Is the decade-long credit bubble ready to burst?

November 30, 2018 11:06
Continued rate-hikes by the Fed and the strong need for the US government to keep issuing more bonds could put further pressure on the US dollar bond market. Photo: Bloomberg

Over a 10-week period ending November 16, investors have withdrawn as much as US$24.8 billion from the credit markets, the highest such pullout since the beginning of 2016.

Meanwhile, speculators are now holding nearly 1.26 million contracts of net short positions in US Treasuries as of November 23, a historically high level.

Last month, average yield of high-yield bond climbed to a two-and-half-year high of 6.67 percent, up 180 basis points from the trough last year.

All these suggest investors are getting more bearish on credit and bond markets.

Going forward, the situation could get worse.

First of all, global economic growth appears to be moderating after nearly three years of expansion.

If the macro environment becomes adverse, the ability of corporates to repay debt could weaken, and debt defaults may pick up.

Continued rate-hikes by the Federal Reserve and the strong need for the US government to keep issuing more bonds would put further pressure on the US dollar bond market, which has already seen the 10-year US Treasury yield breaking the long-term downtrend.

As US Treasury yield goes up, that of corporate bonds will follow.

US dollar strength is also casting shadow on the market. The greenback is likely to stay strong, underpinned by strong US economic growth. That would put pressure on emerging economies and their currencies, in turn hurting demand for their debts.

As major central banks launched rounds of monetary easing measures in the wake of the financial crisis in 2008 and injected massive liquidity into the market, the moves boosted credit growth, especially in emerging markets, rapidly.

Credit to the non-financial sector in developed and developing nations spiked to US$42.16 trillion and US$31.07 trillion respectively as of the first quarter of this year, according to BIS data.

That marks jumps of US$6.1 trillion and US$21.8 trillion respectively compared to the levels in 2008.

Huge credit growth over the last decade and the potential drop in investment interest in debt assets going forward could trigger the bursting of the bubble.

This article appeared in the Hong Kong Economic Journal on Nov 29

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist