Saturday, August 27, 2016

Saturday's News Links

[Reuters] Global central bankers, stuck at zero, unite in plea for help from governments

[Bloomberg] BOJ’s Kuroda Says Ready to Ease as Jackson Hole Debates Options

[Reuters] British PM to trigger Brexit without vote by lawmakers: Telegraph

[Bloomberg] Germany Warns U.K. That Brexit Talks Will Be Very Difficult

[Reuters, Chancellor] Chancellor: Zero-coupon bonds are not a joke

[Reuters] Kurdish-aligned group in north Syria says targeted by Turkish warplanes

Weekly Commentary: Yellen Unveiling, Jackson Hole 2016

The Global Financial Crisis and Great Recession posed daunting new challenges for central banks around the world and spurred innovations in the design, implementation, and communication of monetary policy. With the U.S. economy now nearing the Federal Reserve's statutory goals of maximum employment and price stability, this conference provides a timely opportunity to consider how the lessons we learned are likely to influence the conduct of monetary policy in the future. The theme of the conference, ‘Designing Resilient Monetary Policy Frameworks for the Future,’ encompasses many aspects of monetary policy, from the nitty-gritty details of implementing policy in financial markets to broader questions about how policy affects the economy.” The introduction to Janet Yellen’s speech, “The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future,” Jackson Hole, August 26, 2016

Bloomberg: “Yellen Says Rate-Hike Case ‘Strengthened in Recent Months.’” The FT was almost identical to Bloomberg. It was hardly different at the WSJ: “Fed Chairwoman Janet Yellen Sees Stronger Case for Interest-Rate Increase.” And from CNBC: “Yellen says a rate hike is coming—but markets say not now.” And this from Zerohedge: “Best Reaction Yet: ‘Yellen Speech A Whole Lot Of Nothing.’”

I have a different take: Yellen provided more content for history books. In today’s short-term focused world, analysts and pundits remain fixated on clues to the next policy move. And while Yellen included language unbecoming of ultra-dovishness for the near-term, the Fed chair’s presentation was zany-dovish for the intermediate- and longer-term.

The Yellen Fed has begun methodically laying the analytical foundation for a Federal Reserve (and global central banks) balance sheet of unthinkable dimensions. It’s right there in her writing, as explicit as it is astounding. Before it’s too late, the Fed’s power – and their runaway policy experiment – need to be reined in. Contemporary Central bankers have been operating with blank checkbooks only because it was never contemplated that they would actually exploit their capacity to print “money” with reckless abandon. Who cannot see that these central bankers need clear rules and well-defined restraints? Their judgment is not trustworthy.

The WSJ’s Jon Hilsenrath penned an interesting pre-Jackson Hole piece, “Years of Fed Missteps Fueled Disillusion With the Economy and Washington.” “Once-revered central bank failed to foresee the crisis and has struggled in its aftermath, fostering the rise of populism and distrust of institutions. In the past decade Federal Reserve officials have been flummoxed by a housing bubble that cratered the financial system, a long stretch of slow growth they failed to foresee and inflation persistently undershooting their goal. In response they engineered unpopular financial rescues, launched start-and-stop bond buying and delayed planned interest-rate boosts. ‘There are a lot of things that we thought we knew that haven’t turned out quite as we expected,’ said Eric Rosengren, president of the Federal Reserve Bank of Boston. ‘The economy and financial markets are not as stable as we previously assumed.’”

Yellen’s above speech introduction refers to “lessons we learned.” It is, however, rather obvious that the Federal Reserve has completely failed to recognize how a flawed monetary policy framework was fundamental to a financial Bubble that collapsed into the “worst financial crisis since the Great Depression.”

This year’s Jackson Hole summit is to consider “broader questions about how policy affects the economy.” What’s conspicuously absent from Yellen’s (and others’) analytical framework is the extraordinary impact policy continues to have in the securities and derivatives markets – and over time through the markets to the overall economic structure.

Over the years I’ve detailed how the GSEs, acting as quasi-central banks, in the early nineties began backstopping market liquidity. Having ended 1993 at $1.9 TN, GSE securities (debt and MBS) in just ten years more than tripled to $6.0 TN. Revelations of serious accounting fraud at Fannie and Freddie ended their capacity for “buyer of first and last resort” liquidity support.

I argued at the time that going forward only the Fed would retain the wherewithal to engineer market liquidity backstop operations to counter a serious de-risking/de-leveraging episode, though this would require a major expansion of Fed’s holdings. The mortgage finance Bubble inflated much longer and to far greater excess than I had expected, which ensured that its bursting triggered a historic Trillion plus doubling of Fed holdings. Later, in 2011 the Fed detailed its “exit strategy”, yet proceeded to again double assets to $4.5 TN.

I have posited that the Fed’s balance sheet is likely on course to reach $10 Trillion. This rough guesstimate stems from the view that there is no alternative to the Fed’s balance sheet for future liquidity backstop operations. Moreover, the unprecedented inflation of Bubble excess (securities and asset markets, economic maladjustment) ensures that only another doubling of the Fed’s balance sheet could possibly hold financial collapse at bay.

In the simulations reported by Reifschneider, ‘Gauging the Ability of the FOMC to Respond to Future Recessions,’ in note 8, overcoming the effects of the zero lower bound during a severe recession would require about $4 trillion in asset purchases and pledging to stay low for even longer if the average future level of the federal funds rate is only 2 percent.

The above zinger is footnote #24 embedded in Yellen’s speech. The Fed chair’s inflationist reasoning culminates with her focus on Fed staffer David Reifschneider’s recent paper (cited above). The gist of the analysis is that if the Fed lacks the typical capacity to slash interest rates, policy can compensate with more aggressive asset purchases and forward rate guidance. Undoubtedly, the Fed will face minimal rate flexibility the next time it employs further monetary stimulus. So get ready. Bonds seem ready.

From Yellen: “A recent paper takes a different approach to assessing the FOMC's ability to respond to future recessions by using simulations of the FRB/US model. This analysis begins by asking how the economy would respond to a set of highly adverse shocks if policymakers followed a fairly aggressive policy rule, hypothetically assuming that they can cut the federal funds rate without limit. It then imposes the zero lower bound and asks whether some combination of forward guidance and asset purchases would be sufficient to generate economic conditions at least as good as those that occur under the hypothetical unconstrained policy.

Figure 2 in your handout illustrates this point. It shows simulated paths for interest rates, the unemployment rate, and inflation under three different monetary policy responses--the aggressive rule in the absence of the zero lower bound constraint, the constrained aggressive rule, and the constrained aggressive rule combined with $2 trillion in asset purchases and guidance that the federal funds rate will depart from the rule by staying lower for longer…

But despite the lower bound, asset purchases and forward guidance can push long-term interest rates even lower on average than in the unconstrained case (especially when adjusted for inflation) by reducing term premiums and increasing the downward pressure on the expected average value of future short-term interest rates. Thus, the use of such tools could result in even better outcomes for unemployment and inflation on average.

Of course, this analysis could be too optimistic. For one, the FRB/US simulations may overstate the effectiveness of forward guidance and asset purchases, particularly in an environment where long-term interest rates are also likely to be unusually low. In addition, policymakers could have less ability to cut short-term interest rates in the future than the simulations assume. By some calculations, the real neutral rate is currently close to zero, and it could remain at this low level if we were to continue to see slow productivity growth and high global saving. If so, then the average level of the nominal federal funds rate down the road might turn out to be only 2 percent, implying that asset purchases and forward guidance might have to be pushed to extremes to compensate
… (footnote 24)”

If a 2% Fed funds rate equates to $4.0 TN of Fed purchases, what about 1%? How about 50 bps? Using the Fed’s own framework, a $10 TN Federal Reserve balance sheet no longer seems all that “lunatic fringe.”

Of course, chair Yellen is not about to espouse the stunningly audacious without the obligatory tinge of caution: “Moreover, relying too heavily on these nontraditional tools could have unintended consequences. For example, if future policymakers responded to a severe recession by announcing their intention to keep the federal funds rate near zero for a very long time after the economy had substantially recovered and followed through on that guidance, then they might inadvertently encourage excessive risk-taking and so undermine financial stability.”

My comment: “…Future policymakers… might inadvertently encourage excessive risk-taking and so undermine financial stability.” You think?? Might it be worthwhile contemplating the past and present?

Finally, the simulation analysis certainly overstates the FOMC's current ability to respond to a recession, given that there is little scope to cut the federal funds rate at the moment. But that does not mean that the Federal Reserve would be unable to provide appreciable accommodation should the ongoing expansion falter in the near term. In addition to taking the federal funds rate back down to nearly zero, the FOMC could resume asset purchases and announce its intention to keep the federal funds rate at this level until conditions had improved markedly--although with long-term interest rates already quite low, the net stimulus that would result might be somewhat reduced.”

If markets are willing to cooperate, the Fed may bump up rates 25 bps in September. Friday evening from the WSJ’s Heard on the Street column: “Janet Yellen Cries Wolf - Fed chairwoman tries to convince market that a rate rise is coming, but investors aren’t listening.” Could it be instead that they listened intently and came away even more persuaded? Perhaps the WSJ (and others) is missing the point: it’s not about crying wolf or a lack of credibility with respect to rate hikes. After all, a second little baby-step would be trivial in the context of rising odds of a Fed balance sheet on its way to $10 TN. Global bond markets continue to trade as if there’s a very credible threat of monstrous QE/central bank purchases to eternity. And the greater the scope of the world’s most spectacular asset Bubble, the higher the odds that central bankers will be forced into even more preposterous desperate measures – aka ever larger QE purchases of a widening variety of securities.

Somehow the Fed completely disregards the prominent role loose monetary policy has played in inflating serial financial and economic Bubbles. It gets worse. Revisionism somehow has Yellen expounding analysis that policy was “tight” heading into the 2008 crisis period. Mortgage debt doubled in less than seven years, for heaven’s sake. Unprecedented leverage, speculative excess and financial shenanigans…

From Yellen: “…The federal funds rate at the start of the past seven recessions was appreciably above the level consistent with the economy operating at potential in the longer run. In most cases, this tighter-than-normal stance of policy before the recession appears to have reflected some combination of initially higher-than-normal labor utilization and elevated inflation pressures. As a result, a large portion of the rate cuts that subsequently occurred during these recessions represented the undoing of the earlier tight stance of monetary policy.”

We’re now eight years into history’s greatest monetary stimulus. Global markets have deteriorated to Desolate Bizarro World. After a respite, some volatility has begun to creep back into the markets. It appeared to be another tough week for the leveraged speculator crowd. Some favored shorts significantly outperformed. Periphery Europe was a lovefest. Spanish equities jumped 2.5%. Italian stocks surged 3.3%, led by the banking sector’s almost 10% melt-up. European banks stocks jumped 4.9%. Financials outperformed in the U.S. as well, with the banks up 1.1% and the broker/dealers gaining 1.3%. Utilities and dividend stocks underperformed.

