Inside Vietnam's Plans to Dent China's Rare Earths Dominance

Economic

Summary:

Vietnam plans to restart its largest rare earths mine next year. Dong Pao is among world's biggest mines, draws foreign interest. Australia's Blackstone eyes $100mln Dong Pao investment.

Vietnam plans to restart its biggest rare-earths mine next year with a Western-backed project that could rival the world's largest, according to two companies involved, as part of a broader push to dent China's dominance in a sector that helps power advanced technologies.

The move would be a step toward the Southeast Asian country's aim of building up a rare-earths supply chain, including developing its capacity to refine ores into metals used in magnets for electric vehicles, smartphones and wind turbines.

As an initial step, Vietnam's government intends to launch tenders for multiple blocks of its Dong Pao mine before the year's end, said Tessa Kutscher, an executive at Australia's Blackstone Minerals Ltd, which plans to bid for at least one concession. She cited unpublished information from Vietnam's Ministry of Natural Resources and Environment, which did not respond to requests for comment.

The auction's timing could change but the government plans to restart the mine next year, said Luu Anh Tuan, chairman of Vietnam Rare Earth JSC (VTRE), the country's main refiner and Blackstone's partner in the project.

The proposed restart of Dong Pao - whose timeline, scale and degree of foreign financial support have not been reported previously - comes as many nations fret about their vulnerability to supply disruptions due to China's stranglehold on strategic minerals and its disputes with the U.S. and its allies. Beijing this year-imposed export curbs on minor metals used in semiconductors, which an influential Chinese policy adviser warned was "just a start".

Vietnam has the second-largest rare-earth deposits, according to the U.S. Geological Survey. But they have remained largely untapped, with investment discouraged by low prices that are effectively set by China because of its near-monopoly on the global market. Visiting Hanoi this month to upgrade bilateral relations, U.S. President Joe Biden signed an agreement to boost Vietnam's ability to lure investors for its rare-earth reserves.

In interviews with Reuters, 12 industry executives, investors, analysts and foreign officials described plans for Vietnam, including investments they said showed how talk of derisking supply chains to reduce reliance on China is translating into action. Some acknowledged the difficulties of forging a rare-earths hub but said the gambit could make Vietnam a viable player while assuaging strategic worries, even if China remained dominant.

Kutscher said Blackstone's investment in the project would be worth around $100 million if it wins. She added that the company was talking to potential clients, including electric car makers VinFast and Rivian, about possible contracts with set prices that would shield suppliers from fluctuations and guarantee buyers a secure supply chain.

Sealing such deals would address a hurdle faced by developers in Vietnam. In recent years, Japanese investors Toyota Tsusho and Sojitz abandoned projects at Dong Pao after China ramped up supply, pummelling prices. The Japanese firms did not respond to requests for comment.

Yet despite the focus on derisking, it is unclear whether clients would be ready to pay a premium for Vietnam, said Dylan Kelly, of investment firm Terra Capital, noting the market in general was opaque.

Asked about VinFast's potential involvement, a spokesperson for parent company Vingroup said the group's entity in charge of raw-material procurement, VinES, had no current plans with Blackstone involving rare earths. He did not address subsequent questions about VinFast specifically.

Rivian did not reply to a request for comment.

Rivalling Mountain Pass

Effective exploitation of Dong Pao - which has sat dormant for at least seven years, according to an official at state-controlled miner Lavreco, which owns a concession - would propel Vietnam into the top league of rare-earths producers.

But refining rare earths is complex, and China controls many processing technologies. Dong Pao's estimated deposits also need to be reassessed with modern methods, according to Blackstone.

Inside Vietnam's Plans to Dent China's Rare Earths Dominance_1

Still, rare earths at Dong Pao are relatively easy to access and are mostly concentrated in bastnaesite ores, according to the Hanoi University of Mining and Geology.

These are typically rich in cerium, used in flat screens, and lanthanides, such as praseodymium and neodymium, which go into magnets.

Tuan said VTRE hoped to win a concession that would allow it to extract about 10,000 metric tons of rare-earth oxide (REO) equivalent a year, roughly one-third of the mine's expected annual output. Production could start around the end of 2024, he said.

