TheChek News Flow

One-year credit swaps hit highest level since at least 2008

The price of insuring against a US government default rose to a fresh high this week as traders began pricing in their concerns that the world’s biggest economy might not meet its financial obligations.

One-year US credit default swaps — derivatives that act like insurance and pay out if a company, or country, reneges on its borrowings in the next 12 months — are trading at 106 basis points, Bloomberg data shows.

That is its highest level since at least 2008, up from 15 basis points at the start of the year, and far in excess of 2011 levels, when a stand-off in Washington over the US debt ceiling led to the country losing its top-notch triple-A credit rating. Negotiations this year in Washington over raising the federal borrowing limit are currently deadlocked.

The rise underscores how investors are moving to protect against, or profit from, a default even though it is still viewed as unlikely.

Analysts said the market for one-year swaps was relatively small and illiquid, rendering it difficult to use as a gauge of market expectations of a US default.

Even so, CDS for the most creditworthy countries typically trade between 25 and 50 basis points, according to analysts at ING. “The US is clearly considered a much higher default risk than most [other countries],” said Antoine Bouvet, the bank’s head of European rates.

He pointed out that equivalent CDS for Italy, the UK and Greece were currently trading at 39, 14 and 46 basis points, respectively. “Genuine” near-term default candidates see spread levels in the thousands. Even so, “markets aren’t relaxed about the risk of US default”, Bouvet said.

Indeed, the price of five-year credit default swaps — the most widely traded form of debt insurance — also reached its highest level in more than a decade this month, at 50 basis points.

Lower than expected April tax revenues have only heightened those concerns, dragging forward the so-called “X-date” when the US Treasury runs out of money.

Money market funds flush with cash after the collapse of three banks last month registered $69bn of outflows in the week ending April 19 as Americans rushed to meet the deadline to send payments to the Internal Revenue Service.

The Treasury cash balance now sits at roughly $250bn, meaning that the X-date could come as soon as early June, “significantly earlier” than the previous estimate of between July and September, said analysts at Danske Bank. “A suspension of the debt ceiling until the next round of budget negotiations next winter is beginning to look increasingly likely,” the bank added.

Asked about the potential ramifications of a default, President Joe Biden did not mince his words. Reneging on the country’s national debt would be “a calamity”, exceeding “anything that’s ever happened financially in the United States”, he said in January.

Weakening demand for automotive components compounds slumping PC and smartphone sales

Semiconductor companies have signalled that the industry’s sharpest slowdown in more than a decade is lasting longer than expected, as weakening demand for automotive components compounds slumping personal computer and smartphone sales.

Taiwan Semiconductor Manufacturing Company, the world’s largest chip producer, this week pushed back its expectations for a market recovery, as the industry bellwether projected its first decline in annual revenues since 2009.

After sales of electronics boomed amid widespread component shortages during the peak of the Covid-19 pandemic, industry stockpiles of chips have been building up since last summer.

“Semiconductor inventory adjustment in the first half of 2023 is taking longer than our prior expectation,” CC Wei, TSMC’s chief executive, told investors on Thursday’s quarterly earnings call. “It may extend into the third quarter [of] this year before rebalancing to a healthier level.”

After growing net revenues by 43 per cent last year, TSMC now expects sales to decline in the low- to mid-single digits for 2023.

TSMC’s gloomy outlook followed figures from the Semiconductor Industry Association earlier this month, which showed global industry sales fell 20.7 per cent in February 2023 compared to the same month last year, the sixth consecutive month of declines.

“We’re looking at . . . a typical downturn situation in the semiconductor industry, which actually hasn’t happened for a large number of years, where the supply just exceeds the demand,” said Peter Wennink, chief executive of ASML, the Dutch supplier of advanced chipmaking equipment, in a call with investors this week.

However, this time around, what Wennink described as a “classical semiconductor down cycle” is playing out on a much larger stage.

“There have never been more industries where semis are crucial to their business,” said Ben Bajarin, analyst at Creative Strategies, a Silicon Valley-based consultancy. That means the chip industry’s fluctuations are much larger today than during the last recession of 2008-09.

The PC industry has been particularly hard hit by a slowdown in consumer and corporate spending, with market researchers at IDC estimating a 29 per cent drop in the first quarter of this year compared with 2022. “It’s pretty much the worst PC year on record,” Bajarin said.

