Month: December 2019

Authored by Colin Lloyd via The American Institute for Economic research,

Since the mid-1990s, the number of companies listed on US stock exchanges has been steadily shrinking. There are currently just over 4,000 companies listed, up from the 2012 low but way down from a peak of more than 8,000 in 1996. Europe has not been immune; only 84 companies have listed this year, the lowest in a decade and the lowest by deal value since 2013. European capital markets have always been less equity-centric than the US, but even here the number of listings has shrunk by 29 percent since 2000. 

Source: World Bank, Financial Times

In the post–financial crisis period, three factors have driven the retreat of listed equity:

1. the rise of private equity (an industry that is estimated to be sitting on more than $2 trillion in capital awaiting new opportunities),

2. the slower pace of new companies launching on public markets (due to the availability of private venture capital),

3. and mergers of existing listed companies. Behind these factors lies a more powerful force: artificially low interest rates. 

In a low–interest rate environment, the appeal of debt financing increases relative to equity. This seemingly benign influence has profound implications for capital markets and the economy more broadly. By means of debt finance, earnings per share can be enhanced without the need for productivity gains. For the executives who direct those companies, the incentive to borrow externally, rather than improve internally, increases as debt-financing costs decline. Conversely, in a rising–interest rate environment these same executives are incentivized to improve the internal efficiency of their enterprises. To this extent, higher financing costs can contribute to improved productivity.

Financing costs have generally been falling since the 1980s. During this same period, executive compensation, especially via the award of stock options, has risen dramatically. Owning call options gives an investor a different incentive from a stockholder. The option holder’s preference is for capital over income; high dividends directly reduce capital value. Executive holders of stock options favor lower dividend payouts and higher earnings per share.

Falling interest rates have also impacted income-seeking investors. Faced with declining returns from fixed- and floating-rate investments, these investors have been forced to accept higher risk in the form of increased duration, greater credit risk, or leverage. 

Duration risk is unique to fixed-income investment. All other things equal, the longer the maturity of a fixed-rate bond, the longer the duration — and therefore the more sensitive the price to a given change in the yield to maturity. As short-term interest rates have approached zero, the normally upward-sloping yield curve has flattened. In developed markets, this has been exacerbated by the central bank policy of quantitative easing. By this process, income investors are forced to look elsewhere for returns.

If the return from extending the duration of your portfolio has diminished, an alternative source of yield can be found by the purchase of less creditworthy debt. The insatiable investor’s thirst for yield has been quenched, at least in part, by private equity, venture capital, and leveraged-buyout funds that have securitized their borrowings. Demand has also been met by a wide array of corporate borrowers, many of whom issue debt simply to fund share buybacks. This debt may take the form of fixed- or floating-rate bonds or loans. 

For a small group of income investors, the alternative to fixed coupons or floating-rate notes is the outright purchase of equity. In relative terms, this alternative has disappointed; income stocks have generally underperformed growth stocks during the last few years, in part because capital appreciation pushes stock prices higher, which attracts momentum investors. A stronger influence, however, is lower interest rates, which make higher price/earnings multiples more manageable. In addition, low rates encourage expectations of lower returns; they also make investors more fee conscious, favoring index-tracking products over discretionary funds. 

Where Are We Now?

To recap, the breadth of the listed stock market is in long-term decline. Debt finance is cheaper than equity finance. For corporate executives, share buybacks are preferable to capital investment. Corporate debt levels are at or near all-time highs. The credit quality of the outstanding debt is deteriorating.

Further cause for concern is the changing makeup of debt. While corporate bond issuance has been growing, the corporate loan market has been in the vanguard of the expansion. The chart below shows the changing relationship between bonds and loans. 

Source: EconoFact, Federal Reserve

The level of debt relative to GDP may be at new highs, but the cost of servicing the debt interest is relatively low, due to historically low official interest rates. The real risk in a recession is that credit spreads widen even as official rates are eased. As growth slows, US Treasury bonds may reach make new highs but lower-rated bonds and loans will still be sold. The credit intermediation process relies on the banks continuing to lend, but banks are notoriously procyclic, pulling in their horns just when they are needed most.

The current environment is not entirely negative. Robust corporate profits, during the long, slow recovery, mean that debt as a share of the total firm-financing mix is much lower today (25 percent) than it was during the 1980s and early 1990s (50 percent). The debt mix has tilted, however, toward floating-rate loans rather than fixed-coupon bonds. The weakest link for financial markets today may be found among leveraged loans and their investors.

The principal buyers of leveraged loans are banks and insurance companies. The table below shows the current mix.

Source: Bank of England

As the table reveals, many of the higher-risk tranches of loans are purchased by open-ended mutual funds or ETFs, but a substantial proportion, especially those with lower risk, are held in collateralized loan obligations (CLOs). CLOs are, generally, floating-rate tradable securities backed by a pool of, usually, first-lien loans of corporations. Often these loans have poor credit ratings, many emanating from private equity, venture capital, and leveraged-buyout transactions. On their own, these leveraged loans may rank below investment grade, but, by bundling them together with better-quality loans, CLO managers contrive to turn base metal into gold. 

If this sounds remarkably like the collateralized debt obligations (CDOs) that harbored covenant-lite subprime mortgages, which precipitated the financial crisis of 2008, then you would not be too far from the mark. CLOs do not contain mortgages or credit default swaps, but they do rely on the assumption that a diversified pool of loans has an inherently lower credit risk than the loan of an individual corporation with the same credit rating. Issuers argue that unlike the individual “liar loans” at the heart of the subprime-mortgage debacle, CLOs contain loans of corporations that have been audited and these corporations are from a wide range of industries. Suffice it to say, auditors can be deceived and recessions sink all ships. 

CLOs are also a challenge for investors to value. CLO managers actively adjust their portfolios, and the risk profile is in a constant state of flux. These are opaque investments that are hard to evaluate and difficult to liquidate.

It is not all gloom; despite rating downgrades, CLO defaults are at a seven-year low of 3.42 percent. Investors may not be able to get out, but they should get paid. Or perhaps not. According to an October article in the American Banker, the loans of more than 50 companies have seen their prices decline by more than 10 percent. Moody’s, the rating agency, admits that more than 40 percent of loans are rated B3 or below. While CLOs, by some estimates, hold more than half of all loans, most are not mandated to hold more than 7.5 percent of CCC-rated paper, since CCC is below investment grade.

In a recent post from the Bank of England (“How Large Is the Leveraged Loan Market?”), the authors estimate that there are more than $2.2 trillion of leveraged loans outstanding worldwide, of which $1.8 trillion are denominated in US$. The chart below shows (left-hand side) the speed at which the market has grown and (right-hand side) the increasing leverage of the overall market together with the alarming rise in covenant-lite issuance.

Source: BIS

It is some comfort to know that central banks and financial regulators are cognizant of the potential systemic risk: they may yet contrive to avert a crisis. Covenant-lite loans, however, remain a near and present danger; they constitute 80 percent of issuance, and, by some estimates, as much as 29 percent of investment-grade loans are at risk of downgrade to CCC. If those downgrades come to pass, CLOs’ managers will be forced to liquidate in concert. 

The natural buyers of less creditworthy leveraged loans have been notably absent of late. Leveraged-loan mutual funds and ETFs have seen redemptions for most of the past year. Insurers and banks are mostly full up, and the underwriting banks have been saddled with a large proportion of recent issues that failed to find buyers. Hedge funds are not stepping in to fill the void. Instead they are short-selling high-yield bond ETFs. Short exposure is down from the highs seen in Q1 2019 (which followed the high-yield rout of Q4 2018, when 25 percent of high-yield ETFs were liquidated), but around 40 percent of the market is now out on loan. The chart below highlights the recent change in appetite. 

