Monday, December 15, 2014

10/17/2014 The Downside of Do Whatever it Takes *

Goldman Sachs CEO Lloyd Blankfein provided a market-calming interview late Thursday afternoon with CNBC’s Carl Quintanilla. Not surprisingly, I suppose, Blankfein praised the Fed for being “wise and courageous.” He also stated that extreme market views were wrong. Considering the global backdrop, I actually see a curious lack of extreme views (at least from the bear side). Instead, we’re at the stage of the cycle where even “bearish” pundits go out of their way to distance themselves from “the world is ending” prognosis. I guess I would be considered an extremist, though I don’t see the world ending anytime soon. But this week did offer further evidence that history’s greatest financial Bubble is at significant risk.

Friday’s rally did a lot to paper over what was a disturbing week for global markets. The mini-melt-up successfully took a great deal of value out of index and stock put options that expired Friday. Those seeking market protection will now have to pay up for expensive puts that expire in November, December or later.

But don’t let the S&P 500’s modest 1.0% decline fool you. It was an extraordinary week. Japan’s Nikkei index was hammered for 5.0%, increasing 2014 losses to 10.8%. Japanese two-year yields traded to a record low 0.005%. After beginning the week at 6.60%, Greek 10-year bond yields traded to 9% on Thursday (before closing the week at 8.07%). Wild instability returned to European debt (and equities) markets. Portugal’s 10-year yields were up 75 basis points by Thursday, before a rally cut the week’s jumpe to 35 bps. Germany’s DAX equities index dropped 2.87% on Wednesday then rallied 3.12% on Friday. Italian stocks sank 4.44% and then rallied 3.42%.

Panic buying saw German bund yields trade to a record low 0.71% on Thursday, before ending the week at 86 bps. Spreads to bunds widened meaningfully throughout Europe. The German to Italian spread widened 20 bps to 165 bps, and German to Spanish 13 bps to 131 bps. Curiously, even French bonds showed some vulnerability this week. With French 10-year yields up 6 bps, the spread to bunds widened nine to a three-month high 44 bps. Notably, Cyprus CDS surged 112 bps this week to an eight-month high 482 bps.

Watching the U.S. long-bond surge a full four points on my Bloomberg screen Wednesday morning brought back memories. I recall staring at Quotron and Telerate screens back on “Black Monday,” October 19, 1987, as stocks crashed and Treasury bonds gained an incredible 11 points. Ten-year yields traded to a low of 1.86% on Wednesday, with two-year yields down to 0.25%. In a matter of several hours, five-year Treasury yields traded from 1.47% down as low as 1.11%. In just seven sessions two-year yields sank from 56 bps to 31 bps. Recent trading has seen wild volatility in eurodollar future, CDS and derivatives markets generally. After beginning the week at 21.24, the VIX (equities volatility) index traded above 31 on Wednesday to the highest level since 2011 (surpassing even 2012 European crisis levels!). It is certainly also worth mentioning that the Goldman Sachs “Most Short” index jumped 3.3% this week in one of the bigger recent outperformances posted by commonly shorted stocks. The S&P 500 Homebuilding Index jumped 7.85% this week.

I find the backdrop surreal. And the more everyone acts as if it’s all business as usual the more worried I become. As crazy as I know it sounds, I am these days reminded of my bewilderment when studying the period leading up to the 1929 stock market crash. How could they not have seen it coming? How could everyone remain so bullish (“a permanently high plateau”) considering what in hindsight was an obvious – and quite ominous – deterioration in the market and global economic outlook. I also think often of a quote from that period: “Everyone was determined to hold their ground, but the ground gave way.” Can the world’s central bankers hold everything up?

These days, there are extraordinary divergences in views – two altogether different worlds – two completely opposing views of how things work. Take off the rose-colored glasses and the world is clearly a scary place. So long as the markets go higher the glasses stay on. Increasingly, however, I suspect many in the hedge fund industry see the markets similarly as I do – in complete disarray. Meanwhile, the traditional long-equities investors see yet another dip to buy before another big rally takes stocks to record highs.

So is this just another “healthy correction” or are there more serious dynamics at work? For me, this week’s major market instability supported the bursting global Bubble thesis. In a way, the week was akin to a “flash crash” on a global, multi-asset class basis. Aggressive selling found a dearth of willing buyers – stocks, bonds, commodities and derivatives. Panic buying of Treasuries and bunds found a dearth of sellers. In short, various markets dislocated in illiquidity – simultaneously. I assume leverage and derivatives-related trading played integral roles.

Importantly, wild instability across various markets has surely inflicted meaningful losses on the global leveraged speculating community. With many funds now posting negative returns for the year coupled with markets succumbing to treacherous volatility, a period of de-risking/de-leveraging is likely now at hand. But as we saw this week with many stocks (and sectors) that the speculators were short, market dislocation and short squeezes can fuel spectacular volatility and even big gains.