Smartphones had their fifth consecutive down quarter, with researchers at Canalys estimating a 12 per cent decline year-on-year, as consumer spending is pinched by inflation.

Next month, Apple is expected to report a 5 per cent drop in quarterly revenues, as weaker iPhone demand is coupled with a projected 25 per cent drop in Mac sales, according to analysts’ consensus expectations.

Amid a glut in components for personal electronics, the automotive industry continued to suffer shortages into the first few months of this year, making it a relative bright spot for chipmakers. However, even that market is “showing signs of softening into [the] second half of 2023”, TSMC’s Wei said.

Those comments, alongside Tesla’s price cuts, sent shares in Infineon and STMicroelectronics, among the largest semiconductor companies that supply the auto sector, down about 5 per cent on Thursday.

“Some investors feel this down cycle is being built on top of a fairly long up cycle,” said Amit Harchandani, semiconductor analyst at Citi. “Because the backlogs have gone up so much, they fear the drop is likely to be equally steep. It’s a bit nervous out there.”

Some chip companies are feeling the full force of that plunge. When it releases its latest quarterly figures next week, Intel is expected to report a 39 per cent year-on-year drop in adjusted revenues, a steeper decline than it reported in the wake of the 2008 financial crisis.

Nonetheless, executives at TSMC and ASML insisted the declines would bottom out this year. “All the platforms [say] their performance, their demand will increase in the second half,” Wei said. “We believe we are passing through the bottom of the cycle of TSMC business in the second quarter.”

One challenge for the semiconductor industry is that it is unable to increase production of its most sophisticated chips fast enough to take advantage of a huge surge in demand from artificial intelligence companies. That has led to a race among Big Tech companies and start-ups alike for powerful processors such as Nvidia’s H100.

Wei said TSMC, a supplier to Nvidia, had “recently observed incremental upside in AI-related demand, which helps the ongoing inventory digestion”. He pointed to a call from a customer in the “last two days” requesting a “big increase” in capacity. “We are still evaluating that,” he said.

“Nobody saw what was coming with ChatGPT in November,” said Bajarin of Creative Strategies. “You would have needed 18 months in advance to plan for that demand once you saw it.”

Longer term, ASML’s Wennink said he expected “another year of strong growth”, as chip manufacturers were maintaining their long-term roadmaps and capital spending plans despite the short-term challenges.

“Now the big question is with what speed, at what slope is this recovery? Well, I don’t know. But what I do know is that nobody thinks about this massive recession,” he said. “We just are in this period for one or two quarters more.”

The recent failures of Silicon Valley Bank and Signature brought attention to regional lenders’ weaknesses

Moody’s Investors Service downgraded 11 regional lenders Friday, suggesting higher interest rates and recent bank failures have ushered in greater instability.

The downgrades hit lenders including U.S. Bancorp, USB -3.57% with some $682 billion in assets, Zions Bancorp, ZION -5.69% with $89 billion, and Bank of Hawaii Corp. BOH -1.77% , with $24 billion.

Western Alliance Bancorp, WAL 2.63% one of the banks hardest hit by regional banking turmoil, received a two-notch downgrade. First Republic Bank, which faced a run last month, had its preferred-stock rating cut.

The failures of Silicon Valley Bank and Signature Bank last month focused attention on weaknesses among regional banks, many of which made low-interest loans and bought low-rate securities. Some have a high share of customers with uninsured deposits that became flightier when the turmoil hit.

The rating agency said strains in the way banks are managing their assets and liabilities are becoming “increasingly evident,” and are pressuring profitability. Recent events “have called into question whether some banks’ assumed high stability of deposits, and their operational nature, should be reevaluated,” the ratings firm said in its report.

Regional banks, Moody’s said, are more exposed to hard-hit commercial real estate. U.S. banks hold about half of total CRE debt outstanding, and some are concentrated in construction, office, or land development.

U.S. Bank has a “relatively low capitalization” as well as unrealized losses on its securities, Moody’s said. On an earnings call this week, executives said the bank’s capital levels fell because of a recent acquisition but they expect to rebuild it over the course of this year and next.

Zions has “significant” unrealized losses on its securities portfolio and its capital has deteriorated, Moody’s said.

