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Thursday, March 28, 2024

Let it Blow Up in Their Faces, Rather than in Ours

Let it Blow Up in Their Faces, Rather than in Ours

By Wolf Richter at Wolfstreet.com

What gets stuffed into the Wall-Street sausage maker on the American side are dollar-denominated risky “leveraged loans” – loans issued without collateral by over-indebted junk-rated companies. Banks slice and dice these leveraged loans, lumped them together into Collateralized Loan Obligations, and sell them to other financial institutions. These CLOs are then repackaged and peppered with derivatives to hedge against currency fluctuations.That’s what goes into the sausage maker.

What comes out of the sausage maker on the Japanese side are plump-looking, yen-denominated, highly rated bonds.

Blame the Bank of Japan. Where there’s enough demand, there will be supply. The BOJ, as part of its mega-QE program, is buying every Japanese Government Bond that hasn’t been nailed down. It has been telling banks, insurance companies, and pension funds to dump their vast holdings of JGBs. It pushed 10-year yields to 0.33%. And it’s strangling the JGB market.

Conservative Japanese pension funds, and even the Government Pension Investment Fund with ¥137 trillion ($1.14 trillion) in assets, long reliant on these JGBs, are dumping them into the lap of the central bank to replace them with a variety of goodies that provide some visible yield, including the latest Wall Street sausage.

It’s logical in our absurd world. Corporate America is already racing to sell euro-denominated junk bonds in Europe where the epidemic of negative yields in government bonds has suppressed yields across the corporate spectrum as well, to where junk bonds yield about 200 basis points (2 percentage points!) less than in the US. Low-cost money for high-risk US issuers, the new nirvana [read… Dumping American Junk in Europe, Draghi Asked for it].

But the deal with Japan is vastly more glamorous. These aren’t junk-rated US corporations going to Japan to sell yen-denominated bonds directly. This is Wall Street offloading murky, risky products at a high price.

These leveraged loans that form the base for the CLOs have long worried US banking regulators. Yellen personally warned about them. So they’ve fallen out of favor with banks. Issuance in the first quarter dropped 52% from a year ago. Retail investors have soured on them too, and they’ve been yanking their money out of leveraged-loan mutual funds for 12 months in a row.

The other option for banks to offload their leveraged loans is to slice and dice them and repackage them into highly rated CLOs. That too worries regulators because banks retain some risks. But never mind. Investors are clamoring for CLOs. So year-to-date, US issuance jumped 22% from a year ago, to $30.4 billion, with March issuance setting a new all-time record – though investors suffered “dismal” returns.

Where does this demand for CLOs come from? From all kinds of directions, including from across the Pacific. Now it’s time to turn these dollar-denominated CLOs into yen-denominated bonds for desperate Japanese pension funds – and thereby retirees. “To make it easier for Japanese investors to get to this US debt,” as Bloomberg put it. And it’s in the true spirit of sausage…

Keep reading here. 

Picture via Pixabay. 

 

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