A negative tone is gaining momentum in Asia. Intrigue is returning to China, with policymakers gearing up for yet another shot at curbing Bubbles (bonds, real estate, shadow banking, etc.) and general financial excess. The Shanghai Composite dropped 1.2% this week. The Nikkei 225 index dropped 1.1%, with Japanese banks losing 1.7%. Stocks were down 1.0% in India and 1.3% in Turkey. Generally, instability reemerged in EM and commodities. The South African rand was slammed for 6.3%. The Brazilian real and Mexican peso dropped about 2%, while a list of EM currencies declined around 1% (Russia, Turkey, Singapore, Colombia, Chile). Brazil’s equities were slammed 2.5% and Mexico’s stocks dropped 1.9%. In commodities, copper sank 4.3% and silver fell 3.5%. The soft commodities were under heavy selling pressure as well.

The U.S. dollar index rallied 1% this week. It was as if Fed officials were determined to don hawkish-like garb hoping to draw attention away from Yellen’s QE Eternity Unveiling. I’ve expected currency market stability to be a leading (observable) casualty of heightened global monetary disorder. Over recent months a short squeeze in EM currencies morphed into a dysfunctional trend-following and performance-chasing fracas. This type of dynamic tends to reverse abruptly and, often, dramatically.

Meanwhile, developed currencies oscillate sporadically, as perceptions swing between perpetual king dollar and the prospect of permanent Fed-induced dollar devaluation. A similar dynamic is behind the return of wild commodities trading. Natural gas surged 11% this week. Everyone’s favorite currency short, the British pound, was the only major currency this week to appreciate versus the dollar. Going forward, it will be interesting to see how Bubble markets attempt to reconcile a short-term Fed rate increase versus the Federal Reserve committing itself to boundless QE.

For the Week:

The S&P500 declined 0.7% (up 6.1% y-t-d), and the Dow fell 0.8% (up 5.6%). The Utilities dropped 2.2% (up 13.6%). The Banks gained 1.1% (down 2.8%), and the Broker/Dealers advanced 1.3% (down 4.2%). The Transports fell 1.3% (up 4.2%). The S&P 400 Midcaps slipped 0.2% (up 11.5%), while the small cap Russell 2000 added 0.1% (up 9.0%). The Nasdaq100 declined 0.5% (up 4.1%), while the Morgan Stanley High Tech index increased 0.2% (up 9.2%). The Semiconductors gained 0.5% (up 20.8%). The Biotechs slipped 0.6% (down 13.5%). With bullion down $20, the HUI gold index sank 11.5% (up 111%).

Three-month Treasury bill rates ended the week at 32 bps. Two-year government yields jumped nine bps to 0.84% (down 21bps y-t-d). Five-year T-note yields rose seven bps to 1.23% (down 52bps). Ten-year Treasury yields gained five bps to 1.63% (down 62bps). Long bond yields slipped a basis point to 2.28% (down 74bps).

Greek 10-year yields added a basis point to 7.87% (up 55bps y-t-d). Ten-year Portuguese yields increased another three bps to 3.01% (up 49bps). Italian 10-year yields were unchanged at 1.13% (down 46bps). Spain's 10-year yield slipped a basis point to 0.94% (down 83bps). German bund yields fell three bps to negative 0.07% (down 69bps). French yields declined a basis point to 0.17% (down 82bps). The French to German 10-year bond spread widened two bps to 24 bps. U.K. 10-year gilt yields fell six bps to 0.56% (down 140bps). U.K.'s FTSE equities index slipped 0.3% (up 9.5%).

Japan's Nikkei 225 equities index fell 1.1% (down 14% y-t-d). Japanese 10-year "JGB" yields increased a basis point to negative 0.08% (down 34bps y-t-d). The German DAX equities index added 0.4% (down 1.4%). Spain's IBEX 35 equities index jumped 2.5% (down 9.3%). Italy's FTSE MIB index surged 3.3% (down 21.4%). EM equities were mostly under pressure. Brazil's Bovespa index dropped 2.5% (up 33%). Mexico's Bolsa fell 1.9% (up 10.2%). South Korea's Kospi index declined 0.9% (up 3.9%). India’s Sensex equities lost 1.0% (up 6.4%). China’s Shanghai Exchange dropped 1.2% (down 13.2%). Turkey's Borsa Istanbul National 100 index lost 1.3% (up 7.5%). Russia's MICEX equities index advanced 1.7% (up 13.2%).

Junk bond mutual funds saw inflows of $162 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates were unchanged at 3.43% (down 54bps y-o-y). Fifteen-year rates had no change at 2.74% (down 52bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 3.57% (down 51bps).

Federal Reserve Credit last week slipped $0.7bn to $4.438 TN. Over the past year, Fed Credit declined $9.2bn. Fed Credit inflated $1.627 TN, or 58%, over the past 198 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $3.3bn last week to $3.207 TN. "Custody holdings" were down $135bn y-o-y, or 4.0%.

M2 (narrow) "money" supply last week rose $22.9bn to a record $12.994 TN. "Narrow money" expanded $875bn, or 7.2%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits surged $48.1bn, while Savings Deposits fell $12.1bn. Small Time Deposits were little changed. Retail Money Funds dropped $15.2bn.

Total money market fund assets jumped $24.6bn to $2.735 TN. Money Funds rose $40bn y-o-y (1.5%).

Total Commercial Paper declined another $8.4bn to $1.004 TN. CP declined $46bn y-o-y, or 4.4%.

Currency Watch:

The U.S. dollar index rallied 1.0% to 95.48 (down 3.3% y-t-d). For the week on the upside, the British pound increased 0.5%. For the week on the downside, the South African rand declined 6.3%, the Mexican peso 2.0%, the Brazilian real 1.9%, the Swiss franc 1.8%, the Japanese yen 1.6%, the Swedish krona 1.2%, the euro 1.1%, the Canadian dollar 1.0%, the Australian dollar 0.8%, the Norwegian krone 0.6% and the New Zealand dollar 0.5%. The Chinese yuan declined 0.2% versus the dollar (down 2.7% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.0% (up 16.5% y-t-d). Spot Gold declined 1.5% to $1,321 (up 24%). Silver was hit 3.5% to $18.63 (up 35%). WTI Crude fell 93 cents to $47.64 (up 29%). Gasoline slipped 0.4% (up 19%), while Natural Gas jumped 11.2% (up 23%). Copper sank 4.3% (down 2.4%). Wheat lost 8.4% (down 13%). Corn fell 5.5% (down 9%).

Europe Watch:

August 21 – Wall Street Journal (Christopher Whittall): “The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy. In two instances, the ECB has bought bonds directly from European companies through so-called private placements, in which debt is sold to a tight circle of buyers without the formality of a wider auction. It is a startling example of how banks and companies are quickly adapting to the extremes of monetary policy in what is an already unconventional age.”

August 22 – Bloomberg (Lorenzo Totaro): “The odds are stacked against Matteo Renzi’s economic ambitions for Italy. The prime minister needs to see a blistering pace in the second half of this year to meet his goal of a 1.2% expansion in 2016. Economists say that’s not happening, spelling trouble for Renzi… With Renzi facing a referendum in the autumn that could decide his political future, a stagnant economy and banks hobbled by bad debt are adding to his challenges.”

August 23 – Reuters (John Geddie and Francesco Canepa): “The European Central Bank will have to bump up its monthly purchases of government bonds if it decides to continue buying beyond March 2017, just to ensure maturing paper does not reduce the pace of its money printing. J.P. Morgan estimates 320 billion euros ($363bn) worth of bonds will mature between 2017 and 2019, and will need to be invested again to honour an ECB pledge to redeploy the money it receives when bonds are repaid. This additional buying could compound liquidity problems that have created unpredictable price swings in the bond market…”

Fixed-Income Bubble Watch:

August 25 – Bloomberg (Claire Boston): “U.S. companies feeling pain in short-term debt markets are seeking relief by borrowing longer term, pushing already-high levels of corporate bond issuance toward fresh records. Google… and… Archer-Daniels-Midland Co. are among the companies that have sold more than $5 billion of corporate bonds in the past two months to pay off at least part of their short-term debt… They’re looking to tame their interest expenses after new regulations have lifted some issuers’ borrowing costs for near-term debt to seven-year highs. The changes underscore how money-market rules that take effect in October are distorting debt markets. Total sales for corporate bonds maturing in more than eighteen months are around $950 billion this year… on track to beat the full-year record of about $1.3 trillion… Commercial-paper markets… have shrunk by $108 billion since May…”

August 24 – Associated Press: “U.S. companies are sitting on hundreds of billions of cash, so you might think they are in great financial shape. The reality is different, and worrisome. Most of the cash is held by precious few companies, a mere 1% of 2,000 tracked by S&P Global Ratings. At the remaining 99%, finances have generally gotten worse in recent years. Many have increased debt dramatically while their cash has barely risen, or even fallen, among other signs of potential trouble.”

August 22 – Bloomberg (Selcuk Gokoluk and Sally Bakewell): “Riskier companies are increasingly getting credit agreements that allow them to raise the amount of future cost savings to appear more creditworthy, boosting potential losses for investors. The tweaks make it easier for borrowers to stay in compliance with their loan terms and add more debt, according to Charles Tricomi, a senior analyst at covenant research firm Xtract Research. ‘There is too much money chasing too few loans… Lenders are really at a disadvantage and have to agree to these terms significantly against their own interest, terms that they should be fighting off.’ Whittling away standards that keep a lid on leverage levels may leave investors with soured assets, according to Tricomi.”

Global Bubble Watch:

August 25 – Reuters (Jeff Cox): “The head of Germany's embattled Deutsche Bank believes negative interest rates are posing an imminent danger to the economy, savers and pension funds. Deutsche CEO John Cryan warned of ‘fatal consequences’ that could occur should the European Central Bank continue down the road of negative rates. The ECB is holding its deposit rate at -0.4%; government debt yields through large swaths of Europe are carrying negative rates as well. ‘Monetary policy is thwarting goals to strengthen the economy and to make banks safer by now,’ Cryan told German newspaper Handelsblatt…”

August 24 – Bloomberg (John Detrixhe and Richard Partington): “Derivatives users are the latest group to be hurt by negative interest rates as they get penalized for the cash they park at Europe’s biggest clearinghouses. Traders can thank European Central Bank President Mario Draghi. Futures and swaps are used to hedge or speculate on everything from German interest rates to oil prices. To avoid taking a loss if a counterparty to a trade defaults, they post collateral, such as government bonds or cash, at a clearinghouse. In Europe, the biggest ones are in Frankfurt and London. But with German and U.K. debt yields so low, or even negative, clearinghouse customers are sometimes losing money on those assets.”