The ratings firm’s focus on unrealized losses misses the “tremendous value” of Zions’s granular, low-cost deposit base, said James Abbott, the bank’s director of investor relations. “We estimate that value creates more than $5 billion as a counterbalance to the unrealized losses to the securities portfolio,” he said.

Bank of Hawaii similarly has unrealized losses and is reliant on uninsured deposit funding, Moody’s said. It also has a “somewhat elevated CRE loan portfolio.” The bank said in a statement that it has “the same very strong fundamentals that Moody’s acknowledged early this year.”

Moody’s said that more than half of Western Alliance’s deposits were uninsured at the end of 2022, leading to an 11% outflow in the first quarter. That forced the bank to rely on higher-cost forms of funding.

A spokeswoman for the bank said: “While we disagree with the downgrades, we are pleased Moody’s continues to rate our deposits investment grade and recognizes our stable outlook.”

First Republic suspended payments of quarterly cash dividends on its preferred stock earlier this month. It has also lost tens of billions of dollars in deposits, forcing it to rely on high-cost borrowing that is likely to squeeze its profits, the rating agency said.

The other downgraded banks are Associated Banc-Corp. , Comerica Inc., First Hawaiian Inc., Intrust Financial Corp, Washington Federal Inc. and UMB Financial Corp.

Proposed regulations would steer natural-gas and coal-fired plant operators toward the use of carbon-capture technology

The Environmental Protection Agency is preparing to issue new rules that would slash the amount of planet-warming greenhouse gases produced by U.S. power plants in the coming decades, according to people familiar with the matter.

For the first time, emissions from both new and existing natural-gas plants, as well as existing coal-fired plants, would be regulated, the people said. Electric utilities would have various options for meeting the tougher standards by installing new carbon-capture systems or switching to cleaner fuels such as hydrogen, according to the people.

Older gas and coal power plants that are set to retire, or plants that are used sparingly, wouldn’t be required to meet the same greenhouse gas standard, according to the people. The White House plans to announce the proposed regulations as soon as the first week of May, according to the people, though that timing could change.

EPA officials wouldn’t comment on the details or timing of the release of the proposed rules because they are currently under review.

“But we have been clear from the start that we will use all of our legally-upheld tools, grounded in decades-old bipartisan laws, to address dangerous air pollution and protect the air our children breathe today and for generations to come,” said EPA spokeswoman Maria Michalos.

EPA officials have developed the rules over the past year. The rules are currently being reviewed by the Office of Management and Budget to determine their projected cost and economic impact, according to a summary of the new rules posted on the OMB website.

New technologies allow utilities to remove the carbon dioxide before it is emitted from the smokestacks of power plants, and the CO2 can then be stored in underground formations. But the use of carbon capture and storage in power plants has had an uneven record, and a 2021 report by the Government Accountability Office found the $1.1 billion in taxpayer funds spent on carbon capture since 2009 only resulted in 3 of 11 projects being built.

In February, the Energy Department announced $2.5 billion to fund large-scale carbon-capture projects, four of which will be designed to work with coal and natural-gas power plants. Private investors are also backing carbon-capture efforts in the electric power and oil industries.

Once issued, the EPA proposal would undergo a public comment period before the agency issues a final rule. “EPA anticipates issuing a proposed rule in spring 2023, and promulgating a final rule by Summer 2024,” the OMB summary states.

Over the past few weeks, EPA officials have been briefing both industry and environmental groups to discuss the proposed rules, according to a list of meetings posted on the OMB website. On April 14, agency officials also briefed representatives of attorneys general in California, New York, New Jersey, Massachusetts, Pennsylvania, Maryland, Illinois, Oregon and Hawaii.

The power sector is responsible for 25% of the nation’s carbon-dioxide emissions, second only to emissions from cars, trucks and other vehicles. Earlier this month, the White House introduced new tailpipe emissions restrictions that would be the nation’s toughest-ever restrictions on car pollution—and one of President Biden’s most aggressive moves yet to combat climate change. He had previously called for half of all new vehicle sales to be electric-powered by 2030.

In 2021, Mr. Biden pledged to cut U.S. emissions of greenhouse gases by roughly 50% from 2005 levels by 2030.

In 2022, Mr. Biden signed a climate bill that allocates $374 billion to subsidize clean-power generation, electric vehicles and upgrades to reduce emissions at homes and businesses.

