Saturday, February 25, 2017

Saturday's News Links

[Reuters] Record-setting stock rally faces test in Trump speech

[Reuters] China summons reformer to tackle banking woes

[Reuters] France's Hollande fires back at Trump over Paris comments

[Reuters] Wary of Trump unpredictability, China ramps up naval abilities

Weekly Commentary: Risk On/Risk Off Face-off

The DJIA rose 11 straight sessions (“longest streak since the Reagan administration”) to end the week at a record 20,822. The S&P500 gained 0.7% this week (up 5.7% y-t-d), its fifth consecutive weekly gain. The Morgan Stanley High Tech Index’s 0.5% rise increased y-t-d gains to 11.5%. Already this year the Nasdaq Composite has gained 8.6%. The Nasdaq100/NDX added 0.3% this week (up 9.9%). Bullish analysts continue to point to strong market momentum.

It’s an unusual backdrop where “Risk On” powers a U.S. equities markets melt-up, while safe haven assets trade as if “Risk Off” is lurking right around the corner. Ten-year Treasury yields declined 10 bps this week (to 2.31%) to the lowest level since November 29th. UK yields sank 14 bps (to 1.08%) to lows since October. Gold added $22 this week to $1,257, trading to the high since the election. Silver jumped 2.0% to $18.41, increasing y-t-d gains to 15%. The yen gained 0.6% this week, increasing y-t-d gains versus the dollar to 4.3% (and near a key technical level).

Elsewhere, it appears some favored trades are performing poorly – with popular longs lagging and popular shorts outperforming. The financials continue to lag, while the out-of-favor Utilities surged 4.1% this week. Defensive stocks outperformed this week, while “Trump reflation” wagers underperformed. Low beta outperformed high beta. The small caps underperformed again this week. Meanwhile, the Treasury bond bears are running for cover. All in all, it would appear Market Dynamics continue to frustrate many hedge fund strategies.

At this point, Europe remains at the epicenter of The “Risk On”/“Risk Off” Face-off. Major European equities indices reversed lower into this week’s close. After trading to the highest level since 2015, Germany’s DAX index dropped 1.6% during Thursday’s and Friday’s sessions. Italian equities fell 2.2% this week, and Spanish and French equities posted modest declines. The European Bank Stock Index (STOXX 600) dropped 3.2% this week, trading to the lowest level since early-December. Notably, Italian banks sank 5.8% this week, boosting y-t-d losses to 10.4%.

Through the eyes of the global bond market, something just doesn’t look right. And while this week’s Treasury and gilt yield declines were curious developments, the real action continues to unfold in Europe. German bund yields declined a notable 12 bps this week to 0.18%, the low since December 29th. Even more intriguing, German two-year sovereign yields sank 14 bps this week to a record low negative 0.96%.

The French versus German two-year sovereign spread traded as high as 49 bps this week, the widest since the tumultuous summer of 2012. This spread widened 11 bps for the week (to 43bps), and has doubled thus far in February. The Italian to German 10-year spread widened 12 this week, back to a two-year high 201 bps. The Spanish to German 10-year spread surged 18 bps this week to a seven-month high 151 bps. After beginning the year at 37 bps, the French sovereign Credit default swap (CDS) traded Thursday above 70 for the first time since August 2013.

Markets clearly fret approaching French elections (first round April 23, second May 7). National Front candidate Marine Le Pen is widely expected to win the first round but then lose in May’s two candidate runoff. After Brexit and Trump, markets this time around are less willing to take things for granted. Le Pen is running on a far right platform that includes exiting the EU, returning to the French franc and adopting various “France First” measures. Having watched post-Brexit and post-Trump non-turmoil, perhaps French voters will disregard what has become routine fearmongering.

While markets see a Le Pen Presidency as a relatively low-probability (Citigroup says 20%), there is recognition that such an outcome would be highly market disruptive. Many would view a National Front upset as the beginning of the end of the euro monetary experiment.

February 23 – Reuters (Brian Love and Michel Rose): “France's presidential race took a new turn on Thursday as independent Emmanuel Macron raised the curtain on a partnership with veteran centrist Francois Bayrou to help him beat the far-right's Marine Le Pen. ‘Political times have changed. We cannot continue as before. The National Front is at the gates of power. It plays on fear,’ Macron said… Opinion polls appeared to show the 39-year-old Macron, a political novice who has never held elected office but who has soared to become a favorite to enter the Elysee, was already benefiting from the new-born alliance announced on Wednesday.”

French (to German) bond spreads narrowed Wednesday on prospects for a Macron/Bayrou alliance to counter Le Pen. This development, however, didn’t slow the melt-up in German bund prices or, for that matter, the rally in Treasuries, gilts and safe haven bonds more generally. And it didn’t stop a sell-off in European bank stocks that seemed behind the late-week underperformance in U.S. and global financial stocks.

A Friday Reuters headline caught my attention: “Global Stocks Fall, Bond Markets Rally as Trump Optimism Pauses.” I have a difficult time with the notion of “Trump optimism” fueling international equities. Rather, it’s too much “money” (liquidity) chasing highly speculative markets in stocks, bunds, Treasuries, gilts, JGBs, corporates and EM debt. This same fuel has been behind gold and silver’s 9% and 15% y-t-d gains.

It’s a Theme 2017 that markets are unprepared for what would be a surprising change in the global monetary backdrop. I expect both the BOJ and ECB to at some point this year begin developing strategies for significantly reducing QE liquidity injections. Clearly, the Germans are contemplating a year-end conclusion to ECB QE operations.

February 23 – Reuters (Francesco Canepa): “Germany's central bank posted its smallest profit in more than a decade in 2016 as it set aside more money against potential losses on the bonds it is buying as part of the European Central Bank's stimulus programme… The Bundesbank recorded a net profit of 399 million euros, the lowest since 2004 and a sharp drop from the 3.2 billion euros bagged in 2015… Commenting on the results, Bundesbank president Jens Weidmann said it was right for the ECB to discuss closing the door to a further policy easing in the future.”

February 23 – Bloomberg (Carolynn Look and Manus Cranny): “Investor expectations for an interest-rate increase by the European Central Bank in 2019 aren’t totally unjustified as downside risks to the economic outlook recede, according to Bundesbank President Jens Weidmann… Accelerating inflation and a strengthening economic outlook have fanned a debate in the 19-nation euro area about the appropriate degree of stimulus as central banks prepare for a policy shift. While officials including Weidmann are arguing that the time to talk about an exit is coming closer, ECB President Mario Draghi contends that record low rates and a 2.28 trillion-euro ($2.4 trillion) quantitative-easing plan are still necessary to produce a sustained pickup in inflation… While Weidmann conceded that the ECB is right to keep monetary policy accommodative, he criticized the Governing Council’s decision to extend QE through the end of 2017. ‘I was not very supportive of that step… The monetary-policy stance that I would have been willing to accept is less expansionary than the current one.’ One can certainly ask ‘when we might slow down monetary policy and whether the ECB Governing Council shouldn’t make its communication more symmetrical beforehand, for instance by not only pointing to the fact that monetary policy could be even more expansionary.’”

Angela Merkel appears increasingly vulnerable heading into October elections. Responding to criticism from a Trump advisor, Merkel this week commented: “We have at the moment in the euro zone of course a problem with the value of the euro. The ECB has a monetary policy that is not geared to Germany, rather it is tailored from Portugal to Slovenia or Slovakia. If we still had the D-Mark it would surely have a different value than the euro does at the moment.”

February 23 – Reuters (Francesco Canepa): “Exclusive: ECB seeks to lend out more bonds to avert market freeze – sources: The European Central Bank is looking for ways to lend out more of its huge pile of government debt to avert a freeze in the 5.5 trillion-euro short-term funding market that underpins the financial system, central bank sources told Reuters. The ECB has bought more than a trillion euros ($1.06 trillion) of euro zone government bonds in a bid to shore up economic growth and inflation in the euro zone… By doing so, it has taken away the key ingredient for repurchase agreements, or repos, whereby financial firms lend to each other against collateral, typically high-rated government bonds such as Germany's… Germany, the only large euro zone country with a top-notch credit rating, is where the problem is at its most severe.”

Will the Merkel government and Weidmann Bundesbank finally craft a more aggressive strategy for reining in Mario Draghi? Securities financing markets are already under heightened strain, as ECB purchases ensure an ever-dwindling supply of German debt in the marketplace. Again this week, there was talk of heightened stress and dislocation in the crucial “repo” marketplace. And while German influence over the ECB has waned throughout Draghi’s term, the Bundesbank holds a commanding position over the (by far) most dominant securities in the euro zone: “AAA” German debt. At this point, there’s a case to be made that German bunds are more critical to global securities funding, leveraged speculation and derivatives markets than even Treasuries.

ECB policymaking is increasingly at odds with German interests. I hold the view that German officials have more power to impose their will than is appreciated in today’s complacent markets. Perhaps it was no coincidence that Mr. Weidmann publicly voiced comments critical of ECB policy concurrent with a dislocation in bund trading and associated “repo” market stress. Moreover, I wouldn’t suggest owning risk assets anywhere in the world if European securities financing markets begin to malfunction.

Here at home, perhaps the markets will begin questioning the new Administration’s priorities (along with the ability to get those priorities through Congress). The markets are bullishly positioned in anticipation of a string of tax cuts, deregulation and infrastructure spending. I’m not sure how encouraging markets should find White House chief strategist Steve Bannon’s “three buckets” - “national security and sovereignty,” “economic nationalism” and the “deconstruction of the administrative state,” along with his comment “…one of the most pivotal moments in modern American history was [Trump’s] immediate withdraw from TPP. That got us out of a trade deal and let our sovereignty come back to ourselves.” It’s also worth mentioning that President Trump spent more time at CPAC trumpeting military buildup than offering details for tax reform and deregulation.

