Saturday, December 6, 2014

07/05/2013 Mispricing Risk *

U.S. bonds were crushed Friday on the back of stronger-than-expected payroll data. Long-bond yields jumped 21 bps to an almost 23-month high 3.71%. Ten-year yields rose 24 bps to 2.74% - the highest level since August 5, 2011. Benchmark MBS yields surged 30 bps during the session to a 23-month high 3.69%. The spread between 10-year Treasury yields and benchmark MBS widened six on Friday to a one-year high 95 bps. Notably, MBS yields were up 75 bps in 14 sessions and 140 bps since May 1st.

June 29 – Financial Times (Robin Wigglesworth, Michael Mackenzie and Josh Noble): “Central banks sold a record amount of US Treasury debt last week while bond funds suffered the biggest ever investor withdrawals as markets shuddered at the prospect of the US Federal Reserve ending its quantitative easing programme. Holdings of US Treasuries held at the Fed on behalf of official foreign institutions dropped a record $32.4bn to $2.93tn, eclipsing the prior mark of $24bn in August 2007. It was the third week of outflows in the past four. Private investors are also dumping fixed income. Bond funds tracked by EPFR Global, a data provider, saw total redemptions of $23.3bn in the week to June 26. US funds were the worst hit, with withdrawals totalling $10.6bn, but emerging market debt funds also saw record redemptions of $5.6bn.”

With unprecedented outflows from the bond complex coupled with notable global central bank selling, the Bubble in U.S. fixed income would appear in serious jeopardy. And while analysts and money managers will continue talk of a “fair value” range for Treasury securities, for the time being flow of funds analysis trumps valuation. Will foreign central banks continue reducing their enormous holdings of U.S. Treasury and Agency securities? How much leverage has accumulated throughout U.S. fixed income – especially in corporates, MBS and municipal debt? How long until some hedge funds are in trouble? Redemptions coming? Derivative problems? Will investors continue their retreat from U.S. fixed income mutual funds and ETFs?

A few data points are in order. Since the end of 2007, Rest of World (ROW from the Fed’s Z.1) Treasury holdings have jumped $3.325 TN, or 140%, to $5.701 TN. Over this period, “Official” central bank Treasury holdings were up $2.233 TN, or 134%, to $4.059 TN. I have previously highlighted the extraordinary expansion of central bank International Reserve Assets (as accumulated by Bloomberg). Since the end of 2007, International Reserves have inflated $5.061 TN, or 84%, to $11.122 TN. The Fed’s $85bn monthly QE suddenly doesn’t seem as powerful.

Ongoing selling by foreign central banks could be driven by two key dynamics. First, one would think (thinly capitalized) central banks would seek to contain losses on their outsized bond holdings. Keep in mind that the higher bond yields jump, the more individual central banks will need to monitor the scope of losses and the degree of capital impairment. Second, “developing” central banks will most likely be forced to sell Treasuries and other bond holdings to fund investor and “hot money” flows exiting their markets and economies.

A prominent bullish view has held that emerging market (EM) central banks built up robust international reserve positions (including large quantities of Treasuries) that would be available to backstop their systems in the event of global market turbulence. Well, a surge of outflows (and currency market intervention) coupled with a spike in yields is now in the process of depleting reserves much more quickly than anyone had anticipated. There is a clear possibility that we’re early in what could be unprecedented flows seeking to exit the faltering EMs. Recalling the 1997 SE Asian experience, it was a case of “those who panicked first panicked best.” The more reserve positions were depleted, the faster “hot money” ran to the rapidly closing exits.

As a rough guide, the pain and dislocation associated with a bursting Bubble are commensurate with the degree of excess during the preceding boom (traditional “Austrian”-type analysis). And I’ll be the first to admit this is not the first occasion I’ve believed the U.S./global bond Bubble was in trouble. Timing a Bubble’s demise is always a challenge (at best) – especially in an environment of epic central bank liquidity support. But this time has a different feel to it.

Importantly, the longer the inevitable day of reckoning is delayed the worse the consequences. Years of aggressive market intervention ensured a most protracted period of unprecedented excess – excesses that encompassed virtually all markets and all risk categories. Perhaps Federal Reserve policymaking ensured that the greatest Bubble excess and market distortions materialized in perceived low-risk (fixed income and equities) strategies.

“The danger of mispricing risk is that there is no way out without investors taking losses. And the longer the process continues, the bigger those losses could be. That’s why the Fed should start tapering this summer before financial market distortions become even more damaging.” Martin Feldstein, Wall Street Journal op-ed, July 2, 2013

I appreciate Mr. Feldstein’s focus on “the danger of mispricing risk” – I only wish this would have been part of the monetary policy debate starting a few years back (before the damage had been done). I would argue that never has so much mispriced debt been issued on a global basis. Moreover, never have inflated bond prices – artificially low borrowing costs – had such a profound impact on securities and asset pricing around the world. Never have risk perceptions and market risk premiums in general been so distorted by aggressive central bank market intervention.

