Japan’s Export Growth Slows as External Demand Moderates

Pre-Market U.S. Stock Movers

Source: Barchart

The Reserve Bank of Australia (RBA) said it will focus on the possible use cases for a wholesale central bank digital currency given the modest likely benefits and potential complications from a retail variant.

A retail central bank digital currency (CBDC) would create “non-trivial challenges” for financial stability and monetary policy implementation, RBA assistant governor Brad Jones said in the text of a speech due to be delivered in Melbourne on Sept 18.

As an immediate priority, the central bank will start a new project with the industry on wholesale CBDC and tokenised commercial bank deposits, Mr Jones said. A wholesale CBDC “would represent more an evolution than revolution in our monetary arrangements”, he added.

Central banks around the world are assessing blockchain technology, with potential gains in the speed and cost of real-time interbank payments a key area of interest.

Some 134 countries and currency unions – representing 98 per cent of global gross domestic product – are exploring a CBDC, and three nations have fully launched one, according to the Atlantic Council.

Some critics argue modern digital payments are already efficient and that CBDCs bring potential privacy concerns as transactions can be tracked.

Mr Jones said that if a public policy case were to ever emerge in favour of a retail CBDC, the Australian government would be the ultimate decision authority and it would almost certainly require legislative change. For a wholesale CBDC, the decision making and legislative implications would depend on the new arrangement, Mr Jones added.

The assistant governor laid out a road map for a three-year digital money work plan.

An assessment of how wholesale digital money and new settlement methods could support tokenised markets runs from 2024 to the first half of 2025. An evaluation of the merits of and design issues for a retail CBDC is due to begin in 2026 and conclude in 2027.

The Australian government will publish a joint paper with the RBA on CBDC and the future of digital money on Sept 18. ANZ Group Holdings and Commonwealth Bank of Australia are among the local institutions that have already participated in pilot CBDC projects. BLOOMBERG

Source: Straitstimes

When U.S. based construction material supplier Wilsonart issued a junk bond to raise $500 million to fund an acquisition this summer, a research firm warned potential investors that the terms of the deal offered them weak protections.

The bond’s covenants would allow the company to potentially move valuable assets to a different entity later and raise even more money, putting the investors in the bond at a disadvantage, the research firm, Covenant Review, wrote in a review seen by Reuters.

The warning came against the backdrop of growing worries in credit markets after an increasing number of companies have used similar weaknesses to borrow more against the same assets, in a practice euphemistically called a liability management exercise.

That has favored some creditors over others, a result that’s come to be known as creditor-on-creditor violence. Things have become so bad this year that some creditors have been banding together to fight back.

So, what did investors do in the case of the Wilsonart offering after the warning? They lapped it up.

Wilsonart did not respond immediately to a request for comment.

Wilsonart’s ability to raise the money highlights a paradoxical trend in U.S. credit markets: while investors are suffering the consequences of weak covenants, they are letting a vast majority of companies sell them new paper with the same flaws without significant pushback, credit market bankers, lawyers and investors said.

The reason, these market sources said, is lack of enough supply of junk-rated bonds and the need to lock in higher yields before the Fed begins to cut interest rates as well as diverging interests between the biggest creditors and small investors.

"Investors have a tough choice to make: Do I sit in cash and not buy a bond or loan because of looser documentation and thereby risk hitting my return hurdles," said Peter Toal, global head of fixed income syndicate at Barclays. Toal said the lack of supply was in part because most of the borrowing now has been to refinance old debt.

Several bankers and analysts estimated 90% of high-yield bonds and loans that are coming to the market now are being sold with weak investor protections despite growing concern that stressed companies were taking advantage of them to raise fresh funds to repay maturing debt or simply remain solvent.

More than 90% of the Morningstar LSTA Leveraged Loan Index is now "covenant-lite" or lacking maintenance covenants, a metric that has increased sharply since the financial crisis of 2008, a Barclays research report shows.

Liability management exercises (LMEs) come in many forms, but the most common tactic is for the company to transfer valuable assets into a subsidiary. That subsidiary then raises debt in a side deal from some old and new investors. The cash is then forwarded back to the parent as an intercompany loan.

The side deal gives the new creditors a priority claim on the company’s assets in case of a bankruptcy, pushing existing investors down the line, increasing their potential losses in the event of default.

High-yield bonds and loans bought by investors make their way into funds that are then sold to retail and large institutional investors who, as a result of weaker covenant protections and covert LMEs, may end up facing losses or underperformance of their investments.

DISTRESSED EXCHANGES

So far in 2024, 28 companies have completed a distressed exchange, totaling $35 billion, the second-largest total on record, according to JPMorgan. Their numbers are expected to only grow.

Moody’s has said some 13.5% or $400 billion of the more than $3 trillion junk-debt rated by it is at a high risk of default over the next 12 months, with a bulk structured with little or no guardrails to prevent liability management exercises.