February 24 – Reuters (Emily Stephenson and Steve Holland): “President Donald Trump said he would make a massive budget request for one of the ‘greatest military buildups in American history’ on Friday in a feisty, campaign-style speech extolling robust nationalism to eager conservative activists. Trump used remarks to the Conservative Political Action Conference (CPAC)… to defend his unabashed ‘America first’ policies. Ahead of a nationally televised speech to Congress on Tuesday, Trump outlined plans for strengthening the U.S. military… and other initiatives such as tax reform and regulatory rollback. He offered few specifics on any initiatives, including the budget request that is likely to face a harsh reality on Capitol Hill… Trump said he would aim to upgrade the military in both offensive and defensive capabilities, with a massive spending request to Congress that would make the country's defense ‘bigger and better and stronger than ever before.’ ‘And, hopefully, we’ll never have to use it, but nobody is going to mess with us. Nobody. It will be one of the greatest military buildups in American history…’”


For the Week:

The S&P500 added 0.7% (up 5.7% y-t-d), and the Dow gained 1.0% (up 5.4%). The Utilities surged 4.1% (up 5.4%). The Banks slipped 0.4% (up 4.4%), and the Broker/Dealers fell 1.9% (up 7.6%). The Transports declined 0.8% (up 4.2%). The S&P 400 Midcaps were little changed (up 4.6%), while the small cap Russell 2000 slipped 0.4% (up 2.8%). The Nasdaq100 added 0.3% (up 9.9%), and the Morgan Stanley High Tech Index increased 0.5% (up 11.5%). The Semiconductors dipped 0.3% (up 7.4%). The Biotechs dropped 2.3% (up 10.0%). Though bullion jumped $22, the HUI gold index fell 3.8% (up 13.2%).

Three-month Treasury bill rates ended the week at 50 bps. Two-year government yields fell five bps to 1.15% (down 5bps y-t-d). Five-year T-note yields dropped 10 bps to 1.81% (down 12bps). Ten-year Treasury yields fell 10 bps to 2.31% (down 13bps). Long bond yields declined nine bps to 3.06% (down 1bp).

Greek 10-year yields sank 64 bps to 7.08% (up 6bps y-t-d). Ten-year Portuguese yields fell nine bps to 3.94% (up 19bps). Italian 10-year yields were about unchanged at 2.20% (up 38bps). Spain's 10-year yields rose six bps to 1.70% (up 32bps). German bund yields sank 12 bps to 0.19% (down 2bps). French yields dropped 11 bps to 0.93% (up 27bps). The French to German 10-year bond spread widened one to 74 bps. U.K. 10-year gilt yields dropped 13 bps to 1.08% (down 16bps). U.K.'s FTSE equities index declined 0.8% (up 1.4%).

Japan's Nikkei 225 equities index added 0.3% (up 0.9% y-t-d). Japanese 10-year "JGB" yields were down three bps to 0.07% (up 3bps). The German DAX equities index increased 0.4% (up 2.8%). Spain's IBEX 35 equities index declined 0.5% (up 1.1%). Italy's FTSE MIB index fell 2.2% (down 3.3%). EM equities were mixed. Brazil's Bovespa index fell 1.6% (up 10.7%). Mexico's Bolsa slipped 0.2% (up 3.1%). South Korea's Kospi increased 0.7% (up 3.3%). India’s Sensex equities index jumped 1.5% (up 8.5%). China’s Shanghai Exchange gained 1.6% (up 4.8%). Turkey's Borsa Istanbul National 100 index fell 0.6% (up 13.0%). Russia's MICEX equities index dropped 1.7% (down 6.3%).

Junk bond mutual funds saw inflows of $726 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 4.16% (up 54bps y-o-y). Fifteen-year rates gained two bps to 3.37% (up 44bps). The five-year hybrid ARM rate declined two bps to 3.16% (up 37bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down six bps to 4.28% (up 58bps).

Federal Reserve Credit last week declined $0.8bn to $4.424 TN. Over the past year, Fed Credit fell $24.0bn (down 0.5%). Fed Credit inflated $1.613 TN, or 57%, over the past 224 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $12.3bn last week to $3.181 TN. "Custody holdings" were down $72.8bn y-o-y, or 2.2%.

M2 (narrow) "money" supply last week was little changed at $13.291 TN. "Narrow money" expanded $827bn, or 6.6%, over the past year. For the week, Currency was unchanged. Total Checkable Deposits jumped $29.4bn, while Savings Deposits fell $30.4bn. Small Time Deposits declined $0.9bn. Retail Money Funds gained $2.9bn.

Total money market fund assets gained $5.2bn to $2.680 TN. Money Funds fell $98bn y-o-y (3.5%).

Total Commercial Paper increased $1.9bn to $967bn. CP declined $109bn y-o-y, or 10.1%.

Currency Watch:

The U.S. dollar index was little changed at 101.09 (down 1.3% y-t-d). For the week on the upside, the Mexican peso increased 2.6%, the South Korean won 1.3%, the South African rand 0.7%, the Japanese yen 0.6%, the British pound 0.4%, the New Zealand dollar 0.4% and the Australian dollar 0.2%. For the week on the downside, the Swedish krona declined 1.4%, the euro 0.5%, the Swiss franc 0.5%, the Norwegian krone 0.4% and the Brazilian real 0.3%. The Chinese yuan was about unchanged versus the dollar this week (up 1.1% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.3% (up 0.8% y-t-d). Spot Gold rose 1.8% to $1,257 (up 9.1%). Silver jumped 2.0% to $18.41 (up 15%). Crude increased 59 cents to $53.99 (up 0.3%). Gasoline was about unchanged (down 9%), and Natural Gas fell 1.7% (down 26%). Copper declined 0.9% (up 8%). Wheat fell 1.6% (up 10%). Corn dropped 1.3% (up 5%).

Trump Administration Watch:

February 24 – Reuters (Steve Holland and David Lawder): “President Donald Trump declared China the ‘grand champions’ of currency manipulation on Thursday, just hours after his new Treasury secretary pledged a more methodical approach to analyzing Beijing's foreign exchange practices. …Trump said he has not ‘held back’ in his assessment that China manipulates its yuan currency, despite not acting on a campaign promise to declare it a currency manipulator on his first day in office. ‘Well they, I think they're grand champions at manipulation of currency. So I haven't held back,’ Trump said. ‘We'll see what happens.’ During his presidential campaign Trump frequently accused China of keeping its currency artificially low against the dollar to make Chinese exports cheaper, ‘stealing’ American manufacturing jobs.”

February 20 – Wall Street Journal (Kate Davidson and Ryan Tracy): “President Donald Trump will be able to recast the Federal Reserve by filling three or more vacancies on its seven-member board of governors, and is leaning toward candidates with banking and financial world experience rather than academic economists. After his campaign criticism of the central bank’s low-interest-rate policies, many observers speculated he would seek more ‘hawkish’ candidates who would favor higher borrowing costs. But his choices may be driven less by these issues and more by their practical experience, judging from his early picks for other top economic policy posts in the administration… So far, his team is prioritizing the search for candidates to fill the role of vice chairman for supervision and a seat for someone with a community banking background, as required by law.”

February 24 – Reuters (Steve Holland): “U.S. President Donald Trump on Thursday spoke positively about a border adjustment tax being pushed by Republicans in Congress as a way to boost exports… Trump, who has lashed out at U.S. companies for moving operations and jobs to countries such as Mexico, had previously sent mixed signals on the proposal at the heart of a sweeping Republican plan to overhaul the tax code. ‘It could lead to a lot more jobs in the United States,’ Trump told Reuters in an interview, using his most approving language to date on the proposal.”

China Bubble Watch:

February 22 – Financial Times (Gabriel Wildau): “China’s central bank has drafted new rules to tackle risks from shadow banking, in a tacit acknowledgment that a host of measures in recent years to control off balance sheet credit have failed to control its risks. New credit hit a record high in January, mostly due to lending by non-bank institutions. UBS estimates that China’s ratio of debt to gross domestic product hit 277% at the end of 2016, up 133 percentage points since the global financial crisis. Non-bank lending has grown the fastest. Banks have worked with other financial institutions to shift loans off balance sheet, allowing them to evade credit quotas and capital adequacy requirements… Chinese banks’ off balance sheet wealth management products (WMPs) exceeded Rmb26tn ($3.8tn) by the end of 2016, up 30% from a year earlier, compared with 10% growth for bank loans, the PBoC said.”

February 23 – Bloomberg (Steve Holland and David Lawder): “China has appointed Guo Shuqing as the new head of the banking regulator…. Having spent much of his life working on transforming the nation’s financial system, Guo, 60, faces daunting tasks ahead as he takes on oversight of the world’s largest banking industry by assets… Shadow banking is now in every segment of China’s financial system… The central bank and the securities, banking and insurance regulators are drafting new rules for asset-management products that have swollen to almost $9 trillion as of June 30. So-called wealth-management products issued by banks surged 30% last year, making them the largest component of the banking system that exists largely outside of lenders’ balance sheets.”

February 21 – Bloomberg: “China’s financial regulators are working together to draft sweeping new rules for the country’s rapidly-expanding asset-management products that aim to make it clear there’s no government guarantees on such investments, according to people familiar… The draft rules would apply to products issued by banks, insurers, brokerages and other financial institutions… The rules would be phased in after existing products mature, and would only apply to new issues, they added. Households and companies have poured into asset management products, seeking higher returns than bank deposits can offer. On the other side, banks have created off-balance sheet vehicles to provide such offerings, then channeled funds to riskier borrowers who pay higher interest rates. Most recently, financial institutions have invested in each other’s products, leading to a potential chain reaction in the event of a default. An industry managing assets worth more than three-quarters of China’s $11 trillion gross domestic product has thus blossomed, underpinned by assumptions on all sides that the government would prevent failures should investments sour… ‘Regulators are trying to defuse a bomb,’ said Xia Le, Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria SA. ‘Shadow banking is an important source of financing to small and private companies and property developers, and the tightening measures will weigh on economic growth in the short term.’ … China’s asset-management products totaled about 60 trillion yuan ($8.7 trillion) as of June 30…”

February 19 – Bloomberg (Stephen Spratt): “Chinese banks had more than 26 trillion yuan ($3.8 trillion) of wealth-management products held off their balance sheets at the end of December, a 30% increase from a year earlier, according to the central bank. The expansion of this form of shadow banking, with money eventually being diverted to quasi-loans and bonds, outpaced the 10% growth for normal lending during the same period, raising risks for the broader economy and undermining the country’s ‘deleveraging’ efforts, the People’s Bank of China said… The central bank is including off-balance sheet WMPs in its so-called macro prudential assessment framework starting this quarter to better gauge the expansion of credit and potential risks in the financial system.”

