Monday, December 15, 2014

10/10/2014 Derivatives Story 2014 *

At this point, I’ve seen sufficient market evidence to posit that the global financial Bubble has serious fissures. Emerging market currencies, bonds and equities are in trouble. Commodities are in trouble. The global leveraged speculating community appears close to, if not already in, trouble. Geopolitics is full of trouble. Global “risk off” liquidity issues are becoming a bigger issue – and are now being transmitted to U.S. securities markets through liquidity-challenged sectors such as small cap equities, corporate Credit and surging prices for risk protection. Corporate credit default swap (CDS) prices this week surged to multi-month highs. The VIX stock market volatility index jumped to an eight-month high. Moreover, this week’s bludgeoning in the over-loved and over-owned technology sector could have pushed some to the edge. Examining it all, the unfolding backdrop has me pondering previous vulnerable Bubbles, along with the soundness of global derivatives markets.

And whenever I’m about to dive into analysis of the esoteric derivatives marketplace, I always think back to an early CBB, the fictional “Little Town on the River.” I’ll attempt a brief summary.

“It had for years been a sleepy little place. The expense and limited availability of flood insurance discouraged building and commerce along the river’s edge. There was a long history of occasional flooding that wreaked havoc. But a few years without a significant flood created greater appeal for what had evolved into an extraordinarily profitable insurance business. The newfound availability of insurance encouraged some to build along the waterfront. Others, always hoping to live and work near the water, bid up asset prices. The town’s banks began doing brisk business. And with the Little Town enjoying a simultaneous economic renaissance and drought, writing flood insurance became a booming enterprise. Additional players led to only cheaper insurance, which stimulated more building, more “wealth” creation (asset inflation) and a resulting full-fledged economic boom. And, as “luck” would have it, drought persisted. Over time, the hugely profitable insurance market attracted major speculative interest. All types of “investors” joined the fray, writing policies or taking ownership interests in the insurers, booking easy profits all along the way. Local “banks” became big players. Each year saw concern for a bout of unexpected rain dissipate a little more. And with a thriving, highly-liquid reinsurance marketplace, players were elated to write as much insurance as they could possibly sell. Why not cash in on fabulous wealth gains, operating comfortably without traditional reserves that would protect against future damage claims. The well-crafted plan was to immediately offload risk in the reinsurance market in the low-probability event of torrential rains.”

In my unsuspecting Little Town, the availability of cheap flood insurance fueled a major boom. And Reflexivity played a profound role in spurring self-reinforcing Bubble Dynamics. Cheap risk insurance fostered building and risk-taking, which stoked a generalized economic boom (replete with distortions and maladjustment), with bullish perceptions regarding the soundness of the economic and financial sectors stoking asset prices. Yet when torrential rains finally – inevitably - arrived, the crowd that had speculated on insurance contracts raced to the reinsurance marketplace. Risk players were either unwilling or unable to write more reinsurance – not with the harsh realities coming into greater focus and greed abruptly transforming to fear. Market dislocation ensured those that had been writing insurance – and had accumulated huge risk exposures – faced potential insurance claims without the financial wherewithal to cover major losses. Panic in the dislocated insurance markets then provoked fear and dislocation in the real economy. When the eventual flood arrived, it was a complete wipeout. In hindsight, the booming financial sphere (risk insurance marketplace) ensured that enormous unappreciated risk accumulated throughout the real economy.

I posted my original “A Derivative Story” back in March 2000. While it highlights some of the key concerns I had at the time with the booming derivatives marketplace, there were also some key real world differences. Importantly, no individual or group sought to control the weather. While the prices and quantities of risk insurance had major impacts on risk-taking in both the financial and economic spheres, flood insurance market dynamics didn’t impact the amount of rainfall. In the “real world,” the scope of risk-taking and derivatives trading does have a profound impact on market behavior and the amount of accumulated underlying market risk. In the world in which we operate, the greater the amount of financial insurance written, the greater the risk that market dynamics at some (“black swan”) point might incite market illiquidity, dislocation and panic. This had been made readily apparent in 1987 (“portfolio insurance”), 1994 (“IOs,POs” and interest-rate derivatives), 1997 (SE Asian currency derivatives), 1998 (LTCM derivatives leverage and Russian currency derivatives) and 1999/2000 (Nasdaq and tech stock derivatives).

Some fourteen and a half years ago I just felt there was overwhelming evidence that the Federal Reserve needed to take a more aggressive approach in overseeing what had become a dangerous proliferation of financial risk insurance. The Fed did the very opposite. Our central bank instead adopted a more heavy-handed stance with respect to market intervention. The derivatives marketplace rested upon the (specious) premise of liquid and continuous markets. So the Fed essentially promised the marketplace it would ensure liquidity and guard against market panic and dislocation. We learned absolutely nothing, as derivatives then played an integral role in the mortgage finance Bubble and resulting 2008 financial and economic crisis.

I’m not planning on writing “Derivatives Story 2014.” But if I change my mind, my Little Town would have experienced some radical changes since 2000. Today, interest rates on local savings accounts are a goose egg. Economic activity is bustling. There may not be much building or capital investment, but consumption, services and finance are booming. Reminiscent of 2000, there’s lots of exciting new technologies. There’s certainly lots of money slushing around. Asset prices and confidence are really high. The flood insurance market is bigger and more sophisticated than ever.

Yet the biggest change from 2000 is that everyone has faith in the central authority’s capacity to control the weather. And with central control over flood risk and zero deposit rates, local savings have inundated all types of new vehicles and instruments profiting from the risk markets. You’d have to be a moron to settle for a near-zero return when central control now protects the community from flood and myriad risks. Enlightened policies from central control amount to the greatest financial innovation in the history of the community. Today, it is possible for virtually everyone in our town to participate in unprecedented wealth creation.

Switching back to the real world, I’ll excerpt from Federal Reserve Bank of Richmond’s Jeffrey Lacker and John Weinberg’s excellent and timely op-ed in Wednesday’s Wall Street Journal:

The Fed’s Mortgage Favoritism – When the central bank buys private assets, it distorts markets and undermines its claim to independence… Some will say that central bank credit-market interventions reflect an age-old role as ‘lender of last resort.’ But this expression historically referred to policies aimed at increasing the supply of paper notes when the demand for notes surged during episodes of financial turmoil. Today, fluctuations in the demand for central bank money can easily be accommodated through open-market purchases of Treasury securities. Expansive lending powers raise credit-allocation concerns similar to those raised by the purchase of private assets. Moreover, Federal Reserve actions in the recent crisis bore little resemblance to the historical concept of a lender of last resort. While these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility. Ambiguous boundaries around Fed credit-market intervention create expectations of intervention in future crises, dampening incentives for the private sector to monitor risk-taking and seek out stable funding arrangements.

For “Derivatives Story 2014” purposes, I’ll focus on Lacker’s, Fed “actions in the recent crisis bore little resemblance to the historical concept of a lender of last resort. While these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility. Ambiguous boundaries around Fed credit-market intervention create expectations of intervention in future crises…”

From a macro analytical perspective, it’s such an incredibly fascinating environment. Again falling back to old favorite analytical tools, let’s ponder “economic sphere” versus “financial sphere” analysis. In the economic sphere, for a while now there has been evidence of liquidity over-abundance. General asset inflation and a booming technology sector come first to mind. Securities and asset prices have inflated spectacularly over recent years to record levels. Accordingly, my analytical challenge has been to identify the underlying source of finance – the monetary disorder – fueling the destabilizing asset inflation and Bubbles. And this is where it gets really interesting.

Traditional “financial sphere” bank lending and Credit expansion metrics just do not equate with the type of Credit growth required to fuel systemic asset inflation and securities market booms. Household debt expanded at a 1.6% rate in 2013 and about 3% during this year’s first half. Even with booming corporate and federal borrowings, Total Non-Financial Sector Debt expanded just 3.8% last year and about 4% during 2014’s first half. And while bank lending has picked up, the tepid expansion of this traditional source of finance in no way can explain the liquidity deluge behind Tech Bubble 2.0 and Stock Market Bubble 3.0. If I only had a dollar for every time I’ve heard a Fed official or bullish pundit say it can’t be a Bubble because there’s not the type of leverage consistent with Bubbles.

Truth be told, there is a tremendous amount of leverage. We know that the Fed’s balance sheet (“Fed Credit”) has inflated almost $3.6 TN, or 400%, in about six years. Fed Credit is up an incredible $1.6 TN, or 58%, in just two years. Yet this critical source of system leveraging is supposedly coming to an end soon. Which leads me to my bigger concern: leverage that we do not know – that lurks unrecognized and unappreciated. And my thoughts continually come back to my Little Town and A Derivative Story. These days I really worry about global derivatives markets – and part of the reason I worry is that the marketplace is convinced there’s no reason for worry. Global policymakers – central control – have it all under control. Market risk is not an issue.

Here’s how I see it: Fed market assurances coupled with the ballooning/leveraging of its balance sheet was instrumental in an unprecedented expansion of derivatives-related leverage. “Ambiguous boundaries around Fed credit-market intervention” did “create expectations,” in the process distorting the derivative markets like never before. The cost of financial insurance collapsed across all asset classes all over the world – U.S. and global equities, corporate Credit, European periphery debt, EM stocks and bonds, and “developed” and “developing” currencies. Importantly, global central bank backstops created “too big to fail” distortions in markets for financial institution credit risk around the world. And with central control having eradicated so-called “counter party risk,” there was at that point nothing to hold back a derivatives market speculative feeding frenzy.

I see derivatives as integral to the “global government finance Bubble,” the “Granddaddy of all Bubbles,” thesis. Central (bank) control distortions “promoted greater fragility” – absolutely no doubt about it. Indeed, fragility and inevitable instability have arrived. It appears the Global Bubble has been pierced.

