Monday, December 15, 2014

10/03/2014 The New Mediocre Neutral *

Bloomberg’s Tom Keene: “The ‘new mediocre,’ the new mediocrity that is out there. Color that for us. How is that different from Dr. El-Erian’s or Mr. Gross’s ‘new neutral’? What’s the distinction of your ‘new mediocre’?

IMF managing director Christine Lagarde: “The ‘new mediocre’ has three components… One is it still has the legacies of the crisis: high indebtedness both sovereign and corporate and household sometimes. It has high unemployment in many corners of the world. Those are the legacies. Then we are facing serious clouds on the horizon, and we have a lot of uncertainty. So if you combine the legacies, the clouds and the uncertainty, we have this horizon of the ‘new mediocre’ where we are revising potential growth.

Keene: “Well, the urgency that I heard in your speech today is almost on a calculus basis, a first or second derivative. There's an acceleration – an immediacy. We saw it in the stock market yesterday. Where I see it mostly is in declining commodity prices. When you speak to Olivier Blanchard and your economists, how concerned are they about what the markets are telling them about the ‘new mediocre’?

Lagarde: “We are watching the markets with a concern and with a lot of hesitation, because there is clearly a discrepancy between the buoyancy of the markets in many ways - I think forex is a little bit different - but the buoyancy of the markets, asset values at their highest ever. Volatility is very compressed and low. And then at the other end, we see a real economy where recovery is not really strong. We see areas of very fragile recovery. So there is that discrepancy between the two which is quite worrying.”


The past two years have seen unprecedented monetary measures from the world’s major central banks that went way beyond even the 2008/09 crisis response to collapsing financial markets. Draghi’s “do whatever it takes” coupled with Fed and BOJ open-ended “money” printing has placed an exclamation mark on an ongoing historic experiment in global monetary management. Now, with securities markets booming in the face of stalling growth, heightened financial instability and fragility, and strengthening disinflationary forces, some global policymakers are showing understandable concern. It’s interesting that Lagarde would note the “quite worrying” divergence between “buoyant” asset prices and weak economic performance. After all, she has been a leading proponent of (inflationist) QE measures – and all this “money” inflating global markets is conspicuously at the root of a now precarious Bubble dynamic.

The [Rick] Santelli Exchange segment “Politics vs. Central Banks,” CNBC, September 30, 2014:

“…Everyone on the floor is passing along a [Financial Times] article – interesting title ‘Merkel has a Duty to Stop Draghi’s Illegal Fiscal Meddling,’ by [prominent German economist] Hans-Werner Sinn. Now, think about what that says, and let’s think back, whether it’s our central bank, or the European Central Bank, the Japanese. The issue is central bankers have moved from being nudgers on monetary policy to basically [operators of] fiscal policy. In the U.S. it’s every bit the same. And there’s lots of talk and even comments by Ben Bernanke, Janet Yellen and many commentators – that the central bankers need to dabble in that direction, for an obvious reason: because of the politics, whether it’s the politics of Europe, the unsure nature of how Germany wants to stand up and stand its balance sheet along with the ECB’s, or in this country because there’s a logjam. Things can’t get done at least to the liking of the masses, to the citizens - to the voters. But what that really has done is it’s taken the voters out of the game. If central bankers didn’t have such a large foray into politics, well, politicians would have had to sink or swim on the merit - or lack therein - of their policies that weren’t creating the growth. But central bankers early recognized that they needed to buy time to create stability and the growth would surely come. But the problem is, in the parlance of trading, is that the spread between these two [growth and stability] continues to get wider and wider and wider.

Rick Santelli has distinguished himself as the preeminent “market” commentator throughout this remarkable period in financial, economic and political history. The guy’s a hero, consistently providing unequaled analysis (fighting the good fight!) while too frequently being on the receiving end of hostility from waves of pundits that think they understand much more than they actually do. I thought his above comments were especially pertinent. I’ll try to build on his analysis.

Fundamental to my analysis – and key to understanding today’s backdrop – is appreciating that we continue down a course unique in history. Never before has global finance operated without restraints on either the quantity or quality of Credit – no gold/precious metals regimes, no Bretton Woods, nor even a functioning dollar reserve system to place restraints on Credit expansion. Moreover, Credit expansion has come to be dominated by non-bank finance, removing important traditional constraints to financial excess (i.e. bank capital and reserve requirements). Over time, the inherent instability of unfettered global finance has evoked progressively more “activist” central bank control over “money,” Credit, the financial markets and economies. And this market intervention and manipulation has fostered the greatest ever speculation in global securities markets – which has motivated only greater central control.

Back in the late-nineties, I was convinced there was a momentous evolution in finance that was going unrecognized both in the marketplace and at the Federal Reserve. I believed the Fed would move to responsibly check the explosion of non-bank “Wall Street finance” once they recognized how it was fomenting destabilizing impacts on asset markets (price inflation and precarious Bubbles) and distorting resource allocation to the detriment of the real economy. How dead wrong I was. They instead embraced asset-based lending and became a proponent of leveraged securities speculation. Indeed, manipulating the returns from financial speculation became history’s most powerful monetary transmission mechanism. Borrowing from a Chinese proverb, central bankers jumped on the tiger’s back and can’t get off.

Some might contend I’m delusional, but these days I’m convinced I grasp the unrecognized (fatal) flaw in contemporary finance and monetary management. This most protracted Bubble has come to see a growing majority of global Credit that is backed by inflating asset values. Worse yet, global central bankers have resorted to targeting higher securities prices as the cornerstone of their “activist” (fight the scourge of deflation!) policy measures. Yet a Credit apparatus backed by inflating securities (quantities and values) is precariously unstable, with the world’s monetary managers now trapped in the greatest Bubble in history. After years of interplay between policy, Credit and the securities markets, the global financial system is at perilous risk to a meaningful decline in securities and asset prices. Central bank efforts to inflate their way out of debt problems and fragilities ensure that inflating securities markets diverge only further from troubled real economies. No solution will be found with inflationism – only deeper hardship.

It’s lunacy that central banks would ever target higher equities and risk asset prices as a primary monetary transfer mechanism. It’s reckless that a central banker would promise the markets to “do whatever it takes” to resolve crisis and structural fragilities. This only guarantees distorted market pricing and trading dynamics, certainly including excessive risk-taking and speculative leveraging. Yet central bankers believe that they have no choice but to dominate markets – to dominate seemingly everything. Central bank QE made certain that an already colossal global pool of speculative finance expanded by additional Trillions.

To be sure, a global Credit “system” essentially backed by inflating securities prices and underpinned by policy assurances ensures intractable vulnerability. So central bankers pump and financial speculation ramps. Some get fantastically wealthy. Many aspire to get their share. Societies fray. Global animosities fester.

I believe the small cadre of dominant global central bankers appreciates today’s systemic fragilities. This explains why they did what they did starting back in 2012. It was a case of flooding global markets with liquidity in a desperate attempt to spur global reflation. Their actions incited “terminal phase” speculative excess throughout global securities markets, in the process throwing gas on investment spending booms in China and throughout Asia (not to mention U.S. technology, agriculture and energy exploration). Importantly, securities and asset Bubbles only exacerbated already powerful wealth redistribution dynamics at a heavy cost to social and political stability around the globe. Treasuries, bunds, commodities, EM and the currencies have begun to adjust to floundering global Bubble dynamics.

Circling back to Mr. Santelli, yes, “the voters have been taken out of the game.” Democracy has been benched. “There’s a logjam. Things can’t get done at least to the liking of the masses…” “If central bankers didn’t have such a large foray into politics, well, politicians would have had to sink or swim on the merit - or lack therein - of their policies…” The post-crisis backdrop and reflationary policymaking leave the “masses” disillusioned and bitter. Views on the markets, economy, policy and the future are incongruous and polarized. Trust in institutions has suffered mightily. Divisiveness rules, albeit between “the West” and the Russia/China block, throughout Europe, in the Middle East, between much of the world and the U.S., here at home between the so-called liberals and conservatives, within the ranks of the Democrats and Republican parties, on the streets of Hong Kong and at the micro community and company level. When it comes to the crucial responsibility of monetary management, morality and ethics have been taken out of the game – at enormous unappreciated cost. On an individual, family, company, local, state, national and international basis, there is deepening angst that global finance, global economic systems and policymaking are dysfunctional, unfair and unjust.

Outside the great bull market, so much has become uncertain and disquieting. And central bankers are at this point locked in a singular, overwhelming policy response – unwavering monetary stimulus in hopes of somehow inflating out of financial and economic fragility. Somehow they continue to believe they are the solution instead of the root of the problem. There is this dangerous view that they have become the only game in town. And it’s their game where they have virtually complete discretion to do whatever they think is required. As they’ve done repeatedly throughout history, present-day inflationists have resorted to creative rationalization and justification (i.e. “trickle down” wealth benefits from inflated securities markets).

I’ve in the past highlighted Adam Fergusson’s classic, “When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany.” In lucid and compelling detail, Fergusson chronicles how monetary inflation insidiously destroyed German society. Incredibly, the German central bank went about their money printing fiasco oblivious to the damage they were instigating. They believed they were being forced to print in response to outside forces and dynamics beyond their control. And the more they printed and added zeros the more these forces required ever greater quantities of currency. Once the monetary inflation really got going the central bank became completely hostage to the runaway printing press and attendant inflationary dynamics.

I know. I’m a complete lunatic for mentioning “inflation,” let alone Weimar hyperinflation. Much of the world has become too comfortable rebuking the “dogmatic” Bundesbank, German politicians and the German people for their “inflation paranoia.” But let there be no doubt, the world is in the midst of a hyperinflation in global finance. The outward inflationary consequences of this global inflation of electronic, market-based Credit are of an altogether different nature than those from disseminating newly printed 100 billion Mark paper notes directly into the Weimar economy. Yet the pernicious forces of inequitable wealth distribution, economic maladjustment and social and geopolitical upheaval – the consequence of great monetary inflations - are sadly reminiscent of episodes where money died throughout history.

People will look back at this period and have a really difficult time comprehending how so many intelligent people were convinced that central banks creating Trillions of new “money” out of thin air to buy securities was somehow accepted as “enlightened” policy. The Germans know better and to claim it’s some paranoid societal affliction is ridiculous. For good reason, the notion of “do whatever it takes” central bankers willing to make up the rules as they go along is anathema in Germany.

Mario Draghi this week introduced the ECB’s plan for buying asset-backed securities (ABS) and covered loans (similar to MBS). The Germans are adamantly opposed to a policy that they believe clearly circumvents rules governing ECB policy and would further redistribute German wealth. FT headline: “Mario Draghi Pushes for ECB to Accept Greek and Cypriot ‘Junk’ Loan Bundles.” Leading German economist and president of the Ifo Institute for Economic Research, Hans-Werner Sinn’s FT op-ed (referenced by Santelli), “Merkel has a Duty to Stop Draghi’s Illegal Fiscal Meddling,” concluded with a noteworthy point: “…Germany’s constitutional court has expressly prohibited the German government from sitting back while the ECB oversteps its mandate. If politicians do nothing, any Germany citizen can petition the court and force them to act.”

Global market Bubbles these days have a lot riding on the ECB. Bullish propaganda has focused on Draghi’s plan for expanding the ECB’s balance sheet by a Trillion euros, in the process grabbing the QE baton from chair Yellen. Especially now that an incipient “risk-off” de-risking/de-leveraging dynamic has emerged in global markets, the issue of reliable ongoing central bank market liquidity injections has become market critical. Market participants have of late become somewhat at unease that Draghi might not actually have a Trillion to toss into in the liquidity pot – that perhaps he’s just talking the talk. This concern manifested into what was for a couple hours on Thursday one of those stomach-churning sessions for global markets.

Thursday saw European equities get just blasted. The German DAX was hit for 2.0% and the French CAC 40 sank 2.80%. Italian stocks were slammed for 3.9% and Spanish stocks 3.1%. Losses were not limited to Europe. Argentina’s Merval index rallied off lows yet still ended the session down 7.5%. Brazil’s real currency traded to a five-year low, ending the week down another 1.6%. U.S. equities also succumbed to selling pressure. Curiously, as selling of European equities accelerated, both the yen and Treasuries caught strong bids. Stocks with leveraged exposure to securities markets were under intense selling pressure. The beloved tech stocks started to buckle. Miraculously, U.S. equities reversed and a potentially destabilizing de-risking/de-leveraging episode was left for another day. The S&Ps rallied 46 points from Thursday’s lows to Friday’s highs.

Friday’s market reaction to stronger-than-expected September non-farm payrolls data was similarly intriguing. Immediately upon the release, S&P500 futures advanced slightly. Bond prices traded down just a couple ticks. Meanwhile, in the currency markets all bloody hell broke loose. King dollar surged over 1%, while the euro, yen, British pound, Australian dollar, New Zealand dollar and Canadian dollar were crushed like bugs. Crude, the precious metals and commodities in general were taken out to the woodshed. The heavily bruised EM currencies took some more pounding.

All in all, it was one more in a string of captivating weeks. Global markets have turned increasingly unstable. Unhinged global currency markets, the foundation of international finance, appear a flimsy jumble. I saw added confirmation for the thesis of heightened risk of a problematic bout of contagious global de-risking/de-leveraging. A group of enterprising hedge funds lost a court ruling, with collapsing Fannie and Freddie equities and preferreds on Wednesday hitting funds for losses to the tune of several billion. I’ll assume leveraged players heading for the exits played a major role in Thursday’s European equity rout. It looks like “hot money” is determined to come out of EM. Benefit of the doubt to “risk off.”

Throughout the markets, liquidity issues are becoming a growing concern. Increasingly, operating with leveraged bets in global currency and securities markets is akin to cavorting through a minefield. Unsettled markets have arrived on U.S. shores. This week saw already weakening speculator hands lose some brawn. This ensures ongoing volatility throughout global markets – boosting the probability of a market accident. Of course, our adroit monetary authorities would never allow that. A market pundit suggested that the Fed would be ready to respond in the event Ebola became a major threat. Now that’s comforting.

For the Week:

The S&P500 slipped 0.8% (up 6.5% y-t-d), and the Dow declined 0.6% (up 2.6%). The Utilities jumped 1.5% (up 11.0%). The Banks slipped 0.4% (up 3.6%), and the Broker/Dealers lost 1.0% (up 5.4%). Transports were little changed (up 14.6%). The S&P 400 Midcaps fell 1.6% (up 1.6%), and the small cap Russell 2000 dropped 1.3% (down 5.1%). The Nasdaq100 declined 0.7% (up 12.1%), and the Morgan Stanley High Tech index fell 0.9% (up 6.6%). The Semiconductors were hit for 3.1% (up 16.5%). The Biotechs fell 1.1% (up 32.7%). With bullion down $27, the HUI gold index was hit for 5.9% (down 4.0%).

One- and three-month Treasury bill rates closed the week near zero. Two-year government yields slipped two bps to 0.56% (up 18bps y-t-d). Five-year T-note yields fell seven bps to 1.72% (down 2bps). Ten-year Treasury yields dropped nine bps to 2.44% (down 59bps). Long bond yields fell nine bps to 3.12% (down 88bps). Benchmark Fannie MBS yields dropped eight bps to 3.13% (down 48bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 69 bps. The implied yield on December 2015 eurodollar futures was little changed at 1.09%. The two-year dollar swap spread jumped three to 26 bps, and the 10-year swap spread rose three to 16 bps. Corporate bond spreads and CDS have turned quite volatile. An index of investment grade bond risk fell five to 59 bps. An index of junk bond risk dropped 26 to 329 bps. An index of emerging market (EM) debt risk jumped 18 to 304 bps.

Ten-year Portuguese yields declined five bps to 3.04% (down 309bps y-t-d). Italian 10-yr yields fell eight bps to 2.31% (down 182bps). Spain's 10-year yields were down 10 bps to 2.10% (down 205bps). German bund yields declined five bps to 0.93% (down 100bps). French yields were five bps lower at 1.27% (down 129bps). The French to German 10-year bond spread was unchanged at 34 bps. Greek 10-year yields jumped 18 bps to 6.35% (down 207bps). U.K. 10-year gilt yields fell eight bps to 2.39% (down 63bps).