February 21 – Bloomberg (Kevin Yao): “China's central bank said… that it will extend a preferential scheme for some banks that will free up additional funds for lending, as long as they channel money to weaker, cash-starved sectors of the economy. But it also warned that some banks will no longer enjoy such preferential treatment after a recent review found they had failed to adhere to ‘standards’ intended to channel loans more directly to rural areas and small companies.”

February 23 – Wall Street Journal (LingLing Wei and Chun Han Wong): “President Xi Jinping is shaking up his economic team ahead of a major power shuffle as China battles rising financial risks at home and friction with its trading partners. The change, according to people familiar…, involves China’s top banking regulator, the commerce minister and the top economic-planning official, who have all reached the retirement age of 65. Slated to succeed them are two close associates of Mr. Xi and a well-known technocrat, the people said. The shakeup, expected to be made public within days, was decided on at a Tuesday meeting of the Communist Party’s Politburo hosted by Mr. Xi…”

February 22 – Bloomberg: “China home prices increased last month in the fewest cities in a year, signaling property curbs to deflate a potential housing bubble are taking effect. New-home prices, excluding government-subsidized housing, gained last month in 45 of the 70 cities tracked by the government, down from 46 in December… Prices fell in 20 cities and were unchanged in five. Chinese authorities have expanded curbs on home purchases and tightened restrictions on property lending in an attempt to avoid a housing bubble and reduce financial risks.”

February 22 – Bloomberg (Narae Kim and Carrie Hong): “China’s public-private-partnerships might be pushing more debt on to the state. While PPPs should largely be financed privately, the bulk of funding in China comes from government entities, according to Bank of America Merrill Lynch strategists. This means the market may be underestimating the government’s debt level and inflation risk while overestimating its ability to sustain stimulus and maintain stability of the yuan, they said. ‘We expect that most PPP investment may ultimately transpire as government debt, similar to those undertaken by local government funding vehicles, through the muni-bond program,’ BofAML’s David Cui… wrote… The low returns of PPPs, which are mostly used for infrastructure projects, limit their appeal to private investors. Of the 2.35 trillion yuan ($342 billion) in PPP projects awarded in China last year, 74% went to state-owned enterprises…”

February 22 – Bloomberg: “The chairman of China’s top insurance regulator vowed to impose ‘stringent’ rules and ‘severely’ punish short-term speculation by insurers, the latest sign of tightening controls on the nation’s industry… Insurers shouldn’t attempt to interfere in the management of listed companies, Xiang said. The CIRC ‘will never allow insurance to become a rich man’s club, let alone allow financial crocodiles to use insurance as their channel or hideout,’ Xiang said. Any insurer that ‘challenges the regulatory bottom line, tarnishes the industry’s image or harms the people’s interest’ will be driven out of the market, he said.”

February 21 – Financial Times (Gabriel Wildau and Ma Nan): “At least 180 Chinese listed companies will be forced to cancel or scale back planned rights offerings worth $97bn in response to regulations that target excessive fundraising used for dubious acquisitions and financial speculation. The rules come as Chinese regulators are increasingly concerned about the trend of ‘exit the real, enter the fake’ — a phrase used to denote companies abandoning real economic activity in favour of financial engineering. Listed companies invested a record $110bn into passive financial products in 2016 even as fixed-asset investment grew at its slowest pace since 1999. China’s securities regulator on Friday issued regulations that restrict the use of secondary share offerings through private placements.”

Global Bubble Watch:

February 20 – Financial Times (Mehreen Khan): “Here we go again. The premium investors are demanding to hold French over German 10-year debt has hit a fresh post-eurozone crisis high today – exceeding 0.81 percentage points for the first time since August 2012. The yield gap has swollen to its highest in over four years this month… France’s 10-year bond yield – which reflects the government’s borrowing costs – leapt 7 bps today to 1.1% after latest polls show the far-right Marine Le Pen is on course to emerge as a clear winner in the first round vote held in late April.”

February 20 – Bloomberg (Stephen Spratt): “Hidden under the surface of European bond markets, traders are placing bets that will pay out if the risks in the euro zone severely escalate. Markets across the continent have started to price in the increased potential for anti-euro candidates to win elections in France and Italy. Recent positioning in German and Italian bonds are hedges against a blow-up in the risk of a breakup in the common currency… Six-month German securities have rallied more than benchmark tenors this month and open interest in two-year note futures has surged, suggesting investors are building up long positions in assets that are the closest to cash in terms of safety. The yield spread between Italian low- and high-coupon bonds has widened as traders bet against the latter, which would fall much more if the country’s creditworthiness is called into question.”

February 21 – Bloomberg: “In China’s manufacturing heartland Guangdong, clock maker Dannol Electronics Co. is grappling with higher input costs stemming from tougher environmental regulations. Already squeezed by years of rising wage bills and intensifying domestic competition, the company recently increased asking prices by an average of 15% for new customers and plans to do the same with older buyers soon. A wall clock featuring Manchester United’s logo is now priced at $5.80 for wholesalers, up from $4.80 a year ago. ‘All prices have gone up and inflation is intensifying,’ said senior sales representative Fan Miaochang. ‘As a manufacturer, we can’t just bear the cost ourselves.’”

Brexit Watch:

February 23 – Reuters (Tim Ross): “U.K. lawmakers in Prime Minister Theresa May’s Conservative party hit back at claims from Austrian Chancellor Christian Kern that Britain will be charged 60 billion euros ($63bn) to leave the European Union as tensions surge ahead of Brexit talks. In a Bloomberg interview..., Kern became the first EU leader to put a value on the size of the U.K.’s Brexit bill. While May’s office was muted in its public comments, Kern’s warning that there would be ‘no free lunch’ for the U.K. sparked a furious response from senior members of Parliament.”

Greece Watch:

February 23 – Reuters (Michelle Martin): “Around half of Germans are against granting debt relief to Greece and around three in 10 want the debt-laden country to quit the euro zone, a survey showed… The INSA poll for the newspaper Bild showed 46.4% of people living in Germany, Europe's paymaster, thought giving Greece debt relief would be unfair for other euro zone countries.”

Europe Watch:

February 22 – Bloomberg (Vassilis Karamanis): “Investors in the euro are getting increasingly concerned about the risks surrounding the French presidential elections, pricing in the options market shows. The premium needed to protect against swings in the single currency has now risen to the highest this year, while put options are the most expensive in relation to calls in almost two years. Specifically, investors seem most preoccupied with risks surrounding the second round of elections scheduled for May 7… The increase in options pricing reflects concern that National Front candidate Marine Le Pen may prove opinion polls wrong -- as happened with the outcome of the U.K.’s referendum on the European Union -- to become president.”

February 18 – Reuters (Noah Barkin and Andrea Shala): “German Chancellor Angela Merkel suggested… that the euro was too low for Germany but made clear that Berlin had no power to address this ‘problem’ because monetary policy was set by the independent European Central Bank. Merkel made her remarks at the Munich Security Conference as U.S. Vice President Mike Pence looked on. They seemed aimed at addressing recent criticism from a top trade adviser to President Donald Trump, who has accused Germany of profiting from a ‘grossly undervalued’ euro. ‘We have at the moment in the euro zone of course a problem with the value of the euro,’ Merkel said in an unusual foray into foreign exchange rate policy. ‘The ECB has a monetary policy that is not geared to Germany, rather it is tailored (to countries) from Portugal to Slovenia or Slovakia. If we still had the (German) D-Mark it would surely have a different value than the euro does at the moment. But this is an independent monetary policy over which I have no influence as German chancellor.’”

February 21 – Bloomberg (Carolynn Look): “The euro area’s unexpectedly upbeat economic data on Tuesday might have come with more than one positive message. A gauge for economic activity rose to the highest level in almost six years in February, following previous signals that the region’s frail recovery is finally taking shape. National gauges showed France outpacing Germany for the first time since 2012 -- a development that could signal growth in the 19-nation region is becoming more broad-based.”

Fixed-Income Bubble Watch:

February 23 – Financial Times (Dan McCrum and Thomas Hale): “For footloose international money, the safest place to hide in the European financial system may be two-year German debt. The idea that Europe’s largest economy could not meet such obligations in euros is as close to inconceivable as things get. The debt is also easy and cheap to trade, which means it can be a market signal of investor angst. The price of such safety set a record on Wednesday, with buyers accepting a loss of as much as 0.92% a year… When it comes to the sovereign bond market, there are also multiple reasons for the yield on the two-year German bond, known as the Schatz, to be so far below zero. ‘The 2-year bond is the other side of lots of trades,’ says Michael O’Sullivan, chief investment officer for international wealth management at Credit Suisse.”

U.S. Bubble Watch:

February 22 – Reuters (Lucia Mutikani): “U.S. home resales surged to a 10-year high in January as buyers shrugged off higher prices and mortgage rates, signaling rising confidence in the economy and bolstering expectations of a pickup in growth in the first quarter. The National Association of Realtors' report… came as the labor market nears full employment and investors wait for the Trump administration to act on its promises to cut taxes, increase infrastructure spending and reduce regulations.”