Investors are being forced to consider ways to improve their claims on a company’s assets. Many creditors have been entering into cooperation agreements, or private legal pacts, to increase their ability to negotiate and keep rivals from signing side deals without their knowledge, bankers and lawyers said.

Steven Oh, global head of credit and fixed income at asset management firm Pinebridge Investments, said investors were caught in a "classic prisoner's dilemma."

“Do the side trade with the company and enhance your own interests or align with others and prevent someone else from doing a deal with the company," Oh said.

In some cases, investors are also pushing back on the documentation, refusing to buy new debt unless the borrower agrees to include clauses that stop it from short-changing existing creditors. Moody’s noted in April that Thryv and two other borrowers faced such pushback.

Nevertheless, the market sources said such pushback was still rare. It was again on display in early September, when Clayton, Dubilier & Rice (CD&R) through Fiesta Purchaser marketed a $400 million junk-rated bond.

Covenant Review again issued a market alert urging investors to reject the legal provisions included in it as it would take the company’s ability to issue debt through a subsidiary to a “nonsensical extreme.”

A few days later it pointed out the same flaw in a new $700 million bond by Focus Financial Partners but after both bonds were subsequently upsized and priced on September 9 and 10, it noted the language may have been changed.

CD&R declined to comment and Focus Financial did not respond to a request for comment.

Scott Josefsberg, Covenant Review’s head of high-yield research, said the changes showed if investors are willing to push back hard, covenant protection can be improved but it was a long road ahead to a major overhaul.

"A vast majority of bonds and loans have no guardrails against LMEs, and they are easily sold," Josefsberg said.

Source: Theedgemarkets

Source: Reuters

Why Is Accurately Predicting Monetary Policy Pivots Important?

Part three of the series presented four-quarters-out probabilities of the three growth scenarios of soft-landing, stagflation and recession. This installment develops a framework to employ those probabilities to predict monetary policy decisions. We follow two different paths to gauge the usefulness of our toolkit. The first method predicts monetary policy pivots, and the second approach forecasts the near-term level of the fed funds rate (a topic we’ll cover in the next installment).

We believe accurately predicting the timing of a policy pivot compliments the generation of the future potential path of the fed funds rate. By predicting the timing of a policy pivot, decision makers could anticipate the potential duration of the current stance, at least in theory. The prediction for the fed funds rate would shed light on how many rate cuts (a relevant discussion for the current cycle) are appropriate in the near future.

In our view, accurately predicting periods of monetary policy pivots is vital, as a rate cut that comes too late or too soon (a widely discussed topic in the present cycle) would be harmful to the economy and damage the FOMC’s reputation. Members of the FOMC have repeatedly acknowledged that their goal is to avoid a mistimed rate cut, whether it be too soon or too late. Some analysts suggested the March 2022 rate hike was too late, as the FOMC misjudged higher inflation as “transitory” and waited too long to act. By the same token, significant changes in the FOMC’s SEP (June 2023 vs. June 2024) made some analysts worry that the next policy pivot (which is expected to be a rate cut) may be mistimed as well.

A New Framework To Quantify Episodes of Monetary Policy Pivots

We develop a new framework to quantify episodes of monetary policy pivots and present a probit regression to predict the probability of a policy pivot during the next two quarters. At present, the FOMC regularly meets eight times a year, with four meetings in the first half and four in the second half. Thereby, we set a two-quarters-out forecast horizon to predict the chances of a policy pivot during the next four meetings. Given the volatile nature of the economy during the post-pandemic era, a one-year-out prediction for a policy pivot would suffer lower accuracy, as the rapidly changing nature of potential risks would dictate a faster response from the FOMC, all else equal.

We define a policy pivot as a change in the FOMC’s rate decision compared to the past few meetings. There are two key elements in our definition of a policy pivot. The first is that the FOMC has a different rate decision than the past few meetings. The second condition is that the FOMC keep the stance for the next few meetings, at least. There are three rate decisions that have been utilized by the FOMC, at least in the post-1990 era. The FOMC either (a) raises the target of the fed funds rate, (b) keeps the rate unchanged or (c) reduces the rate (Figure 1).

Historically, once the FOMC adopts a policy stance (a rate hiking stance, for example), it keeps that stance for at least several meetings. In the post-1990 era, the shortest duration of a policy stance was about six months, which occurred in 1995. The FOMC raised the fed funds rate to 6.00% from 5.50% in February 1995, and then kept that rate (a rate pause) until its June meeting. The FOMC reduced the rate by 25 bps in July 1995.

