By John Richardson
THE consequence of either a failure by the US to raise the debt ceiling and/or a downgrading of the country’s Triple A debt rating would have obviously have serious consequences for the Asian and global chemicals industries.
Just how serious nobody really knows as we are in uncharted waters.
At the very worst we could be talking about a global recession, even a multi-year depression, according to this excellent article from my ICIS news colleague Joe Kamalick.
“A short suspension of principal or interest payments on the Treasury’s debt obligations would cause severe disruptions in financial markets and the payments system,” Daniel Meckstroth, chief economist at the US Manufacturers’ Alliance, was quoted as saying in the article.
Banks, money market mutual funds and many other financial institutions use the liquidity of short-term Treasury securities to manage cash needs.
“A default would (therefore) suddenly make the market value of Treasury securities difficult to determine, potentially destabilising the financial sector and creating panic”, he added.
Even if a default is avoided at the 11th hour, and depending on how the debt limit is raised, the US government’s credit ratings may very well be downgraded. Mekstroth warned that this “would hasten the decline of the dollar’s role in the international financial system”.
A ratings downgrade or an outright default would “call into question the status of Treasury securities as a safe haven for foreign investors”, he said, noting that more than one-third of Federal debt is held by foreign governments, the largest being China and Japan.
Analysts at High Frequency Economics (HFE) have warned that a US default or credit downgrade would sharply reduce the value of Beijing’s Treasury securities holdings.
If the US – China’s top trading partner – had to as a result drastically cut spending, China too could slip into recession.
“We have no doubt the world economy would fold with it,” HFE said.
A credit downgrade would drive interest rates up globally, reducing business investment – and in the US, deepening economic problems left over from the sub-prime crisis.
“This debt debate is already further entrenching the pressured US consumer,” a US-based chemicals analyst told the blog.
“Businesses aren’t hiring and consumers aren’t spending.
“The global economy is largely based around the developed world’s consumption of goods. Asia is seen as the growth market while the developed nations are the foundation.
“You take away more consumer spending, which would happen if there is a default or downgrade, and it is just a ripple-down to Asia.
Demand for Asian products would drop significantly from US consumers.”
China is due to enter its peak manufacturing season in August – when factories making finished goods traditionally ramp-up production ready for the Christmas sales season in the West.
Polyolefin traders have partly justified recent prices rises, and their long positions, on the manufacturing season.
A US default and/or downgrade could therefore lead to a much-weaker manufacturing season and end the polyolefin price recovery, as we have discussed before.
At the very least, until or unless the debt crisis is resolved, the converters are likely to stay largely on the sidelines, leaving the traders with substantial stocks of resin.
“Asian petrochemical producers are high cost producers,” continued the chemicals analyst.
“What will US producers do with all their excess material as local demand weakens? Shipping the product to Asia and cratering the market sounds likely.”
The US polyethylene (PE) sector has benefited enormously from cheaper feedstock, as a result of shale gas, and the weaker dollar.
A debt default or downgrade is likely to weaken the dollar further, as well as, as we’ve already said, seriously weakening local demand.
“I don’t think the US PE industry has yet to fully realise the opportunity it has to take market share away from their higher-cost Asian competitors,” a senior executive with a global polyolefins producer told the blog late last week.
The obvious losers in Asia will be the South Koreans, who, according to a recent Nexant ChemSystems report, are already suffering from margin compression.
Other losers will include the Japanese and non-integrated producers which buy ethylene.
The debt crisis – along with the problems we have highlighted in China - should lead to a re-evaluation of the “2014-2015 peak of the cycle” theory.
Some of the numerous shale gas-based petrochemicals projects that have been recently announced in the US might, as a result, be delayed or even shelved (an industry euphemism for “cancelled”).
The good news is that US politicians might have a little longer to reach a deal beyond the widely-publicised 2 August deadline, according to US-based wealth management and private equity company Robert W Baird & Co.
Inflows to the Treasury have been greater than forecast with expenditure lower than anticipated, said Robert W Baird in a fixed income investment note released earlier this week.
“The August 10 date (when it expects the Treasury to run out of money) is not much of an extension but it could provide the White House and Congress valuable additional time to come to an agreement,” continued the note.
“However, we do not feel it will be enough to allow the ‘warring parties’ to come to an agreement on deficit reduction to avoid a ratings downgrade.”
A downgrade would raise US long-term interest rates by 25-50 basis points and would also cut GDP growth by 25-50 basis points, it added.
The vast majority of analysts agree with Robert W Baird & Co that a default is unlikely because politicians realise the consequences would catastrophic.
“It would be Lehman Bros crisis times five,” added the chemicals analyst.
But, as we have said, a downgrade is bad enough.
“My guess is that they have a triage plan to cut some less consequential payments in the short-term to avoid a default,” added a UK-based chemicals consultant.
“But what does this say to the rest of the world about the dysfunctionality of the system?
“It is no longer just waiting weeks to find out who’s been elected because Florida couldn’t count its hanging chads.
“This is being unable to write a simple letter to the bank manager, asking for the loan to be extended. They’ve spent the money, so they have to have the loan.
What kind of planet do they think they are living on?”