August 24 – Wall Street Journal (Selina Williams and Bradley Olson): “Some of the world’s largest energy companies are saddled with their highest debt levels ever as they struggle with low crude prices, raising worries about their ability to pay dividends and find new barrels. Exxon Mobil Corp., Royal Dutch Shell PLC, BP PLC and Chevron Corp. hold a combined net debt of $184 billion—more than double their debt levels in 2014... The soaring debt levels are a fresh reminder of the toll the two-year price slump has taken on the oil industry. Just a decade ago, these four companies were hauled before Congress to explain ‘windfall profits’ but now can’t cover expenses with normal cash flow… The companies spent more than 100% of their profits on dividends last year. This year, the problem got worse.”

U.S. Bubble Watch:

August 23 – Reuters (David Morgan): “The U.S. budget deficit is expected to grow to $590 billion in fiscal year 2016 due to slower than expected growth in revenues and higher spending for programs including Social Security and Medicare, the Congressional Budget Office said… The estimate, which is $56 billion larger than CBO's forecast in March, shows the deficit increasing in relation to economic output for the first time since 2009. CBO said the deficit is expected to be $152 billion higher than in 2015 and will equal 3.2% of economic output. The deficit peaked at $1.4 trillion in 2009 and shrank to $485 billion in 2014.”

August 23 – Washington Examiner (Joseph Lawler): “The national debt this year will jump to the highest level since 1950 relative to the size of the economy, the Congressional Budget Office reported… The agency projected that the debt held by the public will rise 3 percentage points to 77% of U.S. gross domestic product by the end of fiscal year 2016 in September. Debt has not hit that ratio since 1950, when the government was still in the middle of paying down the debt it incurred paying for World War II.”

August 21 – Wall Street Journal (Justin Lahart): “Two of this year’s best stock strategies have a major downside: They are pulling investors into the same crowded and increasingly expensive trade. Johnson & Johnson is hardly the world’s most thrilling company, but the health-care giant’s stock has been an exciting place to be this year, rising 16.7% versus the S&P 500’s 6.8%. AT&T shares, up 19.2%, have been another pleasant one. One thing those companies have going for them is that their share prices don’t bounce around nearly as much as most other companies’ shares do. They count as some of the least volatile stocks in the S&P 500 over the past three years… Low-volatility strategies have been popular this year as investors have sought to protect themselves from market fluctuations. Money has been pouring into exchange-traded funds such as the PowerShares S&P 500 Low Volatility ETF and the iShares Edge MSCI Min Vol USA ETF.”

August 23 – Wall Street Journal (James Mackintosh): “Calm has descended on the U.S. stock market. The past 30 days have been the least volatile of any 30-day period in more than two decades. Only five days during the most recent stretch saw the S&P 500 move by more than 0.5% in either direction, the lowest since the fall of 1995. Back then, the Federal Reserve was paused between rate cuts. This time around, a combination of the summer lull in trading and super-easy global monetary policy has helped drive volatility to levels seen only a dozen times in the past half-century.”

August 23 – Bloomberg (Patrick Clark): “In the late 1990s, Americans started referring to tract-built luxury homes popping up in the suburbs as McMansions, a biting portmanteau implying that the structures were mass-produced and ugly. There was also the implied snark that their denizens, however wealthy, lacked the sophistication to tell filet mignon from a Big Mac. Lately, these homes have been the subject of fresh scorn, thanks to an anonymously authored blog that breaks down the genre’s design flaws in excruciating detail… It’s fun reading that nevertheless raised the question: How well have these homes kept their value? Not well, compared with the rest of the U.S. housing market. The premium that buyers can expect to pay for a McMansion in Fort Lauderdale, Fla., declined by 84% from 2012 to 2016, according to data compiled by Trulia. In Las Vegas, the premium dropped by 46% and in Phoenix, by 42%.

August 25 – Wall Street Journal (Nick Timiraos): “One of the thorniest tasks awaiting a seven-member board charged by Washington with cleaning up Puerto Rico’s debt crisis is deciding how to balance a $70 billion debt load with nearly $43 billion in unfunded pension liabilities. The issue is coming to a head now because the White House is set to name as soon as next week the members of that oversight board… Puerto Rico’s three public pensions have about $2 billion in assets against $45 billion in liabilities, a shortfall far worse than any U.S. state pension system. The pensions are on track to exhaust their assets by 2019.”

August 24 – Bloomberg (Katia Dmitrieva): “Home prices in the U.S. rose 5.6% in the second quarter from a year earlier, extending gains that have cut into affordability for many buyers. Prices increased 1.2% on a seasonally adjusted basis from the previous three months...”

August 25 – Reuters (Tetsushi Kajimoto): “August U.S. auto sales will be 5.2% below a year ago, adding to evidence that the peak of industry sales was in 2015, consultancies J.D. Power and LMC Automotive said…”

Federal Reserve Watch:

August 21 – Wall Street Journal (Jon Hilsenrath): “For much of the post-financial-crisis era, U.S. Federal Reserve officials have held to a belief that they could get back to their old way of doing things. Growth would resume at a modest pace, annual inflation would climb to 2% and interest rates would gradually rise from near zero to a normal level near 4% or higher. As they prepare to gather at their annual retreat in Jackson Hole, Wyo., officials are grimly coming to a view that it isn’t going to happen that way… In this world, unconventional tools used after the financial crisis—including purchases of long-term Treasurys to push down long-term interest rates and assurances of low short-term rates into the future—could be rolled out when another downturn hits. A portfolio of securities, now $4.2 trillion, could grow. Unpopular interest payments to banks for their deposits at the central bank could persist. The new normal, in short, could look a lot like what the Fed has been doing for the past several years.”

August 23 – Reuters (Lindsay Dunsmuir): “The number of regional Federal Reserve banks calling on the central bank to raise the rate it charges commercial banks for emergency loans rose to eight in July, minutes from the Fed's discount rate meeting… showed. That compared to six in June…”

August 24 – Wall Street Journal (Kevin Warsh): “The conduct of monetary policy in recent years has been deeply flawed. U.S. economic growth lags prior recoveries, falling short of forecasts and deteriorating in the most recent quarters. This week in Jackson Hole, Wyo., the Federal Reserve Bank of Kansas City hosts the world’s leading central bankers and academics to consider monetary reform. The task is timely and consequential, but the Fed needs a broader reform agenda. Policy makers around the world neither predicted nor can adequately explain the reasons for current inflation readings below their targets. So it is puzzling that so many academics are pushing to raise the current 2% inflation target to a higher target of 3% or 4%.”

August 25 – Reuters (Howard Schneider): “While markets wait for Janet Yellen's latest message about the direction of monetary policy, the Federal Reserve chief and her colleagues already have one for politicians: the U.S. economy needs more public spending to shift into higher gear. In the past few weeks, Yellen and three of the Fed's other four Washington-based governors have called in speeches and Congressional hearings for government infrastructure spending and other efforts to counter weak growth, sagging productivity improvements, and lagging business investment. The fifth member has supported the idea in the past.”

Central Bank Watch:

August 20 – Bloomberg (Lorenzo Totaro): “Prime Minister Narendra Modi promoted a deputy governor to lead India’s central bank, ensuring that sweeping reforms initiated under Raghuram Rajan would continue. Urjit Patel, who oversees the monetary policy department at the Reserve Bank of India under Rajan, has been appointed for three years from Sept. 4… Patel, 52, has been a key architect of the central bank’s biggest overhaul in eight decades, including a shift to a consumer-price inflation target and the creation of a rate-setting panel.”

August 23 – Bloomberg (Onur Ant): “The Turkish central bank’s decision to lower a benchmark rate amid climbing inflation is fueling expectations that regulators will keep cutting. The bank trimmed its overnight lending rate by 25 bps to 8.5% on Tuesday, the sixth consecutive reduction… The cut comes amid renewed pressure by President Recep Tayyip Erdogan to boost growth with lower lending costs.”

China Bubble Watch:

August 24 – Bloomberg: “The shadow financing that is fueling China’s economic growth is unsustainable and ‘eerily similar’ to developments in the U.S. before the global financial crisis, says Logan Wright at research firm Rhodium Group. The nation has at most about 18 months before this funding -- derived largely from wealth-management products offering higher returns on riskier underlying investments -- hits a wall, says Wright… Banks will then be unable to generate new credit needed to maintain the current pace of economic growth, which is likely to slow to a range of 5 to 5.5%¬¬¬¬ for about two years, he says. ‘It’s pretty shocking just how important this has become and how the funding structures for this type of asset creation have changed… Everyone assumes it’s a stable system, it’s deposit-funded. It’s just not true any more.’ The financial engineering being employed to generate credit needed to fuel growth is reminiscent of the notorious structured investment vehicles and special purpose vehicles that played a central role in triggering the U.S. and global financial crisis in 2007-2008…”

August 24 – Wall Street Journal (Shen Hong): “China’s central bank has made a subtle change to the way it supplies the financial system with cash, a move that market watchers see as an attempt to cool investments in assets such as bonds, which have ballooned on an influx of cheap, short-term money. For the past two weeks, the People’s Bank of China has been decreasing the amount of the cheap seven-day loans—known as reverse repurchase agreements, or repos—that it makes to commercial banks in its daily money-market operations.”

August 25 – Reuters (Lu Jianxin and Nathaniel Taplin): “China's central bank has urged banks to spread out the tenors of their loans, hinting at its displeasure with a recent trend of banks focusing on overnight lending, banking sources told Reuters… Imbalances in China's financial system are increasing as the economy slows, complicating challenges facing policymakers as they try to clamp down on riskier lending practices without roiling markets. The People's Bank of China (PBOC) met with major banks on Wednesday to discuss management of liquidity in Chinese money markets amid rising speculation over whether Beijing would continue its monetary policy easing or not, the sources said… On Thursday, the bank again conducted both seven and 14-day reverse repos, adding 220 billion yuan ($33.05bn) of money market liquidity in the largest single-day injection since June 27 to ease fears of a credit crunch.”

August 22 – Bloomberg: “The best-performing bank in China is in a struggling city in the northeast where weeds sprout alongside the concrete skeletons of high rises in an industrial zone that mostly looks like a ghost town. Steel plants have laid off tens of thousands of workers. Cranes stand idle on construction sites. Wipe away a spiderweb on a dirty glass door at an empty complex with smashed windows and there’s a notice from the local government demanding rent unpaid since November 2014. Yet the Bank of Tangshan’s financial statements hardly reflect these realities. Instead, this small lender reports the fastest growth of 156 Chinese financial institutions and the lowest level of bad loans, a mere 0.06%. Its profit jumped 436% in two years and assets soared almost 400% since the start of 2014 to 177.9 billion yuan ($26.7bn). It’s largely driven by shadow lending.”