The Mispricing of Risk implies market re-pricing risk. And the greater the scope of mispricing – in the volume of securities issuance, price level distortions and risk misperceptions – the greater the scope of Latent Bubble Market Risks. Mispricing also implies wealth redistribution – and this has traditionally been from the less sophisticated to the more sophisticated. Actually, when enormous quantities of non-productive debt are issued at artificially high prices there is initially a perceived increase in wealth (more debt instruments at higher prices). This debt (“bull market”) expansion coupled with perceived wealth creation spurs spending, corporate profits and higher equities and asset prices. But when the Bubble begins to falter – with re-pricing, market losses, risk aversion and tightened financial conditions – the downside of the Credit cycle commences.

I believe we have commenced a “repricing” process that will unfold over weeks, months and years – with vast ramifications and unknown consequences. With this in mind, let’s at least contemplate a few near-term issues.

Various reports claim the strong market reaction to Bernanke’s policy statement caught the Fed by surprise. Despite attempts by various officials to calm the markets, bond yields have just kept rising. As such, it’s now reasonable to suggest the Fed did not anticipate being on the wrong side of a spike in market yields. How much higher do Treasury bond and MBS yields need to rise before the Fed is held to account - and forced to explain - the large losses suffered in its $3.4 TN (and ballooning) portfolio? At this point, the Federal Reserve is akin to a novice trader that keeps adding to a losing position.

Suddenly, with the potential bursting of the global bond Bubble, there’s a litany of important issues that come to the fore. Could mounting losses on its holdings play a role in the Fed’s “tapering” timeline? Keep in mind the market perception that any jump in Treasury yields would likely ensure the Fed’s ongoing QE support. Now much too complacent? What if the markets begin fretting that escalating losses on Fed holdings might become part of the debate – and provoke a less cavalier approach by our central bank – and others - in managing risk? In a way, Fed critics finally have a concrete issue to build their case around.

Market players have surely been stunned by how poorly the bond market has traded – especially with the Fed providing $85bn of monthly support. Assuming the Fed cannot keep purchasing Treasuries and MBS forever, perhaps there is now added impetus for investors, hedge funds, foreign central banks, sovereign wealth funds and others to push liquidations forward. If money managers now realize they are holding higher risk exposures than desired, it might be advantageous to make necessary portfolio adjustments prior to the Fed winding down its QE operations. If foreign central banks have begun a process of reducing bond holdings, does this accelerate hedge fund selling? Are the sophisticated players now anxious to reduce holdings before the next wave of bond fund redemptions and ETF-related selling? How does it work when the “Masters of the Universe” – having accumulated Trillions of assets under management by adeptly playing a most-protracted market Bubble – find themselves on the wrong side of rapidly moving markets?

I am intimately familiar with the bull story for U.S. equities. Corporate profits are strong and stock valuations are attractive. Bond yields are rising because of the underlying strength of the U.S. economy. The “great rotation.” The U.S. economy remains the most vibrant in the world. U.S. equities are the preferred asset class for the current environment.

Well, the U.S. stock market is an integral facet of the greater Credit Bubble. Massive federal deficits, ultra-loose financial conditions and artificially low borrowing costs have been instrumental in inflating profits. Mispriced debt and meager risk premiums have been instrumental in myriad financial engineering mechanisms that have inflated corporate earnings and stock prices. Abundant cheap finance has fueled a powerful global mergers and acquisition boom. If the bond Bubble is indeed bursting, the markets are only in the earliest phase of re-pricing risks and asset prices.

In recent CBBs I have stated that, at least in terms of systemic stability, it would be preferable for some air to begin coming out of U.S. stock prices. Fine, but this would be rather UnBubble-like. With fixed income in some serious trouble, the equity market game becomes all the more critical for all the players. And perhaps this is an important “Mispricing Risk” associated with the Fed’s ongoing QE: investors that have been hit with unexpected bond losses now increase their bets on inflated stock prices. After leading unsuspecting savers into the wild world of mispriced fixed income instruments, the Fed will apparently ensure the public becomes overly exposed to unappreciated risks in the U.S. equity market.

As noted in my “Issues 2013” CBB from early January: A market Bubble implies bipolar outcome possibilities. Either the entrenched Bubble bursts or it becomes an issue of “how crazy do things get?” If the U.S. stock market has evolved into the speculative Bubble of choice, there are a couple things the Fed might want to contemplate. First, QE may now work to spur similar late-cycle speculative excesses that are now coming home to roost throughout the fixed income universe. Second, inflating stock prices may work to pull additional liquidity away from an already liquidity-challenged bond market. It is, after all, the nature of liquidity to seek the inflating asset market.

