Key Signs a Recession is Starting Soon... If It Hasn't Already Started

The Japanese government is considering support measures to make it easier for companies to enter into long-term purchase contracts for liquefied natural gas to ensure a stable supply of the super-chilled fuel, the industry ministry said on last week.

At a meeting with energy experts to discuss fossil fuel procurement, the Ministry of Economy, Trade and Industry (METI) outlined possible measures, including financial support for securing storage tanks in Japan and abroad, and a new scheme to assist LNG buyers committing to long-term contracts.

Details are still being finalised, a ministry official said.

Gas-fired power generation accounts for about 30% of Japan's power mix. Japan, the world's second-biggest LNG importer, faced heightened energy security risks after Russia's invasion of Ukraine, which led to soaring spot LNG prices and subsequently increased electricity costs.

To mitigate these risks, METI is exploring measures to support Japanese power and gas utilities in securing long-term LNG contracts, as LNG remains a crucial fuel source for Japan.

From an energy security perspective, the ministry is also considering forming an index to assess how much LNG Japan can stably procure and use relative to its needs.

Other measures include a government-led initiative to secure LNG in emergencies, potentially through a pre-arranged agreement between gas suppliers and the government, with a fee paid to ensure supply, the ministry official said.

At the meeting, METI emphasised the importance of diversifying sources for crude oil procurement as Japan relies on the Middle East for 95% of its oil.

The ministry also stressed the need to secure a stable supply of thermal coal, despite the global shift away from the dirty fuel.

The ministry said that the rapid divestment from upstream coal assets, especially in developed nations, could create a discrepancy between global supply and demand. METI underscored the benefits of coal, such as its low cost per heat unit, and Japan's need to maintain varied energy sources.

Source: The edge markets

Blue-chip companies are spending more money on US dollar bond interest payments, and even Federal Reserve rate cuts this year won’t immediately reverse the trend.

High-grade issuers are poised to pay around $420 billion in coupons this year, up 18% from last year, according to a note by JPMorgan Chase & Co. That increase is three times the rate of revenue growth for companies in the S&P 500 Index during the second quarter — suggesting the trend is weighing on profit growth for many companies.

The difference between yields on new bonds and maturing bonds so far this year for companies in the US investment-grade market averages about 2.01 percentage points, or 201 basis points, data compiled by Bloomberg show. The higher costs are likely to persist for several more quarters, according to the JPMorgan report.

“Even with some Fed cuts, issuers will still on average be paying more for new debt versus maturing debt,” JPMorgan strategist Nathaniel Rosenbaum wrote in an email.

Fed policymakers are due to meet this week, and interest-rate traders broadly expect them to start cutting rates at that meeting. But for many high-grade companies, that won’t translate to lower bond expenses right away because their maturing debt often comes from the era of low interest rates, and the Fed tightening campaign that started in 2022 has lifted current borrowing costs so much from those levels.

Some companies have taken steps to keep costs manageable, with rate relief solutions including fine-tuning hedging strategies and shifting into debt that matures sooner.

“Now that rates are higher, we’ve tended to have more shorter-dated debt,” said Tim Arndt, chief financial officer at Prologis Inc., a real estate investment trust that focuses on warehouses.

Paying more interest can be punishing for companies, leaving them with less money for items like business investments and wages. For high-grade companies, the interest coverage ratio — which compares a measure of earnings with interest expenses — has come down since 2022, indicating a slight weakening in corporate credit quality, according to a report from S&P Global.

Rising interest costs also make acquisitions more expensive, which can limit companies’ ability to grow, move into adjacent business lines or cut operational expenses through efficiencies.

“You have to ask yourself the question, is it worth it for me to do those types of things given the fact that I have to pay interest, which is higher than it has been in the past?,” said Raj Shah, co-head of US investment grade bonds at PGIM Fixed Income.

ZIRP No More

Overall, though, the higher interest expenses appear to be frustrating rather than debilitating. Many companies were accustomed to rock-bottom interest rates — known as “ZIRP,” for Zero Interest Rate Policy — for such a long time.

Looking ahead, the extent and frequency of the Fed’s rate cuts are center stage for companies and investors. An inflation report on last Wednesday dampened odds of a cut beyond 25 basis points among traders.

If the Fed does cut rates more aggressively, it will probably be because economic growth is slowing fast, said Daniel Sorid, head of U.S. investment grade credit strategy at Citigroup. That would suggest layoffs, lower demand and weaker corporate profits ahead — all of which would hit credit, he said.

In the meantime, investors have been reinvesting interest payments back into the market, driving demand and keeping risk premiums relatively tight. They are getting more money back than they can invest: Bank of America in June forecast total high-grade corporate coupon payments of $220 billion in the second half of 2024, while net issuance will probably be around $89 billion. In that way, any growth in coupon payments could help support corporate bond valuations.

“That eliminates one more thing for investors to worry about,” said Travis King, head of US investment grade corporates at Voya Investment Management.

Source: The edge markets

Since Vice President Kamala Harris replaced Joe Biden as the Democrat Party presidential candidate, she has been strategically silent about her energy and climate policy platform. Her campaign for the 2020 presidential election indeed outlined an aggressive vision, where she proposed to spend $10 trillion to decarbonise the US economy, establish a carbon tax, and ban fracking. But this time around, her ambiguity on climate policy so far is signalling a departure from her 2020 stance and a move toward the centre.

Harris may face mounting pressure to lay out a more detailed energy and climate policy platform as we head to the elections, but either way, we would expect Harris to preserve the Biden administration’s most important climate legacy – the Inflation Reduction Act (IRA) and Infrastructure Investment and Jobs Act (IIJA).