Increasing industrial emissions of greenhouse gases are raising the temperature of the planet’s atmosphere, oceans and land surface. The heat is causing rising sea levels to damage coastal communities, worsening periods of drought, and flooding from storms and periods of intense rainfall, according to the most recent report by the U.N.’s Intergovernmental Panel on Climate Change.

The IPCC said there is a “feasible, but narrow pathway” to avoid the worst effects of climate change, however to do so, the world’s nations must together cut greenhouse-gas emissions 60% by 2035 to limit warming to 1.5 degrees Celsius over preindustrial levels.

Global greenhouse-gas emissions reached record levels in 2022 and are projected to continue their upward trajectory, according to the IPCC’s Sixth Assessment Report, issued in March.

Berlin warns shortening time before generic drugs are allowed to market will stifle industry investment

Germany and several smaller member states have mounted opposing last-ditch lobbying efforts over EU pharmaceutical legislation to be published next week, with Berlin warning that it would damage investment by the drug industry.

The overhaul of pharma legislation is the most significant for 20 years, prompting an outcry from drugmakers who fear the EU will cut exclusivity protection from 10 to eight years, while allowing them to win back the two years by jumping over new hurdles.

In a position paper seen by the Financial Times, Berlin argues that the EU must be “innovation-friendly”, and that a requirement to launch medicines across all member states within two years to gain an extra year of market exclusivity, poses “considerable risks” to the industry.

The German paper echoes concerns raised by the pharmaceutical industry, which has argued that national pricing negotiations that are out of its control often hold back launches across the bloc.

The German government said drugmakers could not count on getting the extra year before generic drugs are allowed on to the market, making it “very difficult” to predict whether their costs could be recouped.

“Such uncertainty could then lead to a significant reduction in investment,” it said. The German government declined to comment.

But a second paper sent to the Commission, supported by six states including Austria, the Netherlands, Poland and Slovakia, also seen by the FT, argues that the current system does not meet the human rights of EU citizens for access to innovative treatments.

They say the EU’s incentives for drugmakers are “quite lavish”, compared to other countries including the US and China, and endorse the plan for incentives that link intellectual property protections to health priorities.

“We urge the European Commission to move towards a patient-centred approach. Such an approach should specifically reward medicines that address an unmet medical need and, simultaneously, improve the balance between availability, accessibility and affordability,” they said.

Germans have access to more medicines than citizens of other member states and its large market increases its purchasing power.

Similarly, 92 per cent of innovative medicines are available in Germany, but less than 30 per cent in smaller and former Communist states, according to research by Efpia, which represents the drug industry.

Brussels wants to force drugmakers to cut deals with them at lower prices or risk losing market share to generic drugmakers.

Despite being praised for developing vaccines at record speed during the pandemic, the pharmaceutical industry has been under political pressure. In the US, last year’s Inflation Reduction Act allowed the public health insurance programme, Medicare, to negotiate drug prices for pensioners for the first time. In the UK, drugmakers have condemned a sharp rise in a tax on the medicines they sell to the NHS.

This month, the chief executive of Eli Lilly, one of the world’s biggest pharma groups, warned that Europe could miss out on new drugs for conditions such as heart disease and cancer if it pushes ahead with the cut in exclusivity.

The draft law, which can be amended by the council of member states and the European parliament, is expected on April 26 after weeks of delay.

Health commissioner Stella Kyriakides told the parliament this week that it was on track despite speculation over a further postponement.

The European Commission said it would “put forward a balanced and patient-centred proposal, while fully supporting an innovative and competitive industry”.

Naftogaz held talks with big US oil groups about Ukraine energy projects

State gas producer says it met with ExxonMobil, Halliburton and Chevron in bid to increase output in war-torn country

Ukraine’s state energy company has held talks with ExxonMobil, Halliburton and Chevron about projects in the war-torn country as Kyiv looks to lure back foreign investment into its energy sector.

The negotiations with big US fossil fuel players are part of a strategic push to increase natural gas production that Ukrainian officials believe could help replace Russian supply to Europe in the years ahead, and come after months of Russian bombardment of Ukraine’s energy network.

Oleksiy Chernyshov, chief executive of Naftogaz, Ukraine’s national energy company, said he held meetings in recent days in Washington with Halliburton and ExxonMobil. He said he met with Chevron leadership in January.