Rather 1929esque, Jeremy Siegel filled the airways trumpeting robust U.S. fundamentals and Dow 18,000 (by year end!). Meanwhile, The Wall Street Journal went with the headline “Corporate-Debt Market Slows to a Crawl.” “Crawl” was generous. Bloomberg hit the mark: "Credit Markets Weaken as New Issuance Halts, Junk Extends Losses.” Importantly, the corporate debt market – especially for high yield bonds and loans that have been issued in record quantities – basically shut down this week. To be sure, the U.S. Bubble economy will be at risk if this key financing market doesn’t get back to business quickly. M&A would be at risk; stock buybacks at risk; and corporate earnings and spending would be at risk.

While it has garnered some boom-time momentum of late, I believe the U.S. economy is more vulnerable than most appreciate. Another Bloomberg headline: “Oil and Junk Don’t Mix as 19% Rout Posted on Worst of Crude Debt.” The U.S. energy revolution has been integral to the bull story on the U.S. economy. Now, with crude prices having collapsed, we’ll begin to tally the damage from one of the more conspicuous Fed policy-induced Bubbles. There are as well plenty more commodity price downturns (corn, wheat, soybeans, cotton, etc.) that will surely unveil plenty of ill-advised lending and investment. And I certainly expect many U.S. companies to suffer at the hands of a weakening global economy.

I subscribe to the “Austrian” focus on the critical importance of a balanced economic expansion. But in our world of central bank policy-induced financial booms and busts, economic balance is relegated to history. Instead, we live in a world of intractable imbalances and destabilizing serial sector Bubbles. The Tech Bubble, the “housing” Bubble and more recently the energy Bubble, Tech Bubble 2.0 and Stock Market Bubble 3.0. After years of excess and resulting resource misallocation, the maladjusted U.S. economy is inherently vulnerable to a reversal of speculative finance and resulting tightening of financial conditions (with deflating U.S. securities prices).

From my perspective, global markets have begun to adjust to what will be momentous changes to the financial and economic landscape. Faltering global fundamentals ensure acute problems for an over-leveraged world. Collapsing commodities prices equate to debt problems for scores of companies, countries, lenders and speculators. And considering the scope of global leverage and speculation, the odds of this market adjustment spiraling into a major financial crisis are high. This week offered unmistakable evidence as to how quickly things can unravel. In powerful crannies in the marketplace, confidence likely took a forceful hit this week. Potential illiquidity became a pressing issue.

At about 10:20 a.m. on Thursday, with European markets tanking and U.S. equities sinking, St. Louis Fed president James Bullard began to be interviewed on Bloomberg Television. Bullard, generally considered a FOMC moderate, had more recently shifted to the hawkish contingent. This ensured that his Thursday morning flutter to join the doves provided notable relief to the markets. The key Bloomberg headline (10:25 am): “Bullard Says Fed Should Consider Delay in Ending QE.” Nervous markets had been awaiting a signal of support from the FOMC. From the market’s 10:18 a.m. low to Friday’s high the S&P500 rallied 3.4%.

San Francisco Fed chief John Williams actually got things going Wednesday with his comment (Reuters interview), “If we really get a sustained, disinflationary forecast ... then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider.” It was close enough to Bernanke’s summer of 2013 assurances that the Fed would “push back” against a tightening of financial conditions. As a longtime close advisor to Janet Yellen, Williams’ views matter to the markets.

The QE issue is a fascinating one. History is rather clear: once major monetary inflations begin they become nearly impossible to stop. I certainly don’t expect the ballooning of the Fed’s balance sheet stops at $4.5 TN. There will be no “exit.” I’m thinking “QE4” might be ushered in with something similar to the Fed’s statement before the stock market opened the day following the 1987 crash: “The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

The bulls absolutely fixate on the Fed (and its cohorts) reliably backstopping the markets – “QE infinity”. I could only chuckle when reading a Wednesday UK Telegraph headline: “World Economy So Damaged It May Need Permanent QE.” Anyone asking how it became so damaged?

From a real world perspective, by now it’s apparent that QE doesn’t work as prescribed – as the propaganda asserts. Global central banks have added Trillions of liquidity and the global economy and markets are as fragile as ever. The Fed has “printed” almost $3.6 TN in six years and the U.S. economy remains extraordinarily vulnerable. Arguably, U.S. securities Bubbles are an accident in the making. Incredible QE in Japan has had only modest economic impact, with sinking stocks now weighing on confidence. In the past two years of incredible global monetary pumping, disinflationary forces have gathered momentum. Many commodities are trading at multi-year lows. Now global market participants and pundits clamor for aggressive ECB QE, while blasting what is commonly viewed as mindless German austerity. The hope has been that ECB QE would sustain the global Bubble. Mindfully, the Germans don’t want to play ball.

