, according to Bass.

Despite the plethora of talking heads proclaiming credit markets as awesomely supportive of stocks - High-Yield bond spreads are flashing red... But that's not stopping investors piling into the worst of the worst. As Liberty Blitzkrieg's Mike Krieger notes, in an all too reminiscent scene from 2007 (MBIA CDS traded 11bps at one point then remember), investors have been buying up bonds with a triple-C-rating en masse.