“We understand that it’s rather hard for the private companies to step in during the war,” he told the Financial Times. “We are working on insurance mechanisms to protect their equity. For sure, it will take some time. But we don’t wait — we go ahead.”

Chernyshov said he also met with White House officials, members of Congress and senators from both parties in recent days in a bid to drum up more political support for US investment in Ukraine’s energy sector.

Ukraine’s energy infrastructure has been battered by Russian missiles since Vladimir Putin ordered a full-scale invasion of its neighbour in February last year. Russian bombardments have targeted energy infrastructure and also demolished the country’s main refinery as part of an attempt to debilitate the economy.

Ukraine has long touted its upstream potential, emphasising the near-term prospects for shale and unconventional production increases onshore in Kharkiv, Poltava and Transcarpathia, in the country’s west. Naftogaz said it hopes to tap US expertise in the kind of onshore shale drilling that has made America the world’s biggest oil and gas producer.

A drop in Ukrainian energy demand amid economic turmoil following the invasion means the country may also have spare natural gas that could be shipped to Europe, as well as storage facilities that could be used as the bloc builds up stocks ahead of the winter.

Ukraine has also boasted of strong prospects for offshore natural gas in the Black Sea off Crimea. But these remain off limits until after the war. The Russian navy seized control of much of Ukraine’s territorial waters after the invasion and has blockaded Ukrainian ports, allowing only grain to leave under a UN deal.

Naftogaz hopes to sign a contract soon with Halliburton that would help increase production to a target of 13.5bn cubic metres this year, a jump of about 1bn cm from 2022 levels. Chernyshov said it was difficult to commit to a long-term production target until the war was over.

“It’s a lot. And in order to achieve it we might need serious service expansion and technological drivers that Halliburton is capable to provide,” said Chernyshov. “We want them to expand [their presence] dramatically. We want them there seriously — boots on the ground.”

The oilfield services group was among the first international companies to enter Iraq after the US invasion in 2003. It has a small presence in Ukraine. Halliburton was not immediately able to provide comment.

The talks with Exxon and Chevron — oil producers which do not have operations in the country — are at an early stage and would take longer to yield results, however. Naftogaz said it was open to a host of different arrangements.

“We will welcome them,” said Chernyshov. “We can do joint production on gas together, PSA agreement — production sharing agreement — they can have a licence and produce by themselves, we will welcome it.”

Chevron and Shell inked shale gas agreements with Ukraine many years ago, before the Maidan revolution of 2014, but pulled out after market conditions changed and Russia annexed Crimea and backed separatists in a war in the eastern Donbas region.

Exxon declined to comment on the talks. Chevron had not responded to a request for comment at the time of publication.

Rating agency also indicates that economic risks have subsided in UK

Greece’s sovereign credit rating outlook was upgraded to positive by S&P Global Ratings on Friday, while Italy’s was kept at stable, highlighting a divergence of the two southern European economies.

S&P said its decision was based on Greece’s recent progress in structural reforms, a surge in investment and its rapidly improving fiscal position, which have made the country one of Europe’s fastest-growing economies.

In contrast, S&P kept its outlook on Italy’s credit rating unchanged, saying it expected the country’s debt to decline gradually over the next few years but that this was “balanced against the risk of a reversal in the delivery of critical reforms” that could delay critical EU funding.

Data published by Eurostat, the EU’s statistics agency, on Friday showed that Greece last year returned to a primary budget surplus of 0.1 per cent of gross domestic product, which excludes the cost of interest payments, after two years of deficits.

However, S&P kept Greece’s credit rating below investment grade at “‘BB+/B”, while Italy’s remains in investment grade at “BBB/A-2”.

Greece, which has an election next month, has benefited from a surge in investment, a reduction in its vast debt burden and more efficient tax collection. Tourism in the country rebounded to reach 97 per cent of pre-pandemic levels last year, while Greek banks have cut toxic loans from 45 per cent of their balance sheets in 2017 to below 10 per cent.

The Greek economy has made one of the strongest recoveries from the Covid-19 pandemic of any eurozone country, growing 8.4 per cent in 2021 and 5.9 per cent last year, with growth widely expected to remain above the eurozone average over the next two years.

The country’s debt as a proportion of GDP fell from a peak of 206 per cent in 2020 to 171 per cent last year, according to S&P, which predicted that it would keep falling to just over 135 per cent by 2026.