The global “reflation trade” is imploding. WTI crude sank 4.4% this week to $85.82. Natural gas dropped 4.5%. Heavily leveraged balance sheets – abroad and at home – in the energy and commodities universe are increasingly suspect. The ability of EM economies to service external debt is becoming an increasing concern. Ongoing currency market instability is causing losses and de-risking/de-leveraging in various derivative “carry trades.” The global leveraged speculating community, big players in derivatives, is close to some serious problems. Losses would be met with redemption notices and forced liquidations. And with lots of players all crowded into similar trades, things could quickly topple into a panic for the exits. Such a circumstance would quickly crack wide open serious shortcomings in derivatives trading, in the securities markets and for leveraged participants throughout these markets.

How “crowded” is the bullish technology trade? And, more importantly, how sound is the underlying finance that has been fueling Tech Bubble 2.0? Few at the time appreciated how the nineties' technology boom was being financed by unstable Bubble finance – industry and Telecom debt, speculative Credit, derivative-related Credit and myriad sources of finance that would so quickly evaporate come the reversal of speculative flows and the bursting of the Bubble. I suspect derivative-related leverage has similarly helped fuel a destabilizing blow-off for Tech Bubble 2.0, with the risk now that the downside of leverage manifests with a bursting industry Bubble.

I believe the increasingly vulnerable leveraged speculator community would now like to reduce exposure to the high-flying tech space. And I would also suggest that a reversal of “hot money” from technology would mark a critical liquidity inflection point for Tech Bubble 2.0. And if you have de-risking in tech combining with de-leveraging in currencies, de-risking/de-leveraging in commodities and EM, and de-risking in corporate Credit – wow, rather quickly you have all the necessary makings for a very problematic “risk off” market backdrop.

There is absolutely no doubt that buoyant derivatives markets have promoted epic risk-taking – in finance generally, in securities markets, in asset and commodities markets, in real economies globally. Especially in our zero short-term financing rate environment, all varieties of derivative strategies have made it too easy to leverage up and chase yields and market returns. What’s your bogey? A pension fund client that requires a 9% annual return? Well, there are a bevy of derivative products easily structured to fulfill your needs. The amount of leverage is a plug variable. If spreads narrow (yields decline), simply employ more leverage. And there’s no reason these days to fret leverage. The Fed promises not to raise rates much – if at all (global deflation!). Besides, if leverage or shaky markets do start to become a worry, there’s cheap derivative insurance available to calm nerves. How much of the seemingly insatiable appetite for higher-yielding securities over recent years has been due to demand from leveraged derivative strategies? Has that leverage been a key source financing Bubbles?

If I were to write a final chapter for “Derivatives Story 2014,” I’d have the local flood insurance market having expanded to communities everywhere: same players, same strategies, same bullish market perceptions and the same faith in central control. And they’d all have written boatloads of cheap flood and risk insurance – and all sold lots of related “investment” products - across the universe, believing that significant losses, if they were ever to occur again, would surely be a localized problem. And in my prosperous Big Town, they’d hear about the rain and flood and losses in some distant communities. But that has nothing to do with our town, right? Actually, doesn’t it make our prosperity all the more appealing? It does, right? Meanwhile, away from all the public exuberance, in the dark caverns of the reinsurance market things start to get a little dicey. The price of reinsurance is surging and there’s newfound fear of marketplace liquidity issues.



For the Week:

The S&P500 was hit for 3.1% (up 3.1% y-t-d), and the Dow fell 2.7% (down 0.2%). The Utilities added 1.1% (up 12.3%). The Banks sank 4.0% (down 0.5%), and the Broker/Dealers were slammed for 5.4% (down 0.3%). Transports were hammered for 6.9% (up 6.7%). The S&P 400 Midcaps fell 4.4% (up 2.8%), and the small cap Russell 2000 dropped 4.7% (down 9.5%). The Nasdaq100 sank 3.9% (up 8.8%), and the Morgan Stanley High Tech index was hit for 5.1% (up 1.2%). The Semiconductors were drilled for 9.9% (up 4.9%). The Biotechs declined 2.6% (up 29.3%). Although bullion rallied $32, the HUI gold index slipped 0.4% (down 4.4%).

One- and three-month Treasury bill rates closed the week near zero. Two-year government yields dropped 13 bps to 0.43% (up 4bps y-t-d). Five-year T-note yields sank 19 bps to 1.53% (down 21bps). Ten-year Treasury yields fell 15 bps to 2.28% (down 75bps). Long bond yields declined 11 bps to 3.01% (down 96bps). Benchmark Fannie MBS yields fell 14 bps to 2.99% (down 62bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 71 bps. The implied yield on December 2015 eurodollar futures sank a notable 19 bps to 0.895%. The two-year dollar swap spread added one to 27 bps, while the 10-year swap spread declined two to 14 bps. Corporate bond spreads widened significantly this week. An index of investment grade bond risk jumped 13 bps to an almost seven-month high 72 bps. An index of junk bond risk surged 55 bps to a one-year high 384 bps. An index of emerging market (EM) debt risk rose nine bps to a seven-month high 313 bps.