August 24 – Bloomberg (Elena Popina): “Yirendai Ltd., a Chinese company that connects borrowers with lenders similarly to LendingClub Corp. in the U.S., plunged the most on record after authorities imposed limits on the peer-to-peer platforms to curb risks in the loosely regulated shadow-banking sector.”

August 22 – Reuters (Sumeet Chatterjee): “Hit by bad loans, Chinese banks are expected to show a weakening in their capital strength in first-half earnings, raising the prospect that government might have to inject more than $100 billion to shore them up, according to some analysts. There are early signs that government is already taking action to help some of the smaller banks, which are struggling to maintain their capital ratios as China's economy slows, interest margins fall, and bad debts climb. ‘We believe the recapitalisation and bailout process is already discretely underway. However, it has gone unnoticed as it has started with the smaller, unlisted banks,’ said Jason Bedford, sector analyst with UBS. ‘We expect this process to accelerate sharply in 2017, particularly among listed joint stock banks,’ Bedford told Reuters, adding closing the capital shortfall would require an infusion of $172 billion.”

August 24 – Financial Times (Mansoor Mohi-uddin): “China’s renminbi seems largely resilient one year after its sudden devaluation. The currency has weakened by only a couple of per cent against the dollar this year... The People’s Bank of China’s foreign reserves have stopped falling and the spread between China’s onshore and offshore exchange rates has almost vanished. The currency’s resilience, however, is unlikely to last. In particular, the amount of offshore renminbi deposits… has continued to shrink this year despite the exchange rate becoming more stable again. The diminishing size of the offshore market is the canary in the mine... Holding the currency outside the mainland, however, allows investors to gain exposure to China’s economy without incurring its capital controls. The persistent decline in offshore deposits — down by nearly a third to $180bn over the past year — thus shows confidence in the currency remains fragile.”

August 24 – Bloomberg: “China imposed limits on lending by peer-to-peer platforms to individuals and companies in an effort to curb risks in one part of the loosely-regulated shadow-banking sector. An individual can borrow as much as 1 million yuan ($150,000) from P2P sites, including a maximum of 200,000 yuan from any one site, the China Banking Regulatory Commission said… Corporate borrowers are capped at five times those levels.”

August 21 – Bloomberg: “Cracks are starting to show in China’s labor market as struggling industrial firms leave millions of workers in flux. While official jobless numbers haven’t budged, the underemployment rate has jumped to more than 5% from near zero in 2010, according to Bai Peiwei, an economics professor at Xiamen University. Bai estimates the rate may be 10% in industries with excess capacity, such as unprofitable steel mills and coal mines… Many state-owned firms battling overcapacity favor putting workers in a holding pattern to avoid mass layoffs that risk fueling social unrest.”

August 22 – Bloomberg: “As China’s sovereign bond yields tumble to decade-lows, investors are piling into the most defensive part of the stock market in search of returns. The Shanghai Stock Exchange Dividend Index, composed largely of banks, utilities and expressway operators, has rallied 5.6% in the past month and climbed to the highest level versus the Shanghai Composite Index in a year…”

August 21 – Reuters (Ben Blanchard): “China has issued new rules demanding the establishment of Communist Party panels in non-government bodies, aiming to beef up the ruling party's role in such social groups, amid a broad crackdown on civil society. Western governments and rights groups have already lambasted a law passed in April, saying it treats foreign non-governmental organizations (NGOs) as a criminal threat and would effectively force many out of the country. The new guidelines… say party committees must be set up to ensure ‘effective cover’ in all NGOs. ‘Strengthen political thought education for responsible people at social groups, and guide them to actively support party building,’ the guidelines said. ‘Promote the place of party building in the social group's charters.’”

Japan Watch:

August 21 – Reuters (Tetsushi Kajimoto): “Japanese companies overwhelmingly say the government's latest stimulus will do little to boost the economy and the Bank of Japan should not ease further, a Reuters poll showed… Prime Minister Shinzo Abe this month unveiled a 13.5 trillion yen ($135bn) fiscal package of public works projects and other measures, vowing a united front with the BOJ to revive the economy and raising speculation of a surge in government spending essentially financed by the central bank. But less than 5% of companies believe the steps will boost the economy near-term or raise its growth potential, according to the Reuters Corporate Survey…”

August 22 – Reuters (Hideyuki Sano and Tomo Uetake): “The Bank of Japan's near doubling of its purchases of Tokyo shares is causing investors to worry the central bank will dominate financial markets, which could lead to price distortions as it continues to grease the economy… More than three years of massive monetary stimulus has already resulted in the central bank cornering the Japanese government bond (JGB) market and distorting interest rates. ‘The increased BOJ purchasing provides a very favorable demand environment for listed equities,’ said Michael Kretschmer, chief investment officer at Pelargos Capital… ‘Nevertheless, in the long run we strongly doubt these type of monetary gimmicks aimed at price setting of risk assets can have a sustained positive impact on economic growth.’”

August 22 – Reuters (Stanley White and Ami Miyazaki): “Japan should spend 10 trillion yen (75.64bn pounds) on fiscal stimulus both in fiscal 2017 and in fiscal 2018 to offset a lack of demand in the economy and eliminate the risk of deflation, an adviser to Prime Minister Shinzo Abe said… Abe has already compiled a stimulus package for the current fiscal year with 7.5 trillion yen in spending, but the government needs to spend more and do so quickly to boost demand, Satoshi Fujii, an adviser to Abe, told Reuters… ‘We need to spend 10 trillion yen next fiscal year and another 10 trillion yen the following fiscal year to eliminate the deflationary gap,’ he said.”

EM Watch:

August 23 – Wall Street Journal (Anjani Trivedi): “As the hunt for yield stretches into emerging-market bonds, investors are finding there isn’t a lot of game to shoot. Such crowded terrain spells danger. The gusher of money into emerging-market bonds has hit extraordinary levels of late. In July, over $18 billion flooded in, and as of last week, $5 billion had entered emerging-market bond funds this month, according to… EPFR… If anything, the balance of flows are looking a lot like the 2009 post-financial crisis world. And like 2009, bond supply is scarce. So even as some investors are driven by negative rates into higher yielding emerging-market bonds, they are meeting a dearth of product.”

August 24 – Bloomberg (Ye Xie, Natasha Doff and Elena Popina): “Currency traders basking in the relative calm of August markets just received a jarring reminder of the dangers of chasing high yields. Recent flare-ups in political risk in emerging markets weakened their currencies and helped send returns on carry trades -- borrowing in locales with relatively low interest rates and investing the proceeds in places where they’re higher -- tumbling from the highest in a year. Turmoil among South Africa’s political leadership this week prompted such a drop in the rand against the dollar that it cut the return on this quarter’s best carry trade in half.”

August 23 – Bloomberg (Eric Martin and Nacha Cattan): “Mexico cut its growth forecast for the second time this year after Latin America’s second-largest economy shrank last quarter, dragged down by a slowdown in the services industry and falling exports. Gross domestic product will grow 2% to 2.6% in 2016, down from a previous estimate of 2.2% to 3.2%...”

August 23 – Bloomberg (Christine Jenkins and Nacha Cattan): “Mexico is at risk of a credit-rating cut after S&P Global Ratings revised its outlook to negative, citing ‘disappointing’ economic growth and a rising debt load. Stocks and the peso extended losses and the cost to hedge against losses in the country’s bonds rose after S&P said there’s at least a one-in-three chance of a downgrade over the next two years if the government’s debt increases more than forecast. S&P’s BBB+ rating for Mexico, three steps above junk, is already one level lower than Moody’s… Mexico cut its 2016 growth forecast for a second time this year Monday after the economy shrank in the second quarter.”

August 23 – Bloomberg (Ahmed A Namatalla and Ahmed Feteha): “According to Egypt’s president, the country’s future is at stake. With its currency trading near a record low in the black market, reserves to cover just three months of imports and a widening current-account deficit, pressure is mounting on the most populous Arab state to devalue the pound to alleviate a dollar shortage that prompted officials to seek help from the International Monetary Fund. Egypt is moving to end the exchange-rate problem within ‘months’ as part of its plan to implement economic reforms, President Abdel-Fattah El-Sisi said…”

Leveraged Speculator Watch:

August 24 – Bloomberg (Hema Parmar): “For hedge funds, the news is getting worse. Investors pulled an estimated $25.2 billion from hedge funds last month, the biggest monthly redemption since February 2009, according to… eVestment… The monthly withdrawals were the second straight for the beleaguered industry, which saw $23.5 billion pulled in June. They bring total outflows this year to $55.9 billion, driven by ‘mediocre’ performance after a number of funds lost money last year… ‘Unless these pressures recede, 2016 will be the third year on record with net annual outflows, and the first since the outflows in 2008 and 2009 -- a result of the global financial crisis,’ eVestment said… Industrywide, funds returned an average of 1.2% this year through July…, compared with about 7.6% for the S&P 500 Index.”

August 24 – Bloomberg (Dani Burger): “The computers seem confused. After trouncing their human counterparts in the first half of the year, equity managers that rely on automated processes are having a rough third quarter. The proportion of quantitative funds whose return exceeds their benchmark has dropped to 28% since July, data from JPMorgan… show. Compare that to fundamental equity managers, where 52% are outperforming.”

Geopolitical Watch:

August 25 – New York Times (Rick Gladstone): “Iranian naval boats made dangerous maneuvers around United States warships in the Persian Gulf area on at least four occasions this week, Pentagon officials said Thursday, including one episode in which the Americans fired warning shots from a 50-caliber deck gun to prevent a collision. It was unclear whether the confrontations — one near the Strait of Hormuz on Tuesday and three in the northern Persian Gulf on Wednesday — were deliberate efforts to send a hostile message about American naval activity. Still, they underscored the risk of an armed clash between Iran and the United States in an area that has been a perennial source of tension for the two countries.”