Source: Financial Times, Astec Analytics

The size of the high-yield bond ETF market is small (estimates range from $34 to $60 billion) and the cost of borrowing stock to fund short exposure is relatively high, but there is more than $500 billion of high-yield bond mutual funds that could follow. The liquidity mismatch between the exchange-traded ETFs and mutual funds on the one hand, and the underlying securities on the other , should not be underestimated. The total outstanding issuance of high-yield bonds is around $1.2 trillion, added to which the risk of contagion spreading to loans and CLOs cannot be ruled out.

Back in the loan market, it seems, the rating agencies are finally beginning to confront reality. S&P recently announced that the number of loan issuers rated B- or lower, referred to as “weakest links,” rose from 243 in August to 263 in September. Notwithstanding the significant increase in the number of issuers, this is still the highest figure recorded since 2009.

The Federal Reserve has been proactive, cutting rates even as unemployment data made fresh lows. In the near term, some headline measures of inflation have increased, but the amount of debt is so vast as to be almost self-righting; any hint that the Fed may raise rates to head off inflation will see stocks fall and credit spreads widen. The effect of these market moves on expectations for economic growth will be negative; commodity prices will decline, inflation will stall, and, provided the Fed moves swiftly enough, a full-blown credit crisis may be averted. Nonetheless, as rates approach the zero bound, the central bank has progressively less room for maneuver.

At the risk of repetition, in the longer term the deleterious effect of artificially low interest rates discourages capital expenditure in favor of debt issuance to fund stock buybacks. It undermines productivity and reduces the long-run rate of economic growth. 

The number of stock market listings will continue to decline while the sustainable level of price-to-earnings ratios will rise due to the diminishing supply. With interest rates near zero, stocks will be supported: there are few viable investment alternatives in public markets. Income inequality will rise in tandem with the stock market, as will the ratio of debt to equity. 

If governments choose to adopt a fiscal rather than a monetary solution to the lack of economic growth (and I am not advocating negative interest rates), they will pile even more debt onto an already over-encumbered marketplace. 

Given the demographic headwinds facing most developed countries, consumption demand is likely to remain lackluster for the foreseeable future. Inflation and interest rates are unlikely to rise in this scenario, while corporate earnings growth will be forced to rely on financial alchemy rather than sustainable productivity. 

Source: Bloomberg

Artificially low interest rates are hollowing out the productive capacity of the economy. The price of stocks and bonds may remain exalted, but this is not a sign of economic health.

Global equities are gliding serenely into the end of 2019, even in the face of a dire economic landscape. To justify an exuberance that looks anything but rational, global activity will need to turn around dramatically.

After a brief moment back above zero, Citigroup’s global economic surprise gauge has dropped back into negative territory

Maybe that’s why markets have been so eager to celebrate data beats such as U.S. GDP and China Caixin PMIs, despite indicators remaining at anemic levels. Shockingly poor releases last week like the South Korean and Japanese industrial output, or the Chicago PMI were shrugged off as revealing nothing new. [ZH: today’s dreadful ISM however was not as easily overlooked].

While the overall tone of the data being released is far more stable, the tinge of green in the economic landscape is more redolent of a stagnant swamp than shoots ready to sprout.

Just look at 3Q U.S. GDP. The 2.1% second reading beat expectations, sure, but it isn’t anything to get hugely excited about. Economists forecast the U.S. will expand less than 2% in each of the next two years — the slowest pace since the 2009 recession.

Meanwhile, global GDP sagged dramatically last year as stocks melted down. Since then, activity has stayed depressed even as equities rebounded.  This behavior is at odds with past episodes – typically growth and stocks bounce back together after such a decline.

Hence the stubborn bid for bonds, which have been reflecting a fragile global economy all year. That’s why swaps are still pricing in rate cuts for many major central banks.

Recent equity rallies were largely driven by optimism the U.S. and China will reach a phase-one deal, so much of the trade upside has been priced in. A milquetoast accord, or more prevarication could lead to a savage reversal. Even a strong agreement would leave stocks still in need of a data rebound to justify further gains.