Ten-year Portuguese yields fell nine bps to 2.94% (down 320bps y-t-d). Italian 10-yr yields rose two bps to 2.32% (down 180bps). Spain's 10-year yields were down three bps to 2.06% (down 209bps). German bund yields fell four bps to 0.89% (down 104bps). French yields were down a basis point to 1.25% (down 131bps). The French to German 10-year bond spread widened three to 36 bps. Greek 10-year yields jumped 26 bps to 6.60% (down 182bps). U.K. 10-year gilt yields dropped 17 bps to 2.22% (down 80bps).

Japan's Nikkei equities index dropped 2.6% (down 6.1% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.50% (down 24bps). The German DAX equities index sank 4.4% to an almost one-year low (down 8.0%). Spain's IBEX 35 equities index fell 4.0% (up 2.4%). Italy's FTSE MIB index was hit for 5.0% (up 1.2%). Emerging equities were mostly lower. Brazil's volatile Bovespa index rallied 1.4% (up 7.4%). Mexico's Bolsa fell 2.8% (up 1.7%). South Korea's Kospi index was down 1.8% (down 3.5%). India’s Sensex equities index declined 1.0% (up 24.2%). China’s Shanghai Exchange added 0.5% in a holiday-shortened week (up 12.2%). Turkey's Borsa Istanbul National 100 index declined 1.2% (up 8.4%). Russia's MICEX equities index fell 1.5% (down 9.3%).

Debt issuance remained relatively slow. Investment-grade issuers included AIG $2.25bn, SBA Tower $1.54bn, Wal-Mart $1.5bn, Keysight Technologies $1.1bn, American Honda $875 million, Dignity Health $850 million, Invista $750 million, MPG $600 million, CDK Global $500 million, Atmos Energy $500 million, Marriott $400 million, Cadence Design $350 million and Wisconsin P&L $250 million.

Junk funds saw inflows of $1.3bn (from Lipper). Junk issuers included Dynegy $5.1bn, HCA $2.0bn, Albertsons $1.15bn, Jefferies $425 million, Eco Services $200 million and Natural Resource Partnership LP $125 million.

Convertible debt issuers included Starwood Waypoint Residential $150 million.

International dollar debt issuers included Kazakhstan $2.5bn, Nippon Life Insurance $2.25bn, Quebec $1.6bn, KFW $1.5bn, Mitsubishi UFJ Trust & Banking $1.5bn, Royal Bank of Canada $1.3bn, European Investment Bank $1.0bn, International Bank of Reconstruction & Development $900 million, International Finance Corp $1.1bn, BNP Paribas $1.0bn, Lundin Mining $1.0bn, Unitymedia KabelWB $900 million, Petroleos Mexicanos $2.0bn, Sensata Technologies $400 million, West Fraser Timber Co $300 million and InRetail Consumer $300 million.

Freddie Mac 30-year fixed mortgage rates fell seven bps to 4.11% (down 11bps y-o-y). Fifteen-year rates were down six basis points to 3.30% (down 1bps). One-year ARM rates were unchanged at 2.42% (down 22bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 30 bps to 4.25% (down 26bps).

Federal Reserve Credit last week expanded $3.9bn to $4.412 TN. During the past year, Fed Credit inflated $701bn, or 18.9%. Fed Credit inflated $1.601 TN, or 57%, over the past 100 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt fell $7.6bn last week to $3.337 TN. "Custody holdings" were down $17.2bn year-to-date, while gaining $43bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $707bn y-o-y, or 6.3%, to $11,958 TN. Over two years, reserves were $1.263 TN higher for 12% growth.

M2 (narrow) "money" supply fell $7.3bn to $11.462 TN. "Narrow money" expanded $581bn, or 5.3%, over the past year. For the week, Currency was about unchanged. Total Checkable Deposits added $2.4bn, while Savings Deposits fell $8.2bn. Small Time Deposits slipped $1.4bn. Retail Money Funds were little changed.

Money market fund assets rose $17.0bn to a six-month high $2.631 TN. Money Fund assets were down $88bn y-t-d and dropped $35bn from a year ago, or 1.3%.

Total Commercial Paper jumped $30.2bn to a 2014 high $1.083 TN. CP was up $37bn year-to-date and $17.4bn, or 1.6%, over the past year.

Currency Watch:

October 8 – Reuters: “South Korea announced several measures to aid local exporters hit by a falling yen, as it expressed concern that prolonged weakness of the Japanese currency could do long-term damage to the Korean economy. The government will work to cut the costs of insurance on exchange-rate volatility for the roughly 4,000 small-to-medium sized companies directly affected by fluctuations in the yen , the Ministry of Strategy and Finance said… Roughly 1 trillion won ($937.7 million) will be allocated for such loans and financial aid for firms... ‘The extended weakness of the Japanese yen could lead to Japanese exporters lowering prices, which could in turn negatively affect our exporters,’ said the ministry.”

The U.S. dollar index gave back 0.9% to 85.912 (up 7.3% y-t-d). For the week on the upside, the South African rand increased 2.0%, the Japanese yen 2.0%, the Brazilian real 1.2%, the Swiss franc 1.1%, the Danish krone 0.9%, the euro 0.9%, the New Zealand dollar 0.7%, the British pound 0.6%, the Swedish krona 0.6%, the Singapore dollar 0.5%, the Canadian dollar 0.4%, the Norwegian krone 0.2%, the Australian dollar 0.1% and the Mexican peso 0.1%. For the week on the downside, the South Korean won declined 0.8%.