Thursday, August 25, 2016

Friday's News Links

[Bloomberg] Stock Rally Fizzles After Fischer’s Hawkish Remarks; Bonds Fall

[Bloomberg] Yellen Says Rate-Hike Case ‘Has Strengthened in Recent Months’

[Bloomberg] Janet Yellen’s Jackson Hole Speech, Annotated

[Bloomberg] Asian Stocks Drop as Investors Avoid Risk Before Yellen Speech

[Bloomberg] Emerging Currencies Decline for Second Week Before Yellen Speech

[Bloomberg] Economy in U.S. Grew at 1.1% Rate, Slower Than First Estimated

[Reuters] Schooled in the short run, central banks struggle with a long-term role

[Bloomberg] China Tightening Risk Seen Looming as Bonds, Property Surge

[Bloomberg] Japan’s CPI Falls for 5th Month, Raising Pressure on Kuroda

[Bloomberg] Swedish Debt Office Says Central Bank Is Nearing Limit of QE

[WSJ] Oil Slide Lifts Corporate Defaults to Seven Year High

[WSJ] Equity in Startups Is Losing Appeal

[NYT] Tensions Rise Between Iran and U.S. in Persian Gulf

Thursday Evening Links

[Reuters] As central bankers gather, some at Fed make interest rate rise case

[Reuters] August U.S. auto sales seen down 5.2 percent; 2015 was peak: forecasters

[WSJ] Puerto Rico’s Pensions: $2 Billion in Assets, $45 Billion in Liabilities

Thursday Afternoon Links

[Bloomberg] Stocks, Bonds, Dollar Run Out of Steam Before Yellen’s Speech

[WSJ, Hilsenrath] Years of Fed Missteps Fueled Disillusion With the Economy and Washington

[CNBC] Deutsche CEO: Negative rates have 'fatal consequences'

[Bloomberg] There's Basically No Alternative to U.S. Corporate Bonds Right Now

Wednesday, August 24, 2016

Thursday's News Links

[Bloomberg] Stocks Decline With Bonds as Traders Brace for Yellen’s Speech

[Bloomberg] European Stocks Retreat as Dollar Rally Fades Before Yellen

[Bloomberg] China Stocks Fall to Two-Week Low, Led by Developers, Small Caps

[Bloomberg] Asia Stocks Fall as Commodity Shares Slump Before Yellen Speech

[Reuters] Central bankers eye public spending to plug $1 trillion investment gap

[Bloomberg] Money Market Dysfunction Helps Fuel U.S. Corporate Bond Bonanza

[Bloomberg] Why China's Shadow Finance Echoes Pre-Crisis U.S.

[Reuters] China central bank urges banks to spread out tenors of loans: sources

[Bloomberg] PBOC Money-Market Tactic Has Traders Trying to Decode Signal

[Bloomberg] China’s Answer to LendingClub Sinks on Industry Crackdown: Chart

[WSJ] China’s Central Bank Moves to Clamp Down on Speculation

[Bloomberg] Top Currency Strategy of 2016 Turns Perilous on Political Risks

[WSJ, Warsh] The Federal Reserve Needs New Thinking

Wednesday Evening Links

[Bloomberg] Stocks Decline on Emerging-Market Risk as U.S. Drugmakers Tumble

[Bloomberg] Hedge Funds See Biggest Redemptions Since ’09 as Returns Lag

[Bloomberg] These Nine Charts Show Just How Quiet the Market Is Right Now

[AP] A Look at Some Companies Struggling With Rising Debt

[Bloomberg] Productivity in the U.S. Looks Bad, But It's Golden Compared With Global Peers

[FT] The canary in the coal mine for China’s currency

Wednesday's News Links

[Bloomberg] Asian Stocks Rise on U.S. Rate Bets as Japanese Shares Advance

[Bloomberg] Developing-Nation Assets Drop on Political Risks as Oil Declines

[Bloomberg] U.S. Existing-Home Sales Drop for First Time Since February

[Bloomberg] U.S. Home Prices Gained 5.6% in Second Quarter From Prior Year

[Bloomberg] Quant Hot Hand Goes Cold in U.S. Stocks as Low-Vol Trade Recedes

[Bloomberg] Derivatives Users Hit as Negative Rates Raise Collateral Costs

[Reuters] China central bank cash injection signals leverage, asset bubble concerns

[Bloomberg] China Imposes Caps on P2P Loans to Curb Shadow-Banking Risks

[Reuters] ECB faces bulked-up govt bond buying if QE extended beyond March

[Bloomberg] Africa’s Next Big Currency Devaluation Seen Unfolding in Egypt

[WSJ] Largest Oil Companies’ Debts Hit Record High

[FT] Political tensions hit South Africa’s rand and Turkey’s lira

Tuesday, August 23, 2016

Saturday, August 20, 2016

Saturday's News Links

[Bloomberg] Rajan’s Deputy Patel Named as India’s Central Bank Governor

[Reuters] Turkey asks Germany for help with Gulen crackdown: report

Weekly Commentary: The "Neutral Rate"

The neutral (or natural) rate of interest is the rate at which real GDP is growing at its trend rate, and inflation is stable. It is attributed to Swedish economist Knut Wicksell, and forms an important part of the Austrian theory of the business cycle. The neutral rate provides an important benchmark for policymakers to compare with the market rate. When interest rates are neutral the economy is on a sustainable path, and it is deviations from neutrality that cause booms and busts.” (Financial Times/lexicon)

Wicksell based his theory on a comparison of the marginal product of capital with the cost of borrowing money. If the money rate of interest was below the natural rate of return on capital, entrepreneurs would borrow at the money rate to purchase capital (equipment and buildings), thereby increasing demand for all types of resources and their prices; the converse would be true if the money rate was greater than the natural rate of return on capital. So long as the money rate of interest persisted below the natural rate of return on capital, upward price pressures would continue… Price stability would result only when the money rate of interest and the natural rate of return on capital—the marginal product of capital—were equal.” “Wicksell’s Natural Rate”, Federal Reserve Bank of St. Louis Monetary Trends, March 2005

Wicksell’s “natural rate” is a powerful analytical concept. In a more traditional backdrop, I would view the so-called “natural rate” as the price of Credit where supply and demand intersect at a point of relative stability for returns on capital. When economic returns are high, heightened demand for Credit (to fund investment) pushes up its cost. Over time, increased investment will result in an expanded supply of output and lower returns. Weak economic returns then engender less demand for borrowings and a resulting lower cost of Credit.

The hypothetical “natural rate” embodies a self-regulating system. During Wicksell’s time, money and Credit entered into the economic system primarily through lending for capital investment. And, importantly, there were constraints on the supply of “money” available to be lent. Banks were the dominant source of lending, and they were subject to specific restraints on Credit expansion (i.e. bank reserve and capital requirements, the gold standard).

Wicksell’s “natural rate” is incompatible with contemporary finance. These days, finance is introduced into systems (economic and financial) with little association to economic returns. Indeed, the primary mechanisms for the creation of new finance are government (fiscal and monetary) spending and asset-based lending. Furthermore, there are no restrains on the available supply of Credit, so its price is outside the purview of supply and demand. For the most part, the government dictates the price of finance. This system is neither self-adjusting nor self-correcting.

Enter the current monetary debate: Things have not progressed as expected. Years of unthinkable monetary stimulus have failed to achieve either general prosperity or consistent inflation in the general price level. Fragilities are as acute as ever. So policymaker reassessment is long overdue. Not surprisingly, however, there’s no second guessing “activist” (inflationist) monetary doctrine. Central bankers are not about to admit that a policy of zero rates and Trillions of monetization is fundamentally flawed. Apparently, we are to believe that forces outside their control have pushed down the “neutral rate.” The solution, predictably, is lower for longer – along with more government spending and programs. So focus on the “neutral rate” becomes the latest elaborate form of policymaking rationalization/justification.

From Ben Bernanke’s August 8, 2016 blog, “The Fed’s Shifting Perspective on the Economy and its Implications for Monetary Policy”: “Projections of r* can be interpreted as estimates of the ‘terminal’ or ‘neutral’ federal funds rate, the level of the funds rate consistent with stable, noninflationary growth in the longer term… As mentioned, a lower value of r* implies that current policy is not as expansionary as thought… In particular, relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited. Moreover, there may be a greater possibility that running the economy a bit ‘hot’ will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.”

Today’s monetary “debate” is reminiscent of Alan Greenspan’s fateful foray into New Paradigm worship. In particular, he viewed (going back to 1996) that technological advancement and attendant productivity gains had fundamentally raised the economy’s “speed limit”. Monetary policy could be run looser than in the past – and run it did. Such fallacious thinking was only temporarily discredited with the the bursting of the “tech” Bubble, as captured in a 2001 WSJ article:

December 28, 2001 – Wall Street Journal (Greg Ip and Jacob M. Schlesinger): “Five years ago, Alan Greenspan began pushing a reluctant Federal Reserve to embrace his New Economy vision of rapid productivity growth and rising living standards. Today, Fed policy makers are debating whether they went too far. The answer could help determine whether the current recession marks a temporary aberration in an era of swift growth, or whether the rapid growth of the late 1990s itself was the aberration. Mr. Greenspan hasn't lost the faith. ‘New capital investment, especially the high-tech type, will continue where it left off,’ he declared in a speech… He ignored the collapse of so many symbols of the 1990s boom, including Enron Corp., the sponsor of the ‘distinguished public service’ award he received that evening. ‘The long-term outlook for productivity growth, as far as I'm concerned, remains substantially undiminished,’ the Fed chairman asserted.”

New technologies are seductive. Rapid technological advancement coupled with momentous financial innovation proved absolutely engrossing. It was easy to ignore Enron, WorldCom and the like, just as it was to disregard 1994’s bond market tumult, the Mexican meltdown, the SE Asia debacle, the Russian collapse and LTCM. By 2001 it was rather obvious that New Age finance was highly unstable. Yet the 2002 corporate debt crisis along with the arrival of Dr. Bernanke to the the Marriner S. Eccles Building ensured that the FOMC pursued even more egregious policy blunders.

The Federal Reserve has been rationalizing loose monetary policies for 20 years now. Instead of Alan Greenspan’s electrifying productivity miracle, it’s a future of dreadful “secular stagnation.” Enron was little small potatoes compared to the frauds that followed. And the key issue from two decades ago somehow remains unaddressed: over-liquefied and speculative securities markets are incapable of effectively allocating financial and real resources. Moreover, central bank command over both the cost of finance and the performance of securities markets ensures dysfunction both financially and economically.

Contemporary notions of a “neutral rate” are deeply flawed – to the point of being ludicrous. From Bloomberg: “The Fed aims to set short-term interest rates in relation to the ‘natural rate’—the one that would produce full employment without excess inflation.” Yet it’s not the Fed funds rate spawning “full employment,” and central bankers certainly do not control a general price level. It is instead the ongoing historic Bubble in market-based finance that dictates the flow of “money” and Credit throughout the economy. One would have to be a diehard optimist to believe either markets or global economies are on a “sustainable path”. Market participants have been incentivized to take excessive risks and to speculate, with central bankers clearly responsible for inflationary Bubbles that have engulfed global securities and asset markets.

There’s no mystery surrounding the sinking employment rate. Ultra-loose monetary policies (rates and QE) have stoked excess securities market inflation, boosting perceived wealth while fostering extremely loose corporate Credit conditions. Such a backdrop spurs business borrowing, spending and hiring. Still, ongoing pathetic growth and productivity dynamics, along with weakening profits, corroborate the view that resources continue to be poorly allocated.