If economic prospects darken, central banks are just about out of ammunition. Further Fed easing from here would signal the previous insurance cuts failed to head off recession. The 2019 FOMO rally’s resilience has taken it far enough in the face of a cloudy forecast.

Any declines from here could get very steep indeed.

Via SchiffGold.com,

Have you heard? The Democrats are going to fix the student loan mess! They’ve brought up the issue in almost every  Democratic Party presidential debate. All we need is a good government program and we can easily solve this $1.64 trillion problem.

Never mind that government programs caused the problem in the first place.

The student loan bubble continues to inflate. Student loan balances jumped by $32.9 billion in the third quarter this year, pushing total outstanding student loan debt to a new record. Student loan balances have grown by 5.1% year-on-year.

Over the last decade, student loan debt has grown by 120%.  Student loan balances now equal to 7.6% of GDP. That’s up from 5.1% in 2009. This despite the fact that college enrollment dropped by 7% between 2010 and 2017, with enrollment projected to remain flat.

In a nutshell, we have fewer students borrowing more money to finance their educations.

Before the government got involved, college wasn’t all that expensive. It was government policy that made it unaffordable. And not only did it manage to dramatically drive up the cost of a college education, but it also succeeded in destroying the value of that degree. Peter Schiff summed it up perfectly:

Before the government tried to solve this ‘problem,’ it really didn’t exist.”

Peter isn’t just spouting rhetoric. Actual studies have shown the influx of government-backed student loan money into the university system is directly linked to the surging cost of a college education.

Millions of Americans carrying this massive debt burden is a big enough problem in-and-of-itself. But it becomes an even more significant issue when you realize the American taxpayer is on the hook for most of this debt. Education Secretary Betsy Devos admitted that the spiraling level of student debt has “very real implications for our economy and our future.”

The student loan program is not only burying students in debt, it is also burying taxpayers and it’s stealing from future generations.”

This is yet another bubble created by government. Despite the campaign rhetoric coming out of the Democratic Party presidential primary debates, it seems highly unlikely Congress will do what is necessary to address the growing student loan bubble. And the Democrats’ solution seems to be to simply erase the debt – as if you can just make more than $1 trillion vanish without serious implications.

Like all bubbles, this one will eventually pop.

The bottom line is that the student debt bubble will ultimately impact US markets and average Americans.

*  *  *

You can learn more, and how to prepare yourself, in Peter’s white paper The Student Loan Bubble: Gambling with America’s Future. Get the free download HERE.

In her much anticipated first appearance as president of the ECB before at the European Parliament, Christine Lagarde asked EU lawmakers on Monday to give her time to “learn the ropes” of her new job and to reshape the ECB’s monetary policy in what is likely to be a lengthy policy review, and said the ECB will be “resolute” in restoring euro-zone price stability, while stressing that an upcoming strategy review will be wide-ranging, including climate change as well as inflation.

“The ECB’s accommodative policy stance has been a key driver of domestic demand during the recovery, and that stance remains in place,” she said ahead of her first monetary policy meeting at the ECB on Dec. 12.

Similar to the Fed, the former convicted criminal and IMF chief who left Argentina near bankruptcy, has promised an overarching review of ECB business ranging from how it defines its inflation objective to whether it includes a fight against climate change among its responsibilities.

“I’m indeed trying to learn German but I’m also trying to learn central bank language,” Lagarde, a former lawyer told the European Parliament’s Committee on Economic and Monetary Affairs in a regular hearing. “So bear with me, show a little bit of patience, don’t over-interpret, if I may say,” said a seemingly nervous Lagarde, who often diverged from the text of her prepared speech and stumbled at times, leaving out phrases or repeating herself.

Lagarde said that a key focus of the review would be to determine whether its objective of keeping inflation at close to but below 2% was still valid, given changes in the global economy.

Speaking a day after it was unveiled that the Fed – which is also in the process of reviewing its policies – was considered launching a new rule that would let inflation run above its 2% target to make up for lost inflation, Lagarde also said the review would look at whether the target should by symmetric, meaning it should be used to tackle both low and high inflation and not just the latter, if the ECB should have leeway in reaching that target, or whether there should be a tolerance band around it.