That would put Dong Pao's output slightly below that of California's Mountain Pass, one of the world's largest mines, which produced 43,000 metric tons of REO equivalent in 2022, according to the USGS.

Vietnam also plans to develop additional mines. In July, Hanoi set a target to produce up to 60,000 tons of REO equivalent a year by 2030. China set a domestic quota of 210,000 tons last year.

Those goals would see Vietnam producing 5% to 15% of China's projected output by the decade's end, said David Merriman, a research analyst at consultancy Project Blue, who expects China to increase production over that period.

Vietnam's targets were "ambitious, though they are not entirely out of the question", he said.

U.S. Encouragement

The U.S. agreed during Biden's visit to help Vietnam better map its rare-earths resources and "attract quality investment", according to a White House fact sheet, a move that could encourage U.S. investors to bid for Vietnam's new concessions.

Reuters could not determine whether concrete plans involving U.S. investors exist at this stage. Officials at the U.S. embassy in Hanoi, the White House and Department of Commerce did not reply to requests for comment.

But recent U.S. attempts to gain a foothold in the Vietnamese industry did not succeed, said John Rockhold, a consultant to the rare-earths sector and president of the Hanoi chapter of the U.S. Chamber of Commerce, adding that one such plan involving VTRE collapsed this year.

That plan would have involved the shipment to the U.S. of rare earths refined by VTRE and possible future investment in Vietnam of $200 million, according to a non-public report for unspecified U.S. investors seen by Reuters.

VTRE confirmed the shipment deal had foundered.

Instead, VTRE in April announced a deal to supply 100 metric tons of rare-earth oxides this year to Australian Strategic Materials. ASM declined to comment on Dong Pao's exploitation.

Blackstone, which is a partner in that deal, operates a nickel mine in Vietnam and has determined that its processing facility in the country could handle ore from Dong Pao, according to a company statement.

From Ore to Magnet

Ultimately, VTRE plans to play a role in the whole rare-earth industry from ore extraction to the final products, said Tuan, who with his wife owns most VTRE shares, according to a list of shareholders he showed to Reuters. Blackstone said the ownership information accorded with its assessment following due diligence.

This is not an easy feat. The U.S. currently exports its rare-earth ores to China for processing as it lacks its own facilities. Inside Vietnam's Plans to Dent China's Rare Earths Dominance_2

Inside Vietnam's Plans to Dent China's Rare Earths Dominance_2

An existing VTRE factory in northern Vietnam specialises in separating rare-earth oxides from the extracted ore. The plant has capacity to process 5,000 tons of REO a year but the company plans to treble that to accommodate input from Dong Pao, Tuan said.

Once separated, oxides are turned into metals for use in magnets and other industrial applications. The metallization process is controlled by China, which produces 90% of rare-earth metals, according to the U.S. Department of Energy.

But VTRE is running a pilot project to build a metallization factory with South Korea's Setopia, said Setopia, which has no previous experience in the sector.

The initial combined investment would be around $4 million, mostly from Setopia, a Setopia official told Reuters, with a plant possibly ready next year.

In the downstream industry, South Korean and Chinese magnet firms are set to open factories in Vietnam, Reuters reported in August.

Dudley Kingsnorth, a professor at the Western Australian School of Mines at Curtin University, said Vietnam had some way to go, including in improving environmental practices, to realise its rare-earth goals.

Still, he said, Vietnam "has the resources, the mining and processing expertise to provide alternatives to China".

Source: Yahoo

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Kevin Du

Economic

Energy

United States thermal coal exports hit their highest levels since 2018 during the first eight months of 2023, climbing 20% from the same period in 2022 thanks to strong demand from key consumers including China, India and South Korea.

Total U.S. exports of coal used for power generation hit 22.5 million tonnes through August, up from 18.3 million in the same period in 2022, according to ship tracking data from Kpler.

In percentage terms, the increase in U.S. exports was the largest among all major thermal coal exporters, surpassing even the 15.7% expansion seen from top coal exporter Indonesia.

U.S. Thermal Coal Exports Jump to 5-Year Highs on Asian Demand_1

The strong gains in U.S. coal exports contrast with the declines seen in domestic coal use for power generation, with U.S. coal-fired power production down over 50% since 2010 as part of efforts to reduce national fossil-fuel emissions.