Italy’s fiscal position also improved but its primary budget remained in a deficit of 0.1 per cent of GDP last year. S&P said it expected Rome to achieve a surplus from next year, while growth in Italy would accelerate from 0.4 per cent this year to 1.4 per cent by 2025.

“Anchored by the reintroduction of EU fiscal rules next year, authorities are set to pursue a gradual pace of consolidation over the next few years, posting slight primary surpluses by 2024, putting debt to GDP on a slight downward path,” S&P said. Italian debt would fall from 144 per cent of GDP last year to 136 per cent by 2026, it forecast.

S&P also revised the UK’s credit outlook to stable from negative, indicating that heightened economic risks have subsided.

“The government’s decision to abandon most of the unfunded budgetary measures proposed in September 2022 has bolstered the fiscal outlook,” S&P said, referring to former prime minister Liz Truss’s proposed fiscal agenda that sent UK government debt into a tailspin and raised risks for pensions in the country when it was announced.

While the agency affirmed the UK’s AA credit rating, it said growth would be below historical averages in the medium term.

India probably surpassed China as the world’s most populous nation this month, so far as one can count developing megastates of 1.4 billion. It marked the occasion with mixed reviews from the global corporate elite.

The Asia Internet Coalition, which unites a dozen luminaries including Meta Platforms (ticker: FB), Twitter, and Amazon.com (AMZN), blasted new social-media controls from Prime Minister Narendra Modi’s government. The rules, which took effect April 6, jeopardize “people’s fundamental right to access information,” the group said.

Days later, Apple (AAPL) CEO Tim Cook jetted to New Delhi to shake Modi’s hand, after opening the iPhone giant’s first two Indian stores. “We’re committed to growing and investing across the country,” he tweeted.

The contrasting rhetoric underlines the crossroads India has reached as Modi, 72, wraps up his second five-year term and likely eyes a third in elections next year: cutting corners on democracy while gunning to be the next-gen growth market as a richer China slows.

Pluses outweigh minuses for most investors, for the moment. “I wouldn’t be concerned about authoritarian drift compared with India’s remarkable infrastructure investment,” says Rajeeb Pramanik, senior emerging markets strategist at BCA Research. “People don’t have to walk two miles to get drinking water anymore. That’s why Modi has a 67% approval rating.”

That’s of limited comfort to Meta, whose Facebook and Instagram apps dominate Indian social media. The company flagged India, Bangladesh, and the Philippines as Facebook’s top drivers of user growth last year.

Delhi’s latest regulations give authorities the right to block any online “misinformation,” based on the judgment of the government’s own Press Information Bureau. A platform that refuses will incur fines and potentially criminal action against compliance officers, says Jeff Paine, the Asia Internet Coalition’s managing director. “It’s very hard for people to invest in such an uncertain regulatory environment,” he comments.

Modi and his Bharatiya Janata Party have cut other democratic corners in recent months. India banned a BBC bio-documentary on Modi and arrested college students who organized a campus screening. Last month, a court sentenced opposition leader Rahul Gandhi to two years in jail for “defamation,” after he implied on the hustings that Modi was a thief. The sentence would conveniently keep him out of the May 2024 poll.

Modi’s strong-arm tactics can serve the public, though, as India seeks a great leap forward toward better railways, roads, and power grids, says Venkat Pasupuleti, portfolio co-manager for India at Dalton Investments. The government announced it will hike capital spending by a third this year to $122 billion. “Stronger central power reduces the amount of leakage and kickbacks,” he says.

Direct electronic payments of state benefits has been another boon to India’s heavily rural population, who used to have to fight red tape and skimming middlemen when their entitlements were doled out in cash.

High valuations leave Pasupuleti cautious on Indian stocks as investors shift to a rebounding China and other cheaper markets. But he would dive back in “after another 10% to 15% correction.”

Investors once embraced similar rationalizations for Vladimir Putin or Turkey’s Recep Erdogan, leaders less in markets’ favor now. India can still avoid following suit, says Perth Tolle, founder of the Life + Liberty indexes, which rank emerging markets on freedom, and excluded India in 2019. “Most investors, including me, are surprised that India is not in the index,” she says. “Their situation is very dynamic and could turn around.”

Let’s hope so.