Last year, the global economy placed high expectations on China's reopening after the Zero-Covid period, which would revitalize global trade activities and reduce inflation (due to normalized trade reducing commodity prices). But in reality, China's economy is currently entering a cooling period with the real estate market frozen for nearly 2 years and consumption-investment demand collapsing.
Meanwhile, last week, the US, Europe, and Japan markets witnessed government bond yields continuously rising, exacerbating the public debt burden. The possibility of sovereign default, previously only seen in less developed countries, is now looming over the world's leading economic powerhouses.
So what impact does the public debt crisis have on the economy?
This weekend's macroeconomic article from Viet Hustler will review the borrowing difficulties of the world's largest governments last week, amid many adverse macroeconomic developments.
In particular, Viet Hustler will thoroughly analyze the interlinkages of these countries' bond markets, with the consequential effects of the current public debt crisis on global economic growth.
Most governments of major powers are beginning to face difficulties in borrowing activities
Major powers (US, Europe, Japan, China, and Arab countries) lead in public debt/GDP ratios, far exceeding low-income countries (LIC). This trend is projected to continue until 2027.
Globally: total government debt has reached nearly USD 305,000 billion as of Q1/2023.
=> Public debt risks have spread to the richest countries:
Reduced demand for long-term government bonds or continuously rising borrowing costs is a major issue that major powers faced last week.
Global bond yields are all rising, along with a sell-off wave in global government bonds.
US Bond Market
US long-term 30Y Treasury bond yields have risen to 4.42%, the highest since 2011.
The “high risk - high return” rule is breaking down in the world's largest financial market: US 10-year bond yield is currently at 4.28%, nearly matching the 2007 level, and close to catching up with the S&P 500 yield (4.66%).
=> Instead of investing capital into businesses and markets, financial institutions can invest in the government bond market, which is both safe and offers good yields.
This is the main reason prolonging the current credit crunch.
However, global demand for US bonds is also gradually declining:
China has reduced its holdings ratio of US Treasury bonds, with the average maturity dropping to 14 years (meaning China is reducing holdings of long-term T-bond).
Saudi Arabia's T-bond reserves have also fallen to the lowest level in over six years (chart from Bloomberg)
After Japan's 10-year bond yield rose (due to Japan easing YCC), Japanese investors (the largest foreign holders of US bonds) have become less interested in US bonds and are demanding higher premiums for US bonds (demanding higher yields).
Related articles: …surprising policy from Bank of Japan (later part of the article).
European Bond Market
This market is quite fragmented as the Eurozone shares a common currency and monetary policy, but government bonds are issued individually by member governments.
For the Eurozone (red dots), government bond yields are high for countries with high debt/GDP ratios.
In the past six months, German bond yields (the benchmark for credit spreads in the Eurozone) have continuously risen.
Hungary is an example of an economy outside the Eurozone but in the EU with inflation still at 18%.
Hungarian bond yields have risen too high, leading to credit crunch risks like in the US: Hungarians are stopping depositing money in banks and instead pouring their savings into high-yield government bonds.
Japanese Bond Market
In the auction for Japan's 20-year bonds (JPB), investor buying demand plunged rapidly right after the trading session…
This move continues to push investor demand for Japanese bonds on the free market to the lowest since 1987.
Also in this auction session, the yield on the 20Y Japanese bond rose to the highest since 1987, due to pressure from investors demanding higher yields to buy JGB.
On the international front:
Rising JGB yields will threaten a decline in global bond demand, because (as mentioned above), Japanese investors previously held quite a lot of foreign bonds from the US and EU…
This is also the reason why EU and US bond yields continue to rise higher than last week.
The 10-year yield spread between US-Japan has risen to 3.6%:
…yields on bonds of both countries have risen, but the pace of increase for US bonds is still faster due to the substitution effect as above.
Rising JPB yields also cause the value of this government's domestic currency to increase: The value of the JPY has surged similarly to when the BOJ intervened in the free market by changing the adjustment range of the yield curve (YCC).
Chinese Market
This country's massive real estate market shows no signs of recovery after the collapse of Evergrande nearly 2 years ago, causing the entire market to freeze.
China's real estate business environment index is in freefall.
Meanwhile, up to 27 million m2 of real estate are vacant in Beijing, and the area of vacant real estate is continuously increasing there...
Along with the frozen real estate market, declining consumer strength accompanied by price deflation, local governments at risk of default are what's happening in China right now.
Related articles:
China's economy has completely collapsed:
…retail sales not growing (+0%),
…investment declining accompanied by industrial output falling to the lowest level in three decades.
Has China ended its period of hot growth?
The situation may be even worse in the labor market: the unemployment rate among young people has surged to 21.3% (1 in every 5 young people is unemployed).
Immediately after this extremely bad labor data, the Chinese government announced it will stop publishing the youth unemployment rate in China.
The value of China's Renminbi is nearing its lowest level in 14 years due to the impact of interest rate cut policies from the People's Bank of China (PBOC).
