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Stock markets focus on central banks, ignore debt default risk

Economic growth
By Paul Hodges on 12-Jan-2015

GU 10Jan15Some extraordinary things are happening in global chemical markets.  They indicate something is very wrong in the real world outside financial markets.  The chart above highlights some key developments since 18 August when the Great Unwinding of policymaker stimulus began:

  • Brent oil prices have halved and are down 51% (blue)
  • Naphtha, the main feedstock for the global industry, has also halved and is down 57% (black)
  • PTA in China, a good proxy for the local economy, is down 42% (red)
  • Benzene, my favourite indicator for the global economy is down 58% (green)

Yet most commentators continue to insist that everything is ‘business as usual’.  Almost unbelievably, the US S&P 500 continues to float in its own bubble, and is up 5% thanks to the support from US Federal Reserve money printing.

The reason is that many analysts now only worry about the outlook for interest rates, and ignore the lack of demand in the real world.  Those who argued a year ago that high oil prices meant the global economy was strong, happily argue the same for low oil prices.   They believe only an upwards move in US interest rates could destabilise the economy.

Unknowingly, they highlight the insight of the classic novel Candide by the great French writer, Voltaire.  It features an earlier version of these commentators, Professor Pangloss, who keeps insisting despite all evidence to the contrary, that “everything is for the best, in this best of all possible worlds”.

GU 10Jan15aThe second chart above looks more closely at the two key developments of the past 6 months.  The blue line is the collapse of Brent oil prices, and the red line is the rise of the US$ Index versus the other major world currencies.  It is impossible to over-estimate the importance of both developments.

As Ambrose Evans-Pritchard has warned in The Telegraph, the 12% rise in the US$ Index means $5.7tn of emerging market debt is now at risk:

They have collectively borrowed $5.7 trillion in US dollars, a currency they cannot print and do not control. This hard-currency debt has tripled in a decade, split between $3.1 trillion in bank loans and $2.6 trillion in bonds. It is comparable in scale and ratio-terms to any of the biggest cross-border lending sprees of the past two centuries. 

“Much of the debt was taken out at real interest rates of 1% on the implicit assumption that the Fed would continue to flood the world with liquidity for years to come. The borrowers are “short dollars”, in trading parlance. They now face the margin call from Hell as the global monetary hegemon pivots.

The second assumption was that China would continue to drive a commodity supercycle even after Premier Li Keqiang vowed to overthrow his country’s obsolete, 30-year model of industrial hyper-growth, and wean the economy off $26tn of credit leverage before it is too late.”

Chemical markets are the best leading indicator for the global economy.  Developments in these over the past 6 months are the canary in the coal-mine that confirm Evans-Pritchard’s analysis.  We are getting closer and closer to the opening of the debt-fuelled “Ring of Fire” created by the central banks.


The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 58%. “Falling upstream crude oil values and thin market participation have pulled benzene prices lower”
Naphtha Europe, down 57%. “A free fall in naphtha prices has increased the air of caution in the petrochemical markets, making buyers hold back from making additional purchases”
Brent crude oil, down 51%
PTA China, down 42%. ”Prevailing weak downstream demand has largely curbed buying interest for higher-priced materials.  Ample inventories in the region have also resulted in buyers adopting a wait-and-see stance, without rushing to procure cargoes”
¥:$, down 16%
HDPE US export, down 12%. “US-made material is still priced too high to compete with Asian imports”
S&P 500 stock market index, up 5%