Commodities Watch:

The CRB index slipped 0.3% this week (down 1.6% y-t-d). The Goldman Sachs Commodities Index fell another 2.0% (down 12.3%). Spot Gold rallied 2.7% to $1,223 (up 1.4%). December Silver recovered 2.8% to $17.303 (down 10.7%). November Crude sank $3.92 to an almost two-year low $85.82 (down 13%). November Gasoline dropped 5.1% (down 19%), and November Natural Gas sank 4.5% (down 9%). December Copper gained 1.2% (down 11%). December Wheat recovered 2.6% (down 18%). December Corn rallied 3.6% (down 21%).

U.S. Fixed Income Bubble Watch:

October 10 – Bloomberg (Lisa Abramowicz): “It’s been a painful week for Wall Street’s biggest bond brokers. Primary dealers had the biggest short position on benchmark government notes at the beginning of the month since last year’s taper tantrum. It was the wrong bet: The debt has gained 1.5% in October as 10-year Treasury yields plunged to the lowest since June 2013. The surprise rally has even the most experienced bond traders struggling to figure out how to maneuver in this market… ‘Over the last year, what’s sort of been the market’s focus is everyone is bearish,’ preparing for rates to rise, said David Ader, head of interest-rate strategy at CRT Capital Group LLC…. The 22 primary dealers that trade with the U.S. central bank had a net $20.7 billion wager against notes maturing in the seven-to-eleven year range during the week ended Oct. 1, Fed data show. That’s the biggest short position on the notes since June 2013.”

Federal Reserve Watch:

October 10 – MarketNews International: “Philadelphia Federal Reserve Bank President Charles Plosser said Friday the U.S. central bank's focus on its employment mandate could cost it credibility when it comes to achieving its longer-term price stability objective. ‘In my view, excessive focus on short-run control of employment weakens the credibility and effectiveness of the Fed in achieving its price stability objective,’ Plosser said… He also warned the Fed's dual mandate of maximum employment and price stability ‘has contributed to a view that monetary policy can do accomplish far more than it is, perhaps, capable of achieving.’ Recent policy statements from the Federal Open Market Committee ‘have increasingly given the impression that it wants to achieve an employment goal as quickly as possible through aggressive monetary accommodation,’ he said”

U.S. Bubble Watch:

October 8 – Bloomberg (Isaac Arnsdorf): “The U.S. shale boom is producing record amounts of new oil as demand weakens, pushing prices down toward levels that threaten to reduce future drilling. Domestic fields will add an unprecedented 1.1 million barrels a day of output this year and another 963,000 in 2015, raising production to the most since 1970… More supply from hydraulic fracturing and horizontal drilling, and less demand, are contributing to the tumble in West Texas Intermediate crude. The U.S. benchmark is down 18% since June 20 and fell below $90 a barrel… for the first time in 17 months. ‘If prices go to $80 or lower, which I think is possible, then we are going to see a reduction in drilling activity,’ Ralph Eads, vice chairman and global head of energy investment banking at Jefferies…‘It will be uncharted territory.’”

October 6 – Bloomberg (David M. Levitt): “New York City’s Waldorf Astoria hotel is set to become the biggest prize yet for buyers from China who have been pouring money into U.S. real estate as they seek stable investments outside their country. Beijing’s Anbang Insurance Group Co. agreed to pay $1.95 billion for the 1,232-room tower on Park Avenue, an Art Deco landmark and one of Manhattan’s signature properties. That would be the highest price for a single existing hotel in the country, and the most paid for a standing U.S. building by a Chinese buyer, said Kevin Mallory, global head of the hotels unit of commercial real estate brokerage CBRE Group Inc.”

Central Bank Watch:

October 5 – Reuters (Michelle Martin): “The European Central Bank's plans to buy rebundled packages of debt have drawn sharp criticism from officials in Germany… On Thursday, the ECB laid out plans to buy reparcelled debt and covered bonds… It will include buying debt with a ‘junk’ credit rating from Greece and Cyprus as long as such countries are under a formal international financial programme. Bundesbank chief Jens Weidmann warned… that there was a danger the ECB would buy ‘low-quality loan securitisations’ at inflated prices as part of its programme to buy so-called asset-backed securities (ABS)… ‘Then the credit risks taken by private banks would be transferred to the central bank and therefore taxpayers without them getting anything in return,’ said Weidmann… ‘But that goes against the basic principle of liability that is fundamental to a market economy: Those who derive benefit from something should bear the loss if there are negative developments…’ Weidmann added that the global financial crisis had shown how dangerous it could be to abandon this principle. He also warned against devaluing the euro: ‘A policy which tries to deliberately weaken the currency would also provoke counter reactions. There can ultimately only be losers in such competitive devaluation,’ he said… Former ECB chief economist Juergen Stark… said… that the ECB's unconventional measures were ‘an act of desperation’… He said while he was not surprised that politicians in Paris and Rome were calling for a devaluation of the euro, ‘the fact the ECB is giving in to this and justifying measures with a targeted weakening of the euro shows the extent to which it is on the wrong track now. There are no taboos there anymore’. Stark said the ECB would put ‘incalculable risks’ on its balance sheet with its ABS programme and euro zone taxpayers would be liable for these in case of losses. ‘That could lead to significant redistributive effects between member states. The ECB has no democratic legitimation for this,’ he said… Two senior allies of German Chancellor Angela Merkel also criticised the ECB over its ABS purchase plans.”

