A semester of financial turbulence that should worsen

The global financial system’s warning signals are starting to flash red as inflation continues to rise and central banks’ willingness to raise interest rates sharply even as it triggers a recession.

Traders work on the floor of the New York Stock Exchange in New York, Friday, July 1, 2022. (AP Photo/Seth Wenig)

Wall Street recorded its worst six-month open since 1970, when the US economy was in recession. On Thursday, the S&P 500 index fell 0.9%, leaving it down 20.6% for the year. The drop in the technology-heavy NASDAQ index was even greater, with losses for the year approaching 30%.

Around $9 trillion has been wiped out of the equity market, according to Bloomberg’s calculations, with the total value of the broad S&P 1500 index falling from $45.8 trillion at the end of 2021 to just over $36 trillion.

Summarizing the situation, the wall street journal Financial columnist James Mackintosh noted that mid-year “markets are starting to worry we’re not even halfway through the bad news 2022 has in store for us”, while pointing to the “surprises” of the top six month.

These included inflation, the biggest bond sell-off in four decades, “a drop in tech stocks rarely matched in history” and the “implosion” of crypto.

There are indications that the unrest is spreading from high-risk areas to supposedly safer areas of the market. According to a report published in the Loginvestment grade bonds fell 11% in the first six months, “their worst start to the year in history”.

The prospect of a recession is rising, with the US economy registering a 1.6% annualized contraction in the first quarter, while forecasts indicate that the second quarter result will not be much better. Economists interviewed by the Log said they saw a 44% probability of a recession over the next 12 months, up from 18% in January.

As it began its rate tightening, Federal Reserve Chairman Jerome Powell and other central bank officials argued it was possible to stage a ‘soft landing’ for the US economy. without causing a recession. But that scenario fell by the wayside, with Powell saying the interest hikes – aimed at ending what he has repeatedly called a “very tight” labor market – will cause “pains”.

Research by the Federal Reserve Bank of St Louis on monetary tightening cycles over the past four decades concluded that the US economy has entered recession four of the last six times it has started raising rates.

It has been reported that major investment banks, including Bank of America, Credit Suisse and Goldman Sachs, as well as others, could collectively lose billions of dollars on leveraged buyout transactions, in which they make loans for buyback transactions which they then sell.

But according to a Log report, as of June 23, they were receiving an average of 94.8 cents on the dollar for newly issued buyout debt, up from 99.2 cents at the end of January.

Losses on the $15 billion leveraged buyout of cloud computing company Citrix, the largest such deal this year, are expected to total up to $1 billion.

Financial conditions in Europe are also rapidly deteriorating. A FinancialTimes (FT) published over the weekend drew attention to the situation in the corporate bond market, where 40 billion euros of debt is now trading at “distressed” levels, compared to 6 billion dollars at the end of last year. And the slide seems to be accelerating.

“The stock of distressed corporate debt more than doubled between May 31 and June 30 alone, underscoring how quickly concerns are mounting that central bank decisions to tighten monetary policy could tip major economies in recession,” the article said.

Last week, ratings agency S&P Global warned of an “increasingly troubled outlook for credit quality” in Europe.

“Credit ratings are expected to come under pressure in 2023 as supply constraints keep food and energy prices high, households increasingly grapple with falling real incomes and central banks are prioritizing inflation over growth,” he said.

According to calculations by Ice Data Services, reported by the FT, in the market for euro-denominated junk bonds – those rated below investment grade – 8.8% were now trading at levels “in difficulty”. In other words, they were more than 10 percentage points higher than government bonds, compared to 1.3% at the end of last year.

But it’s not just the riskiest segments of the market that are being hit by growing fears that higher interest rates could lead to a recession. A note released Friday by European credit analysts JPMorgan said there has been “an alarming freeze in lending conditions in the capital market, which has gradually extended the quality curve.”

One of the clearest expressions of the results of central bank interest rate hikes and credit crunch is the collapse of cryptocurrency markets – a kind of “canary in the coal mine” for the financial system as a whole.

Three weeks after crypto lender Celsius Network halted customer withdrawals, investors are facing the prospect of never getting their money back. On Thursday, he posted a blog post saying he continues to “take important steps to preserve and protect assets and explore the options available to us.”

Celsius has reportedly hired lawyers and consultants for a possible bankruptcy filing under which clients may not be able to recover cryptocurrencies in their accounts or collateral they have put in place for loans. Many individuals, lured by the crypto hype and the promise of 20% returns, will be affected, with the possibility that major financial players may also be involved.

On Friday, crypto hedge fund Three Arrows filed for bankruptcy in the United States after going into liquidation in the Virgin Islands after failing to pay $80 million to digital asset exchange Deribit.

Big crypto firms stand to lose hundreds of millions of dollars. Toronto-based crypto lender Voyager Digital said late last month it could lose more than $650 million and suspended withdrawals and halted transactions as it considered “strategic alternatives.”

The FT said the failure of Three Arrows was the latest example of how the crypto turmoil has caught some of the industry’s biggest players off guard and how “a company’s problems can ricochet into entire industry due to opaque ties between investors, crypto exchanges, and lending.” businesses. »

Since hitting its high of $3 trillion last November, the crypto market value has fallen to less than $1 trillion. The question is how much of that loss was taken by the major hedge funds that entered the crypto market in the past two years.

The significance of the crypto crash is that while it was seen as some sort of outlier, its modus operandi was the same as the rest of the financial system. He used essentially free money provided by the Fed to fund ever riskier financial bets.

It bears recalling that when the problems in the subprime mortgage market first emerged in 2007, then-Fed Chairman Ben Bernanke insisted that it was only of a small segment of the financial system, it would not have wider effects. But as the financial crisis of 2008 revealed, it was the trigger for a collapse because the practices developed in the subprimes, some of which were criminal, raged throughout the system.

Amanda J. Marsh