Of course, just like the Fed, the issue for the ECB is two-fold:

i) ignoring soaring asset price inflation which is where central banks have blown the biggest asset bubble in history, and

ii) failing to properly measure consumer price inflation, instead applying a spate of adjustments that make it seem inflation is subdued when in reality for many prices are rising so high, the cost of living is no longer bearable.

Then there is the question of whether targeting higher prices is sensible at a time when the middle class is shrinking across the developed world. As a reminder, back in June, a Bloomberg report looked at the stark disconnect between Fed policy and well, everybody else but banks and the 1%.

While the Fed sees low inflation as “one of the major challenges of our time,” Shawn Smith, who trains some of the nation’s most vulnerable, low-income workers stated the obvious: people don’t want higher prices.  Smith is the director of workforce development at Goodwill of Central and Coastal Virginia.

In fact, he said that “even slight increases make a huge difference to someone who is living on a limited income. Whether it is a 50 cents here or 10 cents there, they are managing their dollars day to day and trying to figure out how to make it all work.’’ Indeed, as we discussed in  “How The Fed’s New Monetary Policy Will Crush America’s Poorest“, it is the low-income workers – not the “1%”ers, who are most impacted by rising prices, as such all attempts by the Fed to “help” just make life even more unaffordable for millions of Americans.

None of this was a concern to Lagarde, however, who said taht the ECB’s “strategy review will be guided by two principles: thorough analysis and an open mind,” Lagarde told lawmakers. “This will require time for reflection and for wide consultation.”

In a recent note, HSBC discussed several options in terms of changing the mandate, from small tweaks to more fundamental changes, which the ECB may pursue. The problem, however, as HSBC noted is that the success of some of these options depends on the degree of confidence in the ECB’s ability to meet it. As a result, the risk of creating a new mandate, only to fail to achieve it as soon as it is implemented, is significant, particularly with policy already so loose and little left in the tank. This was a risk already flagged by Mario Draghi at the September meeting.

These risks, alongside seemingly inevitable compromises in the Governing Council – hawks will likely be averse to any option that risks persistently elevated inflation – lead HSBC to believe that if there will be changes in the ECB mandate as a result of the strategic review, they are likely to be fairly minor. Even moving to a 2% inflation target – removing the uncertainty created by the “below, but close to” – might be too contentious for some.

None of this prevented Lagarde from thinking big. As in climate change big. Because what was more shocking for a central bank which admits it has failed dismally in hitting its price inflation, was its mission creep into seeking to “tame” climate change as well. 

Many of the questions at the parliament hearing focused on climate change, an area where the central bank has come under increasing pressure to play a bigger role. In response, Lagarde said that while inflation is the bank’s primary objective, the fight against climate change should be a central part of policy. She said that the ECB’s economic analysis should include the impact of climate change and that its bank supervision arm should also be asking lenders for transparency disclosures and climate risk assessments.

And the punchline: while the ECB’s private sector bond purchases have been market neutral, Lagarde said it was also worth discussing whether climate concerns should impact the ECB’s QE.

How would that work we wonder: “It’s hot outside, so let’s print more money?”

So far the ecofascists have not completely taken over yet, and as we reported previously, German Bundesbank President Jens Weidmann warned against heavy-handed steps such as barring the bonds of polluters from QE, as proposed recently by a group of activists and academics in an open letter to Lagarde. Lagarde said she agreed with Weidmann, but that it doesn’t stop the ECB looking into incorporating climate change into its operations, economic analysis and bank supervision.

To be sure, any mission creep in the ECB’s mandate will only serve to make future monetary easing, well, easier and what better virtue-signaling smokescreen than to use “global warming” as an excuse to print an extra trillion here and there.

Ironically, her linking of QE to climate change took place even as she acknowledged the adverse side effects of the ECB’s ultra-loose policy, and said the review will try to gain a better understanding of how longer-term trends affect what the central bank can control.