Japan's Nikkei equities index sank 3.2% (down 3.6% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.52% (down 22bps). The German DAX equities index was hit for 3.1% (down 3.7%). Spain's IBEX 35 equities index sank 2.6% (up 6.6%). Italy's FTSE MIB index were clobbered for 2.9% (up 6.5%). Emerging equities were mostly lower. Brazil's volatile Bovespa index sank 4.7% (up 5.9%). Mexico's Bolsa slipped 0.5% (up 4.6%). South Korea's Kospi index was slammed for 2.7% (down 1.8%). India’s Sensex equities index slipped 0.2% (up 25.5%). China’s Shanghai Exchange added 0.7% in a holiday-shortened week (up 11.7%). Turkey's Borsa Istanbul National 100 index declined 0.3% (up 9.7%). Russia's MICEX equities index fell 3.5% (down 7.9%).

Debt issuance slowed meaningfully. Investment-grade issuers included Bayer $6.5bn, Enterprise Products $3.35bn, BAE Systems $1.1bn, MetLife $1.0bn, Farmers $500 million, Johnson & Son $500 million, Enterprise Products $400 million, Ares Finance $250 million and CBL & Associates LP $300 million.

Junk funds saw outflows surge to $2.28bn (from Lipper). Junk issuers included Consolidated Energy $1.25bn, Starwood Property Trust $431 million, Halyard Health $250 million and Heligear $160 million

Convertible debt issuers included Zebra Technologies $1.05bn, Red Hat $700 million, Starwood Property Trust $375 million, Sabra Health $500 million and Trina Solar $100 million.

International dollar debt issuers included International Bank of Reconstruction & Development $4.0bn, Dexia Credit $2.0bn, Inter-American Development Bank $500 million, Petroleos Mexicanos $500 million and Cemex SAB $200 million.

Freddie Mac 30-year fixed mortgage rates dipped a basis point to 4.19% (down 3bps y-o-y). Fifteen-year rates were unchanged at 3.36% (down 7bps). One-year ARM rates were down one basis point to 2.42% (down 21bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 38 bps to 4.51% (down 4bps).

Federal Reserve Credit last week contracted $9.9bn to $4.408 TN. During the past year, Fed Credit inflated $711bn, or 19.2%. Fed Credit inflated $1.597 TN, or 57%, over the past 99 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $15.4bn last week to $3.344 TN. "Custody holdings" were down $9.6bn year-to-date, while gaining $53bn from a year ago.

M2 (narrow) "money" supply fell $10.0bn to $11.495 TN. "Narrow money" expanded $667bn, or 6.2%, over the past year. For the week, Currency increased $0.6bn. Total Checkable Deposits fell $32.7bn, while Savings Deposits jumped $22.6bn. Small Time Deposits declined $1.60bn. Retail Money Funds increased $1.2bn.

Money market fund assets jumped $22.8bn to a six-month high $2.614 TN. Money Fund assets were down $105bn y-t-d and dropped $71bn from a year ago, or 2.7%.

Total Commercial Paper declined $4.8bn to $1.053 TN. CP was up $7.2bn year-to-date, with a one-year decline of $1.8bn, or 0.2%.

Currency Watch:

The U.S. dollar index jumped 1.2% to 86.694 (up 7.0% y-t-d). For the week on the downside, the British pound declined 1.7%, the South Korean won 1.7%, the Swiss franc 1.7%, the Brazilian real 1.6%, the Danish krone 1.4%, the euro 1.3%, the New Zealand dollar 1.3%, the Norwegian krone 1.0%, the Australian dollar 1.0%, the South African rand 1.0%, the Canadian dollar 0.8%, the Singapore dollar 0.6%, the Japanese yen 0.4%, the Taiwanese dollar 0.4%, the Mexican peso 0.3% and the Swedish krona 0.2%.

Commodities Watch:

The CRB index fell 1.4% this week (down 1.4% y-t-d). The Goldman Sachs Commodities Index sank 2.9% (down 10.5%). Spot Gold fell 2.2% to $1,191 (down 1.2%). December Silver sank 4.1% to $16.826 (down 13%). November Crude dropped $3.80 to $89.74 (down 9%). October Gasoline sank 4.4% (down 14.6%), while November Natural Gas added 0.2% (down 5%). December Copper declined 1.2% (down 12%). December Wheat recovered 2.4% (down 20%). December Corn was little changed (down 24%).

U.S. Fixed Income Bubble Watch:

October 1 – Bloomberg (Dave Michaels): “The $10 trillion U.S. corporate bond market has been inflated by companies taking advantage of record low interest rates for the last five years, Securities and Exchange Commission member Daniel M. Gallagher said… ‘It clearly looks like a bubble,’ Gallagher said at a market structure conference sponsored by the Security Traders Association. ‘You have a buildup of assets and you have to think about the downside if the bubble gets pricked.’”

October 3 – Bloomberg (Lisa Abramowicz): “If stock investors are any guide, the $1.3 trillion U.S. junk-bond market is being inflated by a growing amount of leverage being used by buyers. Both stock and junk-bond managers tend to deploy more leverage when markets are booming, and more than ever is being used to purchase U.S. equities…, according to UBS AG analysts. That suggests junk-debt buyers are engaging in similar financing activities… This trend adds to concern that six years of unprecedented Federal Reserve stimulus has produced a bubble in the junk-bond market -- and one that will be all the more painful when it eventually pops. ‘Rising debt levels will be a problem going forward,’ UBS analysts Stephen Caprio and Matthew Mish wrote… Investors increase ‘leverage to meet return hurdles that are more challenging to hit as prices rise.’”