The diverging trends in coal use and exports leave the United States vulnerable to accusations that it contributes to harmful global emissions trends by sustaining high exports of coal even as it reduces coal consumption at home.

But the strong exports pace also highlights the enduring demand for U.S. coal even as domestic power producers steadily reduce coal's share of the power generation mix.

Top Markets

Asia accounted for 48% of total U.S. exports, or around 10.6 million tonnes, with 7 million tonnes going to India, 1.3 million tonnes to Japan, 1.1 million tonnes to China and 600,000 tonnes to South Korea.

U.S. Thermal Coal Exports Jump to 5-Year Highs on Asian Demand_2

Europe accounted for 26.6% of U.S. exports, with the Netherlands the second-largest buyer overall with 3.2 million tonnes of imports. Germany, Spain and Poland were other notable European buyers, bringing in 1 million, 712,000 and 217,000 tonnes, respectively.

Elsewhere, Egypt (1.9 million tonnes), Morocco (1.0 million tonnes) and the Dominican Republic (662,000 tonnes) were other large buyers, underscoring a wide geographic span of markets for U.S. coal so far in 2023.

Pollution Impact

While China and India, the world's two largest coal consumers, secure a majority of their coal needs from domestic production, imported coal contributes to total emissions from power plants.

In 2022, those two countries accounted for just over 70% of total global power emissions from coal use, discharging over 5.4 billion tonnes of carbon dioxide and equivalent gases, data from think tank Ember shows.

Japan, South Korea, the Philippines, Germany and Poland accounted for a further 8%. U.S. Thermal Coal Exports Jump to 5-Year Highs on Asian Demand_3

Over the near term, the wide range of coal importing markets bodes well for U.S. coal exporters, and outbound shipments should climb again over the winter months as long as U.S. prices remain competitive to other suppliers.

But over the longer term, U.S. coal exporters may start to struggle to profitably find willing buyers for their production, as a growing number of power generation companies have pledged to boost renewable energy supplies and will cut back on coal imports.

In addition, some major coal producers, including China, may increase coal exports over time even as power producers there follow the U.S. lead and reduce coal use in their own generation mixes.

That may lead to greater competition with the U.S. for coal export market share, and lead to steady declines in U.S. export potential over time.

Source: ET EnergyWorld

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Justin

Economic

Central Bank

The US personal income and spending report contains lots of numbers, but the August 0.1% month-on-month core PCE deflator print catches the eye. The consensus was 0.2% and we had been fearing a 0.3% outcome given what we saw from core CPI. There are quite a lot of revisions, but now we have three consecutive 0.2% or 0.1% MoM prints for what is the Fed's favoured measure of inflation. That should argue against the need for a fourth quarter rate hike, especially if we aren't going to get much data over the next month due to the strong likelihood of a government shutdown.

The year-on-year rate remains elevated at 3.9%, but we are hopeful of ongoing declines over the next few months given we have 0.5% MoM and 0.4% MoM readings from September and October 2022 dropping out of the annual comparison. The three-month annualised rates are already getting close to the Fed's 2% target and assuming we see 0.2% MoM prints for the rest of the year we would have annual core inflation near to 3% YoY by year-end, which should calm some of the fears of the hawks on the Fed.

US core personal consumer expenditure deflator (% change)

US Inflation Slows, but Higher Savings Mean a Resilient Consumer_1

Huge revisions to income and spending mean households have more residual savings than thought

Meanwhile household incomes rose 0.4% MoM and spending increased 0.4%, but for GDP growth we are interested in the real, inflation-adjusted numbers. This had real spending increase 0.1% MoM after a 0.6% gain in July, meaning we are on track for real consumer spending growth of around 3.7% annualised in the third quarter, which would help to get GDP growth of around 3.5%.

There were significant revisions to the history though with incomes revised higher and consumer spending revised lower. This is important as it suggests that the household sector accrued more savings during the pandemic and have run down less than previously thought. These aren’t insignificant numbers either. We are talking upwards of $700bn of pandemic-era accrued savings being available to households over and above what we previously thought, which could keep consumer spending more resilient than we had been thinking.