A low unemployment rate concurrent with mild CPI inflation is no conundrum either. On a global basis, unfettered finance has spurred unprecedented over- and malinvestment, ensuring downward price pressures. To be sure, the proliferation of new technologies and digitized output has fundamentally broadened the available supply of goods. Moreover, at home and abroad, unsound global finance has fomented wealth inequality that plays prominently in the disinflationary backdrop more generally.

A low “neutral rate” might be consistent with an economic boom, or it could just as well be compatible with financial and economic collapse. Causation – the driving force behind either boom or bust - is found with intertwined and closely correlated global securities markets. Two decades of persistently loose monetary policies have created deep economic maladjustment and historic asset price Bubbles. And these days central bankers see resulting stagnation (growth, productivity, pricing power, profits, etc.) as evidence of a historically low “neutral rate” - that is then used to justify their runaway experiment in ultra-loose monetary management.

Back in 2013, in the midst of a bout of market tumult, chairman Bernanke reassured the markets that the Fed was prepared to “push back against a tightening of financial conditions.” In the eyes of the market, this significantly augmented/clarified “whatever it takes.” The Federal Reserve – and global central bankers more generally – could simply not tolerate fledgling risk aversion (“risk off”) in the securities markets that would impinge financial conditions more generally. The Fed would use its rate and QE policy specifically to backstop the securities markets, in the process sustaining Bubble Dynamics.

“Whatever it takes” and “pushing back” unleashed a precarious Terminal Bubble Phase. With economic and market risks now so elevated, even the thought of recession or bear market has become unacceptable to central bankers.

There was a research piece this week from Federal Reserve Bank of San Francisco President John Williams, “Monetary Policy in a Low R-star World:” “The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest. While price level or nominal GDP targeting by monetary authorities are options, fiscal and other policies must also take on some of the burden to help sustain economic growth and stability.” And there was Thursday’s Washington Post op-ed from Larry Summers: “What We Need to do to Get Out of This Economic Malaise.” “I cannot see how policy could go wrong by setting a level target of 4 to 5% growth in nominal gross domestic product and think that there could be substantial benefits.”

Let me suggest what is going wrong.  Even after several years of typical recovery, there would be the issue of mounting imbalances and excesses. With almost eight years of history’s most extreme monetary stimulus – including zero rates, massive monetization and the direct targeting of securities and asset inflation – there is surely an extraordinary degree of underlying economic maladjustment. One should expect an inordinate number of uneconomic enterprises, along with the now typical amounts of fraud and nonsense (that prosper on loose finance).

Historic excess and distortions have for years accumulated throughout the securities markets. The underlying amount of speculative leverage likely exceeds 2008. Eight years of Federal Reserve zero rates and liquidity backstops have severely perverted market risk perceptions. Literally Trillions have flowed into perceived liquid and low-risk securities – fixed-income and equities. Trillions have chased yields and returns, assuming liquidity while being indifferent to risk. The unwieldy global pool of speculative finance has inflated by Trillions. Meanwhile, the Fed’s serial interventions to smother “Risk Off” has undoubtedly cultivated major latent fragilities within the derivatives trading complex.

The current policy objective should be for Fed to begin extricating itself from market dominance. It’s absolutely crucial for the economy and markets to commence the process of learning to stand on their own. At this point, such a transition would not go smoothly. The alternative is only deeper structural impairment and more extreme financial and economic fragility.

The system has been put in a quite precarious position, but it’s time to let Capitalism sorts its way through. The very opposite seems ensured. We’re in the early stage of even more egregious government (fiscal and monetary) intervention in the economy and markets. The election will usher in a surge of deficit spending. Meanwhile, the Federal Reserve appears poised to use a low “neutral rate” as an excuse to cling to ultra-loose monetary policies.

I am often reminded of misguided late-nineties dollar optimism. New Paradigm thinking had the markets content to overlook underlying U.S. financial and economic fragilities, not to mention massive intractable Current Account Deficits. King dollar had become a Crowded Trade, although nothing in comparison to this cycle’s dollar exuberance. Curiously, the dollar index declined 1.2% this week. In the face of Japan’s deep problems and policy shortcomings, the $/yen traded below 100 this week (yen up 16.9% y-t-d). Despite the eurozone’s serious deficiencies, the euro ended the week above 113 (up 4.3% y-t-d). In general, emerging markets are a mess, yet many EM currencies have rallied strongly against the dollar.

Integral to the dollar bull case have been expectations that an outperforming U.S. economy would ensure rising U.S. rates and attractive interest-rate differentials. Yet king dollar excesses (foreign and speculative flows) exacerbated Bubble Dynamics, with market and economic vulnerabilities now having trapped the Yellen Fed in ultra-loose monetary measures. Global markets appear to have begun anticipating a weaker dollar. This would certainly help to explain the big turnarounds in commodities and EM.

If the Fed is hellbent on spurring inflation (at home and abroad), a weaker dollar could go a long way. But policy savants be careful what you wish for. After all, global markets are awash in Crowded Trades betting on dollar strength, disinflationary forces, low bond yields and market stability - as far as the eye can see. There is today no “neutral rate” that could possibly neutralize such a perilous global Bubble.

For the Week:

The S&P500 was unchanged (up 6.8% y-t-d), while the Dow slipped 0.1% (up 6.5%). The Utilities dropped 1.3% (up 16.2%). The Banks jumped 1.7% (down 3.9%), and the Broker/Dealers rose 1.1% (down 6.3%). The Transports advanced 1.6% (up 5.6%). The S&P 400 Midcaps added 0.3% (up 11.7%), and the small cap Russell 2000 increased 0.6% (up 8.9%). The Nasdaq100 was unchanged (up 4.6%), and the Morgan Stanley High Tech index gained 1.2% (up 9.1%). The Semiconductors jumped 2.2% (up 20.1%). The Biotechs declined 0.7% (down 13.0%). Though bullion added $6, the HUI gold index fell 3.6% (up 142%).

Three-month Treasury bill rates ended the week at 30 bps. Two-year government yields rose five bps to 0.75% (down 30bps y-t-d). Five-year T-note yields rose seven bps to 1.16% (down 59bps). Ten-year Treasury yields gained seven bps to 1.58% (down 67bps). Long bond yields increased six bps to 2.29% (down 73bps).

Greek 10-year yields fell 13 bps to 7.86% (up 54bps y-t-d). Ten-year Portuguese yields surged 31 bps to 2.98% (up 46bps). Italian 10-year yields jumped nine bps to 1.13% (down 46bps). Spain's 10-year yield increased three bps to 0.95% (down 82bps). German bund yields rose seven bps to negative 0.04% (down 66bps). French yields gained seven bps to 0.18% (down 81bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields rose 10 bps to 0.62% (down 134bps). U.K.'s FTSE equities index declined 0.8% (up 9.9%).

Japan's Nikkei 225 equities index dropped 2.2% (down 13.1% y-t-d). Japanese 10-year "JGB" yields increased three bps to negative 0.09% (down 26bps y-t-d). The German DAX equities index fell 1.6% (down 1.8%). Spain's IBEX 35 equities index sank 3.0% (down 11.5%). Italy's FTSE MIB index was hit 4.0% (down 23.9%). EM equities were mixed. Brazil's Bovespa index gained another 1.5% (up 36.5%). Mexico's Bolsa was little changed (up 12.4%). South Korea's Kospi index added 0.3% (up 4.8%). India’s Sensex equities slipped 0.3% (up 7.5%). China’s Shanghai Exchange jumped 1.9% (down 12.2%). Turkey's Borsa Istanbul National 100 index was about unchanged (up 8.9%). Russia's MICEX equities index slipped 0.4% (up 11.3%).

Junk bond mutual funds saw inflows of $889 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined two bps to 3.43% (down 54bps y-o-y). Fifteen-year rates slipped two bps to 2.74% (down 52bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 3.61% (down 47bps).

Federal Reserve Credit last week expanded $10.4bn to $4.438 TN. Over the past year, Fed Credit declined $22.3bn. Fed Credit inflated $1.627 TN, or 58%, over the past 197 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.9bn last week to $3.203 TN. "Custody holdings" were down $153bn y-o-y, or 4.6%.

M2 (narrow) "money" supply last week increased $5.6bn to a record $12.971 TN. "Narrow money" expanded $884bn, or 7.3%, over the past year. For the week, Currency increased $0.8bn. Total Checkable Deposits surged $69.8bn, while Savings Deposits dropped $65.3bn. Small Time Deposits added $1.0bn. Retail Money Funds slipped $0.7bn.

Total money market fund assets dropped $34.9bn to a six-week low $2.710 TN. Money Funds rose $24bn y-o-y (0.9%).

Total Commercial Paper dropped $11.0bn to $1.012 TN. CP declined $45bn y-o-y, or 4.2%.

Currency Watch:

The U.S. dollar index dropped 1.2% to 94.5 (down 4.2% y-t-d). For the week on the upside, the euro increased 1.5%, the Swiss franc 1.4%, the British pound 1.2%, the Japanese yen 1.1%, the New Zealand dollar 1.0%, the Swedish krona 0.8%, the Canadian dollar 0.6%, and the Mexican peso 0.2%. For the week on the downside, the Brazilian real declined 0.4%, the Australian dollar 0.3%, the South African rand 0.3%, and the Norwegian krone 0.1%. The Chinese yuan declined 0.3% versus the dollar (down 2.5% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index surged 4.9% (up 18.9% y-t-d). Spot Gold added 0.4% to $1,341 (up 26%). Silver declined 2.1% to $19.31 (up 40%). WTI Crude surged $4.08 to $48.57 (up 31%). Gasoline jumped 10.8% (up 20%), while Natural Gas slipped 0.4% (up 10%). Copper gained 1.8% (up 2%). Wheat surged 5.3% (down 5%). Corn advanced 3.2% (down 4%).

Turkey Watch:

August 14 – Reuters (Humeyra Pamuk): “Turkey will not compromise with Washington over the extradition of the Islamic cleric it accuses of orchestrating a failed coup, Prime Minister Binali Yildirim said…, warning of rising anti-Americanism if the United States fails to extradite.”