October 9 – Bloomberg (Jana Randow): “Mario Draghi’s policy tools are being blunted in Berlin… Support for anti-euro groups such as Alternative for Germany has risen and the ECB’s latest plan to buy assets sparked an outcry within all major parties. ‘German public opinion matters an awful lot,’ said Anatoli Annenkov, senior economist at Societe Generale… ‘Draghi wants the ECB to be a central bank like any other, one that can go and buy government debt. But he’s perfectly aware of Germany’s opposition, and the storm now is a clear signal that it’ll be much more difficult.’ …German Finance Minister Wolfgang Schaeuble said that while he understands the ECB has a difficult mandate, it ‘should always take into account the issue of wrong incentives or, to put it differently, lame excuses.’ The ECB is continuing ‘its pernicious policy’ of transferring risks from European banks to German taxpayers, said Jan Bollinger, a member of Alternative for Germany. The party emerged last year on a platform of opposing the single European currency and bailouts to indebted euro-area member states, and has won seats in three state parliaments in the past two months…”

October 7 – Reuters (Andreas Framke, Leigh Thomas and Philipp Halstrick): “The European Central Bank's unprecedented decision to use outside help for new asset purchases is stirring conflict among policymakers, highlighting the difficulty for the ECB of considering even more extreme policy action. ECB President Mario Draghi outlined last week new programs under which the euro zone's central bank will buy asset-backed securities… Concerned that individual central banks lack the required expertise, the ECB plans to employ an external bank or professional asset manager to buy the securities on its behalf… But within the ECB's Governing Council there are clashing views over how far it should go to revive lending in the euro zone and how these debt purchases should be carried out. Such friction over a key tool at a time of stagnating growth and worryingly weak price pressures in the euro zone risks weakening the ECB's resolve in the fight against deflation and poses questions as to how easily it could take further steps… German politicians have also raised objections. Others, such as Banque de France governor Christian Noyer, disagree with the way the ECB wants to go about the purchases…”

EM Bubble Watch:

October 10 – Bloomberg (Vladimir Kuznetsov): “Russia’s currency interventions have exceeded $3 billion this month as a domestic dollar shortage and slumping oil prices batter the ruble… The currency of the world’s biggest energy exporter suffered the world’s worst slide since June as U.S. and European sanctions make it harder for companies to refinance the nearly $55 billion of debt the central bank estimates is due through December.”

October 10 – Bloomberg (Natasha Doff): “Rising U.S. bond yields will weigh on an already battered lira this quarter as Turkey’s dependence on foreign capital is exposed by a stronger dollar, according to the currency’s top forecasters… Turkey’s currency is less than 5% away from its January record low as investors weigh the consequences of an eventual interest-rate increase by the Federal Reserve and as the war in neighboring Syria sparks Kurdish unrest at home. The lira’s fate may hang on whether the central bank in Ankara responds to the Fed by raising borrowing costs in a bid to limit capital outflows and deeper losses, according to Credit Suisse Group AG.”

October 10 – Bloomberg (Christopher Langner, Pooja Thakur and Tanya Angerer): “Singapore’s listed developers and real-estate investment trusts face their heaviest burden of near-term maturities on record just as home prices drop. The 80 property companies on Singapore’s stock exchange reported a combined S$23.5 billion ($18.5bn) of borrowings that have to be repaid within a year in their latest filings… The looming debt wall comes as the vacancy rate for condominiums soared to the highest since 2006, pushing prices to the lowest in almost two years…”

Europe Watch:

October 10 – Bloomberg (Mark Deen): “France’s credit rating outlook was reduced to negative from stable by Standard & Poor’s, which cited a deteriorating budgetary position amid constrained economic growth prospects… ‘We believe that, due to policy implementation risk related to the budgetary consolidation and structural reforms, a recovery of the French economy could prove elusive and that France’s public finances might deteriorate beyond 2014, although this is not our base-case scenario,’ according to the statement.”

October 7 – Reuters: “Europe's executive arm does not have the authority to reject France's budget over missed deficit-cutting targets, French Finance Minister Michel Sapin said… as he announced that no further spending cuts would be made next year. Euro zone officials have told Reuters that the European Commission is likely to reject the French draft budget at the end of the month and ask for a new one that would be more in line with its commitments. French officials have said they did not expect the budget to be rejected. Sapin said the reports were ‘wrong’. Rejecting the budget ‘is not within the powers of the Commission,’ he told RTL radio. ‘It cannot censure, it cannot reject the French budget or any other budget,’ he said. ‘Thankfully, in our democracies, the only place where we adopt, we reject, we censure, are the parliaments of the countries concerned."