Stock of excess savings accrued since the pandemic ($bn)

US Inflation Slows, but Higher Savings Mean a Resilient Consumer_2

No fourth quarter hike, but interest rates could indeed be higher for longer

The proviso is we don’t have a breakdown on who has these savings and the assumption has to be that many low-income households have already burnt through most of them. This was an assertion made within the Federal Reserve’s Beige book which stated that “some Districts highlighted reports suggesting consumers may have exhausted their savings and are relying more on borrowing to support spending”.

The challenges being faced by the household sector are growing, be it from low real income growth, difficulty obtaining credit, rising gasoline prices eroding spending power, student loan repayments restarting and strike/government shutdowns hitting paychecks. But if there are residual savings out there then consumer spending could end up being more resilient, which would justify the market’s belief in Federal Reserve monetary policy staying tighter for longer.

Source: ING

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Devin

Economic

Britain, which was quick to set ambitious climate goals, is now stumbling on the path to reach net zero emissions by 2050 and facing hurdles that could resonate with nations trying to balance their targets with politics and the cost of action.

After setting world-leading CO2-cutting targets into law in 2019, Britain has struggled to get on track to make them happen. Electric vehicle charging points are being installed slower than targeted, and despite early success in rolling out offshore wind, the government’s latest renewable energy auction awarded zero contracts to wind developers.

Analysts and politicians say that the British government’s move last week to delay targets for green vehicles and heating systems ahead of a looming election reflects a crunch point that other countries may face as they attempt to turn far-off climate goals into concrete measures - with costs for companies and consumers as soon as this decade.

"The UK has been one of the real leaders in climate diplomacy and in their own emissions reductions," Ireland’s climate minister Eamon Ryan told Reuters. "As a friend and a neighbour, I’d have to say some of that has been put at risk."

Britain, which hosted the United Nations annual climate conference COP26 in 2021, still leads the G7 when it comes to slashing output of climate-warming gases — reducing emissions by 49% between 1990 and 2022 with cutting down on coal the biggest driver.

But according to the Climate Change Committee’s June 2023 progress report to parliament, to hit mid-way climate targets, Britain must quadruple its annual emissions reductions outside the electricity supply sector by 2030.

The committee, an independent body set up under Britain's climate change law, had already said in 2022 that the country's strategy "will not deliver net zero".

Prime Minister Rishi Sunak said last week he remained committed to the legally binding target of reaching net zero by 2050 but said Britain could afford to make slower progress in getting there because it was "so far ahead of every other country in the world".

He said he was changing the policy because previous governments had moved too quickly to set net zero targets, without securing the support of the public.

Delaying net zero transition investments could prove politically popular, analysts observed, if an election was on the horizon.

But "this framing only works if you think climate policy is a burden", said Bob Ward, a climate policy researcher at the London School of Economics and Political Science, adding that avoiding short-term costs was likely to lead to a greater bill for taxpayers down the road.

Rollback or reality?

Sunak's own Conservatives defended his decision as advocating for consumers facing a cost-of-living crisis.

"It's right we tweak as, at the moment, these green policies and targets hurt those worse off," one conservative lawmaker told Reuters.

Global gas prices rocketed last year following Russia’s invasion of Ukraine. Although they have fallen in recent months, average British household energy bills are expected to remain high in part due to the country’s reliance on gas for home heating.

Charging infrastructure lags behind what is needed for a growing fleet of electric vehicles and a target of some 600,000 heat pump installations by 2028 looks distant due to a lack of skilled engineers, with only 72,000 installed in 2022.

Britain's move comes as climate change policies come under threat from politicians in other European nations – even as countries face mounting costs from intensifying wildfires, deadly heat and floods fuelled by climate change.

With Poland, Slovakia, the Netherlands, and the European Union's Parliament all holding elections in the coming months, analysts said political pushback could intensify as countries consider policies that - unless coupled with more support to incentivise greener choices - would hit citizens' wallets.

"Transport and buildings are going to be our major problem because that's where climate policy becomes visible to people in their daily life," said Simone Tagliapietra, senior fellow at Brussels-based think tank Bruegel.

Governments not on track to deliver their green targets face a choice: either cut back on commitments, or strengthen policies and financing to deliver them. The U.S., with its Inflation Reduction Act, is offering nearly $400 billion in federal funding for clean energy and technologies.

The German government said on Sunday it would put on hold plans to require more stringent building insulation standards to help the building industry - even after passing new energy-saving targets for 2030 last week.

