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Yesterday was Blue Monday when the reality of the New Year sets in: whatever excitement there was around the holidays has faded, the decorations are back in the attic, and we’ve all gotten used to writing ‘2023’ on our checks. And there was a similar feeling with the key metrics: movements are relatively gentle and valuations seem to be stabilizing for the moment as things settle into the New year. Unfortunately, some of this stability comes from pretty grim contributing factors – there’s no let up in Russia’s attacks on Ukraine, for example – and the results are no less pleasant as the cost of living bites and layoffs continue. Nevertheless, this is a moment of relative calm which should be appreciated. And a bit like your New Year’s resolutions, it’s worth reviewing any big plans you made for your organization in early January to see if those are still great ideas now the enthusiasm has ebbed a little.
Sovereign debt and defaults is next on the list of ‘What I’m Watching in 2023’. While I was finishing that piece on Friday, US Treasury Secretary Janet Yellen announced that extraordinary measures would be starting soon to help manage the run up to hitting the debt ceiling this summer. There’s a broader look at the countries at risk of default below and this is a good reminder to pay attention to this longer-term, but very significant, threat and plan accordingly.
On to the numbers.
(Not sure of how to use these metrics in your risk analysis? Read the white paper here and look out for a detailed user’s guide coming in the early New Year.)
Relative Values (90-Days)
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Commentary and Evaluation
Brent Crude has crept up slightly into the mid-range for this 90-day interval. Prices ended relatively flat over the last 21 days after moderate fluctuation.
What to Watch
(No change) Market commentary and analysis vary wildly about what oil will do in 2023 and the broad analysis I shared earlier holds for many: ‘prices will peak around $95 with an average of around $90, a drop from previous 2023 estimates which reflects a gloomy outlook for the year’.
However, within that range, the opportunity for significant movements remain and China’s plans for a great economic boom are leading some to forecast oil moving up as high as $110 by Q3. The exact number is less important here than the reinforcement of the idea that China’s reopening will kick in soon and will lead to significant increases in demand for oil as well as other commodities by mid-year.
Iran remains worth watching as their motivation and ability to inflame tension in the Gulf remain.
Talk of the rise of the petroyuan in 2023 is overblown. See Friday’s update for more.
Iron and Steel
Iron and Steel remain very high for this 90-day interval. Prices ended relatively flat over the last 21 days after slight fluctuation.
What to Watch
(No change) The Chinese construction and manufacturing boom that many expected in 2023 is off to a very unsteady start as COVID spreads rapidly after December’s relaxations. Sectors that had struggled under the strict COVID restrictions are suffering just as much in the current laissez-faire environment. This is temporarily delaying the expected economic boom but many analysts expect things to take off in late Q1 meaning that demand for oil, shipping and commodities will all rise significantly thereafter.
Market Volatility (VIX-US)
Volatility (VIX) is very low for this 90-day interval. The index has decreased sharply over the last 21 days after significant fluctuation and spikes around the New Year.
What to Watch
Messaging from the US Fed and ECB remain consistent and the end-of-year turbulence has faded, meaning that, although the news in many sectors isn’t welcome, the general market conditions seem to have been broadly accepted and priced in. Layoffs continue in tech, banking and retail while some large brick-and-mortar stores, like Bed Bath and Beyond, seem to be slipping further into difficulty. So although decision-makers have greater clarity as to what lies ahead, economic conditions are grim for many and look to remain so for short- to mid-term.
However, negotiations around raising the US debt limit will be contentious and cause significant turbulence in the run up to hitting the ceiling, likely in late Q2, early Q3. See ‘What I’m Watching in 2023’ below for more.
(No change) Wheat remains low for this 90-day interval. Prices ended relatively flat over the last 21 days after moderate fluctuation.
What to Watch
(No change) Despite agreements brokered by Turkey, Russia could still impose a complete blockade on Ukrainian grain exports to exert pressure on Kyiv and her allies. Meanwhile, even strict controls and inspections for outbound shipments mean that exports remain slowed. Moscow could also conduct military operations to disrupt spring planting meaning that prices could rise again next spring and summer.
Ocean Freight (FBX)
Shipping (FBX) is very low for this 90-day interval. Prices decreased sharply over the last 21 days after the spike we saw in December.
What to watch
(No change) China’s reopening and the effects of recessions on demand in the US and elsewhere remain the biggest issues to track but there are no definitive signs to watch at the moment.
What I’m Watching in 2023: Sovereign Debt and Defaults
Several countries are at risk of defaulting on loans which will cause a range of difficulties for them, their citizens, and the organizations and institutions left holding the bag.
The complications of COVID and inflation
Countries default all the time (although some more than others) for different reasons, but two unusual factors heighten the current risk of default.
First, the twin effects of COVID were a reduction in economic output coupled with an increase in costs for most countries. Some places with less diversified economies, such as Belize’s reliance on tourism, were hit particularly hard.
Second, inflation increases the actual price of debt payments meaning that rising rates over the past 12 months have made debt servicing more costly.
In addition to these common elements, each country has its own set of factors at play. From the poor handling of inflation in Sri Lanka and Turkey to Russia’s invasion of Ukraine, other elements also increase the likelihood of default. Therefore, while looking at any particular situation, it’s not enough to just look at post-COVID recovery or interest rates when trying to decide if a default is more or less likely.