For the Week:

The S&P500 jumped 1.6% (up 14.4% y-t-d), and the Dow rose 1.5% (up 15.5%). The Morgan Stanley Consumer index gained 1.4% (up 19.1%), while the Utilities dropped 1.9% (up 5.3%). The Banks surged 4.1% (up 24.7%), and the Broker/Dealers jumped 4.2% (up 38.6%). The Morgan Stanley Cyclicals were up 1.9% (up 14.9%), and the Transports gained 1.9% (up 18.5%). The broader market was notably strong. The S&P 400 MidCaps jumped 2.2% (up 16.2%), and the small cap Russell 2000 surged 2.9% (up 18.4%). The Nasdaq100 rose 1.8% (up 11.4%), and the Morgan Stanley High Tech index increased 1.6% (up 10.4%). The Semiconductors gained 1.6% (up 24.0%). The InteractiveWeek Internet index rose 1.7% (up 17.3%). The Biotechs surged 4.1% (up 31.7%). Although bullion was down only $11, the HUI gold index fell another 5.3% (down 51.4%).

One-month Treasury bill rates ended the week at three bps and three-month bill rates closed at four bps. Two-year government yields increased four bps to 0.40%. Five-year T-note yields ended the week up 22 bps to 1.61%. Ten-year yields surged 25 bps to 2.74%. Long bond yields jumped 21 bps to 3.71%. Benchmark Fannie MBS yields surged 37 bps to a 23-month high 3.69%. The spread between benchmark MBS and 10-year Treasury yields widened 12 to a one-year high 95 bps. The implied yield on December 2014 eurodollar futures jumped 11.5 bps to 0.79%. The two-year dollar swap spread jumped 3 to 19 bps, and the 10-year swap spread gained 6 to 26 bps. Corporate bond spreads mostly narrowed. An index of investment grade bond risk was little changed at 87 bps. An index of junk bond risk declined 3 to 432 bps. An index of emerging market debt risk declined 20 to 321 bps.

Debt issuance slowed to a crawl. I saw no investment grade issues.

Outflows from junk bond funds and ETFs jumped to $4.63bn (from Lipper). I saw no junk issues this week.

Convertible debt issuers included Healthways $125 million.

International dollar debt issuers included Israel Electric $1.4bn, KFW $1.0bn, Nigeria $1.0bn, Mona Lisa RE $150 million and Tradewynd RE $125 million.

Italian 10-yr yields fell 12 bps to 4.42% (down 8bps y-t-d). Spain's 10-year yields dropped 11 bps to 4.64% (down 63bps). German bund yields slipped a basis point to 1.72% (up 40bps), and French yields declined 5 bps to 2.29% (up 29bps). The French to German 10-year bond spread narrowed four bps to 57 bps. Ten-year Portuguese yields traded above 8% before ending the week 59 bps higher at 6.91% (up 16bps). Greek 10-year note yields jumped 32 bps to 10.94% (up 47bps). U.K. 10-year gilt yields rose 4 bps to 2.48% (up 66bps).

Japan's Nikkei equities index surged another 4.6% (up 37.7% y-t-d). Japanese 10-year "JGB" yields ended the week up a basis point to 0.85% (up 7bps). The German DAX equities index fell 1.9% for the week (up 2.5%). Spain's IBEX 35 equities index rallied 1.4% (down 3.7%). Italy's FTSE MIB was up 1.9% (down 4.6%). Emerging markets were mixed. Brazil's Bovespa index dropped another 4.7% (down 25.8%), while Mexico's Bolsa was unchanged (down 7.1%). South Korea's Kospi index dropped 1.6% (down 8.2%). India’s Sensex equities index added 0.5% (up 0.4%). China’s Shanghai Exchange rallied 1.4% (down 11.5%).

Freddie Mac 30-year fixed mortgage rates fell 17 bps to 4.29%, with an nine-week gain of 94 bps (up 67bps y-o-y). Fifteen-year fixed rates were down 11 bps to 3.39% (up 50bps). One-year ARM rates were unchanged at 2.66% (down 2bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 2 bps to 4.68% (up 42bps).

Federal Reserve Credit increased $2.0bn to a record $3.445 TN. Fed Credit expanded $659bn during the past 39 weeks. Over the past year, Fed Credit surged $599bn, or 21.1%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $653bn y-o-y, or 6.2%, to $11.122 TN. Over two years, reserves were $1.244 TN higher, for 13% growth.

M2 (narrow) "money" supply fell $22.1bn to $10.572 TN. "Narrow money" expanded 6.3% ($624bn) over the past year. For the week, Currency increased $3.7bn. Total Checkable deposits gained $11.4bn, while Savings Deposits dropped $38bn. Small Time Deposits slipped $3.1bn. Retail Money Funds gained $3.9bn.

Money market fund assets added $1.7bn to $2.596 TN. Money Fund assets were up $63bn from a year ago, or 2.5%.

Total Commercial Paper outstanding declined $4.1bn this week to $1.036 TN. CP has declined $30bn y-t-d, while having expanded $63bn, or 6.5%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index jumped 1.6% to a three-year high 84.45 (up 5.9% y-t-d). For the week on the downside, the South African rand declined 3.2%, the Norwegian krone 2.9%, the British pound 2.1%, the Japanese yen 2.0%, the Swiss franc 2.0%, the Swedish krona 1.5%, the Danish krone 1.4%, the euro 1.4%, the Mexican peso 1.1%, the Singapore dollar 1.1%, the Brazilian real 0.9%, the Australian dollar 0.8%, the Canadian dollar 0.6%, the New Zealand dollar 0.4% and the Taiwanese dollar 0.2%.

Commodities Watch:

July 5 – Bloomberg (Mark Shenk): “West Texas Intermediate crude rose to a 14-month high after the U.S. reported adding more jobs than forecast in June, boosting economic optimism, and on concern that unrest in Egypt will escalate. Futures capped the biggest weekly gain in more than two years…”

The CRB index rallied 1.9% this week (down 4.8% y-t-d). The Goldman Sachs Commodities Index jumped 3.7% (down 1.9%). Spot Gold declined 0.9% to $1,223 (down 27%). Silver dropped 3.8% to $18.74 (down 38%). September Crude surged $6.66 to $103.22. (up 12%). September Gasoline jumped 6.7% (up 5%), and September Natural Gas rallied 1.5% (up 8%). September Copper was little changed (down 16%). July Wheat increased 1.2% (down 16%), and July Corn gained 0.8% (down 2%).

U.S. Bubble Economy Watch:

July 5 – Bloomberg (Michelle Kaske): “The steepest losses in almost three years for U.S. municipal debt may wind up helping bondholders. Issuers jolted by rising yields are scaling back sales to the slowest pace since 2011, helping limit declines in the $3.7 trillion market. From California to New York, localities may postpone or reduce borrowings in the second half of 2013 after benchmark 10-year yields reached 2.96% in June, the highest level since April 2011…”

July 2 – Bloomberg (David M. Levitt): “Manhattan office rents rose to the highest in more than four years, helped by small firms signing pricier leases, Cushman & Wakefield Inc. reported. Asking rents averaged $61.81 a square foot at the end of June, up 5% from a year earlier… There have been 36 deals for more than $100 a square foot this year, compared with 35 for all of 2012. Smaller financial companies and foreign banks were behind the surge, said Melissa Bazar, an executive director at Cushman. ‘The boutique guys are making money again. There’s more confidence with the financial boutique firms,’ she said…”

Central Bank Watch:

July 5 – New York Times (Jack Ewing and Julia Werdigier): “Answering critics who said they were running out of ways to promote growth and lending, the European Central Bank and the Bank of England on Thursday did something neither had done before, committing themselves to keeping interest rates low indefinitely. The bid to reassure investors brought the two central banks into closer alignment with the Federal Reserve, which, under Chairman Ben S. Bernanke, has adopted a policy of becoming more open about its intentions… Mario Draghi, the president of the European Central Bank, said… that crucial interest rates would ‘remain at present or lower levels for an extended period of time.’ Until Thursday, the central bank had steadfastly refused to pin itself down on future policy… Only hours earlier, Mark J. Carney, who became governor of the Bank of England on Monday, made a similar break with tradition. The British central bank said… that any expectations that interest rates would rise soon from their current record low level were misguided.”

U.S. Fixed Income Bubble Watch:

June 29 – Financial Times (Robin Wigglesworth, Michael Mackenzie and Josh Noble): “Central banks sold a record amount of US Treasury debt last week while bond funds suffered the biggest ever investor withdrawals… Holdings of US Treasuries held at the Fed on behalf of official foreign institutions dropped a record $32.4bn to $2.93tn, eclipsing the prior mark of $24bn in August 2007. It was the third week of outflows in the past four. Private investors are also dumping fixed income. Bond funds tracked by EPFR Global… saw total redemptions of $23.3bn in the week to June 26. US funds were the worst hit, with withdrawals totalling $10.6bn, but emerging market debt funds also saw record redemptions of $5.6bn.”

July 4 – Bloomberg (Margaret Collins and Charles Stein): “Investors have pulled about $60 billion from U.S. bond funds since Federal Reserve Chairman Ben S. Bernanke rattled markets by outlining his plan to end the central bank’s unprecedented asset purchases… Bond funds had $28.1 billion in net redemptions in the week ended June 26, the… Investment Company Institute said… Retail investors, who fled volatile stock markets to pour about $1 trillion into the perceived safety of bond funds since the beginning of 2009, reversed that pattern in the past month… Casey, Quirk & Associates LLC, a consulting firm, in May warned that money managers that rely on bonds could face a difficult future as investors shift $1 trillion away from traditional fixed-income strategies.”

July 3 – Bloomberg (Margaret Collins): “Fixed-income mutual funds in the U.S. had their biggest weekly redemptions in more than six years as investors fled bonds… Bond funds had $28.1 billion in net redemptions in the period ended June 26, the… Investment Company Institute said… That’s the biggest withdrawal since the trade group started tracking weekly numbers in January of 2007. Taxable bond funds had redemptions of $20.4 billion and municipal bond funds saw $7.68 billion pulled… Money flowing into equity funds slowed, as the category attracted an estimated $169 million for the week, compared with $1.98 billion in the prior period, according to the ICI.”

July 5 – Reuters: “Investors in funds based in the United States pulled a record amount of cash out of high-yield junk bond funds in the latest week…, data from Thomson Reuters' Lipper service showed… Mutual funds and exchange-traded funds that hold riskier high-yield bonds had $4.63 billion in outflows in the week ended June 5, the most since records began in 1992. All taxable bond funds, meanwhile, had outflows of $9.1 billion, the most since October 2008.”

July 3 – Financial Times (Vivianne Rodrigues): “The second half of the year has started with a whimper for the US corporate debt market as a sell-off in bond prices and record outflows from funds investing in fixed-income assets have spooked borrowers. In contrast to the typically vibrant activity in the first few days of a new quarter, issuance of dollar-denominated bonds has dried up. No corporate debt was offered on Monday and no deal was scheduled for Tuesday… In comparison, the first two trading days of the past quarter saw sales of new high-grade and high-yield bonds in the US reaching $8bn. Companies were choosing to postpone sales until markets stabilised, analysts said, rather than see their newly-issued debt sharply decline in secondary markets.”

July 2 – Bloomberg (Sridhar Natarajan): “Junk-rated companies agreed to boost interest rates on more U.S. loans than any time since at least 2011, as lenders extracted more compensation with prices of the floating-rate debt tumbling from a six-year high. Drug distributor Valeant Pharmaceuticals… to …Water Pik Inc. were among companies that sweetened terms on $17.7 billion of loans in June, accounting for 43% of total deals, according to Standard & Poor’s… That’s 10 times greater than in May and the highest in data going back to January 2011. Twenty issuers failed to get loan financing, versus 22 for the first five months of the year, as the average price of the senior-ranking debt fell by the most since May 2012.”

July 5 – Bloomberg (Jody Shenn and Dan Kruger): “Real estate investment trusts that buy mortgage debt slumped after a better-than-forecast employment report stoked speculation the Federal Reserve will begin to reduce the size of its asset purchases. A Bloomberg index of shares in the REITs tumbled 3.9%..., the largest drop since October 2011.”

Bursting EM Bubble Watch:

July 2 – Wall Street Journal (Alex Frangos and Patrick McGroarty): “Countries from Turkey to Brazil to China are getting hit by a brutal combination of events, as economies slow, investors pull out cash, commodity prices tumble and protesters take to the streets… An outflow of funds from so-called emerging markets has picked up pace over the past month, triggered by expectations among some investors that the days of easy money globally are coming to an end… It is a stark turnaround for these countries, whose growth helped offset weakness in the U.S. and Europe during the financial crisis. Seeking better returns, investors poured money into emerging-market economies in the past four years. Private capital flows into emerging markets from 2009 to 2012 were $4.2 trillion, according to the Institute of International Finance… While the amount of money leaving these markets hasn't reached levels seen during the 2008 crisis, the outflows are expected to continue as sentiment sours further."

July 2 – Bloomberg (Fion Li): “The cost of borrowing in Hong Kong’s Dim Sum bond market jumped the most on record in June, climbing to an all-time high as China’s worst cash squeeze in at least a decade spurred concern an economic slowdown will worsen. The average yield on the securities surged 153 bps, or 1.53 percentage points, to 5.06%, the most since… Index was introduced at the start of 2011… ‘The outbreak of one of the worst liquidity crunches in China’s interbank market has spilled over to offshore,’ said Becky Liu, a Hong Kong-based rates strategist at Standard Chartered Plc, the second-largest Dim Sum bond underwriter. ‘A sharp rise in the cost of funding on the back of tight liquidity has pushed up bond yields.’”

July 2 – Bloomberg (Boris Korby and Julia Leite): “The longest overseas drought for bond sales in three years is causing a backlog among Brazilian companies trying to obtain financing at a time when borrowing costs have soared to a four-year high. While no company has priced bonds abroad since May 15, Banco BTG Pactual SA, the biggest underwriter this year of Brazilian corporate debt by number of mandates, said it has as many as four first-time issuers that want to sell notes… The biggest emerging debt market has been shuttered as yields on debt from companies based in Latin America’s largest country surged to 7.11% last week, the highest since July 2009…”

Global Bubble Watch:

July 5 – Bloomberg (Kelly Bit and Saijel Kishan): “Hedge funds posted their biggest monthly loss in more than a year after signs that the U.S. Federal Reserve may scale back its unprecedented stimulus triggered a selloff across global markets. Hedge funds lost 1.4% in June, the most since May 2012, paring the gain in the first six months of 2013 to 1.4%... Hedge funds that use computer models to decide when to buy and sell securities slumped 6.3% last month, extending losses for the year to 7.1%, and emerging-market stock funds declined 6.6%, leaving them down 9.7% in 2013.”

July 1 – Bloomberg (Victoria Stilwell): “Investors are finding no shelter from the worst corporate-bond losses in almost five years as debt plunges for the most creditworthy to the riskiest borrowers in every industry worldwide. Company debentures erased 2.2% the last three months, the worst quarterly decline since a 5.2% plunge in the period ended September 2008… All 16 industries in the index lost during the period, from a 0.7% decline for the debt of automakers to a 3.5% drop in energy-company bonds… ‘There has been no safe haven,’ said Jeroen van den Broek, head of credit strategy for ING Bank… ‘We’re seeing a complete focus on rates and everything surrounding Bernanke.’”

July 3 – Bloomberg (Alex Morales): “The planet has warmed faster since the turn of the century than ever recorded, almost doubling the pace of sea-level increase and causing a 20-fold jump in heat- related deaths, the United Nations said. The decade through 2010 was the warmest for both hemispheres and for land and sea, the UN’s World Meteorological Organization said… Almost 94% of countries logged their warmest 10 years on record, it said. ‘The decadal rate of increase between 1991-2000 and 2001-2010 was unprecedented,’ WMO Secretary-General Michel Jarraud said… ‘Rising concentrations of heat- trapping greenhouse gases are changing our climate, with far- reaching implications for our environment and our oceans.’”

Global Credit Watch:

July 3 – Bloomberg (Laura Marcinek and Donal Griffin): “Barclays Plc, Deutsche Bank AG and Credit Suisse Group AG had their credit ratings lowered by Standard & Poor’s as new rules and ‘uncertain market conditions’ threaten their business… The four European lenders are among the most exposed to proposed rules that could reduce revenue from trading and investment banking operations, the ratings firm said. ‘We consider that these banks’ debtholders face heightened credit risk owing to the industry’s tighter regulation, fragile global markets, stagnant European economies and rising litigation risk stemming from the financial crisis,’ S&P said. ‘A large number of global regulatory initiatives are increasingly demanding for capital market operations.’”

July 2 – Bloomberg: “Chinese banks’ valuations are close to their lowest on record as the nation’s interbank funding crisis exacerbated investors’ concern that earnings growth will stall and defaults may surge as the economy slows. Industrial & Commercial Bank of China Ltd., the world’s largest lender by market value, ended Hong Kong trading last week at 5.3 times estimated earnings… Investors’ disenchantment with Chinese banks reflects concern that a crackdown on shadow banking and measures to direct new credit away from repaying old loans and toward boosting economic productivity will undermine earnings and trigger a surge of bad loans… ‘The golden era of banking is over,’ said Mike Werner, an analyst at Sanford C. Bernstein… ‘Investors have to recognize that more market discipline is going to be imposed upon the banks.’”

China Bubble Watch:

July 2 – Wall Street Journal (Lingling Wei and Bob Davis): “A rare peek into the actions of China's leaders in a month when a Chinese cash crunch spooked global investors shows a leadership falling short in its struggle to redirect China's economy and also faltering in its efforts to communicate its intentions to markets. The People's Bank of China instigated the cash shortages that catapulted Chinese interest rates to nosebleed highs during the past two weeks because the central bank felt it had no alternative amid what it saw as out-of-control credit growth, according to an internal document… Since 2009, Chinese domestic debt has been growing so rapidly it approximates credit bubbles in the U.S., Europe, Japan and Korea that precipitated recessions. In the spring of 2013, the central bank and banking regulators tightened regulations but to little avail. For the first five months of 2013, domestic credit, called total social financing in China, rose 52% from 2012. According to a… summary of a PBOC internal meeting on June 19, the central bank was especially concerned that in the first 10 days of June, Chinese banks increased lending by 1 trillion yuan ($163bn)—an amount the central bank said ‘had never been seen in history.’ About 70% of that amount consisted of short-term notes that mostly don't show up on banks' balance sheets—making it easier for the banks to get around regulatory lending restrictions-—rather than lending the money to promising companies or projects.”

July 5 – Reuters: “A senior Chinese official said on Friday that the government did not know precisely know how much debt local governments had built up and warned that it could be more than previous estimates. Estimates of local government debt range from Standard Chartered’s 15% of the country’s GDP at end-2012 to Credit Suisse's 36%. Fitch put the figure at 25% when it downgraded China's sovereign debt rating in April. Vice Finance Minister Zhu Guangyao said China had not released official figures since a 2010 auditing report that put local government debt at 10.7 trillion yuan. ‘Currently, [according to] nationwide surveys, I think this number will rise,’ Zhu said, defending the debt as mostly geared toward fuelling infrastructure projects. ‘A very important task for this administration is to clearly determine the level of local financing platforms,’ Zhu told reporters…”

July 5 – Bloomberg: “A Chinese vice finance minister warned the nation must be on ‘high alert’ to the dangers of rising debt in companies set up by local governments to fund investment projects. ‘Prominent risks are not only in the shadow-banking area but also in local government financing vehicles, and we do need to be on high alert,’ Zhu Guangyao said… At the same time, companies are mainly investing in infrastructure projects with relatively good operations and repayment abilities, he said.”

July 1 – Bloomberg (Kristine Aquino and Rachel Evans): “China’s top-rated dollar-denominated bonds are losing more than any other BRIC nation as a record cash crunch threatens to slow economic growth and strain corporate finances. Chinese notes, the only gainers in March as debt from Brazil, Russia and India slumped, lost 6.1% last quarter, the most in Bank of America Merrill Lynch indexes going back to 1999… Company debt tumbled as overnight borrowing rates jumped to the highest level since at least 2003… The surge fueled concerns about nonpayment as People’s Bank of China Governor Zhou Xiaochuan seeks to rein in risky lending while reviving the world’s second-largest economy. The premium investors demand to hold Chinese dollar debt surged to a 10-month high of 225 bps on June 26…”

July 1 – Bloomberg: “China’s new home prices jumped in June by the most since they reversed declines in December, defying the government’s tightened property curbs as increased sales supported developers’ efforts to avoid price cuts. Prices surged 7.4% last month from a year earlier to 10,258 yuan ($1,671) per square meter (10.76 square feet), SouFun Holdings Ltd., the nation’s biggest real estate website owner, said… The Chinese government is facing a dilemma to cool the property market while sustaining growth in the world’s second- largest economy…”

July 3 – Bloomberg: “Zhou Xiaochuan earned distinction as the G-20’s longest-serving central bank chief helping keep China out of a financial crisis the past decade. In the wake of June’s record liquidity squeeze, his legacy hangs in the balance. Zhou and his colleagues at the People’s Bank of China left investors, bankers and market participants in the dark for four days after the overnight lending rate between banks hit a record 11.7% June 20 before releasing a week-old statement… The communications gap fanned speculation over the central bank’s intentions, denting confidence in an institution that steered China through the Asian and global financial crises. Zhou’s challenge now, three months into an unprecedented third term as governor, is to implement the curbing of speculative credit that Premier Li Keqiang’s government wants, without further market disruptions that sow confusion. ‘Zhou’s reputation is still intact at the moment but it may suffer because of this if nothing fundamentally changes,’ said Fraser Howie… co-author of ‘Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.’ ‘They must now follow through and dramatically reduce the dependence on credit.’”

July 4 – Bloomberg: “China’s crackdown on shadow banking is backfiring as a plunge in stocks prompts individual investors to pump increasing amounts of cash into wealth management products that offer yields more than double the deposit rate. A record 1,137 of the investment plans were sold by about 70 banks in the last two weeks, almost 50% more than the similar period ended June 14, according to Benefit Wealth… China Minsheng Banking Corp., the nation’s first privately owned lender, last week sold a 35-day product with an annualized yield of 7%.”

July 2 – Bloomberg: “Chinese landlords are forgoing rent and paying to outfit stores for mass-market fashion brands including Zara and H&M, a bid to blunt the impact of a boom in shopping-mall construction that threatens to push up vacancies… Chinese developers built more malls and expanded into smaller cities as consumer spending and incomes grew, elevating China’s economy to the largest in the world after the U.S. Half of the 32 million square meters (344 million square feet) of shopping centers under construction around the world are in China, according to CBRE Group Inc. About 21 million square meters of retail space is expected to be completed by next year, a 38% increase in supply, according to…Cushman…”

July 5 – Bloomberg: “China suspended the release of industry-specific data from a monthly survey of manufacturing purchasing managers, with an official saying there’s limited time to analyze the large volume of responses… The disappearance of data on industries including steel adds to issues hampering analysis of the world’s second-biggest economy, after fake invoices inflated trade numbers this year.”

July 5 – Bloomberg (Stephanie Tong and Jasmine Wang): “China Rongsheng Heavy Industries Group Holdings Ltd., the nation’s biggest shipyard outside state control, sought government financial support as orders plunged, sending its shares to a record low.”

Japan Bubble Watch:

July 5 – Bloomberg (Candice Zachariahs ang): “Record sales of foreign bonds by Japanese investors are signaling a bottom for the yen to traders who are trimming bets on further declines in the year’s worst- performing major currency. Investors in the Asian nation offloaded 10.6 trillion yen ($106bn) of foreign debt in the first half of 2013, the most since at least 2001… Futures traders reduced bets on a yen drop versus the dollar to the least in four months last week and options protecting against gains in the Japanese currency are trading at a premium.”

July 5 – Bloomberg (Janet Ong): “The Bank of Japan is worried it still may not be strong enough to withstand sudden shocks from overseas, the Wall Street Journal reported, citing unidentified people familiar with the BOJ’s thinking. Concern over whether China can achieve a soft landing likely put it near the top of the agenda of next week’s BOJ policy- board meeting, the people said…”

Asian Bubble Watch:

July 5 – Bloomberg (Simon Kennedy): “China, Hong Kong and India are in a ‘high-risk danger zone’ because their monetary policies have stayed too loose over the past four years, according to Nomura Holdings Inc. A June 28 report by the bank’s economists and strategists showed the average ratio of domestic private debt to gross domestic product across Asia had ballooned to 167% in 2012 and most of the region’s property markets are ‘frothy.’ The debt ratio has increased by over 50 percentage points in Hong Kong and Singapore and between 30 and 40 points in Malaysia, South Korea, China and Thailand.”

Latin America Watch:

July 5 – Bloomberg (Rodrigo Orihuela and Francisco Marcelino): "Brazilian billionaire Eike Batista cut output and jobs at one of his iron-ore mines to contain spending in the latest move to save his commodities empire.”

Europe Crisis Watch:

July 4 – Financial Times (Peter Wise in Lisbon and Joshua Chaffin): “A deepening political crisis in Portugal and Greece’s inability to push ahead with public sector job cuts sent bond yields rocketing, reigniting concerns about the breakdown of eurozone bailout programmes after months of relative calm in the bloc. The turbulence reverberated in the rest of the eurozone periphery. While Italy’s bond market was relatively calm, Spain’s 10-year bond yield rose 14 bps to 4.74%, and Greece’s comparable bond yield jumped 34 bps to 11.1%. Investors were also unnerved by another brewing showdown between Greece and its creditors after international lenders warned it that they would withhold an €8.1bn loan payment unless the government redoubled stalled efforts to gut a bloated public sector workforce.”

July 3 – Financial Times (Gene Frieda): “The newly agreed bank recovery and resolution directive swings Europe from one extreme – a system laden with implicit government guarantees that protected bank creditors from bearing losses – to the other. The regime creates a serious time inconsistency problem by requiring private bank creditors to cover any significant losses without first cleaning up legacy debt problems. Without comprehensive efforts to restructure corporate debt, clean up banks’ balance sheets and fortify the European Stability Mechanism, bail-in will leave Europe much more prone to old-fashioned bank runs than in the past.”

Portugal Watch:

July 3 – Bloomberg (David Goodman and Neal Armstrong): “Portugal’s bonds slumped, pushing 10- year yields above 8% for the first time since November, on concern the resignation of two ministers will derail the government’s attempts to implement austerity measures. Spanish and Italian securities fell for a second day after Portuguese Prime Minister Pedro Passos Coelho told voters from Lisbon last night he’s trying to hold his government together.”

Germany Watch:

July 5 – Bloomberg (Stefan Riecher): “German factory orders unexpectedly declined for a second month in May, signaling an uncertain recovery in Europe’s largest economy… Orders… dropped 1.3% from April, when they fell a revised 2.2%... Economists forecast a gain of 1.2%... Orders slid 2% from a year ago…"

Spain Watch:

July 3 – Financial Times (Tobias Buck): “Madrid’s search for a buyer for two of the banks it nationalised last year received a setback after Moody’s downgraded Catalunya Banc and NCG Banco – as well as Bankia – amid warnings that their credit profiles remained ‘very vulnerable’. Bankia, the biggest by far of the lenders that remain in the hands of the Spanish state, had its debt and deposit rating lowered by two notches to B1… All three lenders have a negative outlook, Moody’s said… The rating agency said: ‘Asset quality of all three banks remains weak both in absolute and in relative terms . . . Further credit deterioration is likely.’ It also warned that the lenders would struggle to restore profitability: ‘The banks’ ongoing balance-sheet deleveraging, low interest rates and sizeable non-earning assets have significantly diminished their capacity to generate recurring earnings.”