February 21 – Bloomberg (Julie Verhage): “Peak optimism is fast approaching. Goldman Sachs Group Inc. says the surge in confidence following Donald Trump’s November victory is reaching an inflection point. Investors counting on tax cuts and an economic boom to fuel a surge in corporate profits are getting ahead of themselves, according to the bank. ‘Financial market reconciliation lies ahead,’ David Kostin, Goldman’s chief U.S. equity strategist, wrote…The ‘S&P 500 Index will give back recent gains as investors embrace the reality that tax reform is likely to provide a smaller, later tailwind to corporate earnings than originally expected.’ Kostin and his team pointed out that while corporate earnings estimates for 2017 have fallen by 1% since the election, the S&P has surged 10%.”

February 21 – Wall Street Journal (Laura Kusisto): “Swelling supplies of apartment units are prompting big banks to pull back from new projects, forcing developers to scramble for capital, in a sign that the U.S. apartment industry headed for a downturn. The apartment sector… has been a winning bet for investors since the housing crash, as the economy recovered and more renters sought out units. Since 2010, average U.S. apartment rents have increased by 26%, according to… MPF Research… But fresh supply is beginning to overwhelm demand. More than 378,000 new apartments are expected to be completed in 2017, a 30-year high… In the fourth quarter of last year, 88,000 units were completed but only 50,000 of those were rented by tenants, according to MPF. ‘Our business has radically changed,’ said Toby Bozzuto, president and chief executive of the Bozzuto Group, which owns or manages 59,000 apartments… ‘I haven’t seen anything this seismically different since 2008, when credit dried up.’ Now banks are in retreat, forcing developers to look to nontraditional lenders...”

Central Banker Watch:

February 18 – Reuters (Erik Kirschbaum): “European Central Bank board member Sabine Lautenschlaeger has said the ECB needs to wait to see if inflation stabilizes in its target zone of just under 2% before interest rates can be raised, but that she hopes its bond-buying program can be scaled down before year-end. Euro zone consumer prices were up by an annual 1.8% in January, the highest rate since February 2013…”

Japan Watch:

February 21 – Nikkei Asian Review (Keidai Sanda): “The Bank of Japan is straining to bend an unruly yield curve to its policy goal, sowing doubts among bond market participants that could make for more trouble ahead. Thankfully for an anxious BOJ, U.S. President Donald Trump did not raise the subject of the yen at his summit with Japanese Prime Minister Shinzo Abe earlier this month. Stung by criticism that Japan deliberately uses monetary easing to weaken its currency, the central bank had feared such a confrontation. Yet the past month has proven volatile enough in the domestic bond market. The 10-year Japanese government bond yield went for a wild ride Feb. 3 after the BOJ kept its bond buying at the same level as the previous round, despite mounting upward pressure on yields from rising U.S. interest rates. The upswing in U.S. yields in turn owes to Trump's bold proposals for infrastructure spending and tax cuts.”

EM Watch:

February 21 – Bloomberg (Julie Verhage): “U.S. President Donald Trump has supported many policies that could harm emerging market economies. But investors are betting that his bark will turn out to be worse than his bite. More than $7 billion has poured into exchange-traded funds tracking emerging market stocks and bonds this year through Feb. 19…”

Leveraged Speculation Watch:

February 21 – Bloomberg (Dani Burger): “Hedge funds can’t get enough of momentum -- even if it means embracing an investing strategy they hate. Loosely defined as betting on shares that went up the fastest over the preceding nine-to-12 months, hedge funds are the most reliant on momentum strategies since at least 2010, according to an Evercore ISI… Meanwhile, they’ve reduced their bearish bet on value stocks, which are priced at deep discounts to earnings and assets, for the first time in nine quarters, the study shows. Investors rarely take on momentum and value positions at the same time, which is what’s happening now.”

February 21 – Bloomberg (Dani Burger): “Hedge funds largely failed in their legal challenge to the U.S. government’s capture of billions of dollars in profits generated by Fannie Mae and Freddie Mac after their bailout, sending shares of the mortgage guarantors plunging. Perry Capital LLC, the Fairholme Funds and other big investors lost a bid to overturn a judge’s ruling that said they can’t sue the government over the dividend change. The change known as the ‘net-worth sweep’ forced the companies to send almost all their profits to the U.S. Treasury, leaving shareholders with nothing…”

Geopolitical Watch:

February 18 – Reuters (Matthew Tostevin): “A United States aircraft carrier strike group has begun patrols in the South China Sea amid growing tension with China over control of the disputed waterway and concerns it could become a flashpoint under the new U.S. administration. China's Foreign Ministry… warned Washington against challenging its sovereignty in the South China Sea. The U.S. navy said the force, including Nimitz-class aircraft carrier USS Carl Vinson, began routine operations in the South China Sea on Saturday.”

February 22 – Reuters (Idrees Ali): “China, in an early test of U.S. President Donald Trump, has nearly finished building almost two dozen structures on artificial islands in the South China Sea that appear designed to house long-range surface-to-air missiles, two U.S. officials told Reuters. The development is likely to raise questions about whether and how the United States will respond, given its vows to take a tough line on China in the South China Sea. China claims almost all the waters, which carry a third of the world's maritime traffic… Trump's administration has called China's island building in the South China Sea illegal. Building the concrete structures with retractable roofs on Subi, Mischief and Fiery Cross reefs… could be considered a military escalation, the U.S. officials said in recent days…”

February 22 – Reuters (Paul Carrel and Holger Hansen): “His only experience of governing in Germany is as a town mayor. She is Europe's most powerful leader. Yet Martin Schulz wants to end Angela Merkel's 11-year run as chancellor and fundamentally shift Germany's role in Europe. He might just pull it off. Schulz has revitalized his Social Democrats' (SPD) fortunes since they nominated him last month to challenge Merkel in a Sept. 24 federal election, narrowing a popularity gap with her conservatives… One year Merkel's junior at 61, Schulz is the former president of the European Parliament. While she has a doctorate in physics, he left school without his final exams before working his way up through local politics and on to Brussels. He brings oratory and a common touch she cannot match.”

February 23 – Reuters (Steve Holland and David Lawder): “Germany's Social Democrats have overtaken Chancellor Angela Merkel's conservatives in an opinion poll by Infratest dimap for the first time since October 2006, with seven months to go before a federal election. The survey for German broadcaster ARD put the SPD, which has gained strength since nominating former European Parliament President Martin Schulz as its candidate, on 32% while Merkel's conservative bloc was on 31%.”

Friday, February 24, 2017

Friday Evening Links

[Bloomberg] Stocks Post Gains Before Trump Speech to Congress: Markets Wrap

[CNBC] Citi sees a 20% chance of Le Pen winning which could 're-ignite a fully-fledged sovereign debt crisis'

[Reuters] Bundesbank braces for QE losses after lowest profit in decade

[Reuters] Trump vows military build-up, hammers nationalist themes

[Bloomberg] Americans Haven't Been This Optimistic About the Job Market in Over 30 Years

[Reuters] If Trump imposes punitive tariffs, Europe must counter them: Merkel ally

Friday's News Links

[Bloomberg] Stocks Sell Off as Gold Rises Before Trump Speech: Markets Wrap

[Reuters] Exclusive: Trump calls Chinese 'grand champions' of currency manipulation

[Reuters] China says no intention of using currency devaluation to its advantage

[Bloomberg] Mnuchin Tells Carney to Expect America-First Push on Regulation

[Bloomberg] The Trump Team's Evolving Currency-Market Rhetoric: A Timeline

[Politico] Trump’s ‘big fat bubble’ trouble in the stock market

[Reuters] Exclusive: Trump says Republican border tax could boost U.S. jobs

[Bloomberg] J.C. Penney to Shut as Many as 140 Stores as Industry Slumps

[Bloomberg] China's New Banking Regulator Chief Faces Daunting Challenges

[Bloomberg] China Said to Name Reformer Guo as Head of Banking Regulator

[Reuters] China steams past U.S., France to be Germany's biggest trading partner

[Bloomberg] Canadian Inflation Surges to 2.1% in January on High Gas Prices

[NYT] The Big Question for the U.S. Economy: How Much Room Is There to Grow?

[NYT] China Names Guo Shuqing, a Rapid-Fire Regulator, to Oversee Troubled Banks

[WSJ] Fed Isn’t Ready to Cut Balance Sheet Yet

[WSJ] Trump Team Broadens Search for Fed Regulatory Post

[FT] Germany and Italy back Brussels on Brexit

Thursday, February 23, 2017

Thursday Evening Links

[Bloomberg] Asia Stocks Fall; Topix Pares Loss as Yen Slips: Markets Wrap

[CNBC] How Mnuchin's comments dinged the dollar, pumped up the peso

[Bloomberg] Republicans Call on Fed to Halt Rules Until Trump's Picks Are in Place

[Bloomberg] El-Erian Warns Bond Market It's Underestimating March Fed Odds

[Bloomberg] Pimco Says China Needs to Get Tougher in Cat-and-Mouse Debt Game

[CNBC] Stocks and bonds are at war over how much growth is coming under Trump

[CNBC] Trump's 'phenomenal' tax plan may have a hard time paying for itself

[Reuters] Germany's Social Democrats overtake Merkel's conservatives in poll

[Reuters] Upset at Trump, Mexico voices 'worry and irritation' to U.S. envoys

[WSJ] Can You Make Money in a Euro Collapse?