Countries at risk of default.
The countries listed below are assessed as having a high risk of default by the Council for Foreign Relations (CFR) as of November 2022. These countries are rated nine or ten (out of ten) on the CFR’s Sovereign Risk Tracker, where the maximum score equates to a 50% chance of default in the next five years. The countries in bold are already in default.
(* Elections scheduled in 2023.)
What happens when a country defaults?
Creditors take a haircut
Generally, creditors have to accept that they’re not going to get back what they’re owed and have to accept a lower rate of return (‘taking a haircut’ as it’s called). As part of the restructuring negotiations, there are usually requirements for austerity and increased fiscal discipline. These measures can be harsh, and the International Monetary Fund (IMF) has a reputation for demanding tough concessions.
Cash dries up
As the likelihood of default rises, so does the fear that cash will dry up. People rush to withdraw their savings, and ATMs run dry. Then, banks are ordered to halt withdrawals. The upshot is that money is in short supply, so all trade dries up and, even though they might have money in the bank, depositors can’t access it. This is why we saw people ‘robbing’ banks in Lebanon: it was the only way they could get their funds out to help sick relatives.
Everything gets more expensive
The lack of cash and higher interest rates makes everything more expensive, making it even more difficult for people to afford the basics. Assuming you have a way to pay for them, importing materials and goods becomes much more expensive.
Austerity measures – whether at the insistence of creditors or as a way for the government to get things under control – start to hurt. Civil servants have their pay frozen or cut, services suffer, and the quality of life drops for everyone, most notably the poor, sick, and most vulnerable. For the general population, this is a case of the cure being worse than the disease.
Tension rises, protests, and unrest increase
The exact combination of factors will differ, country by country, and be exacerbated or diminished by other conditions. Nevertheless, the effects of a default hurt, and frustration boils over. Protests can begin peacefully but often become more heated, and clashes with the police are not uncommon. In the case of Sri Lanka, largely peaceful protests were so widespread that the president and prime minister fled the country back in July 2022.
Where there are underlying social tensions, the solidarity of shared suffering may bring groups together, albeit temporarily. However, in many cases, these fault lines are exploited by political and community leaders: blaming ‘the other’ for your economic woes is a tried-and-tested technique that’s been refined over hundreds of years.
Elections disappoint everyone
Another effect of this kind of economic hardship is that everyone ends up disappointed after an election. The party(ies) that lost are unhappy, as you’d expect, but so is the winning side and their followers because there’s often no way for them to make good on their promises of economic reform. Coalitions are weaker, public support ebbs quickly, and the likelihood that the ruling party can govern effectively diminishes.
Suffice it to say, no matter the specific consequences, default has a range of consequences, none good.
Is America Approaching a Self-imposed Default?
So far, the attention has been on frontier markets, but the most consequential default pending in 2023 might be America, the World’s largest economy. And, worst of all, if there were an American default, it would be entirely self-imposed.
How Could America Default?
America regularly bumps up against its self-imposed debt limit but, as the World’s reserve currency, the U.S. can easily issue more government bonds that will find willing buyers. However, the new Speaker of the U.S. House of Representatives has promised to use the debt ceiling negotiations to force budget concessions from the opposition.
In itself, this shouldn’t be a problem: in fact, some fiscal discipline in Washington would be a welcome change.
However, the problem is that the current Republican caucus includes some members with unorthodox ideas concerning the Global economy. Moreover, the GOP’s Freedom Caucus has an outsized ability to interfere with House business, as they showed by forcing McCarthy to go through a dozen or so rounds of voting for Speaker, instead of the normal one or two. Combined, this means there’s no chance of a clean, well-ordered debt limit extension this year.
And keep in mind that there is no firm default date. ‘X-date’ is constantly updated by the Treasury, but it is not an exact science. On January 13, Secretary Yellen notified Congress that she believed the U.S. will run out of money in early June. (See Bloomberg for more) However, when I started writing this piece the week before, estimates of X-Date were mid-August, so this is a moving target.
What Happens Then?
It’s unlikely that America will default in the true sense by not paying back creditors at all. However, there is a real risk of a short default period if there are miscalculations during the debt discussions.
Moreover, we know that even approaching default causes significant damage – damage that can take years to repair – because this happened in 2011 when a similar situation occurred. The U.S. Treasury described the 2011 situation thus’:
Unfortunately, the 2023 debt negotiations in the U.S. will be more treacherous. There’s a much higher chance of a miscalculation by McCarthy and a real risk of sabotage by the geniuses in the Freedom Caucus. And, because the U.S. economy is already shaky, the effects would be much more significant than in 2011.
This doesn’t just mean tough times for America, as it’s hard to insulate the World economy from that of the U.S., which means that of all the potential defaults to track in 2023, the place to watch most closely is Washington, DC.
1 million tonnes, 10 years
Last week, Sweden announced an incredible million-tonne reserve of rare earth minerals had been discovered in the country’s far north. Although the full extent of the deposit will take years to determine, this find is substantial and will shift reliance away from China although not in the short term. Estimates are that it will be at least 10 years before the minerals can be extracted. Nevertheless, this is a significant development for both Europe – which currently has no supply of domestic rare earth elements (REE) – and the world more broadly the demand for REE continues to increase to aid the transition to electric vehicles and other technologies.
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