While Sunak’s move rattled investors and companies, some said the prime minister’s announcement was aligned with reality.

"Delaying the ban on the sale of new petrol and diesel cars is disappointing, but reflects the reality that this is where most of the major car manufacturing nations are," said Britain's environmental audit committee chairman Philip Dunne.

Source: Reuters

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Economic

Inflation is when the cost of living goes up over time. The Consumer Price Index, or CPI, measures inflation by tracking changes in the prices of common goods and services.

When the CPI rises, it usually means inflation is happening. How prices come to rise can happen in a number of ways. Here are the main ones:

Demand-pull - When demand is higher than supply, prices go up.
Cost-push - When supply falls but demand stays the same, prices go up.
Expectations - When people expect inflation, they act in ways that cause it. For example, if a café chain expects the coffee price to rise, they could raise the price per cup of coffee to pre-empt the expected price increase. By doing that they raise the price of a cup of coffee even though there hasn't been any other inflationary factors at play.

As investors and traders it's important to understand how CPI affects markets. The table below suggests some questions to consider to help get to the answer:

As you can see, there's no one-size-fits-all answer – each market has its unique context. Let's look at three historical examples to try to understand how inflation might impact markets. What CPI Means for Investors and Traders_1

What CPI Means for Investors and Traders_1

Stocks in the '70s

In the early 1970s, prices for goods and services rose very quickly in the United States due to events like oil shortages and government spending. This made the dollar weaker, so people could buy less with their money. The cost of living went up

To try to slow inflation down, the Federal Reserve raised interest rates a lot. With higher rates, it was more expensive for companies to borrow money. This hurt their profits and made investors worried, causing the stock market to crash badly - one of its worst declines since the Great Depression long before.

Some people think the stock market goes up when inflation rises. But this shows that when prices rise too fast, eventually it damages markets. What climbs quickly can come down even faster. The 1970s showed that sudden, massive inflation can crush the markets.

Gold in the 2000s

In the 2000s, rising inflation helped gold prices a lot. Investors saw gold as a hedge against inflation and dollar weakness. However, gold prices don't rise in isolation. The rise in gold prices in the 2000s didn't just happen because of inflation expectations. Other major factors were also at play. These included:

After 9/11, the war in Afghanistan, and the war in Iraq all drove investors toward gold as a safe haven.
Central banks like those in China and Russia boosted their gold reserves to diversify away from U.S. dollars.
New gold exchange-traded funds (ETFs) made it easier for mainstream investors to buy gold.

While inflation concerns did play a role, gold's strong performance in the 2000s resulted from a combination of factors like geopolitics, central bank demand, and financial innovation. The financial markets are complex, with many interrelated forces driving prices up or down. It's important to keep the global context in mind while keeping an eye on CPI numbers. What CPI Means for Investors and Traders_3

What CPI Means for Investors and Traders_3

Bonds during Japan's "lost decades"

In the 1980s, Japan experienced an economic boom that led to an unsustainable asset bubble. To control speculation and prevent a collapse, the Bank of Japan raised interest rates. Unfortunately, this caused the bubble to burst. Japan's stock and real estate markets crashed, kicking off a long period of stagnation and very low inflation.

With stocks and real estate in decline, investors shifted to Japanese government bonds (JGBs) as a safe haven, driving up bond prices. Note that bond prices didn't directly rise because of low inflation. Rather, low inflation was a symptom of broader economic stagnation.

Inflation and bond prices were correlated, but inflation did not directly cause the increase in bond prices. The low CPI figure reflected the weak economic conditions that led investors toward bonds in the first place. This example shows that CPI is intertwined with the overall economy. It is often a symptom, not a key driver, of economic shifts.

How can investors and traders use this information?

CPI can impact markets, but it doesn't drive markets on its own. If you would like to understand how the market behaves around CPI announcements, here are two things to keep an eye on:

If you think CPI will be higher than the market expected (known as a 'positive surprise'), keep an eye on the performance of value stocks. These are companies that are considered undervalued or "cheap" compared to their intrinsic value. These types of companies tend to outperform during inflationary periods.
If you think CPI will be lower than the market expected (known as a 'negative surprise'), keep an eye on the country's key commodity. Low CPI sometimes suggests lower commodity prices.