October 1 – Bloomberg (Craig Torres, Kristen Haunss and Christine Idzelis): “The Federal Reserve is stepping up its oversight of high-risk leveraged loans, shifting to a deal-by-deal review after its previous industry-wide guidelines were largely ignored by banks. The Fed is now looking at loans each month... Supervisors are looking at individual deals and risks such as a borrower’s ability to repay, they said. ‘Banks have been scolded and they have been warned, and yet you are seeing a lot of signals that the market is heating up,’ said Mayra Rodriguez Valladares, managing principal at MRV Associates…, a consultant on regulation to some of the world’s largest banks. ‘We have seen this bad movie before. The issue now is, will the regulators deploy the rest of the arsenal of tools they have?’”

October 3 – Bloomberg (Abigail Moses): “Credit derivatives traders cut $1 trillion of outstanding positions last month as they prepare for the market’s biggest overhaul. The total amount of money at risk with credit-default swaps dropped to $17.1 trillion… Traders are closing positions as they prepare to buy contracts governed by updated rules that take effect on Oct. 6 when benchmark indexes roll into the series. The overhaul seeks to fix flaws in sovereign and bank swaps that prevented some insurance contracts from paying out as intended since the financial crisis.”

Federal Reserve Watch:

September 30 – Bloomberg (Andrew Zajac): “U.S. regulators feared they lacked authority to structure the rescue of American International Group Inc. in a way that would allow them to take control of the insurer and head off shareholder opposition, according to e- mails introduced as part of a Starr International Co. lawsuit. Maurice ‘Hank’ Greenberg’s Starr is challenging the 2008 bailout of the insurance giant, arguing that the assumption of AIG stock by the Federal Reserve Bank of New York in 2008 violated shareholders’ constitutional rights… Today, Starr attorney David Boies introduced e-mails and other correspondence revealing U.S. uncertainty about whether regulators were on solid ground in granting Starr an $85 billion loan in exchange for 80% of AIG’s equity.”

U.S. Bubble Watch:

September 29 – UK Mail (Kieran Corcoran): “America’s wealthiest are worth more than ever - with the top 400 billionaires worth a breathtaking $2.3 trillion, according to the latest edition of the Forbes 400. The renowned rich list was again topped by Bill Gates - the richest American for the past 21 years - whose fortune was $81.2billion. But the Microsoft founder, 58, had newer technology billionaires snapping at his heels, including Facebook CEO Mark Zuckerberg, who broke the top 10 for the first time having gained $15billion in the past year.”

Central Bank Watch:

October 1 – Financial Times (Claire Jones and Sam Fleming): “Mario Draghi is to push the European Central Bank to buy bundles of Greek and Cypriot bank loans with ‘junk’ ratings, in a move that is set to exacerbate tensions between Germany and the bank. Mr Draghi, ECB president, will this week unveil details of a plan to buy hundreds of billions of euros’ worth of private-sector assets – the central bank’s latest attempt to save the eurozone from economic stagnation. The ECB’s executive board will propose that existing requirements on the quality of assets accepted by the bank are relaxed to allow the eurozone’s monetary guardian to buy the safer slices of Greek and Cypriot asset backed securities… say people familiar with the matter. Mr Draghi’s proposal is designed to make the programme of buying ABS… as inclusive as possible. If it is backed by the majority of members of the ECB’s governing council, the central bank would be able to buy instruments from banks of all 18 eurozone member states. However, the idea is likely to face staunch opposition in Germany, straining already tense relations between the ECB and officials in the eurozone’s largest economy.”

October 2 – Bloomberg (Stefan Riecher and Alessandro Speciale): “The European Central Bank will buy assets for at least two years to boost inflation and economic growth in the euro area, President Mario Draghi said. The… central bank will start buying covered bonds this month and plans to purchase asset-backed securities starting this quarter, Draghi said… ‘These purchases will have a sizable impact on the balance sheet,’ he said. The purchase program is part of an easing plan Draghi has said will steer the balance sheet back to levels seen at the start of 2012, signaling as much as 1 trillion euros ($1.3 trillion) in assets could be added. Since June the ECB has cut interest rates twice and announced a range of measures such as loans to banks aimed at boosting credit to the real economy.”

October 1 – Wall Street Journal (Giovanni Legorano, Brian Blackstone and Liam Moloney): “Annual inflation in the eurozone weakened to a five-year low in September and consumer prices actually fell in Italy, raising pressure on the European Central Bank to do more to stimulate the region's struggling economy. But economists have grown increasingly concerned that even beefed-up ECB action, such as large-scale government bond purchases, would be far less effective in the eurozone than similar measures in the U.S. and U.K. have been in boosting growth there. In short, the ECB's patients aren't responding to its medicine. Italy, economists and business leaders say, is Exhibit A. ‘There's very little demand for loans for investments, because entrepreneurs' confidence is at an all-time low,’ said Giuseppe Castagna, chief executive of Banca Popolare di Milano.”

EM Bubble Watch:

September 30 - Bloomberg (Evgenia Pismennaya): “Russia’s central bank is weighing the introduction of temporary capital controls if the flow of money out of the country intensifies, according to two officials with direct knowledge… Such measures would be preventative and used only if net outflows rise significantly, the people said… They didn’t give a timeline or a level that may force such a move, saying they are looking at all possible scenarios. The discussions are the latest sign that U.S. and European sanctions are hurting Russia and making its monetary authority rethink policies it sought to avoid.”