Germany Watch:

October 10 – Bloomberg (Stefan Riecher, Rainer Buergin and Simon Kennedy): “European Central Bank President Mario Draghi and German Finance Minister Wolfgang Schaeuble differed over what further steps to take if the euro-area economy keeps weakening as the region came under renewed foreign pressure to revive growth. As the International Monetary Fund’s annual meeting in Washington began, Draghi pledged anew to loosen monetary policy more if needed and called on those governments with the room to ease fiscal policy to do so. By contrast, Schaeuble warned against U.S.-style quantitative easing and urged continued budgetary discipline. The differences demonstrate the lack of a common front in euro-area policy making as its economy continues to deteriorate…”

Global Bubble Watch:

October 10 – Bloomberg (Kelly Bit): “Some of the biggest hedge-fund firms have slumped since September, sideswiped by falling stock and bond markets and a legal decision that sent Fannie Mae and Freddie Mac securities plunging. Billionaire John Paulson’s namesake firm had some of the biggest declines last month, losing as much as 11% in one of its funds. Owl Creek Asset Management LP posted a 3.4% decline in the first three days of October driven largely by its Fannie Mae and Freddie Mac stakes, and is down 7.5% this year… Road Asset Management LLC lost 5% in the first week of October because of its investments in the two U.S.-owned mortgage companies, wiping out gains for 2014. Hedge funds, which aim to make money in rising and falling markets, returned 2.3% this year through September…”

October 6 – Bloomberg (Angeline Benoit and Esteban Duarte): “Spanish Prime Minister Mariano Rajoy is battling to keep his country together, facing down Catalan separatists. Even if he wins, the standoff risks weakening the economy that the two sides are fighting over. Catalan President Artur Mas, backed by about two-thirds of the region’s lawmakers, is defying orders from Spain’s highest court and pressing ahead with a vote on independence on Nov. 9… ‘Investors are pricing the risk of political instability in Catalonia,’ said Francesco Marani, a fixed-income trader at Auriga Global Investors SA in Madrid… “The independence issue has already been hurting the Spanish economy, and it’s not over.’ Spain’s economy is losing momentum amid a slowdown for its European trading partners.”

October 6 – Financial Times (Michael Mackenzie and Gregory Meyer): “Investors have liquidated hundreds of billions of dollars of positions in interest rate derivatives contracts, an asset class favoured by Bill Gross, in moves that traders suggested showed Pimco cashing in holdings to meet redemption demands. The massive shift in positions marks the most visible sign yet of the market turmoil that has followed the exit of Mr Gross from Pimco and its resulting efforts to meet redemptions while other investors seek to profit from the dislocation. Under Mr Gross, Pimco’s Total Return Fund was a large investor in three-month ‘eurodollar’ interest rate contracts on the Chicago Mercantile Exchange. The futures, which enable buyers to lock in a rate for three months during the next 10 years, are highly liquid and the most actively traded contract on the CME.”

October 8 – Bloomberg (Tom Schoenberg, Greg Farrell and David McLaughlin): “U.S. prosecutors are pressing to bring charges against a bank for currency-rate rigging by the end of the year, and actions against individuals will probably follow in 2015, according to people familiar with the probe. The Justice Department may seek guilty pleas from several firms, including at least one in the U.S., said one of the people, asking not to be named because details of the investigation aren’t public. While federal prosecutors have wrested convictions from foreign banks this year for wrongdoing, they’ve yet to win a guilty plea from a U.S. lender in that push, and they’re preparing for strong resistance if they attempt to do so. Justice Department officials have vowed to hold more institutions and individuals accountable for criminal conduct amid public frustration over the lack of prosecutions against top Wall Street executives for the worst financial crisis since the Great Depression.”

October 6 – Bloomberg (Sharon Chen): “The World Bank lowered its forecasts for growth in developing East Asia this year and next as China’s expansion moderates and policy makers brace for tighter global monetary conditions. The region is forecast to grow 6.9% in 2014 and 2015, down from 7.1% projected in April…”

Geopolitical Watch:

October 10 – Bloomberg (Kateryna Choursina): “Thirty military vehicles crossed Ukraine’s border from Russia in last 2 days and 40 buses arrived with fighters trained across border, Ukrainian military spokesman Andriy Lysenko says at Kiev briefing.”

October 10 – Bloomberg (Selcan Hacaoglu): “On Diyarbakir’s main roads, Turkey’s army is in charge, with soldiers and armed vehicles standing guard. Not far away, Kurdish youths have turned boulders and burnt-out cars into makeshift checkpoints… The main city in Turkey’s largely Kurdish southeast has been under curfew for two nights. Kurds are protesting what they say is Turkey’s failure to come to the aid of Kobani, a largely Kurdish town just across the border in Syria that’s under siege by Islamic State militants. The eruption of anger threatens Turkey’s bid to end three decades of conflict with Kurdish groups seeking wider rights… Violence flared again across the southeast late yesterday, bringing the death toll above 30.”