Remember, one indicator doesn't provide enough information to make complex financial decisions. In addition to the CPI number, look at price charts, how much risk you can afford to take on, and fundamental indicators.

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Justin

Central Bank

Economic

Forex

Stellar economic performance revives hike bets

Back in August, the Reserve Bank of New Zealand (RBNZ) decided to maintain the Official Cash Rate (OCR) at 5.5%, adding that the current level of interest rates is constraining spending and thereby inflation pressures, also expressing confidence that with rates staying at restrictive levels for some time, inflation will return to the 1-3% target range.

Back then, they noted that the economy is evolving broadly as expected, with activity continuing to slow in parts of the economy that are more sensitive to interest rates. However, just last week, GDP data revealed that the economy grew by nearly double the anticipated pace in Q2, after stagnating in the first three months of the year. Although this appears to be a relief for the current government, which is under fire for how they’ve been handling the economy ahead of an election on October 14, it may worry the central bank which likely needs slower growth to achieve its inflation goal.

With the Bank projecting that the economy would slip into recession in the second half of 2023 and the data offering no such sign, investors have begun pricing in around a 60% probability for another quarter-point hike by the end of the year as the stronger economic performance, combined with the latest rally in oil prices, adds upside risks to the nation’s 6% inflation rate. Yes, 1-year inflation expectations are much lower, but still above the Bank’s target, with only the 2-year projection lying slightly below the upper bound of the 1-3% target range.

Will officials adopt a more hawkish language?

For Wednesday’s meeting, investors are 90% confident that policymakers will refrain from acting, and should this be the case, they may dig into the statement of hints on whether the Bank will open the door to another hike.

All that suggests that, even if the Bank stands pat, the meeting could be a live one. The kiwi may slide in the case of policymakers abstaining from commenting on the possibility of additional hikes, as those expecting more may be disappointed. The opposite may be true should they bring to the table the likelihood of more action.

Given that this will be one of the shorter meetings that are not accompanied by updated economic projections, and that policymakeres may prefer to have the CPI numbers for Q3 in hand before examining whether higher rates are needed, the former outcome may be more likely. The November gathering appears to be a wiser choice for proceeding with any policy or language changes.

Kiwi traders may get disappointed

The kiwi has been in a recovery mode the last couple of days against the US dollar, but this was mainly due to the dollar pulling back, perhaps as traders are rebalancing their portfolios and liquidating some long-dollar positions on the last trading of the quarter.

A potentially dovish RBNZ could keep that recovery in check and bring the kiwi back under pressure. That said, given that monetary policy is not the only variable in the equation of the risk-linked currency, traders may have more than the RBNZ decision to examine. The challenges facing China, the world’s second-largest economy and New Zealand’s main trading partner, as well as concerns about the economic performance of Europe and the UK, could constitute another element of anxiety, and thereby add extra weight on the currency.

Kiwi/dollar headed towards key resistance

Kiwi/dollar rallied above the 0.5985 zone today, confirming a temporary bottom at around 0.5855. However, the pair looks to be headed towards the very important zone of 0.6080, which acted as the lower end of the sideways range that contained most of the price action between February and August. The bulls may get rejected there if indeed the RBNZ appears dovish, with the potential subsequent decline aiming for another test at 0.5985. A break lower could encourage extensions towards the low of September 6, at 0.5855.

On the upside, even if kiwi/dollar climbs above the 0.6080 barrier, the picture would not be painted positive. Such a move may only signal the pair’s return within the aforementioned range, and thereby turn the outlook to neutral.

Source:XM

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Cohen

Bond

The expanding shadows of private credit seem an odd place to lurk if central banks' 'higher-for-longer' mantra on interest rates suggests they keep things tight until something breaks.

And yet many asset managers are doubling down on the growing direct lending universe - assuming the higher returns in a "soft-landing" scenario for the world economy compensate for default or restructuring risks that are more manageable than in publicly-traded high-risk junk bonds.

Screening out a lot of noise and holding your nerve in an inherently illiquid space seems to be a tall order.

Right now, the noise is deafening and nerve is in short supply in the seemingly safest part of the debt market as longer-term government bonds that set base borrowing costs get whacked anew on rising uncertainty about where inflation and policy rates settle in the coming years and as debt piles rise.