October 1 – Bloomberg (Vladimir Kuznetsov and Ksenia Galouchko): “Holders of Russia’s ruble-denominated bonds, stung by the worst losses in emerging markets in the third quarter, are weighing the consequences of possible capital controls as the currency sinks. ‘It would be very negative for your investments in the local currency,’ Peter Schottmueller, who helps manage $17 billion as head of emerging-market fixed income at Deka Investment GmbH in Frankfurt, said…”

September 30 - Bloomberg (Sally Bakewell): “Russian companies are facing a squeeze in funding as sanctions targeting industries smother lending to all borrowers, including those that aren’t blacklisted. ‘As long as those sanctions measures remain in force, one anticipates there will be very little international lending,’ Philip Hanson, an associate fellow at the Chatham House research group in London, said… ‘They’d rather just play safe and avoid the risk.’ Syndicated loans plunged 53% this quarter from a year earlier to $2.68 billion, the lowest level in at least five years…”

September 30 - Bloomberg (Patricia Lara): “Brazil needs to improve fiscal trend urgently to avoid losing investment-grade rating, Luciano Rostagno, chief strategist at Banco Mizuho do Brasil, says… ‘The truth is that the government couldn’t deliver what it promised even with budget handling and extraordinary revenue. August fiscal result was ‘very bad’ and it’s difficult to make changes in a stagnation scenario…”

October 1 – Bloomberg (Ken Kohn and Minh Bui): “U.S. exchange-traded funds that invest in emerging-markets had slowing net inflows during September, led by a 90% decline to China and Hong Kong. Total deposits into ETFs that invest across developing nations as well as those that target specific countries fell to $977.9 million from $5.6 billion in August… The MSCI Emerging Markets Index declined 7.6% for the month.”

Europe Watch:

October 1 – Reuters (Leigh Thomas): “France laid down the gauntlet to EU partners on Wednesday with a 2015 budget setting out how it would bring its borrowing back to within EU limits two years later than promised… Without specifically naming France, German Chancellor Angela Merkel quickly stressed that rebuilding sound public finances could not be taken lightly. The announcement from Paris came hours after news that Italy too planned to ease the pace of painful deficit reduction to try to counter another year of recession. ‘We have taken the decision to adapt the pace of deficit reduction to the economic situation of the country,’ French Finance Minister Michel Sapin told a news conference… Under the French budget plan, the public deficit is set to fall from 4.4% of output this year to 4.3% next year, 3.8% in 2016 and 2.8% in 2017 - below the European Union-mandated threshold of 3%.”

September 30 - Bloomberg (Esteban Duarte): “Spain’s Constitutional Court temporarily blocked Catalan government plans to hold a vote on independence, raising the stakes in the central government’s standoff with the regional administration in Barcelona. Catalan president Artur Mas signed a decree on Sept. 27 calling for a Nov. 9 ballot as a non-binding consultation on independence for the region of about 7.5 million people in northeastern Spain. Spanish Prime Minister Mariano Rajoy denounced the vote as unconstitutional and said… his government had filed a lawsuit to block it… ‘It’s false that the right to vote can be assigned unilaterally to one region about a matter that affects all Spaniards,” Rajoy told reporters… ‘It’s profoundly anti-democratic.’”

Germany Watch:

October 1 – Bloomberg (Dalia Fahmy and Brian Parkin): “Chancellor Angela Merkel’s cabinet backed legislation to curb rents as rising housing costs in Germany put pressure on her government to act. The draft law caps rents for new contracts in existing homes at 10% above the local average in areas identified as having ‘tight’ housing markets starting next year… ‘The rent cap will help keep rents affordable for average earners,’ German Justice Minister Heiko Maas said… ‘Rent increases of 30 or 40% in some urban areas are simply unacceptable.’”

Global Bubble Watch:

October 1 – Bloomberg (Sandrine Rastello): “The International Monetary Fund urged regulators to pay closer attention to a shadow banking system that has grown to as much as $60 trillion worldwide to help prevent risks from building outside the bounds of traditional financial oversight. ‘Shadow banking tends to take off when strict banking regulations are in place, which leads to circumvention of regulations,’ Gaston Gelos, chief of the IMF’s global financial analysis division, said… Non-traditional lending ‘also grows when real interest rates and yield spreads are low and investors are searching for higher returns, and when there is a large institutional demand for ‘safe assets’ such as insurance companies and pension funds, he said. Shadow banks include money-market mutual funds, hedge funds, finance companies and broker-dealers. They pose a risk to the broader financial system because they rely on short-term funding, ‘which can lead to forced asset sales and downward price spirals when investors want their money back at short notice.’”

October 1 – Bloomberg (Lyubov Pronina): “Emerging-market bond sales are headed for an unprecedented year after the busiest nine months on record… Governments and companies in developing nations raised $942 billion in the first three quarters in overseas and local markets, up 11% from the year earlier… While sanctions over the Ukraine crisis brought Russian issuance to a halt, Asian sales jumped by a fifth, led by China… ‘I expect issuance from Asia, Latin America and the Middle East to remain high as corporates try to lock in low funding rates,’ Max Wolman, who helps oversee $13.5 billion in emerging-market debt at Aberdeen Asset Management…, said…”

September 29 – Financial Times (Chris Giles): “A ‘poisonous combination’ of record debt and slowing growth suggest the global economy could be heading for another crisis, a hard-hitting report will warn on Monday. The 16th annual Geneva Report, commissioned by the International Centre for Monetary and Banking Studies and written by a panel of senior economists including three former senior central bankers, predicts interest rates across the world will have to stay low for a ‘very, very long’ time to enable households, companies and governments to service their debts and avoid another crash… The total burden of world debt, private and public, has risen from 160% of national income in 2001 to almost 200% after the crisis struck in 2009 and 215% in 2013. ‘Contrary to widely held beliefs, the world has not yet begun to delever and the global debt to GDP ratio is still growing, breaking new highs,’ the report said.”