October 9 – Wall Street Journal (Harriet Torry and Andrea Thomas): “Germany’s equivalent of the FBI has warned local police forces that the fall of Syrian border town Kobani could trigger more clashes between Kurds and Islamists on German streets after violent confrontations in two cities this week fanned fears the conflict in Syria is spilling over to home. Several regional police officials told The Wall Street Journal they had received a written warning this week from the Federal Criminal Police Office, or BKA, to prepare for more violence between communities with links to the conflict region should the mainly Kurdish town in northern Syria fall into the hands of Islamic State fighters.”

October 10 – Bloomberg (Nadeem Hamid): “Iranian, Turkish officials have consulted over situation in Kurdish town of Kobani, under attack by Islamic State, Press TV says, citing Hossein Amir- Abdollahian, deputy foreign minister. Iran warned against any Turkish ground operation in Syria…”

October 9 – Bloomberg (Henry Meyer): “UN Security Council [is the] only body capable of authorizing buffer zones, Russian Foreign Ministry spokesman Alexander Lukashevich tells reporters… ‘Decisions of specific countries or even coalitions in this matter are illegitimate.’ Even when UN approval given, as in case of Libya no-fly zone, ‘remember what happened after that.’ U.S. has rebuffed Turkey’s pleas to help create buffer zone in Syria near Turkish border…”

October 9 – Bloomberg (Joel Achenbach;Lena H. Sun;Brady Dennis): “When the experts describe the Ebola disaster, they do so with numbers. The statistics include not just the obvious ones such as caseloads, deaths and the rate of infection, but also the ones that describe the speed of the global response. Right now, the math still favors the virus. Global health officials are looking closely at the ‘reproduction number,’ which estimates how many people, on average, will catch the virus from each person stricken with Ebola. The epidemic will begin to decline when that number falls below one. A recent analysis estimated the number 1.5 to two. Ebola cases in West Africa have been doubling about every three weeks, and no data suggests a major change in that trendline. ‘The speed at which things are moving on the ground, it's hard for people to get their minds around. People don't understand the concept of exponential growth,’ said Tom Frieden, director of the U.S. Centers for Disease Control and Prevention.”

October 9 – Bloomberg (Michael Riley and Jordan Robertson): “The hackers who raided the data banks of JPMorgan Chase & Co. used computers now linked to possible attacks on at least 13 more financial companies… More than a month after the JPMorgan hack was made public, it’s now clear that the perpetrators had attempted a broad campaign aimed at a payroll-servicing company, a popular stock brokerage and some of the world’s biggest banks. The depth of the JPMorgan breach and the scope of the intended targets have sent a shudder through Wall Street… The group set its sights on companies including Citigroup Inc., HSBC Holdings Plc, E*Trade Financial Corp., Regions Financial Corp. and Automatic Data Processing Inc., the payroll firm…"

October 8 – Reuters: “Five civilians were killed and thousands took refuge in camps in the disputed region of Kashmir… after some of the most intense fighting between nuclear-armed neighbours Pakistan and India in a decade… Kashmir is claimed by both countries and has been a major focus of tension in South Asia. Each side has accused the other of targeting civilians and unprovoked violations of a border truce that has largely held since 2003.”

China Bubble Watch:

October 8 – Wall Street Journal (Grace Zhu): “One of China’s biggest financial firms is offering to lend money to home buyers for down payments, part of a trend that could help the housing market but has prompted worry about risks to the financial system. Ping An Insurance (Group) Co., one of China’s largest insurers and a financial conglomerate, has started offering loans to consumers to cover down payments… Another unit of Ping An, peer-to-peer lending website lufax.com, will provide funding for the loans…”

October 10 – Bloomberg: “Agile Property Holdings Ltd., the Chinese developer whose shares have been halted since Oct. 3, said it will not proceed with a HK$2.8 billion ($361 million) rights offering… The agreement with banks to arrange the sale will lapse as a result and the offering won’t proceed, it added. ‘As it can’t be done now, there’ll be greater pressure on its liquidity situation,’ said Donald Yu… analyst at Guotai Junan Securities Co. ‘It’ll also face certain difficulties in issuing debt. The one thing it could do is syndicated loans, but interest rates will have to be discussed.’”

Latin America Watch:

October 10 – Bloomberg (Raymond Colitt): “Brazil’s economy probably will experience slow growth rates for some time, regardless of who wins this month’s presidential election, the head of the International Monetary Fund’s Western Hemisphere department, Alejandro Werner, said… Brazil has low investment and productivity rates that don’t allow it to ‘accelerate its growth rates quickly in coming years,’ Werner said… Brazil’s economy slipped into recession in the first half of 2014 and growth is forecast at 0.3% this year and 1.4% in 2015, according to the IMF.”

Japan Bubble Watch:


October 8 – Reuters: “Japanese Prime Minister Shinzo Abe said… that a weaker yen burdens households and small firms by increasing fuel prices. A weaker yen has both benefits and costs as it will help exporters while negatively impact importers of raw materials, Abe told the parliament, where some lawmakers criticized Abe's policy as hurting households.”