One wonders: perhaps the ECB should have conducted such reviews before it bought nearly €3 trillion in assets starting in 2015, long after the European sovereign debt crisis was over, and was merely meant to stabilize risk prices and avoid a market crash.

The take home message however was clear: it is now only a matter of time before the ECB becomes the EcoCB and is “tasked” with a loose, vague and intangible climate change mandate, one which gives the central bank a carte blanche to do virtually anything “in the name of the environment.” Sure enough, at the Parliament hearing, Lagarde said that while the ECB’s primary mandate is price stability, the secondary mandate – to support the general economic policies of the European Union – can cover climate change. European Commission President Ursula von der Leyen has pledged to turn Europe into the first climate-neutral continent in the world by 2050, and green parties made significant gains in recent parliamentary elections.

Finally, reaffirming the ECB’s most recent assessment of the economy, Lagarde added that growth looks weak but that the ECB was determined to use all it available tools to reach its mandate.  Asked to predict what the inflation rate will be in eight year’s time when her term ends, Lagarde refused.

“I don’t think that anybody in their right mind would venture to forecast any number, be it growth or inflation, eight years from today,” she said, yet clearly confident it is her job to predict how the climate will do over the same time period.

Via S&P Global Platts Insight blog,

As COP25 kicks off in Madrid, S&P Global Platts editors take a look at the CO2 impact from OPEC oil production. European gas and nuclear, and IMO 2020’s impact on commodities as diverse as fuel oil and iron ore, are also on the agenda in this week’s pick of charts.

1. OPEC oil-only CO2 output dwarfs EU total emissions

Click to enlarge

What’s happening? OPEC is meeting this week to decide on output quotas, but climate change isn’t on the agenda for the group of 15 major oil producers. OPEC’s total crude output for 2018 would have been responsible for carbon dioxide pollution equal to 5 billion mt, calculated based on average emissions figures for oil from the US Environmental Protection Agency (EPA). That exceeds Europe’s total emissions of the greenhouse gas, from all sources, last year. The cartel currently has no plan in place to mitigate the impact its oil has on global warming despite the growing pressure from consuming nations and business to cut back investment in fossil fuels.

How did we get to these numbers? A barrel of crude weighs about 300 lb, or 136 kg. The CO2 from fuel weighs more than the fuel itself because the carbon element combines with oxygen in the air to form CO2 gas. Carbon-based fuels derived from oil give off CO2 which is on average 3.15 times the weight of the fuel. A standard barrel is 159 liters, and in the US gets refined into 44.1% gasoline, 20.8% distillate fuel oil, 9.3% kerosene-type jet fuel and 5.2% residual fuel oil. So an average barrel of oil will produce at least 317 kg CO2 for just the above four fuels, making the EPA’s average figure of 430 kg seem quite sensible.

What’s next? OPEC and its allies, which pump more than 45% of the world’s crude, are scheduled to meet on December 5 and December 6 in Vienna where a decision on a possible extension to the production cut deal could be taken. The gathering coincides with the 25th Conference of the Parties, or COP, held in Madrid where 200 countries will discuss climate change action as new figures released by the World Meteorological Organization show that green house gas levels reached their highest recorded levels last year.

2. European gas spot prices have risen but December turns bearish

What’s happening? Europe’s benchmark prompt gas contract, the Dutch TTF Day-ahead, crept to a seven-month high last week despite healthy supply. Lower temperatures, reduced storage withdrawals and continued buying combined to tighten the market. The contract has risen Eur6/MWh since October 31, when it dipped below Eur10/MWh. Utility traders are holding onto stocks in anticipation of a greater premium in Q1 2020.

What’s next? While Q1 2020 TTF gas remains over Eur16/MWh, front month December is coming under pressure as Europe’s gas glut looks set to continue. A deluge of LNG is expected to complement already comfortable Russian and Norwegian supply, while gas is seen by market participants as detaching from carbon, and temperatures forecasts have ticked up. Q1 2020 has been more resistant to bearish sentiment because of the risk that transit talks will fail between Russia and Ukraine.