[WSJ] Trump Strategist Steve Bannon: ‘Every Day Is Going to Be a Fight’

[FT] Russia mobilises an elite band of cyber warriors

[FT] US prime property is magnet for illicit wealth, warns Treasury

Thursday's News Links

[CNBC] Dow and S&P hit record highs after Treasury Secretary points to significant tax reform

[CNBC] Treasury Secretary Mnuchin: We're committed to 'very significant' tax reform by August recess

[Bloomberg] Landlords Are Taking Over the U.S. Housing Market

[Bloomberg] Mnuchin Signals No Urgency to Name China a Currency Manipulator

[Bloomberg] Carney's Inflation Equation Heats Up as Stores Plan Price Hikes

[Politico] Trump looks for a reset with his address to Congress

[WSJ] Treasury Secretary Steven Mnuchin Sees Tax Overhaul by August

[WSJ] Border-Adjustment Tax Divides Energy Sector

[WSJ] China Shakes Up Top Economic Team Ahead of Major Power Shuffle

[WSJ] Top U.S. Officials Met With Defiance in Visit to Mexico

[FT] Reasons for Bunds rush go beyond fears of Le Pen win

[FT] Marine Le Pen has a better chance in France than you think

Tuesday, February 21, 2017

Tuesday Afternoon Links

[Bloomberg] U.S. Stocks Add to Records, Dollar Gains With Oil: Markets Wrap

[Bloomberg] Goldman Sachs Warns U.S. Stocks Are Now Reaching Peak Optimism

[Bloomberg] From China's Factories to Your Shopping Cart, Price Hikes Loom

[Bloomberg] Investors Are Charging Into Emerging Market ETFs

[Bloomberg] Hedge Funds Continue to Chase the Herd With Record Momentum Bets

[CNBC] Cashin skeptical of record highs: 'We're really vulnerable'

[CNBC] The Fed and the market are having a hard time getting on the same page

[Bloomberg] ETF Investors Miss Out on the Best Commodity Trade of the Year

[Bloomberg] Dallas Police and Fire Pension Backs Cutbacks to Avoid Collapse

[Bloomberg] Hedge Funds Can't Sue Over Investments in Fannie and Freddie

[NYT] As an Age of Nationalism Dawns, a Multinational Deal Collapses

Tuesday's News LInks

[Bloomberg] Dollar Rises as Gain in Mining Stocks Offsets HSBC: Markets Wrap

[Bloomberg] European Bonds Decline as PMI Data Point to Faster Inflation

[Bloomberg] China to Draft Rules to Rein in Asset Management Risks

[Bloomberg] HSBC Plunges After Missing Profit Estimates on Revenue Drop

[Nikkei Asian Review] Yield curve proves hard to steer for nervous BOJ

[Bloomberg] Euro-Area Economic Recovery Broadens as France Outpaces Germany

[Reuters] China offers banks lure of lower reserves to get more money to ailing sectors

[Bloomberg] How Political Risk Is Shifting to Developed Markets

[WSJ] President Trump Will Be Able to Recast the Fed by Filling Vacancies

[WSJ] Banks Retreat From Apartment Market

[FT] German 2-year debt yields hit record low

[FT] Rules threaten $100bn worth of China share sales

Saturday, February 18, 2017

Saturday's News Links

[Reuters] ECB's Lautenschlaeger: if inflation rise persists, rate hike should come this year

[Reuters] Global Economy Weekahead: How do you say deja vu in Greek?

[Reuters] Merkel suggests euro is too low for Germany

[CNBC] Remember the debt ceiling? Here it comes again

[CNBC] 'Massive exodus' continues from active funds, and Vanguard is reaping the gains

[NYT] Money, Power, Family: Inside South Korea’s Chaebol

[WSJ] Defaults Slash Returns for Online Loan Investors

[WSJ] Merkel Defends German Trade Surplus After U.S. Criticism

Weekly Commentary: China Credit and Global Inflationary Dynamics

February 14 – Bloomberg: “China added more credit last month than the equivalent of Swedish or Polish economic output, revving up growth and supporting prices but also fueling concerns about the sustainability of such a spree. Aggregate financing, the broadest measure of new credit, climbed to a record 3.74 trillion yuan ($545bn) in January… New yuan loans rose to a one-year high of 2.03 trillion yuan, less than the 2.44 trillion yuan estimate. The credit surge highlights the challenges facing Chinese policy makers as they seek to balance ensuring steady growth with curbing excess leverage in the financial system.”

Like so many things in The World of Finance, we’re all numb to Chinese Credit data: Broad Credit growth expanded a record $545 billion in the month of January, about a quarter above estimates. Amazingly, last month’s Chinese Credit bonanza exceeded even January 2016’s epic Credit onslaught by 8%. Moreover, as Bloomberg noted, “The main categories of shadow finance all increased significantly. Bankers acceptances -- a bank-backed guarantee for future payment -- soared to 613.1 billion yuan from 158.9 billion yuan the prior month.”

February 14 – Bloomberg: “China’s shadow banking is back in full swing. Off-balance sheet lending surged by a record 1.2 trillion yuan ($175bn) last month… Efforts by the People’s Bank of China to curb fresh lending may have prompted banks to book some loan transactions as shadow credit, according to Sanford C. Bernstein.”

Yet this was no one-month wonder. China’s aggregate Credit (excluding the government sector) expanded a record $1.05 TN over the past three months, led by a resurgence in “shadow” lending. According to Bloomberg data, China’s shadow finance expanded $350 over the past three months (Nov. through Jan.), up three-fold from the comparable year ago period.

Friday from Bloomberg: “White House Chaos Doesn’t Bother the Stock Market.” Many are confounded by stock market resilience in the face of Washington discord. Perhaps it’s because global liquidity and price dynamics are currently dictated by China, the BOJ and the ECB - rather than Washington and New York. Eurozone and Japanese QE operations continue to add about $150bn of new liquidity each month. Meanwhile, Chinese Credit growth has accelerated from last year’s record $3.0 TN (plus) annual expansion.

February 14 – Bloomberg (Malcolm Scott and Christopher Anstey): “Forget about Donald Trump. The global reflation trade may have another driver that proves to be more durable: China’s rebounding factory prices. The producer price index has staged a 10 percentage-point turnaround in the past 10 months, posting for January a 6.9% jump from a year earlier. Though much of that reflects a rebound in commodity prices including iron ore and oil, China’s economic stabilization and its efforts to shutter surplus capacity are also having an impact.”

China’s January PPI index posted a stronger-than-expected 6.9% y-o-y increase. A year ago – back in January 2016 – y-o-y producer price inflation was a negative 5.3%.  It’s worth noting that China’s y-o-y PPI bottomed in December 2015 at negative 5.9%, the greatest downward price pressure since 2009. In contrast, last month’s y-o-y PPI jump was the strongest since August 2011 (7.3%). China’s remarkable one-year inflationary turnaround was not isolated in producer prices. China's 2.5% January (y-o-y) CPI increase was up from the year ago 1.8%, matching the peak in 2014.

There are two contrasting analyses of China’s record January Credit growth. The consensus view holds that Chinese officials basically control Credit growth, and a big January confirms that Beijing will ensure/tolerate the ongoing rapid Credit expansion required to meet its 6.5% 2017 growth target (and hold Bubble collapse at bay). This is viewed as constructive for the global reflation view, constructive for global growth and constructive for global risk markets. Chinese tightening measures remain the timid “lean against the wind” variety, measures that at this point pose minimal overall risk to Chinese financial and economic booms.

An opposing view, one I adhere to, questions whether Chinese officials are really on top of extraordinary happenings throughout Chinese finance, let alone in control of system Credit expansion. Years of explosive growth in Credit, institutions and myriad types of instruments and financial intermediation have created what I suspect is a regulatory nightmare. I seriously doubt that PBOC officials take comfort from $1.0 TN of non-government Credit growth over just the past three months.

Indeed, I suspect authorities will be compelled to ratchet up tightening measures. Not only is timid ineffective in the face of rampant monetary inflation. It actually works to promote only greater excesses and resulting maladjustment. I would argue that Chinese officials today face a more daunting task of containing mounting financial leverage and imbalances than just a few months ago. The clock continues to tick, with rising odds that Beijing will be forced to take the types of forceful measures that risk an accident.

Inflationary biases evolve significantly over time. For example, QE in one market environment can have profoundly different inflationary effects than in a different backdrop. Liquidity will tend to further inflate the already inflating asset class(s); “hot money” will chase the hottest speculative Bubble. Inflationary surges in Credit growth can, as well, have profoundly different impacts depending on inflationary expectations, economic structure and the nature of financial flows.

I strongly contend that a more than one-half Trillion ($) one-month Chinese Credit expansion in early 2017 will exert divergent inflationary impacts to those from early 2016. Why? Because of distinct differences in respective inflationary backdrops. This time last year, disinflationary pressures were demonstrating powerful momentum. The Chinese economic slowdown was gathering force, the financial system was under mounting stress, funds were fleeing the country, and fear was overwhelming greed. Compared to this time last year, crude prices are today about a third higher. Importantly, last year’s massive Credit expansion upended disinflationary forces.

Today’s inflationary backdrop offers a notable contrast: the inflationary path of least resistance is now higher. This argues that Credit excesses will exert a more robust impact on inflationary biases throughout the Chinese economy - inflationary forces that have achieved powerful self-reinforcing momentum. Furthermore, official efforts to restrict financial outflows add a further dimension to the analysis. Not only do I expect this year’s Credit to exhibit more potent effects, it is also likely that tighter regulations ensure less finance leaks out of the system through international flows. In short, unprecedented quantities of new “money” and Credit will in 2017 further inflate a Chinese economic system already terribly maladjusted by years of unprecedented monetary excess.

Already this year, Emerging Market equities (EEM) have posted double-digit gains (10.1%). Stocks in Brazil and Argentina are up 12.5% and 16.3%. Indian stocks have risen 6.9%. Too be sure, the incredible Chinese Credit boom is playing a major role in fueling strengthening inflationary biases throughout developing markets and economies.