October 1 – Financial Times (Jeremy Grant): “What do a chicken farmer, a brewer and an international shipping line have in common? All three are among the largest companies in the Association of Southeast Asian Nations (Asean), a 10-member bloc whose member states boast a combined gross domestic product larger than India’s. All three are also typical of a new breed of Asean ‘champion’ with increasingly global ambitions. Thailand’s CP Group has a food unit that is one of the world’s biggest producers of chickens… In the Philippines, San Miguel group is a diversified business but best known as a globally recognised beer brand. Neptune Orient Lines is among the world’s 10 biggest shipping lines and listed in Singapore. But all three share one worrying characteristic. Standard & Poor’s thinks they have a debt problem. S&P has spent months crunching the numbers on the 100 biggest companies in Asean and concluded that these three and 23 more are overleveraged. The rating agency looked at the 100 companies and found that they collectively spent almost $300bn on a debt-fuelled acquisition binge between the end of 2008 and the first quarter of this year…”

October 1 – Bloomberg (David Goodman): “Germany auctioned 10-year bonds to yield less than 1% for the first time, as a weakening euro-area economy and the prospect of further stimulus from the European Central Bank reduce borrowing costs across the region.”

September 30 - Bloomberg (Wes Goodman and Kevin Buckland): “Sovereign bonds around the world beat corporate debt this quarter by the most in three years as consumer-price gains slowed in the U.S. and disinflation threatened Europe. Government securities returned 1.4% from the end of June through yesterday, while company debt earned 0.3%... ‘High-yield, lower-rated corporate bonds have underperformed significantly,’ said Hajime Nagata, a bond portfolio manager in Tokyo at Diam Co., which oversees $129 billion.”

October 1 – Bloomberg (Zachary Tracer and Jody Shenn): “The collapse of securities tied to Fannie Mae and Freddie Mac punished some of Wall Street’s best known money managers, with star investor Bruce Berkowitz’s main mutual fund losing about $600 million… Berkowitz’s Fairholme Capital Management LLC lost a legal bid yesterday to force the bailed-out companies to share profits with private stockholders. Investors had sued the U.S. for breach of contract over allegedly promised dividends and liquidation preferences. All told, investors today saw the market value of their preferred securities tumble by more than $6 billion, with the value of the common stock held by private investors losing about $2 billion...”

Geopolitical Watch:

September 30 - Sydney Morning Herald (Peter Hartcher): “Apparently out of nowhere, China's communist party confronts the most serious test to its authority since it massacred student protesters in Tiananmen Square in 1989. An upsurge of mass democratic protest in Hong Kong presents Beijing with a choice that will illuminate starkly the very heart of modern China. And Geremie Barme, the director of the Australian Centre on China in the World at ANU, doesn’t think it's going to illuminate anything very cheering: ‘Something unpleasant is going to happen,’ he says. ‘Anything like this does touch on the big issues of freedom in China itself; it's very serious indeed.’ One telling sign of deep anxiety in Beijing is that it has imposed strict censorship within the mainland on news of the protests in Hong Kong.”

October 3 – Bloomberg (Glen Carey): “The Middle East may be sliding toward a warlord era, with nation-states increasingly struggling to control all their territory and millions living under the rule of emergent local chiefs and movements. Armed irregular forces hold effective power over growing areas of Iraq, Syria, Yemen and Libya where central government authority barely reaches. Motivated by religious ideology or regional separatism, they have grabbed oil facilities and weapons, imposed taxes or changed school curriculums, and fought each other as well as national armies. ‘It is almost like the whole regional order that was built in the 20th century is collapsing,’ Nadim Shehadi, associate fellow at the Middle East and North Africa Programme at Chatham House in London, said… ‘Non-state actors are filling the vacuum.’ The breakdown, in a region that holds more than half the world’s oil, has allowed extremist groups to thrive and drawn in external powers bent on stopping them. Underlying many of the conflicts is the inability of governments to provide security and basic services. In turn, economic failure will be even harder to remedy without functioning administrations.”

September 30 – Wall Street Journal (Gregory L. White): “Vladimir Yakunin, a longtime friend of President Vladimir Putin, is still indignant that he was slapped with U.S. sanctions in March. But asked whether they have changed the minds of Kremlin insiders like himself regarding Russian policy in Ukraine, his answer is a resounding no. ‘That's wishful thinking,’ he scoffed in a recent interview. Mr. Yakunin, president of state-owned Russian Railways, the country's largest employer, says the Ukraine crisis has vindicated his long-held stance that the U.S. and Russia are ineluctable rivals, and that U.S. efforts to sabotage Russia have continued since the end of the Cold War, using weapons as varied as Hollywood movies and monetarist economics. Critics who dismissed a study he co-wrote a year ago as ‘a work of conspiracy theory’ now recognize ‘it's a very realistic assessment of the situation,’ he says. The hardening attitudes suggest repairing the worst breach in East-West relations since the Cold War could be difficult, if not impossible…”

October 2 – Bloomberg (Agnes Lovasz and Daryna Krasnolutska): “The bloody conflict in Ukraine’s east is severing the arteries that connect the nation’s economy. The effects are being felt hundreds of miles from the unrest in industries as different as electricity and food processing. Power plants at the other end of the country are being starved of coal because of disruptions to mining, while in Kiev, one of Ukraine’s biggest poultry producers is looking abroad for incubatory eggs after output was halted at its facility near the war-ravaged city of Donetsk. Months of fighting have left pro-Russian rebels in control of a swathe of Ukraine’s easternmost regions, which generated almost a quarter of industrial output at the start of the year. The knock-on effects of idle factories are seeping through an economy at risk of a 10% contraction in 2014… The International Monetary Fund says $17 billion may not be enough to avert a default.”

