Is The Credit Event Upon Us?
Spoiler Alert: I'll Tell You By End Of Year
Is the credit event upon us? With China’s Evergrande declaring bankruptcy this week and Country Garden teetering on the brink of doing the same, it would certainly seem that conditions more than favor this argument. China stocks did get walloped this week and global stocks broadly had their worst week since March, but my signals didn’t necessarily indicate the larger risk-off pivot that I thought they might given the news overseas.
In fairness, utilities did outperform the S&P 500 by a fair margin from Wednesday on this past week, the dollar rallied again and the VIX touched its highest level since May, but these are still comparatively minor shifts. Treasuries, however, is the one asset class that just refuses to budge. The 10-year yield, at 4.28%, touched its highest since October 2007. GDP growth, retail sales and a mixed, but generally reassuring, set of earnings results from the big retailers have the markets believing in the resilient economy narrative at the expense of some compelling and worsening tail risks. We’ll hear more from Powell at Jackson Hole, but clearly investors think that the Fed might need to hike even further given the totality of the data (or at least remain higher for longer).
There’s a lot of tinder out there right now and any one of these things could trigger a big credit event. I still think China is the most likely given how the real estate sector is collapsing right in front of us and the government is using any and all means necessary to halt the slide in both Chinese stocks and the value of the yuan. The economy is already on the path to a deep deflationary bust and it’s beginning to look more and more inevitable. Japan is still hanging in there though. It’s become clear that its economy’s growth rate is picking up while inflation remains elevated. Under these conditions, the BoJ can’t stay ultra-dovish forever and not expect something to break along the way. With the yen extending its swoon, a policy adjustment from the central bank might come sooner than later.
It’s still all about path here. As I noted on Twitter, Treasury yields soared in the lead-up to Black Monday in 1987 before everything fell apart. A similar path might be possible here the more that monetary conditions and underlying market risks continue to disconnect.
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