February 15 – Bloomberg (Sho Chandra): “Forget wondering when U.S. inflation will reach the Federal Reserve’s goal. It may be there already. The biggest monthly jump in almost four years in the Labor Department’s consumer-price index led some analysts to raise their estimates… for the Fed’s preferred inflation gauge, the Commerce Department’s personal consumption expenditures price index. Morgan Stanley’s Ted Wieseman and Michelle Girard of NatWest Markets both said that the PCE measure probably rose 2% in January from a year earlier, up from previous projections of 1.8%. Economists at Goldman Sachs gave an estimate of 1.98%.”

Here at home, January CPI rose 2.5% y-o-y, the strongest gain since early 2012 (core CPI up 2.3% y-o-y). After drifting around zero for much of 2014, y-o-y CPI increased to 1.4% by January 2016. Anyone doubting that global inflationary dynamics have evolved from a year ago should examine a few CPI charts.

Talk one year ago was of indomitable global deflationary forces. The ECB and BOJ stepped up with major QE expansions, while the Fed put rate normalization on hold after a single little baby step. Central bank buying coupled with already over-liquefied markets spurred a historic collapse in global bond yields. After beginning the year at 62 bps, a melt-up in bund prices saw yields sink to below zero by June (on the way to negative 19bps). Italian yields dropped from 1.59% to 1.04%. Spanish yields fell from 1.77% to 0.88%, while French yields dropped from 0.99% to 0.10%. Yields in the UK sank from 1.96% to 0.52%. Japanese yields dropped from 0.26% to negative 0.29%. After beginning 2016 at 2.25%, ten-year Treasury yields were down to 1.36% near mid-year. Too much “money” (speculative and otherwise) chasing too few bonds.

There are now apparently ample quantities of bonds for global buyers. With inflation dynamics pointing to rising general price levels, “risk free” sovereign bonds are no longer the securities of choice. Importantly, ongoing QE has ensured that markets have become only more over-liquefied. These days, however, it’s much more a case of “too much ‘money’ chasing too few equities and corporate debt instruments”

Highly speculative sovereign debt markets dislocated back in 2016. It was the type of speculative blow-off and derivative-related melt-up that previously would have ended in tears (along with bloody havoc). So far, ongoing QE and near-zero rates have ensured a most orderly of major market reversals. At the same time, the monetary backdrop has guaranteed that speculative melt-up dynamics have turned their sights on equities, corporate debt and EM. Global markets are today being dictated by extraordinary monetary and speculative dynamics. Trump policy proclamations provide convenient market justification and rationalization.

It is a prevailing 2017 theme that global markets are extraordinarily vulnerable to an unexpected change in the monetary backdrop. Count me just as skeptical of the current equities surge as I was of last year’s surging bond markets. In my mind, the 2017 bull story for equities is as dubious as last year’s deflation histrionics - rationalization for a surge in bond prices driven more by a powerful global market dislocation than underlying fundamentals.

I’m not necessarily arguing that we’ve commenced a sustainable surge in consumer price inflation. An accident in China, Europe or Japan (to name only the most obvious), and the world could sink right back into the disinflationary muck. At least in the short-term, the upward momentum in inflationary pressures could be enough to sway central bank decision making. So long as CPI trends were pointing downward, it was easy to rationalize the positive case for QE. CPI pointing upward around the globe just might have central bankers thinking twice about QE infinity. For a number of years now, market operators have slept soundly at night knowing any meaningful “Risk Off” (de-risking/de-leveraging) would be countered with yet another batch of QE.

Yellen took on a relatively more hawkish tone this week. The March 15 FOMC meeting is now in play for a rate rise, while an increasing number of analysts are now forecasting three increases during 2017. The ECB will clearly face heightened pressure to wind down QE. And even BOJ chief Kuroda this week made uncharacteristically cautious comments with respect to the risks of monetary stimulus. But in the short-term, I’ll look to Beijing for perhaps the most intriguing monetary developments. And there is support for the view that recent equity gains have been fueled by market dislocation dynamics, the type of advance that would leave risk assets especially vulnerable to a changing monetary backdrop.

February 16 – Wall Street Journal (Chris Dieterich and Gunjan Banerji): “It is the buzz of Wall Street: a five-day, 15% plunge in a U.S. mutual fund whose bearish bets were undone by the S&P 500’s latest run to fresh records. The decline of Catalyst Hedged Futures Strategy fund, a $3.4 billion fund employing complex derivatives, is topic du jour on trading desks fixated on the surprising resilience of the postelection U.S. stock rally and the long decline of volatility, or price swings. Many investors have been surprised by the S&P 500’s 9.7% run-up following the Nov. 8 election… The Catalyst fund typically uses options positions in a configuration that seeks to maximize gains from stable or gently rising markets, or else shield investors from sudden declines.”



For the Week:

The S&P500 rose 1.5% (up 5.0% y-t-d), and the Dow gained 1.7% (up 4.4%). The Utilities added 0.3% (up 1.3%). The Banks jumped 3.3% (up 4.9%), and the Broker/Dealers rose 1.5% (up 9.6%). The Transports gained 1.1% (up 5.0%). The S&P 400 Midcaps added 0.8% (up 4.5%), and the small cap Russell 2000 gained 0.8% (up 3.1%). The Nasdaq100 advanced 1.9% (up 9.5%), and the Morgan Stanley High Tech index jumped 1.9% (up 11.0%). The Semiconductors rose 1.4% (up 7.8%). The Biotechs surged 3.8% (up 12.6%). Though bullion was little changed, the HUI gold index declined 2.0% (up 17.7%).

Three-month Treasury bill rates ended the week at 51 bps. Two-year government yields were unchanged at 1.19% (unchanged y-t-d). Five-year T-note yields increased two bps to 1.90% (down 3bps). Ten-year Treasury yields added a basis point to 2.42% (down 3bps). Long bond yields rose two bps to 3.14% (up 7bps).

Greek 10-year yields surged 45 bps to 7.71% (up 69bps y-t-d). Ten-year Portuguese yields dropped nine bps to 4.03% (up 28bps). Italian 10-year yields retreated eight bps to 2.19% (up 38bps). Spain's 10-year yields declined seven bps to 1.64% (up 26bps). German bund yields slipped two bps to 0.30% (up 10bps). French yields declined two bps to 1.04% (up 36bps). The French to German 10-year bond spread was little changed at 74 bps. U.K. 10-year gilt yields fell four bps to 1.21% (down 2bps). U.K.'s FTSE equities index added 0.6% (up 2.2%).

Japan's Nikkei 225 equities index declined 0.7% (up 0.6% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.09% (up 5bps). The German DAX equities index increased 0.8% (up 2.4%). Spain's IBEX 35 equities index jumped 1.3% (up 1.6%). Italy's FTSE MIB index recovered 0.8% (down 1.2%). EM equities were mixed. Brazil's Bovespa index jumped 2.5% (up 12.5%). Mexico's Bolsa fell 1.3% (up 3.3%). South Korea's Kospi added 0.3% (up 2.7%). India’s Sensex equities index rose 0.5% (up 6.9%). China’s Shanghai Exchange increased 0.2% (up 3.2%). Turkey's Borsa Istanbul National 100 index jumped 1.6% (up 13.7%). Russia's MICEX equities index fell 1.6% (down 4.7%).

Junk bond mutual funds saw inflows of $158 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined two bps to 4.17% (up 50bps y-o-y). Fifteen-year rates fell four bps to 3.35% (up 40bps). The five-year hybrid ARM rate dipped three bps to 3.18% (up 33bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up seven bps to 4.34% (up 59bps).

Federal Reserve Credit last week expanded $7.8bn to $4.424 TN. Over the past year, Fed Credit fell $34.6bn (down 0.8%). Fed Credit inflated $1.614 TN, or 57%, over the past 223 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt were little changed last week at $3.169 TN. "Custody holdings" were down $86.1bn y-o-y, or 2.6%.

M2 (narrow) "money" supply last week gained $7.7 billion to $13.290 TN. "Narrow money" expanded $875bn, or 7.1%, over the past year. For the week, Currency declined $1.8bn. Total Checkable Deposits dropped $66.7bn, while Savings Deposits jumped $76.1bn. Small Time Deposits and Retail Money Funds were both little changed.

Total money market fund assets declined $2.0bn to $2.675 TN. Money Funds declined $88bn y-o-y (3.2%).

Total Commercial Paper was about unchanged at $965.3bn. CP declined $119bn y-o-y, or 11.0%.

Currency Watch:

The U.S. dollar index was little changed at 100.95 (down 1.4% y-t-d). For the week on the upside, the South African rand increased 2.3%, the Brazilian real 0.9%, the South Korean won 0.3%, the Japanese yen 0.3%, the Norwegian krone 0.3% and the Singapore dollar 0.1%. For the week on the downside, the British pound declined 0.6%, the Mexican peso 0.4%, the euro 0.3%, the Australian dollar 0.1%, the New Zealand dollar 0.1% and the Canadian dollar 0.1%. The Chinese yuan increased 0.17% versus the dollar this week (up 1.14% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 1.2% (up 1.1% y-t-d). Spot Gold was little changed at $1,235 (up 7.2%). Silver added 0.7% to $18.05 (up 13%). Crude slipped 46 cents to $53.40 (down 1%). Gasoline fell 4.6% (down 9.2%), and Natural Gas sank 6.6% (down 24%). Copper dropped 1.7% (up 9%). Wheat gained 1.4% (up 12%). Corn added 0.3% (up 7%).

Trump Administration Watch:

February 17 – Bloomberg (Saleha Mohsin): “Within hours of being sworn in, U.S. Treasury Secretary Steven Mnuchin’s counterparts from Tokyo to Berlin started telegraphing warnings to him: Please don’t call the yen weak. Be careful how you talk about cutting financial regulations -- Europe is listening. As President Donald Trump waited a few weeks for the U.S. Senate to confirm his Treasury secretary pick, the world watched as he and his advisers talked down the dollar and called out China and Japan for gaming foreign-exchange markets… ‘The bottom line is whether this is seen as urgent and highly problematic for the rest of the world -- specifically if the administration continues to publicly work through what the strategy for managing the dollar is going to be,’ said Nathan Sheets, who was undersecretary for international affairs at the Treasury during the Obama administration.”

February 17 – Wall Street Journal (Richard Rubin): “An uncomfortable question looms over the tax debate in Congress: What’s Plan B? Border adjustment, a pillar of House Republicans’ tax proposal, is taking a beating. Big retailers are lobbying aggressively against the concept, which would tax imports and exempt exports. Senate Republicans have expressed views ranging from skepticism to hostility. Even some House Ways and Means Republicans are wary. With Democrats sidelined, just three GOP senators could kill the House tax plan; already, more than that oppose border adjustment. Despite that daunting math, border adjustment isn’t dead, and that is partly because Republicans haven’t developed palatable alternatives that avoid huge budget deficits or prevent the corporate tax base from fleeing abroad.”

February 13 – Wall Street Journal (Bob Davis): “The White House is exploring a new tactic to discourage China from undervaluing its currency to boost exports, part of an evolving Trump administration strategy to challenge the practices of the U.S.’s largest trading partner while stepping back from direct confrontation. Under the plan, the commerce secretary would designate the practice of currency manipulation as an unfair subsidy when employed by any country, instead of singling out China… U.S. companies would then be in a position to bring antisubsidy actions themselves to the U.S. Commerce Department against China or other countries.”

February 15 – Reuters (Stanley White and Leika Kihara): “Japanese Prime Minister Shinzo Abe said… U.S. President Donald Trump shared his view at last week's summit that Japan's monetary policy was not currency manipulation but was intended to end deflation. Abe's comments about the Feb. 10 summit suggest Trump may be softening his criticism that Japan was manipulating its currency to gain a trade advantage.”

China Bubble Watch:

February 12 – Bloomberg (Justina Lee): “TLF, MLF, OMO. China’s monetary policy is looking increasingly like an alphabet soup, sowing volatility in markets. So far this year, the People’s Bank of China has boosted rates on three different liquidity facilities, created a new one, and ordered banks to cut lending. Its most high-profile tools -- the benchmark borrowing cost and reserve-requirement ratio -- have been left untouched. Since liberalizing interest rates in 2015, China has been seeking to modernize its monetary toolbox while tackling slower economic growth, currency weakness and swelling debt. This has prompted the central bank to forge an array of new tools -- a process that has sparked bigger swings in the money market as investors try to interpret them…”

February 14 – Reuters (Elias Glenn): “China's producer price inflation picked up more than expected in January to near six-year highs as prices of steel and other raw materials extended a torrid rally… China consumer inflation also rose more than expected, nearing a three-year high as fuel and food prices jumped… Consumer inflation quickened to 2.5% in January from a year earlier, the highest since May 2014… Producer price inflation accelerated to 6.9% -- the fastest since August 2011 -- from December's rise of 5.5%.”

February 17 – Reuters: “China's central bank said… it plans to tighten up its oversight in a range of areas including corporate debt and bank assets, as policymakers fret over fast-rising leverage and the risk of asset bubbles in the rapidly growing economy. The People's Bank of China (PBOC) also said it will keep the yuan currency basically stable while maintaining a prudent and neutral monetary policy. ‘We will increase monitoring of corporate debt risk, bank asset quality and liquidity, abnormal stock market fluctuations, use of insurance funds, property bubble risks...and cross-border capital flows,’ the central bank said in its fourth-quarter monetary policy implementation report.”

February 14 – Bloomberg (Enda Curran): “China’s economy may have slipped down the global worry list, but significant risks remain, including an abrupt end to a massive credit boom or an overly aggressive policy response if inflation should speed up, according to Goldman Sachs… While a hard landing isn’t the… bank’s base case for 2017… economists warn that a push to rein in cheap loans will weigh on key sectors such as housing. Officials are trying to keep a lid on frothy house prices without harming the wider economy, where growth remains heavily reliant on government spending. The scale of the lending boom was laid bare in data Tuesday showing China added more credit in January than the equivalent of Swedish or Polish economic output, fueling worries about the spree’s sustainability… ‘We see the biggest risks in China centering on the country’s rising credit imbalances, with mis-calibration of policy or a sharp external shock as possible triggers of a sharp tightening in credit conditions and hard landing in growth,’ economists led by Andrew Tilton wrote.”

Global Bubble Watch:

February 15 – Reuters (Leika Kihara): “Bank of Japan Governor Haruhiko Kuroda said low profitability at financial institutions could sow the seeds of a new financial crisis, offering his strongest warning to date of the demerits of aggressive monetary easing pursued by major central banks… ‘A new challenge has emerged in the form of low profitability at financial institutions," Kuroda said... ‘These developments suggest that a different kind of financial crisis could happen in the future,’ he told an international conference on deposit insurers… The remarks contrast with Kuroda's previous comments emphasizing that the benefits of massive stimulus on the economy make up for potential negatives such as the hit to banks.”

February 16 – Reuters (Yawen Chen, Elias Glenn, Samuel Shen, Esha Vaish, Gabriel Yiu and Nicole Mordant): “Property investment by Chinese companies plunged in January as authorities tightened restrictions on capital outflows to support the ailing yuan currency and ease pressure on the country's foreign exchange reserves. Investment by Chinese firms in offshore properties -- which has helped fuel sharp and often contentious home price rises from London to Vancouver -- tumbled 84.3% in January from a year earlier... That helped drag China's outbound direct investment (ODI) down 35.7% in January to 53.27 billion yuan ($7.77bn), the weakest in 16 months.”

Brexit Watch:

February 17 – Bloomberg (Simon Kennedy): “Former U.K. Prime Minister Tony Blair… cast himself as the leader of the Brexit resistance. In his first major intervention since June’s referendum, Blair urged those Britons who want to stay in the European Union to ‘rise up in defense of what we believe’ in a bid to change people’s minds and reverse last year’s vote. His aim is to show Prime Minister Theresa May that she won’t get everything her own way as she seeks a so-called hard Brexit, prioritizing control of immigration over safeguarding trade ties.”

Greece Watch:

February 12 – Financial Times (Wolfgang M√ľnchau): “Failure to tell truth to power lies beneath much of what is going wrong in Europe right now. It may not be the principal cause of the Greek debt crisis, which is now on its umpteenth iteration. But it is more than a mere contributing factor. You notice it particularly at those moments when others speak the truth, as the staff of the International Monetary Fund have done recently. In its latest survey of the Greek economy it states that ‘public debt has reached 179% [of gross domestic product] at end-2015, and is unsustainable’. Europeans are not used to such bluntness. The Germans protested. The European Commission protested. So did the Greeks. They all want to keep up the fairy tale of Greek debt sustainability for a little while longer.”

February 12 – Wall Street Journal (Simon Nixon): “As a new Greek debt crisis gathers pace, one of the major players in the drama has remained remarkably calm: the International Monetary Fund. European governments and institutions are desperate to resolve a months-old standoff over the next phase of Greece’s bailout program. The window for a deal is fast closing with the imminent start of the Dutch election campaign and may not reopen until after the French election in May. But the IMF is proving impervious to political pressure. Some European governments have said they won’t give any more money to Greece unless the IMF gives it money too. But the IMF is sticking to its mantra that it won’t participate in any new Greek bailout unless it is satisfied the numbers add up. As things stand, it is far from satisfied.”

February 11 – AFP (Catherine Boitard): “Greek Prime Minister Alexis Tsipras… warned the International Monetary Fund and EU economic powerhouse Germany to stop playing with fire over his country's debt problems… Months of feuding with the IMF has rattled markets and raised fears of a new debt crisis, with Athens resisting pressure to cut public services any more than has already been agreed with creditors. The Greek premier urged a change of course from the IMF. ‘We expect as soon as possible that the IMF revise its forecast.. so that discussions can continue at the technical level,’ …Tsipras called for Chancellor Angela Merkel to ‘encourage her finance minister to end his permanent aggressiveness’ towards Greece and ‘stop playing with fire’. ‘The IMF is playing a game of poker by dragging things aside because it does not want to blame the intransigence of the German minister,’ Tsipras said, criticising the ‘new absurd demands’ targeted at Greece.

February 13 – Bloomberg (Marcus Bensasson and Sotiris Nikas): “Greece must immediately reach an agreement with creditors on the release of bailout funds or risk another recession and even more austerity measures, the country’s central bank chief said. ‘Any further delay in completion beyond this month will feed a new circle of uncertainty,’ Bank of Greece Governor Yannis Stournaras told lawmakers… ‘Such a vicious cycle could return the economy to recession and a rerun of the negative developments that took place in the first half of 2015.’”

Europe Watch:

February 13 – Bloomberg (Sid Verma): “National Front leader Marine Le Pen’s odds of securing an upset in the French presidential race have climbed to 33%, according to bookmakers, from 25% at the end of January. That echoes opinion polls showing the far-right candidate gaining on front-runner Emmanuel Macron, even while they still favor Macron to win the May 7 runoff. The uptick in the implied probability of a Le Pen victory is one of the reasons investors are demanding a higher premium for holding French bonds over similar-maturity German debt.”

February 12 – Bloomberg (Patrick Donahue): “Frank-Walter Steinmeier, a vocal critic of Donald Trump elected as Germany’s 12th postwar president on Sunday, predicted ‘difficulties’ in relations with the U.S. as the global order is upended by the new administration in Washington. Asked whether he would seek to improve relations with Russia… said the world was confronting a ‘complete re-ordering of international relations.’ ‘In the past we were always certain that we would have more difficult negotiating partners in the east’” Steinmeier told broadcaster ZDF… ‘Suddenly we’re confronted with a situation in which we’ll at the very least deal with uncertainty and also difficulties in trans-Atlantic relations.”