3. French nuclear at record-low lifts December power prices

What’s happening? French nuclear generation is set for a record-low fourth quarter due to maintenance delays and safety inspections at the Cruas nuclear plant following an earthquake. November output averaged 40 GW, down 11% on year, the third month in a row with a double-digit on year decline.

What’s next?  17 of France’s 58 reactors won’t be available at the start of December. French spot power prices are set to hit their highest so far this winter this week despite a generally bearish market, characterized by cheap gas and growing wind output. Colder weather is set to boost demand above 80 GW on Tuesday for the first time this winter with a strike looming as well on Thursday. French gas and coal plants are poised to fill the nuclear shortfall, while stronger hydro and reduced exports should act to ease French price.

4. IMO 2020 sends high sulfur fuel oil cracks tumbling…

What’s happening? Global cracks for high sulfur fuel oil have weakened sharply over the past two months after a year of abnormal strength, reflecting the drastic change in oil products demand due to the International Maritime Organization‘s impending sulfur limit on marine fuels. This month regional prices for HSFO in Asia, Europe, Africa, and the Americas have all reached record discounts to crude as demand falls in the run-up to the IMO 2020 rule limiting sulfur content to 0.5% from January 1, although in some regions they have rebounded somewhat in the past two weeks.

What’s next? Most market watchers believe HSFO prices have now largely bottomed out and are set for a recovery next year. Uncertainty persists, however, over the extent of recovery as pricing economics and uptake of exhaust gas scrubbers – which allow ships to continue burning HSFO – will play a key role in determining HSFO demand.  Looking ahead to 2020, the HSFO crack forward curve in Europe is in contango, suggesting regional prices are already set for a recovery.

5. …and complicates shipping costs for iron ore buyers

What’s happening? Iron ore contract buyers this year may be paying as much as $10/dmt more for FOB cargos using industry freight formulas, rather than pricing off spot freight rates. Freight rates are used for invoicing FOB iron ore prices based on benchmark China CFR indices such as Platts IODEX 62% Fe, and Platts 65% Fe fines index. Greater comparative volatility has emerged between spot and long-term industry freight formulas, for Brazil-China Capesize dry bulk rates used to reference contract FOB iron ore prices. Agreeing formulas rather than spot rates may be becoming more complex as bunker oil, a key component in determining long term freight rates under formulas, switches to use lower sulfur marine fuel under IMO 2020 fuel regulations.

What’s next? The extent to which IMO 2020 affects bunker fuel prices and demand for grades consumed, and continued use of industry longer-term freight formulas, remains to be seen. The changes in fuel oil and shipping rates may be discussed by iron ore buyers as they move into new iron ore pricing contracts for 2020 calendar year and fiscal 2020-2021 terms. Some suppliers are already moving contract pricing terms away from formulas to reference spot freight rates, to simplify pricing comparisons with iron ore delivered to markets in China and the rest of the world.

6. Corn prices shoot up in Brazil’s Mato Grosso

 

What’s happening? Corn prices in Mato Grosso, Brazil’s largest producer, are surging as supplies dwindle and domestic consumption rises, according to Mato Grosso Institute of Agricultural Economics. The state accounts for over 42% of second corn crop, or safrinha, produced in the country. Last week, corn prices in the state hit Reais 29.51 per 60 kg ($116.39/mt), up 53% from the same period a year ago. Strong domestic demand is mainly coming from the ethanol and animal protein industries.

What’s next? As Brazil is the world’s second-largest corn exporter, markets will be closely watching the price movements, as higher corn prices may encourage farmers to expand the crop area for second corn. The second corn planting in the state begins in February. Any increase in domestic consumption is also expected to reduce the supply for exports. The state exported 18.8 million mt of corn in January-October, 54% of Brazil’s total exports of the crop, up from 17.7 million mt in the full calendar year of 2018.