The Economist May 28th 2022 Finance&economics 67
Carbontrading
Up intheair
C
arbon markets, for years short of
puff,haveatlastbecome oneofthe
mostwidespreadtoolsinthefightagainst
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
asgovernmentsseefit.
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 difference.
Mostschemesoperateontheprinciple
of“capandtrade”.Regulatorssetatotal
levelofpermittedannualemissions—the
cap—andauctiontheseallowancestothe
companiesincludedinthescheme.Busi
nessescanthentradetheallowancesbe
tweenthemselves,puttinga priceoncar
bondioxide.Someetss alsoallowfinan
cialfirmssuchashedgefundsto trade,
purelyforprofit,ontheirownaccount.
Thebestmarketsputahighpriceon
carbonthankstoa lowcapthatgoeslower
overtime,providinga strongincentiveto
gogreen.Theyalsocovera broadspectrum
ofeconomicactivity,allowing agentsto
tradeoffbetweenburningpetrolincars,
coal in blast furnaces or natural gas in
power plants. The widescope ensures that
trading systems find the cheapest way of
reducing emissions, lowering the overall
Carbonmarketsaregoingglobal.Willtheymakea difference?
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 firms most likely to
make a return on it. But the arrow of cau
sality can also fly the other way. A dysfunc
tional market can choke off the supply of
capital even to healthy firms, forcing them
into default for no better reason than that
financial conditions have tightened.
The worst instances of this occur when
the credit market comes unstuck, as it did
in the financial 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 five, 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 figure is 6.4% in the euro
zone. Most issuers need only worry about
earning enough to meet their interest pay
ments rather than finding 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 firms that do need to refinance
are likely to find a receptive market. A
monthly survey by America’s National As
sociation of Credit Managers found finan
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
profitsdisappointsomuchthatborrowers
areunabletopayeventheirinterest.The
bigger one is that riskaverse investors,
perhapsspookedbyfearsofarecession,
pulltheirmoneyfrombondfundsenmas
se and hoard cash instead. That would
leavesuchfundswithlesstolendtonew
issuers.Worsestill,theymaybeforcedto
firesellexistingdebttofundredemptions.
Shouldthathappen,theexperiencesof
CarvanaandMorrisonspointtoasafety
valve.Ultimatelybothfirmsmanagedtois
suetheirdebtbyturningtoprivatelenders
and offering sweetened terms. Between
2008 and 2021 the assets managed by such
lenders tripled, to $1.2trn. Unlike tradi
tional bond funds, they don’t offer 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 fire 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.