Based on these two laws, she may propose to expand clean energy spending and put a stronger emphasis on certain aspects, such as environmental justice and affordable energy. She is also likely to toughen environmental regulations, such as on vehicles and oil and gas. But those regulations run a high risk of being struck down now that the Supreme Court has overturned the Chevron Doctrine and shifted much of government agencies’ power to the judiciary branch.

Oil and gas

Harris would need to carefully handle the delicate balancing act among energy transition, energy security, and market stability. This will remain difficult given the exacerbated political polarisation, increased cost of living, as well as the US’s role as the world’s largest oil and gas exporter. Thus, as discussed before, we would not expect Harris to take an extreme approach toward the oil and gas industry – in fact, she has already indicated that she no longer supports a fracking ban.

US oil output would likely continue to hit record highs regardless of who is in the White House as we have seen over the last few presidencies. We would also likely see caution from Harris on new LNG export licensing bans, as the January ban has already been overturned by a federal judge and would similarly be struck down by the Supreme Court.

Instead, a Harris administration might try to implement policies asking oil and gas companies to pay more royalties for drilling on federal lands or toughening the rule of fee collection over methane emissions. Harris might even try to reduce current subsidies to oil and gas companies – as newly indicated on the Democrat Party’s policy website. However, this latter policy may prove to be difficult to implement because of the stubborn existing system and the strong lobbying power of the oil and gas industry, especially if the Democrat Party does not control Congress.

IRA

The IRA will not go away, because even if Congress somehow succeeded in voting to repeal the act, the decision would be vetoed by Harris. Nevertheless, the Democrats may need to make compromises on certain IRA provisions. The compromises may be done by cutting certain clean incentives such as for electric vehicles (EVs), making more clean fossil fuel power plants eligible for clean power tax credits, and favouring blue hydrogen over green hydrogen, among others. Additionally, more compromises might be necessary if the deficit issue in the US becomes more severe.  

In any case, we expect the Harris administration to work on an even better implementation of the IRA. Harris’ Vice President pick of Governor of Minnesota Tim Walz has signed into law various legislation to help the state tap into the clean energy funding of the IRA and reduce emissions. While not easy to replicate at the national level, the Harris administration can leverage Walz’s experience to work with federal agencies and ensure more efficient flows of funding to states.

EVs

If Democrats do not control Congress, the US EV policy would remain vulnerable, even with Harris winning the White House. Harris would want to support the EV industry even more, but any EV provisions under the IRA – tax credits, charging network funding – would be first in line to be sacrificed for a compromise. Nevertheless, we can still expect the Harris administration to push for educational programmes and work with car manufacturers to upskill the industry’s workforce and promote the adoption of EVs.

EV and hybrid vehicle sales as a percentage of total light-duty vehicles

Hybrid electric vehicle without plug: HEV, battery electric vehicle: BEV, plug-in hybrid electric vehicle: PHEV

Source: Argonne National Laboratory, ING Research

Renewable power

Supportive policies on renewable power would stay largely intact with possible additional efforts to reform the transmission lines and shorten permitting timelines. The renewable industry in the US would continue to develop steadily, further driving down the cost of production.

Hydrogen and CCS

The hydrogen and CCS tax credits have the highest chances of staying among all incentives provided under the IRA. However, without Democratic control of Congress, we would still see pressure to make the tax credit eligibility requirements looser for both hydrogen and CCS. And since the Department of Energy's LPO’s funding does not differentiate among technologies, it is likely to be cut in this scenario, too. Efforts from corporates to develop pipelines will continue, though support from the government will not be high.

Critical minerals  

Onshoring key technologies (such as batteries) and securing the critical mineral supply chain would also be a priority for Harris. But as opposed to Trump’s comprehensive tariff proposal, Harris might target tariff hikes on strategic goods, including batteries, graphite, and permanent magnets, among others, with existing/further exemptions or delays in implementation.

Regulation

Harris may put a strong emphasis on strengthening environmental regulation to push the US to a cleaner economy faster. But there is a strong resistance force – the Supreme Court.

In recent years, the conservative Supreme Court has made several decisions limiting the EPA’s regulatory power. In 2022, it ruled that the EPA does not have the authority to limit emissions from power plants by taking a broad view of the Clean Air Act (CAA) and forcing them to switch from one source of generation to another. Power plants must instead be regulated based on the best system of emissions reduction (BSER) method authorised under the CAA.

In June this year, the Supreme Court overturned the 40-year-old “Chevron doctrine” under which lower courts needed to defer to federal agencies to implement legislation that was ambiguous in interpretation. Moreover, the Supreme Court recently temporarily blocked the EPA’s “Good Neighbour” rule to regulate power plant nitrogen oxide emissions from upwind states.

These decisions have shifted more power of interpreting federal law from the executive branch to the judiciary branch. This means that despite Harris’ will, the EPA’s newly finalised vehicle tailpipe emissions rule, its new regulations on coal and gas power plants (following the 2022 Supreme Court guidance on using BSER), and any new regulations could all be at risk. Consequently, the US may need to rely even more on carrots than sticks to drive the energy transition.

Climate leadership

A Harris administration would advance climate leadership through continued engagement in the United Nations Conference of the Parties on climate change. But the US’s climate credibility may be hard to enhance given its lack of a comprehensive climate policy ecosystem, its lagging progress in mandating sustainability disclosure, as well as potential clean energy funding pullbacks.

Your team recently upped its forecast for US home prices, noting that “bad news is likely good news” for home prices. What did you mean by that?

How does your anticipated home price appreciation compare to recent history?

But isn’t the unaffordability of housing impacting their buying decisions?

If home prices keep rising, though, how does that impact the affordability problem?

Why haven’t we seen mortgage applications respond yet to the decline in borrowing rates?

What are some of the big differences you’re seeing among US regions?

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