Fixed-Income Bubble Watch:

February 16 – Financial Times (Stephen Foley): “In US corporate bonds right now, it is an issuer’s market. Big beasts such as Apple, Microsoft and AT&T found so many wannabe buyers that they were able to supersize their multibillion-dollar fundraisings at the start of February, and even lesser known US companies are issuing debt on the cheap. For example, Snap-on, a maker of tools, sold $300m of bonds this week and was able to slash almost half a percentage point off its interest rate because demand came in higher than expected. This current balance of supply and demand favours issuers, and means that the extra yield on corporate bonds relative to Treasuries has fallen to its lowest level since 2014.”

February 13 – Bloomberg (Brian Chappatta): “In the age of Trump, America’s biggest foreign creditors are suddenly having second thoughts about financing the U.S. government. In Japan, the largest holder of Treasuries, investors culled their stakes in December by the most in almost four years… And it’s not just the Japanese. Across the world, foreigners are pulling back from U.S. debt like never before. From Tokyo to Beijing and London, the consensus is clear: few overseas investors want to step into the $13.9 trillion U.S. Treasury market right now. Whether it’s the prospect of bigger deficits and more inflation under President Donald Trump or higher interest rates from the Federal Reserve, the world’s safest debt market seems less of a sure thing…”

February 15 – Bloomberg (Sridhar Natarajan and Anders Melin): “When a silicon producer controlled by one-time Spanish finance minster Juan-Miguel Villar Mir came to the U.S. junk-bond market last week, the deal had one curious provision. Ferroglobe Plc earmarked a piece of the bond sale to help fund most of a roughly $30 million payment to Alan Kestenbaum, the former executive chairman who resigned a year after merging his North America-focused Globe Specialty Metals Inc. with billionaire Villar Mir’s Spanish conglomerate. Issuers typically don’t turn to debt investors to fund golden parachutes, and companies this size don’t often have a cash commitment this big for an executive headed out the door… What’s more, the company is expected to post an annual loss for the calendar year.”

U.S. Bubble Watch:

February 14 – Wall Street Journal (Liz Hoffman and Christina Rexrode): “Shares in America’s banks are booming again, with Goldman Sachs…, J.P. Morgan Chase… and Bank of America Corp. hitting fresh trading milestones Tuesday that seemed unreachable during the crucible of the financial crisis. Investor expectations of higher interest rates, lower taxes, lighter regulation and faster economic growth under the Trump administration have added $280 billion in combined market value to the nation’s six largest banks since Nov. 8. On Tuesday, shares of Goldman hit a record high, passing a bar first set in 2007 before the financial crisis. J.P. Morgan also hit an all-time closing high.”

February 16 – Reuters (Alistair Gray): “More than a million US consumers have fallen at least two months behind on car loan repayments as the delinquency rate reaches its highest level since 2009, in the latest sign of stress in the $1.1tn market. The proportion of soured car loans showed a 13% increase to 1.44% in 2016, according to… TransUnion, the US credit bureau with an anonymised database of 220m consumers. Delinquencies on credit cards also rose by about the same amount over the period to 1.79% — the highest since 2011.”

February 14 – Wall Street Journal (Katy Burne): “The Federal Reserve’s payments to the U.S. Treasury are projected to fall by more than half in coming years… The payments, called remittances, are projected to fall to around $40 billion annually by 2020, well below the estimated $92 billion the Fed sent last year… That is still way above their average around $25 billion a year from 2001 to 2007, but below the record of $97.7 billion in 2015… Declining remittances come as the new Congress prepares for fresh battles over how to restrain the growth of the federal budget deficit, which was $587 billion in the fiscal year that ended Sept. 30. It is projected to rise sharply in the next decade…”

Federal Reserve Watch:

February 15 – Bloomberg (Patricia Laya and Sho Chandra): “The U.S. cost of living increased in January by the most since February 2013, led by higher costs for gasoline and other goods and services that indicate inflation is gathering momentum. The consumer-price index rose a larger-than-forecast 0.6% after a 0.3% gain in December… Compared with the same month last year, costs paid by Americans for goods and services rose 2.5%, the most since March 2012.”

February 15 – Bloomberg (Andrea Wong): “A March interest-rate increase by the Federal Reserve, an unlikely scenario just days ago, is now suddenly on the table after an unexpectedly strong inflation print and hawkish testimony from Fed Chair Janet Yellen to Congress. Derivatives traders are pricing in a 42% probability that the Fed raises rates at its March 14-15 meeting, up from 24% on Feb. 6.”

February 14 – Reuters (Jason Lange and David Lawder): “The Federal Reserve will likely need to raise interest rates at an upcoming meeting, Fed Chair Janet Yellen said on Tuesday, although she flagged considerable uncertainty over economic policy under the Trump administration. Yellen said delaying rate increases could leave the Fed's policymaking committee behind the curve and eventually lead it to hike rates quickly… ‘Waiting too long to remove accommodation would be unwise,’ Yellen told the U.S. Senate Banking Committee, citing the central bank's expectations the job market will tighten further and that inflation would rise to 2%.”

February 13 – Bloomberg (Matthew Boesler): “U.S. households’ expectations for consumer price inflation rose to the highest level since mid-2015, according to a Federal Reserve Bank of New York survey. The median survey respondent reported an expected inflation rate last month of 2.9% three years ahead, up from 2.8% in December… Expected inflation for one year from now rose to 3%, from 2.8% the month earlier.”

February 14 – Reuters: “U.S. producer prices rose more than expected in January, recording their largest gain in four years amid increases in the cost of energy products and some services… The… producer price index for final demand jumped 0.6% last month. That was the largest increase since September 2012 and followed a 0.2% rise in December.”

February 14 – Reuters (Jonathan Spicer): “The Federal Reserve will likely have to raise interest rates more rapidly than financial markets currently expect given that any new policies by the Trump administration, while uncertain, will force the Fed's hand, a hawkish central banker said… Since the election of Donald Trump as U.S. president, markets have rallied on hopes of fiscal stimulus. Yet while forecasts from Fed officials suggest roughly three rate hikes could come this year, futures markets see only two, based on probabilities. ‘Rates need to rise more briskly than markets now seem to expect,’ Richmond Fed President Jeffrey Lacker, a long-time proponent of tighter monetary policy who is retiring in September, said…”

February 14 – Bloomberg (Rich Miller): “Federal Reserve Chair Janet Yellen set a relatively high hurdle for shrinking the central bank’s balance sheet, leading some analysts to conclude that such a move won’t occur this year. She told the Senate Banking Committee… that the Fed’s focus was on raising interest rates to keep the economy in balance, and not on reducing its holdings of bonds. Rates first need to reach sufficiently high levels that the Fed feels it has some room to cut them to offset a weakening economy. Only then would the central bank begin to shrink its $4.5 trillion balance sheet, she said. ‘What we would like to do is to find a time when we judge that our need to provide substantial accommodation to the economy in the coming years is minimal,’ she said.”

Japan Watch:

February 13 – Bloomberg (James Mayger and Garfield Clinton Reynolds): “Governor Haruhiko Kuroda once chuckled that the Bank of Japan had only gobbled up half as much in government bonds as the Bank of England once did. It soon won’t be a laughing matter. The BOJ holds more than 40% of Japanese government bonds… The BOJ snapped up a record 2.1 trillion yen ($18bn) of five- to 10-year JGBs between Feb. 3 and Feb. 8 -- buying on three out of four trading days.”

February 14 – Reuters (Leika Kihara): “The Bank of Japan must lay the grounds for exiting its massive stimulus program by slowing asset purchases and raising its long-term interest rate target to 0.5% this year, a former central bank policymaker said… With its huge buying distorting the bond market, the BOJ should start phasing out its stimulus… former board member Sayuri Shirai said. She said that to avoid having to top up an unsustainable pace of bond buying, the BOJ may have to raise its 10-year government bond yield target to 0.5% this year - from around zero - as global bond yields and domestic inflation pick up.”

Leveraged Speculation Watch:

February 14 – Reuters (David Randall): “The winning bets come as equity hedge funds gained 2.1% in January, the strongest start to a calendar year for the industry since 2013, according to Hedge Fund Research. Total assets under management in the hedge fund industry reached $3.02 trillion at the end of the fourth quarter…”

Geopolitical Watch:

February 12 – Bloomberg (Kanga Kong and Isabel Reynolds): “President Donald Trump will be forced to deal with ongoing threats from North Korea as that country gains the ability to threaten the continental U.S. with a nuclear strike, an official said… hours after Pyongyang fired a ballistic missile into nearby seas. North Korea will probably develop its ballistic missile technology enough to pair with its nuclear weapons to reach the U.S. during Trump’s tenure, said Richard Haass, president of the Council on Foreign Relations. Either the U.S. gets the Chinese to help increase pressure on North Korea through sanctions, or Trump will have ‘a truly consequential decision’…”

February 13 – Reuters (Ben Blanchard): “China's Foreign Ministry expressed concern on Monday after Japan got continued U.S. backing for its dispute with Beijing over islands in the East China Sea during a meeting between U.S. President Donald Trump and Japanese Prime Minister Shinzo Abe. A joint Japanese-U.S. statement after the weekend meeting in the United States said the two leaders affirmed that Article 5 of the U.S.-Japan security treaty covered the islands, known as the Senkaku in Japan and the Diaoyu in China. Chinese Foreign Ministry spokesman Geng Shuang said China was ‘seriously concerned and resolutely opposed’, adding that the islands had been China's inherent territory since ancient times. ‘No matter what anyone says or does, it cannot change the fact that the Diaoyu Islands belong to China, and cannot shake China's resolve and determination to protect national sovereignty and territory’…”

February 15 – Reuters (Philip Wen and Matthew Tostevin): “China's Foreign Ministry… warned Washington against challenging its sovereignty, responding to reports the United States was planning fresh naval patrols in the disputed South China Sea. On Sunday, the Navy Times reported that U.S. Navy and Pacific Command leaders were considering freedom of navigation patrols in the busy waterway by the… Carl Vinson carrier strike group…”