(Note: the y-axis direction in the image below is reversed)
Also due to PBOC's QE policy, contrary to US and European bonds (yields rising as investors demand more default risk insurance), China's 10-year bond yield continues to fall, providing more reason for investors to turn away from this bond:
China's 10-year bond yield is currently at 2.6%, the lowest since the COVID crisis (2020).
US bond yields have never been as far ahead of Chinese bond yields as in the chart below during the 10 years before the COVID period (because Chinese bonds have higher risk).
But currently, the bond market is witnessing a reversal that makes US bonds have much higher yields than Chinese bonds.
The reason is not that US bonds have higher risk than Chinese bonds, but mostly because China's economy has stopped hot growth and interest rate cut policies are causing the CNY value to depreciate.
What will the global economy be like if major governments face difficulties in borrowing?
Governments facing difficulties in borrowing (demand for government bonds decreases and bond yields rise), they will have to cut spending on economic development projects.
Most of the suspension of public projects for economic development will affect economic growth:
GDP growth of defaulting countries is always lower than the pre-default growth trend.
In the context of most developed economies on the verge of recession, governments cutting government spending could prolong the recession phase.
Especially in the US, the possibility of recession is really approaching if consumption collapses due to deflationary risk:
Currently, Americans are still consuming quite a lot, which contributes to maintaining economic growth at the present time: retail sales in July 2023 continued to increase 0.7% m/m.
However, according to Bloomberg, in the past 2 years, US consumers have withdrawn USD 2,000 billion from pandemic-era savings to spend:
Soon, we will observe the impact of the savings rate being eroded…
In the labor market: wage growth appears to be on a downward trend.
According to the latest data from Indeed, wage growth in July fell to +4.7% y/y, (down from +5.1% in June and +6.2% y/y earlier this year).
=> Businesses are relieved of wage burdens:
The frequency of mentioning the phrase wage pressure in earning calls of S&P 500 companies has significantly decreased during this period.
The trend of wage growth (labor costs) normalizing also shows that businesses' labor demand is no longer high:
… if a wave of layoffs comes, it will increase unemployment and heighten the possibility of recession.
But the current situation is quite special: more time is needed to observe whether labor market events can occur, as businesses are currently limiting layoffs (due to difficulties in rehiring employees they faced post-pandemic).
The composite leading indicators index (indicators reflecting real-time consumption, labor, and macroeconomic conditions…) continues to decline -0.4% m/m (16th consecutive month of decline) and -7.5% y/y.
This is a level equivalent to past recession periods.
In addition, the public debt crisis of major governments also sends a very bad signal to the financial market: causing investor confidence to plummet.
Last week, Put Option purchase orders on CBOE (Chicago Options Exchange) reached the highest level since the banking crisis in March 2023 due to the market's bearish sentiment towards the economic backdrop.
(Note: The left y-axis of the Put/Call ratio below - red line inverted from high to low).
The possibility of a developed country defaulting will cause market panic: if these countries' government bonds are no longer risk-free assets, then the yields on these bonds and a series of other assets will rise sharply.
If corporate stocks and bonds haven't adjusted yields upward yet => the risk-return trade-off rule in the financial market is destroyed (current situation).
=> financial institutions invest in high-yield bonds instead of other risky financial assets.
If businesses adjust corporate bond/stock yields upward => corporate borrowing costs will increase.
Both cases above lead to businesses having difficulty accessing capital, reducing industrial output and growth.
CONCLUSION
Governments are sitting on huge debt piles accompanied by a difficult macroeconomic context (high inflation, credit crisis in the West, or collapsing consumption and frozen real estate in China). As a result, most governments of economic powerhouses are facing difficulties in borrowing.
For countries maintaining tight monetary policy, governments face continuously rising borrowing costs along with reduced bond purchase demand.
Meanwhile, for China, the economy has entered a deflationary period and the government is striving to stimulate consumption with loose monetary policy. As a result, the CNY depreciates and Chinese government bond yields decline. With low central government bond yields while local governments are in default, China's bond market will be even more dismal.
Difficulties in borrowing and high interest payment costs will force governments to cut spending. This will directly affect the quality of public services and indirectly economic growth (as government spending is part of GDP and governments will limit investment in public economic development projects).
As a result, if a recession occurs, it may last longer than usual because governments will be limited in stimulus policies through fiscal policy.
In the US, the economy is still resilient due to strong consumption and tight labor market. Soft-landing or hard-landing still depends on the duration of the Fed's higher-for-longer interest rate policy.
Labor market data for July and August is very important for the Fed in planning interest rate policy for the second half of the year.
Related articles: FOMC and the surprise policy from Bank of Japan
Meanwhile, the strength of US consumer spending will be tested in Q4/2023 as the income shock for households begins to materialize:
Household savings rate begins to deplete.
Banks are tightening credit lending conditions even for credit cards.
Student loan repayments will resume in October.
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