The Economist - UK (2022-05-28)

The Economist May 28th 2022 Finance&economics 67

Carbontrading

Up intheair

C

arbon markets, for years short of

puff,haveatlastbecome oneofthe

mostwidespreadtoolsinthefightagainst

climatechange.Bytheendof 2021 more

than21%oftheworld’semissionswereco­

veredbysomeformofcarbonpricing,up

from15%in2020.Evermorebusinesses

havetopayregulatorsfortherighttore­

leasea tonneofcarbondioxideintotheat­

mosphere.Investorsaregettinginterested

too:tradingonthesemarketsgrewby164%

lastyear,to€760bn($897bn).

Thatisundoubtedlygreatnews.Carbon

pricesensurecompaniesthatburnmore

fossilfuelsareata competitivedisadvan­

tagewhilegreeninnovationisrewarded.

Therevenuefromthesaleofcarbonper­

mits,meanwhile,canbereinvestedinre­

newableenergyorothervirtuousventures

asgovernmentsseefit.

Theproblemisthatveryfewmarkets

workasintended.Ofthe 64 carbontaxes

andemissions­tradingsystems(etss)that

existed in 2021, only a tiny minority, cover­

ing 3.8% of emissions, priced the gas above

$40 a tonne, which the Carbon Price Lead­

ership Coalition, a group of businesses and

governments,estimatesastheminimum

social cost ofcarbon(a measure ofthe

damagedonetoglobalwelfarebyincreas­

ingemissions).Andthatmaybetoogener­

ousalready: some economists put itat

morethan$200.Manycarbonmarketsare

toocheaptomakea difference.

Mostschemesoperateontheprinciple

of“capandtrade”.Regulatorssetatotal

levelofpermittedannualemissions—the

cap—andauctiontheseallowancestothe

companiesincludedinthescheme.Busi­

nessescanthentradetheallowancesbe­

tweenthemselves,puttinga priceoncar­

bondioxide.Someetss alsoallowfinan­

cialfirmssuchashedgefundsto trade,

purelyforprofit,ontheirownaccount.

Thebestmarketsputahighpriceon

carbonthankstoa lowcapthatgoeslower

overtime,providinga strongincentiveto

gogreen.Theyalsocovera broadspectrum

ofeconomicactivity,allowing agentsto

tradeoffbetweenburningpetrolincars,

coal  in  blast  furnaces  or  natural  gas  in

power plants. The widescope ensures that

trading  systems  find  the  cheapest  way  of

reducing  emissions,  lowering  the  overall

Carbonmarketsaregoingglobal.Willtheymakea difference?

Corporatedebt

Bloody but

unbowed

A

t theirbest, capitalmarketsholdupa
mirror  to  the  real  economy.  They  rise
and  fall  in  tandem  with  companies’  for­
tunes,  encouraging  investors  to  direct
money  towards  the  firms  most  likely  to
make a return on it. But the arrow of cau­
sality can also fly the other way. A dysfunc­
tional  market  can  choke  off  the  supply  of
capital even to healthy firms, forcing them
into default for no better reason than that
financial conditions have tightened.
The worst instances of this occur when
the credit market comes unstuck, as it did
in the financial crisis of 2007­09. That adds
an  ominous  ring  to  the  unusually  sharp
losses  credit  investors  have  endured  re­
cently.  Based  on  total  returns,  American
investment­grade  bonds  are  down  by  14%
since  September.  European  ones  have
dropped by around 10%, their worst peak­
to­trough  plunge.  The  credit  spread,  or
premium  paid  by  risky  “high­yield”  bor­
rowers compared to Treasuries, has spiked
from  three  percentage  points  in  late  De­
cember  to  nearly  five,  with  around  half
that  increase  coming  in  May.  Firms  from
Carvana, an American car retailer, to Mor­
risons,  a  British  supermarket  chain,  have
struggled to issue debt. Is it time to panic?
To understand why not, start with cred­
it  spreads.  Those  for  American  high­yield
bonds  began  2022  close  to  all­time  lows.
Even after their recent rise, they remain be­
low their long­run average and far from the
levels  seen  in  2008  and  during  the  covid
convulsion in 2020 (see chart). Jonas Gol­
termann  of  Capital  Economics,  a  consul­
tancy, says the tightening is more reminis­
cent  of  the  growth  scares  of  2015­16  and
2018 than of a credit crunch.
A  tsunami  of  corporate  defaults  re­
mains unlikely. Few of the riskiest borrow­
ers  have  to  repay  their  debt  in  the  next  18
months.  Of  America’s  $1.5trn­worth  of
high­yield  bonds,  just  4.5%  falls  due  be­
fore  2024;  the  figure  is  6.4%  in  the  euro
zone. Most issuers need only worry about
earning enough to meet their interest pay­
ments  rather  than  finding  new  lenders  to
roll over their debt. Moody’s, a rating agen­
cy,  reckons  the  global  default  rate  will  hit
3% over the 12 months to April 2023—high­

er than the 1.9% for the year to April 2022,

but below the historical average of 4.1%.

Those  firms  that  do  need  to  refinance

are  likely  to  find  a  receptive  market.  A

monthly survey by America’s National As­

sociation of Credit Managers found finan­

cial conditions in April to be slightly tight­

er than in late 2021, but looser than at any

time before that going back to 2004. As the

Federal  Reserve  starts  winding  down  its

$5.8trn  portfolio  of  Treasuries  from  June

1st,someliquidityislikelytodrainfrom

themarket.Fornow,however,caseslike

CarvanaandMorrisonslooklikeoutliers.

Tworisksremain.Oneisthatcorporate

profitsdisappointsomuchthatborrowers

areunabletopayeventheirinterest.The

bigger one is that risk­averse investors,

perhapsspookedbyfearsofarecession,

pulltheirmoneyfrombondfundsenmas­

se and hoard cash instead. That would

leavesuchfundswithlesstolendtonew

issuers.Worsestill,theymaybeforcedto

fire­sellexistingdebttofundredemptions.

Shouldthathappen,theexperiencesof

CarvanaandMorrisonspointtoasafety

valve.Ultimatelybothfirmsmanagedtois­

suetheirdebtbyturningtoprivatelenders

and offering sweetened terms. Between

2008 and 2021 the assets managed by such

lenders  tripled,  to  $1.2trn.  Unlike  tradi­

tional  bond  funds,  they  don’t  offer  inves­

tors  daily  withdrawals,  meaning  they  are

less  susceptible  to  swings  in  sentiment

and  more  able  to  deploy  capital  when  the

market  is  stressed.  They  are  sitting  on

more than $420bn of “dry powder”, or un­

spent  cash.  Daniel  Lamy of JPMorgan

Chase,  a  bank,  does  not  expectthem  to

hold fire for very much longer.n

Despite a painful repricing, the credit
market hasn’t cracked

Taking credit

United States, high-yield corporate-bond spread

over Treasuries, percentage points

Source: Federal Reserve

25

20

15

10

5

0

221917151311092007

Average

Correction:The table in our story on housing
(“Braced for a storm”, May 14th) contained a
mistake. The second column showed the share of
households with a mortgage, not the share of
homeowners with a mortgage. This has been
corrected online. Sorry.