During the autumn of 2007, a bond manager from California popped into the Financial Times’s New York office with a timely warning after a long road trip through the then-frothy housing states of the US south-west.
Lately, investors fresh from fact-finding missions to China and Hong Kong have voiced concerns that a major shift is playing out behind the smoke of trade tensions — a change that helps provide context for the massive rally seen in global bond prices over the past month.
The mood across government bond markets reflects a dour outlook for the global economy and a need for owning insurance against a bigger shock for investment portfolios. This month’s clamour for long-dated government debt suggests that buyers reckon the recession clock is counting down to a day of reckoning, as it did in 2007.
Historically, recessions take time to emerge, usually about 18 months, whenever bond markets send 10-year and 30-year yields below rates set by central banks and short-term government paper with a maturity of two years.
Certainly an escalating trade war worries many, particularly as it suggests that a long era of global co-operation is fading. That point was underlined by the lack of an official communiqué from last weekend’s G7 meeting of leading nations, marking the first time there had been no formal sign-off.
But the ramifications of a prolonged stand-off over trade do not justify the collapse seen in bond yields over the past month or the rapid rise in gold prices.
For example, one barometer of future growth expectations are real yields, adjusted for inflation. Here, the US 10-year measure is negative and this week fell below its nadir of 2016, the previous time that global growth worries sparked pronounced risk aversion.
Markets can often run well ahead of fundamentals, but as a clearing house of countless transactions from around the world, they do send a valuable message, which means extreme moves warrant close attention.
What the bond and gold markets are now implying goes beyond the popular narrative of a trade war clipping global manufacturing and unsettling complex supply chains.
They are sending a far more worrying message: China, now growing at its slowest pace in three decades, is not going to ride to the rescue as it did in 2009 and 2015 when it sparked another global upswing via significant spending. This time is different, as Beijing faces structural challenges while it weans the country off its export- and infrastructure-led growth.
Indeed, the costs of past fiscal and credit binges and the threat of a deflationary wave via a sliding renminbi are what worry many investors and explain in part this month’s big drive into havens — particularly when they look at heavily indebted Chinese companies and the Asia region in general.
Recently, McKinsey & Co released a study of stress levels on corporate balance sheets from more than 23,000 companies across 11 markets in the Asia-Pacific region.
The results were far from comforting, with the global consulting firm concluding: “In 2017, Australia, mainland China, Hong Kong . . ., India, and Indonesia had more than 25 per cent of long-term debt held by companies with an interest coverage ratio of less than 1.5, and the share has increased materially since 2007.”
When companies are spending a significant amount of earnings to service their debts, broader economic conditions are vulnerable to any kind of shock.
More specifically, China in recent years has been trying to tame its vast shadow banking sector, efforts that have helped cool this murky $9.1tn sector for the first time in a decade, but a side-effect is that corporate defaults are picking up.
Although McKinsey notes “a large share of the lending in mainland China continues to be denominated in local currency’’, which spares these borrowers from the pain of a stronger US dollar, the consultancy adds: “Default risk remains high, especially from corporate clients in poor financial health.”
Of late, China has been bolstering its economy’s credit conditions after clipping the shadow lending sector, and together with many other central banks easing policies, this has supported a view among some observers that there will be a rebound in global activity early next year.
That suggests the current state of low and, in many cases, deeply negative-yielding government debt is vulnerable and has scope for reversal, but only briefly. But the longer-term view from global havens is that the likelihood of China spurring another synchronised global upswing has passed.
Not only are buyers of global sovereign debt and gold casting plenty of doubt over a repeat performance, they are questioning the ability of central banks and mooted fiscal stimulus in Europe and the US to step up and prevent an extended period of slumbering yields and inflation expectations.