China Bubble Watch:

October 1 - South China Morning Post (Cary Huang): “President Xi Jinping called for solidarity in party ranks yesterday as he delivered a speech at a National Day gathering attended by almost all retired and current leaders. The rare public appearance together of the present and former leaders comes amid intense internal debate over the current anti-corruption drive before a crucial party meeting. Among those present were former presidents Jiang Zemin , and Hu Jintao , former premiers Li Peng , Wen Jiabao and Zhu Rongji , and almost all surviving former members of the Communist Party’s Politburo Standing Committee…”

September 30 - Bloomberg (Dexter Roberts): “The swelling protests in Hong Kong that have gripped the world’s attention are Xi Jinping’s and the Chinese Communist Party’s worst nightmare. The fear is that if not properly contained, the street protests could flare into China’s own version of a color revolution (like the Orange Revolution in Ukraine) and prove an existential threat to the leadership. ‘Street movements can evolve into revolution when more demonstrators become embroiled in them,’ wrote the English edition of the People’s Daily… But even without such a dramatic and still probably very unlikely outcome, equally damaging is what the protests are doing right now to the standing of Xi and the rest of the top Chinese leadership. Just as Xi wants to demonstrate to all that he’s the most forceful and effective leader in decades, that the party is fully in charge despite China’s myriad problems, including corruption, income inequality, and social unrest, and that he has an inclusive vision for all Chinese people, including those in Hong Kong and Taiwan, the protests are sending just the opposite message.”

October 2 – Bloomberg: “China announced plans to cap the amount of debt local governments can take on and ban them from additional borrowing through financing vehicles as authorities step up efforts to control risks to the financial system. All borrowing by provinces and cities will need to be within a quota set by the State Council… The central government won’t bail out local authorities, it said. China’s borrowing spree since the global financial crisis has prompted economists including those at JPMorgan… to compare it to debt surges that tipped Asian nations into crisis in the late 1990s and preceded Japan’s lost decade.”

September 29 – Bloomberg: “Land sales in 300 cites followed by Soufun fell almost 50% y/y to 415.9b yuan in 3Q, SouFun Holdings Ltd., owner of the country’s biggest real-estate website, says… Residential land sales declined more than 50% to 265.3b yuan”

September 30 - Bloomberg: “China’s central bank made it easier for people to qualify for smaller down payments that were previously available only to first-home buyers, as the government seeks to boost the slumping property market. People applying for a loan to buy a second home may be treated as first-home buyers so long as they have paid off their other mortgage… The central government is stepping in after regional efforts failed to stem a slide in home sales, dragging down economic growth.”

Latin America Watch:

October 3 – Bloomberg (Julia Leite): “Minutes after being sworn in as president of Brazil in January 2011, Dilma Rousseff delivered an emotional inaugural address in which she proclaimed the country was at the ‘beginning of a new era.’ For investors, she was right for all the wrong reasons. The Rousseff era has ushered in year after year of declines in financial markets, a stark contrast to the go-go days overseen by her predecessor and mentor, Luiz Inacio Lula da Silva, that made Brazil a market darling. She is seeking re-election this weekend after a first term in which the country’s benchmark stock index plunged 23%, erasing $300 billion of market value, and the real sank 33%. It’s a grim snapshot for a president who took over what Lula said in November 2010 was a country enjoying a ‘magical moment,’ posting the fastest expansion in a quarter century… After four years of Rousseff’s intervention across the economy and a slump in prices for Brazilian commodity exports, the country is mired in something akin to stagflation as growth weakens to the slowest pace in two decades and inflation surges.”

October 3 – Bloomberg (Filipe Pacheco): “The prospect President Dilma Rousseff will be re-elected is putting Brazil on the verge of junk status in the bond market. The extra yield that investors demand to own Brazil’s debt securities instead of Treasuries is within 0.3 percentage point of the average for speculative-grade bonds, the closest the nation has been to junk since it ascended to investment grade in 2008… Moody’s… last month cut the nation’s outlook to negative and raised the possibility that Brazil may eventually be lowered to junk status.”

October 1 – Bloomberg (Julia Leite): “Bond investors are coming to the conclusion that Brazil President Dilma Rousseff will win in elections that start this weekend. That’s spurred the biggest rout in its corporate debt market in 15 months. The notes slumped 2.3% last month through Sept. 29, almost triple the average decline for company bonds in emerging markets. State-run oil producer Petroleo Brasileiro SA, the biggest overseas issuer in developing nations with $55 billion of debt, has seen its securities sink 2.9%

Japan Bubble Watch:


October 3 – Bloomberg (Rachel Evans): “The yen’s steepest decline in 20 months is prompting concern in Japan that the central bank’s support for a weaker currency may hurt consumers and companies. Monetary authorities intervention to curb the slump is ‘possible,’ according to Hirohisa Fujii, a former finance minister and member of the opposition party… Some companies are suffering from the weaker yen, Nobuhide Minorikawa, Japan’s vice finance minister said this week, following comments from the nation’s economy minister on the risk of excessive gains or declines in the yen. The chorus of dissent against the Bank of Japan’s accommodative monetary policy, which has seen 60 trillion yen ($553bn) to 70 trillion yen committed to annual asset purchases, is growing louder…”