August 18 – Reuters (Ayla Jean Yackley): “Turkish authorities ordered the detention of nearly 200 people, including leading businessmen, and seized their assets as an investigation into suspects in last month's failed military rebellion shifted to the private sector. President Tayyip Erdogan has vowed to choke off businesses linked to U.S.-based Muslim cleric Fethullah Gulen, whom he blames for the July 15 coup attempt, describing his schools, firms and charities as ‘nests of terrorism.’ Tens of thousands of troops, civil servants, judges and officials have been detained or dismissed in a massive purge…”

August 14 – Reuters (Michelle Martin and Humeyra Pamuk): “Turkey could walk away from its promise to stem the flow of illegal migrants to Europe if the European Union fails to grant Turks visa-free travel to the bloc in October, Foreign Minister Mevlut Cavusoglu told a German newspaper. His comments… coincide with rising tensions between Ankara and the West that have been exacerbated by the failed coup attempt… Turkey is incensed by what it sees as an insensitive response from Western allies to the failed putsch, in which 240 people were killed.”

Brexit Watch:

August 13 – Bloomberg (Scott Hamilton and Colin Keatinge): “Monetary policy is only a ‘short-term balm’ that can’t fully insulate the U.K. from the long-term impacts of the vote to leave the European Union, Bank of England Chief Economist Andrew Haldane wrote… The bank’s package of monetary policy measures unleashed earlier this month, including the first interest-rate cut in seven years, are designed to be a shot in the arm for business and consumer confidence after the vote to leave the European Union ‘has thrown up a dust cloud of economic uncertainty, making it harder for companies to plan, with potentially adverse implications for future investment and jobs,’ Haldane said…”

August 15 – Reuters (Ana Nicolaci da Costa): “The price of homes for sale in England and Wales fell in August, posting the biggest drop since November… Asking prices fell by a monthly 1.2%..., after shedding 0.9% in July. The biggest drop was in London and the South East, with asking prices falling by 2.6% and 2.0% respectively.”

August 16 – Bloomberg (Janet Lorin): “Larger investment banks with their European headquarters in London are already making plans for their own withdrawal. Many plan to start the process of moving jobs from the U.K. within weeks of the government triggering Brexit, people briefed on the plans of four of the biggest firms told Bloomberg's Gavin Finch. That suggests the banks may move faster than their public messages of patience would imply, and reflects dismay with the U.K.'s lack of a clear plan to protect its status as a global financial hub. There are concerns British-based banks will lose the right to sell services freely around the European Union.”

Europe Watch:

August 18 – New York Times (Landon Thomas Jr.): “In Italy, where two decades of economic stagnation have created a long line of barely breathing companies, Feltrinelli, one of the country’s largest booksellers, stands out. Since 2012, the company has chalked up three consecutive years of losses totaling nearly 11 million euros ($12.4 million). Even so, late last year, Feltrinelli was able to secure a fresh €50 million line of credit from a syndicate that included two of Italy’s largest banks, UniCredit and Intesa Sanpaolo, at an interest rate below what top-rated companies in Europe were paying. As Italy and Europe more broadly struggle to come to grips with an escalating problem with bad loans, a new paper by economists connected to the Center for Economic Policy Research… highlights the extent to which Italy’s main banks — known to be the weakest in the eurozone in terms of cash reserves — have stepped up their lending to the country’s most troubled companies.”

Fixed-Income Bubble Watch:

August 14 – Wall Street Journal (Carolyn Cui and Mike Bird): “Bond investment funds that usually have little appetite for riskier debt are boosting their exposure to the developing world, a move that is helping drive this year’s emerging-markets rally. International bond funds run by BlackRock Inc., Legg Mason Inc. and OppenheimerFunds are among the big money managers that have been increasing their positions in emerging-market debt in recent months. That shift reflects how global bond funds are feeling the pinch from low U.S. interest rates and negative rates in Japan and much of Europe.”

Global Bubble Watch:

August 18 – New York Times (Robin Wigglesworth): “Paul Singer, head of $28bn hedge fund Elliott Management, has warned that the global bond market is ‘broken’, and predicted that the end of the current environment is ‘likely to be surprising, sudden, intense, and large’… In his second quarter letter to investors… Mr Singer sounded an ominous warning on the state of the global debt market, with more than $13tn of bonds trading with negative yields. The hedge fund manager said it was ‘the biggest bond bubble in world history,’ and cautioned that investors should shy away from sub-zero yielding debt. ‘Hold such instruments at your own risk; danger of serious injury or death to your capital!’, he wrote… He added that ‘the ultimate breakdown (or series of breakdowns) from this environment is likely to be surprising, sudden, intense, and large’.”

August 16 – Reuters (Claire Milhench): “Global investors have cut their cash holdings sharply and added to emerging market and U.S. stocks in August as global growth expectations have rebounded, a Bank of America Merrill Lynch (BAML) survey indicated… Cash levels dropped to 5.4% from a 15-year high of 5.8% in July… A net 23% of investors now expect the global economy to improve over the next 12 months, an optimism reflected in the overall equity allocation recovering to a net overweight of 9%. This was up from a net 1% underweight last month - the first underweight in four years. Among the biggest beneficiaries of this switch were emerging market stocks, where the allocation rose to a net 13% overweight - the highest level since September 2014. This was up from 10% last month.”

August 16 – Bloomberg (Vincent Cignarella): “This wasn't supposed to happen. The central banks of Australia and New Zealand lowered benchmark interest rates and their respective currencies promptly strengthened. Traders puzzled by the way foreign-exchange markets are behaving should consider that potential for capital appreciation, in addition to yield, may be a significant driver of recent moves. Investors are engaging in a type of 'reverse carry trade,' buying low-yield currencies for high-yield pairs and accepting small interest rate differential losses for potential large capital gains where central banks are cutting rates or buying more domestic bonds. Those moves should push up the price of underlying assets and, in theory, outweigh small losses on interest rate carry.”

U.S. Bubble Watch:

August 18 – The Economist: “WHAT are the most dysfunctional parts of the global financial system? China’s banking industry, you might say, with its great wall of bad debts and state-sponsored cronyism. Or the euro zone’s taped-together single currency, which stretches across 19 different countries, each with its own debts and frail financial firms. Both are worrying. But if sheer size is your yardstick, nothing beats America’s housing market. It is the world’s largest asset class, worth $26 trillion, more than America’s stockmarket. The slab of mortgage debt lurking beneath it is the planet’s biggest concentration of financial risk. When house prices started tumbling in the summer of 2006, a chain reaction led to a global crisis in 2008-09. A decade on, the presumption is that the mortgage-debt monster has been tamed. In fact, vast, nationalised, unprofitable and undercapitalised, it remains a menace to the world’s biggest economy.”

August 18 – Bloomberg (Joe Light): “The hole at the corner of 15th and L streets, in downtown Washington, is deep -- and getting deeper. Earth-movers there are laying the foundations of a shiny new headquarters for Fannie Mae, the bailed-out giant of American mortgages. But the sleek design, replete with glass sky bridges, belies a sober reality: Fannie Mae and its cousin, Freddie Mac, are once again headed for trouble. In fact, there’s almost no way around it. On Jan. 1, 2018, the two government-sponsored enterprises will officially run out of capital under the current terms of their bailout. After that, any losses would be shouldered by taxpayers. Granted, few people are predicting a disaster like the one in 2008, when the GSEs had to be thrown a $187.5 billion federal lifeline. But eight years later, people still don’t agree on what to do with these wards of the state… ‘Everyone agreed that this was a broken business model that made no sense,’’ said Douglas Holtz-Eakin, president of the American Action Forum… ‘Now, inertia is driving the way.’”

August 16 – Bloomberg (Sid Verma and Luke Kawa): “Stock buybacks appear to be slowing down, suggesting either corporate America's outlook has dimmed, stock valuations have become prohibitively high or, most optimistically, that companies are starting to listen to investors and put funds toward other uses. Buybacks announced for the second quarter's earnings season between July 8 and August 15 totaled an average of $1.8 billion a day, the lowest volume in an earnings season since the summer of 2012, according to TrimTabs Investment Research… In the first seven months of 2016, buybacks totaled $376.5 billion, according to TrimTabs. That's down 21% from $478.4 billion in the first seven months of last year.”

August 19 – Wall Street Journal (Mike Bird, Vipal Monga and Aaron Kuriloff): “Big companies are handing more of their profits to shareholders than at any time since the financial crisis, as record-low bond yields put a premium on dividends. Payouts at S&P 500 companies for the past 12 months amounted to almost 38% of net income over the period, according to FactSet, the most since February 2009. In the second quarter, 44 S&P 500 companies paid an annual dividend that exceeded their latest 12 months of net income… That is the most in a decade and a practice some analysts deem unsustainable.”

August 12 – Wall Street Journal (Maria Armental): “As U.S. stocks rally, private-equity firms are taking the other side of the trade. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Index all notched record highs Thursday, a triple-threat that hadn’t occurred since the dot-com boom. Meanwhile, 15 block trades, bulk sales of big chunks of stock, raised a total of $5 billion in the biggest week for such deals since March 2015. Private-equity firms, which use block trades to sell out of companies they previously took public, accounted for nine of the 15 deals.”

August 17 – Bloomberg (Rachel Evans): “Store closures by Macy’s Inc. could hurt more than the mall rats, according to Morningstar Credit Ratings. Almost $30 billion of bonds backed by commercial mortgages are exposed to the retailer, which last week announced plans to shutter 100 outlets, the rating company wrote… More than $3.6 billion in loans would be affected by the closing of 28 stores that Morningstar identifies as most at risk, several of which support multiple asset-backed securities…”

Federal Reserve Watch:

August 17 – Financial Times (Sam Fleming): “A divided Federal Reserve left open the prospect of a further interest rate rise this year even as policymakers insisted they needed more evidence on the durability of the rebound before feeling confident enough to pull the trigger. Minutes to their latest July meeting revealed a hard-fought debate over when to move rates, with a couple of participants urging an immediate move, while others were urging caution amid questions over how rapidly inflation will return to target.”

August 16 – Bloomberg (Matthew Boesler): “The Federal Reserve could potentially raise interest rates as soon as next month, New York Fed President William Dudley said, warning investors that they are underestimating the likelihood of increases in borrowing costs. ‘We’re edging closer towards the point in time where it will be appropriate, I think, to raise interest rates further,’ Dudley… said… Asked whether the FOMC could vote to raise the benchmark rate at its next meeting Sept. 20-21, Dudley said, ‘I think it’s possible.’”

Central Bank Watch:

August 16 – Bloomberg (Jeanna Smialek): “The world made it through the Great Recession. Now it's entered what you might call the Great Reassessment. High-profile researchers are publicly questioning the most basic tenets of monetary policy in the run-up to the Federal Reserve Bank of Kansas City’s economic symposium in Jackson Hole, Wyoming, which starts Aug. 25. San Francisco Fed President John Williams has issued a call for a major rethink among central bankers and fiscal policy makers, with an eye on scrapping low-inflation targeting. Former Fed Chairman Ben Bernanke analyzes why the Fed has been revising its economic projections. Meanwhile, a new IMF paper assesses both the effectiveness of, and the outlook for, Europe’s negative interest-rate policies.”