Without much change in near-term assumptions about peaking Federal Reserve policy rates, investors are starting to reprice long-term bonds to cope with a potentially more resilient, higher-inflation economy where the unwinding of central banks' gigantic balance sheets of bonds also whips away market supports.

Fed or European Central Bank policy rates may well be cresting now at last, but if they don't come down again soon due to persistently above-target inflation - they could well start rising again from current levels if another cyclical expansion were to emerge without a recession ever occurring in this cycle.

Debt supply projections and central bank balance sheet 'normalization' add to the angst.

The result has been benchmark U.S. 10-year yields have spiralled almost a full percentage point higher to 16-year highs near 4.7% over the past quarter - with real, inflation-adjusted yields up 80 basis points to some 2.34%.

The deeply inverted 2-to-10-year yield curve gap that many has assumed was a harbinger of recession is narrowing sharply.

But perhaps the best indication of long-term uncertainty and a lack of visibility is the return of a so-called term premium - an often fuzzy measure of the added compensation in yield that investors demand for holding long-term bonds to maturity against rolling shorter-term paper over the same period.

Bond Quake Sees Doubling Down On The Shadows_1

Bond analysts have differing models to measure this, but the New York Fed's estimate turned positive this week for the first time in more than two years - having been in negative territory for all but two brief occasions in the past eight years.

Shadow Play

And yet despite the government debt ructions and forecasts of gradually rising junk debt default rates close to 5% next year, the lack of an imminent recession has meant high-yield bond markets have remained relatively calm - with spreads over rising government yields still more than half a percentage point lower than the end of last year.

The prospect of 'higher-for-longer' rates seems scary for fragile companies on floating-rate loans or who will be forced to refinance at much higher rates over that prolonged period - just as bank credit shrinks, lending standards tighten and bond markets gyrate.

But at least public bond and leverage loan markets have visibility in pricing and offer some liquidity to get in or out.

Many have long-feared the more opaque performance in private credit - direct lending by asset managers that Moody's estimates has more than doubled in size since 2015 to some $1.5 trillion and which is now as big as the global junk bond market.

With a lack of transparent data, especially in Europe, the sheer size of this debt pool hasn't really been tested in a major downturn or period of prolonged high interest rates. And regulators have fretted about system risks - even if investors are typically pension, insurance and sovereign wealth funds that can better deal with illiquidity over long periods.

Unfazed, BlackRock credit strategists this week said the growing private credit world was well priced and structured to weather the storm - and the illiquidity premia worth it even if the more active name selection and widening dispersion of performance was now inevitable.

That the numbers of borrowers in that space may grow further as banks scale back lending is no surprise.

Bond Quake Sees Doubling Down On The Shadows_3

But investment performance so far in this tightening cycle seems to stack up.

Using a data set of 13,000 middle market loans totalling $284 billion embedded in the Cliffwater Direct Lending Index (CDLI), BlackRock showed realized loss rates from defaults or restructurings in the first half were 0.55% - compared to interest income of 5.63%.

It also spotlighted data from the Lincoln International Senior Debt Index tracking 4,500 private borrowers that showed 425 loan terms were amended successfully in the first half of 2023 due largely to higher interest expenses. This meant loan covenant default rates actually fell during the second quarter.

"This long-term relationship between lender and borrower can often result in a more efficient process for negotiating amendments versus what would otherwise occur in the syndicated public market," the BlackRock team reckoned, adding this was on top of a 170-basis-point yield pickup on the CDLI over comparable leveraged loan indexes.

Bond Quake Sees Doubling Down On The Shadows_4

Thierry Celestin, head of private assets at Lombard Odier, argues that, contrary to regulator concerns, the rise of private credit may actually lower systemic risks in a crisis by shifting the burden away from banks more vulnerable to short-term stress, dependent on deposits and subject to runs.

"The illiquidity of private credit can be a barrier to some investors," he concluded, but the high returns, low volatility and diversification involved works for those "with the appropriate risk tolerance, appetite and long-term time frame".

Shadowy or shining, the private credit world is set to face its first big test in a higher-for-longer world of unfolding bond market anxiety. Bond Quake Sees Doubling Down On The Shadows_5