We use these conditions to identify periods of policy pivots. The last policy pivot date was in August 2023, as that was the first month after the fed funds rate peaked at 5.50% in July 2023. After 13 consecutive months, the fed funds rate is still at 5.50%. Essentially, August 2023 marks the end of the rate hike stance that started in March 2022. If the FOMC cuts rates in September 2024, then that would be the next policy pivot, as it would be the start of a rate-cut cycle (a policy normalization stance). Of course, this is assuming the FOMC will adopt a rate-cut stance for the near future.

Episodes of the Monetary Policy Pivot in the Post-1990 Era

Our framework estimated that there are 26 episodes of policy pivots in the post-1990 period (for detail see Table 1). We concentrated on the post-1990 era, where the FOMC’s communications about policy decisions are more transparent and shared with the public in a timely matter. One example of the FOMC’s communications can be seen in the fed funds rate series, as the post-1990 data are smoother, and policy stances (from rate cuts to policy pauses, for example) can be identified with a reasonable confidence. (Figure 1)

By our definition, there are four types of policy pivots: (1) pause-to-cut, which is the start of a rate-cut stance, (2) cut-to-pause, which is the end of a rate-cut stance, (3) pause-to-hike, which is the start of a rate-hike stance and (4) hike-to-pause, which is the end of a rate-hike stance. There are eight episodes of pause-to-cut, six of cut-to-pause, seven of pause-to-hike and five of hike-to-pause. Most policy pivots in the post-1990 era included a pause stance (11 pivots are either cut-to-pause or hike-to-pause), while eight took an easing/rate-cut stance and seven took a tightening/rate-hike stance. Our forecast horizon is only two quarters out, therefore the type of policy pivot would be known to a forecaster. Thus, we only concentrate on predicting the timing of a policy pivot.

A Probit Approach To Predict the Probability of Monetary Policy Pivots

The major benefit of identifying periods of policy pivots is that we can build a regression to generate the probability of a policy pivot in the near future. For example, we identifed 26 episodes of policy pivots in the 1990-2024:Q2 period, and then we created a dummy variable where a value of one represents a pivot occurring and zero is otherwise. Using the dummy variable, a probit regression is developed to predict the two-quarters-out probability of a policy pivot. Part III of the series presented four-quarters-out probabilities of the three growth scenarios of soft-landing, stagflation and recession. We employ those probabilities as predictors of the probit regression.

Figure 2 shows the two-quarter-out probability of a policy pivot, and the bars represent actual periods of policy pivots (based on our framework; see Table 1 for detail about those pivots). Using the average probability of 35% as a threshold (dotted line in Figure 2), the framework accurately predicted all episodes of policy pivots in the post-1990 era.

As seen in Figure 2, the probability of a policy pivot started trending upward in Q2-2021 and breached the threshold in Q3-2021. The framework suggested starting a rate hike cycle sooner than Q1-2022, with a possibility of a rate hike in 2021. Neither the FOMC nor the Blue Chip consensus provide an explicit probability of a policy pivot, but the FOMC’s SEP and the Blue Chip consensus did not predict a rate hike in 2021 (i.e., no policy pivot in 2021). However, both forecasts did predict rate hikes in 2022. In retrospect, our framework would have helped decision makers determine appropriate timing for the rate-hike cycle back in 2021-2022.

The policy pivot probability jumped in Q2-2023 (from 34% to 42%), and then peaked in Q3-2023, which is consistent with the most recent policy pivot of Q3-2023—a hike-to-pause pivot. Q4-2023 and Q1-2024 noted a declining trend (but still above the threshold line) which may have cautioned analysts that a policy pivot to rate cuts were potentially further away. The latest probability (Q2-2024) of 43% indicates that a rate cut cycle may start soon (within the next two quarters), which is consistent with financial markets participants’ expectations for the upcoming September FOMC meeting. Given the historical accuracy of our framework, we believe the toolkit would provide useful insights for decision makers, as it can be updated in real time to gauge the likely duration of the upcoming easing cycle.

A Policy Pivot Is Most Likely, but What About the Pace/Duration of the Easing Cycle?

In summary, the latest probability (Q2-2024) of 43% indicates that a rate cut cycle may start soon (within the next two quarters), which is consistent with both the FOMC and Blue Chip forecasts, as they are also predicting a policy pivot in 2024.

FOMC members provide their near-term (as well as long-run) fed funds rate forecast. The June 2024 SEP suggests one 25 bps rate cut in 2024 and four more cuts throughout 2025. The FOMC employs its fed funds forecast (along with their other forecasts) to signal its near-term policy stance. In the short run, significant changes in the forecast would send undesirable signals and raise questions about the accuracy of the fed funds forecast. Therefore, in our view, accurately predicting the near-term path of the fed funds rate is vital for effective policymaking as well as policy communication. The next installment of the series will present a new approach to predict the fed funds rate two-quarters-out (up to four FOMC meetings ahead).

Table 1

Source: Federal Reserve Board and Wells Fargo Economics

The price of gold is mainly determined by fluctuations in demand