US Fed’s gift to corporate debt issuers in China
Managing the level of corporate debt in China, at some 160 per cent of the country’s gross domestic product, brings its own challenges but the United States too has its own vulnerabilities in this area.
Some might even conclude the Federal Reserve’s dovish monetary policy stance in March might, at least in part, reflect an understanding that such domestic US vulnerabilities exist.
Touching first on China, aside the scale of corporate debt, there is also the fact that much of it is dollar-denominated and by definition has to be repaid in greenbacks, a task rendered harder as yuan revenues buy fewer dollars if exchange rate moves benefit the US currency.
An overview of China’s corporate bond issuance illustrates the kind of numbers involved in just one segment of that debt pile.
The Bank for International Settlements, often referred to as the central bank’s central bank, has calculated that there was “about $1.2 trillion debt issuance” from emerging market economies (EMEs) “on international markets over the 5-year period from 2010 to 2014” and that it was “consistently dominated by Chinese companies (US$376 billion).”
The “latest estimate is that scheduled repayments [for EMEs] for the three years 2016, 2017 and 2018 will exceed $340 billion”, the BIS said, and a large chunk of that will likely be repayments by Chinese issuers.
In total, the BIS estimated cross-border claims on China as a whole were US$877 billion in the third quarter of 2015.
Much Chinese corporate debt is related to fixed asset investment, in projects that currently appear economically unviable. Of course the same could also be said of the debt-financed US shale oil sector projects that, to survive, need a price per barrel significantly higher than can currently be achieved.
But in the United States, corporate debt has also been used to finance share buybacks. In December, a Reuters analysis, of Federal Reserve data, said US non-financial companies had spent US$2.24 trillion on buybacks since 2009, while borrowing an extra US$1.9 trillion to help finance those purchases.
At the same time data from the US’ Bureau of Economic Analysis shows that between 2009 and 2015, the current cost average age of US fixed assets rose from 21 to 22.7 years.
US share buybacks funded by corporate debt have flourished even as US fixed assets, whose productivity helps generate the earnings with which firms repay debt, have been allowed to age gracefully.
Corporate America, not oblivious to the fixed-asset ageing, has opted to coax productivity out of the capital stock by increased labour hiring, which helps explain the continuing fall in the US jobless rate to levels that the Federal Reserve would normally equate to full employment.
But as labour becomes scarcer, the cost of hiring it rises and, as analyst Albert Edwards at French bank Societe Generale wrote on March 17, “the resulting surge in unit labour costs, in excess of the growth in corporate output prices, squeezes corporate margins”.
And US corporate profit margins are indeed coming under pressure.
US research firm FactSet estimates US S&P 500 companies will have experienced an 8.4 per cent fall in earnings in Q1 2016, year over year, and said on March 18 that, if so, that would mark “four consecutive quarters of year-over-year declines in earnings” for the first time “since Q4 2008 through Q3 2009”.
Moreover, of the 118 S&P 500 companies that have issued earnings per share (EPS) guidance for the first quarter of 2016, “92 have issued negative EPS guidance”, FactSet said, and that against a backdrop of buybacks meant to enhance EPS.
Could it be that US corporates who have accumulated corporate debt to fund share buybacks might be about to find the debt burden is becoming more onerous?
If the Fed is thinking along similar lines, it could help explain the US central bank’s dovish monetary policy stance earlier this month, a stance seemingly at odds with rises in both US core inflation, and the Fed’s own preferred personal consumption expenditure price index, that otherwise might have justified a rate hike.
The Fed’s dovish stance could well support risk assets such as US equities, while keeping US interest rates unchanged awhile longer arguably buys US corporates time to address corporate debt issues.
Fed dovishness also weighed initially on the value of the dollar. That has implications for the management of China’s own corporate debt as less upward pressure on the greenback versus the yuan could benefit Chinese corporates as they manage down dollar-denominated corporate debt, bringing the story full circle.
The Fed’s present stance might prove a boon to both Chinese and US corporate debtors.