August 18 – Bloomberg (Jana Randow and Carolynn Look): “European Central Bank officials ‘widely’ agreed that their immediate reaction to the outcome of the U.K.’s referendum shouldn’t fuel excessive speculation about more stimulus. ‘The view was widely shared that the Governing Council needed to reiterate its capacity and readiness to act, if warranted, to achieve its objective, using all the instruments available within its mandate, while not fostering undue expectations about the future course of monetary policy,’…”

China Bubble Watch:

August 12 – Bloomberg (Paul Panckhurst): “International Monetary Fund staff said that 19 trillion yuan ($2.9 trillion) of Chinese ‘shadow’ credit products are high-risk compared with corporate loans and highlighted the danger that defaults could lead to liquidity shocks. The investment products are structured by the likes of trust and securities companies and based on equities or on debt -- typically loans -- that isn’t traded… The commentary highlighted the potential for risks bigger to the nation’s financial stability than from companies’ loan defaults. While loan losses can be realized gradually, defaults on the shadow products could trigger risk aversion that’s harder to manage… The ‘high-risk’ products offer yields of 11% to 14%, compared with 6 percent on loans and 3% to 4% on bonds, the commentary said. The lowest-quality of these products are based on ‘nonstandard credit assets,’ typically loans, it said.”

August 15 – Bloomberg: “China’s central bank urged investors not to focus too much on short-term concerns and said the diverging pace of credit expansion doesn’t mean monetary policy is losing steam. July credit growth slowing to a two-year low was a distortion and the reports for August and September will show it rebounding… Markets should avoid over-interpretation of short-term data for a specific month, the PBOC said. The commentary also said the growing gap between two money-supply gauges, M1 and M2, isn’t an indicator of a ‘liquidity trap,’ an economics term for when central bank cash injections into the economy fail to spur growth as monetary policy loses potency.”

August 17 – Reuters (Yawen Chen and Sue-Lin Wong): “China home prices rose 0.8% in July nationwide, but stalled or fell in more cities than in June, adding to concerns that one of the economy's key growth drivers is losing steam but offering some relief for policymakers worried about property bubbles. A robust recovery in home prices and sales gave a stronger-than-expected boost to the world's second-largest economy in the first half of the year, helping to offset stubbornly weak exports.”

Japan Watch:

August 14 – Bloomberg (Anna Kitanaka, Yuji Nakamura and Toshiro Hasegawa): “The Bank of Japan’s controversial march to the top of shareholder rankings in the world’s third-largest equity market is picking up pace. Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year… BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy.”

August 15 – Reuters (Leika Kihara): “The Bank of Japan's policy review could put up for debate its target for expanding base money through massive asset purchases, sources say, but the challenge would be to avoid spooking bond markets… The BOJ's announcement last month of a thorough review of its policy and its effects triggered a sharp bond sell-off as investors feared the central bank, wary of its dwindling policy tools, might lean toward reducing its government bond purchases. It is currently buying roughly 110-120 trillion yen in bonds each year to meet its pledge to expand base money… by an annual 80 trillion yen ($790bn). But after initial successes in the asset-buying program, which is aimed at ending two decades of deflationary pressure, prices are falling again.”

August 16 – Nikkei AR: “Tuesday marked six months since the Bank of Japan introduced negative interest rates, and the effects and drawbacks of the unusual step have come to the fore. The policy has yet to produce falls in the yen's value, arousing concern about adverse effects on earnings at financial institutions… It thus remains halfway to its target of stimulating the real economy to push up prices. Negative interest rates ‘will help the [Japanese] economy expand by stimulating investment and consumption,’ BOJ Gov. Haruhiko Kuroda said… ‘Together with an increase in inflation expectations, the rate of price growth will move toward 2%,’ he said.”

August 15 – Reuters (Leika Kihara and Tetsushi Kajimoto): “Japan's economic growth ground to a halt in April-June as weak exports and shaky domestic demand prompted companies to cut spending… The weak reading underscores the challenges policymakers face in ending two decades of crippling deflation, as an initial boost from Abe's stimulus programs, dubbed ‘Abenomics’, appears to be quickly fading. The world's third-largest economy expanded by an annualized 0.2% in the second quarter, less than the 0.7% increase markets had expected and a sharp slowdown from a revised 2.0% increase in January-March…”

August 17 – Bloomberg (Connor Cislo): “Japan’s exports declined the most since 2009, with shipments down for a 10th consecutive month. The continued drop highlights the difficulty of kick-starting growth and pulling Japan’s economy out of the doldrums. Overseas shipments fell 14% in July from a year earlier… Imports dropped 24.7%, leaving a trade surplus of 513.5 billion yen ($5.2bn).”

EM Watch:

August 18 – Bloomberg (Marton Eder): “The rout in Ukrainian assets worsened, with the nation’s restructured bonds heading for their worst week since May, on concern a flare-up in fighting between government troops and separatists in the country’s east may be a precursor to a full-blown conflict. The yield on the government’s $1.7 billion Eurobond due 2019 rose 15 bps to 8.51%..., bringing the increase this week to 44 bps. The hryvnia currency slumped toward to the weakest level in three months…”

August 18 – Bloomberg (Ye Xie): “A 40% increase in the amount of corporate debt coming due in developing nations over the next three years is creating a potential default risk if investors start pulling money out of emerging markets, according to the Bank for International Settlements. About $340 billion of debt is maturing between this year and 2018… The total payments due each year during the period is equivalent to the net bond sales by non-financial companies in developing nations in 2015, it said. ‘Given the steep repayment schedule that lies ahead, the refinancing capacity of highly leveraged EME companies is likely to be tested soon, especially if the rise of the U.S. dollar continues,’ economists led by Nikola Tarashev wrote… Debt sold by non-financial companies in developing nations increased to 110% of their gross domestic product by 2015, up from less than 60% in 2006, BIS said…”

August 16 – Bloomberg (Ye Xie and Natasha Doff): “Central banks in developing economies are taking advantage of the biggest rally in their currencies since 2010. Led by Turkey and Thailand, they’re using stronger exchange rates to build up foreign reserves for the first time in two years, replenishing shortfalls created as they attempted to prop up their currencies during recent routs… International reserves have grown by $154 billion, or 1.4%, since the end of March to $11 trillion… Turkey’s cash coffer expanded the most during the period, increasing more than 6%. Thailand’s currency pile rose 5.5%, while Indonesia’s climbed 3.6%”

Leveraged Speculator Watch:

August 16 – Wall Street Journal (Laurence Fletcher and Gregory Zuckerman): “A growing exodus from hedge funds extended to two of the biggest names in the industry Tuesday, Tudor Investment Corp. and Brevan Howard, as disenchanted investors increasingly shun what was once the hottest place to put money. The funds’ problem is clear: They just aren’t performing. Hedge funds and actively managed mutual funds have been underperforming since financial markets began their rebound in early 2009. The average hedge fund is up 3% this year through the end of July, according to… HFR Inc., less than half the S&P 500’s rise… Funds in the $2.9 trillion hedge-fund sector have now experienced three consecutive quarters of withdrawals for the first time since 2009, according to HFR.”

August 16 – Bloomberg (Lu Wang): “The steady drumbeat of gains that has lifted the S&P 500 Index in six of the last seven weeks is making life difficult for bears. Hedge funds that aim to profit from long and short bets have raised net equity holdings in the past three months, with bullish positions now exceeding bearish ones by 22.7 percentage points. That’s higher than 97% of the time since Credit Suisse Group AG began tracking the data in 2009. Perhaps not coincidentally, marketwide readings of short interest just posted the biggest decline in four years, while shares of the most-hated companies led in the rally that just lifted the S&P 500 to another record Monday, its 10th since early July.”

August 15 – Wall Street Journal (Maria Armental): “Billionaire investor George Soros, who rose to fame and fortune by betting against the sterling in 1992, on Monday showed his latest hand: nearly doubling down on his bearish bet against the market. The 86-year-old’s fund disclosed in a regulatory filing it had increased its bet against the S&P 500…, reporting ‘put’ options on roughly 4 million shares as of June 30 in an exchange-traded fund that tracks the index. That’s up from ‘puts’ on 2.1 million shares as of March 31.”

August 16 – Bloomberg (Janet Lorin): “Following the lead of pensions, some U.S. endowments and foundations are souring on hedge funds. Hedge fund fees and lagging performance are cause for concern for nonprofit investors, who are reducing their allocation, according to a survey published Monday by NEPC, a Boston-based consulting firm with 118 endowment and foundation clients with assets of $57 billion… ‘The last several years have been difficult for the industry and investors are starting to look very closely at how hedge funds can work for them,’ Cathy Konicki, who oversees the company’s endowment and foundation business, said…”

Geopolitical Watch:

August 18 – Bloomberg (Daryna Krasnolutska Aliaksandr Kudrytski): “Ukraine isn’t ruling out a full-scale Russian invasion and may institute a military draft if the situation with its neighbor worsens, President Petro Poroshenko said… The confrontation between Ukrainian forces and the rebels in Ukraine’s eastern Donbas region has worsened, Poroshenko said… Putin vowed to respond with ‘serious measures.’ ‘The probability of escalation and conflict remains very significant,’ Poroshenko said… ‘We don’t rule out full-scale Russian invasion.’”

August 19 – Wall Street Journal (James Marson and Thomas Grove): “Russia is bolstering its military presence on its western border, sending tens of thousands of soldiers to newly built installations within easy striking distance of Ukraine. The moves, which come as Moscow ratchets up confrontation over the Black Sea peninsula of Crimea, are a centerpiece of a new military strategy the Kremlin says is meant to counter perceived threats from the North Atlantic Treaty Organization.”

August 13 – Bloomberg (Monami Yui): “The Japanese government has decided on a plan to develop land-to-sea missiles with a range of 300 kilometers (186 miles) to protect the nation’s isolated islands, including the Senkaku, the Yomiuri newspaper reported… China has been stepping up pressure on Japan over the disputed Senkaku Islands, which are called Diaoyu in Chinese. Hundreds of fishing boats and more than a dozen coastguard vessels have been spotted recently in the area, encroaching at times on what Japan sees as its territorial waters.”

August 17 – Bloomberg (Iain Marlow): “From the sandstone walls of the 17th-century Red Fort in India’s capital, Prime Minister Narendra Modi sent a warning shot this week to his counterparts in Islamabad and Beijing. Modi’s reference to disputed territories on Monday during his annual Independence Day speech -- his most high-profile appearance of the year -- signaled that India would become more aggressive in asserting its claims to Pakistan-controlled areas of Kashmir. The region is a key transit point in the $45 billion China-Pakistan Economic Corridor known as CPEC that will give Beijing access to the Arabian Sea through the port of Gwadar.”