If only Bubbles lasted forever. And, unfortunately, the longer they persist and the bigger they inflate -the more problematic the unavoidable collapse. This important reality is ignored at everyone’s peril. Determination to avoid collapse only ensures greater and more precarious Bubble distortions and maladjustment. “World Braces as Deflation Tremors Hit Eurozone Bond Markets,” read another UK Telegraph headline. And Bullard and the global central bank community fret a “collapse in inflation expectations.” It is important to recognize that disinflation and collapsing “inflation expectations” are symptomatic of a bursting global financial Bubble, providing early evidence of what will be a spectacular failure in experimental “activist” central banking.

Predictably, the calls for more “money” printing turn boisterous and increasingly desperate. But more QE only delays the day of reckoning. I guess I am an “extremist” for stating that printing “money” out of thin air and inflating global securities markets are not going to resolve deep structural deficiencies in global Credit and economic “systems.”

So how long can global policymakers and bullish pundits keep the Bubble psychology alive? Indeed, we’re now facing two radically different world backdrops: the historic Bubble regains some momentum - or it continues to deflate. These quite contrasting worlds imply widely divergent market values for so many things around the world, certainly including securities prices. So long as confidence holds, many will argue that securities are attractively valued. But if markets continue to weaken, financial conditions further tighten and liquidity continues to wane (i.e. contagious de-risking/de-leveraging), then securities markets will face a very problematic period of instability and revaluation.

I’ll state it again, I find the current global backdrop much more problematic than 2007/08. Having become a historic Bubble, China’s financial system and economy are incredibly more fragile than six years ago. Throughout the emerging markets, economies and Credit systems have been damaged by six years of reckless excess. And how about Europe – financial systems, economies, societies and geopolitics? Across the board, European fundamentals have suffered frightening deterioration. And I can only concur with comments repeated Friday by Bundesbank President Weidmann: “ECB’s QE will not fix the Eurozone’s problems.”

This week saw some of the problems associated with aggressive central banking come home to roost. In a serious crack at the “periphery,” Greek bond yields spiked 250 basis points in three sessions. In the halcyon world of endless cheap liquidity, Greece’s debt load appeared manageable. So why not leverage in higher-yielding Greek debt with Fed, BOJ and Draghi all backstopping the markets? Why not debt from Portugal, Italy, Spain and France? Why not all higher-yielding “periphery” debt, including European and U.S. junk bonds? What difference do fundamentals matter when central bankers are promising to do “Whatever it Takes.”

Meanwhile, two years of booming securities markets took the heat off of European politicians (just as the Germans warned!). France is in the process of (again) flouting EU deficit rules, while Italy has also decided to boost deficit spending (with debt-to-GDP above 130%!). For monetary integration to have any chance of success would require strict fiscal integration. Things are instead going in the opposite direction, and there’s going to be some heated battles ahead. As I’ve said in the past, at the end of the day I do not expect the Italians (or the Greeks or French) and the Germans to share the same currency.

October 16 – Bloomberg (Patrick Donahue and Ilya Arkhipov): “Talks between Vladimir Putin and German Chancellor Angela Merkel, who blamed Russia for stoking the crisis in Ukraine, were scrapped when the Russian leader overstayed a celebration of a Soviet defeat of the Nazis in Serbia. Serbia’s government, which has refused to implement European Union sanctions against Russia even as it’s trying to join the bloc, welcomed Putin with the country’s first military parade since the days of Cold-War President Josip Broz Tito.”

I expect the markets will be confronted by myriad troubling European issues. From the markets’ perspective, the Ukraine crisis has been resolved. Putin buckled under the pressure of Western economic sanctions, in another win for contemporary finance. I suspect this thinking is way too optimistic. Actually, I believe Putin is determined that Western sanctions don't win. And there were some rather ominous warnings this week regarding the potential consequences of “blackmailing” Russia. So don’t be surprised if Putin turns the tables and blackmails the West (i.e. if sanctions are not lifted there will be a renewed land grab in Ukraine, along with a more belligerent stance generally).

And while the focus was more on market volatility and the Ebola virus, the geopolitical backdrop worsens by the week. Putin and Beijing seem to be singing from the same hymnbook, as the Chinese turned more outspoken in blaming the U.S. for the Hong Kong protests (and other “color revolutions”). The situation in the Middle East becomes more alarming by the week. Overall, the gap between disconcerting global prospects and ebullient securities prices is as wide as ever. Clearly, central bankers would hope to maintain this gap – to defend the Truman Show World. And I don’t believe it is an extremist view to see this as one big financial scheme. Moreover, it’s not extremist to fear how things will play out when confidence wanes - when this scheme falters. Actually, the extremists are the inflationists that believe printing money will resolve the world’s ills. The Fed has been neither “wise” nor “courageous.” Have we not seen enough already?


For the Week:

The S&P500 declined 1.0% (up 2.1% y-t-d), and the Dow fell 1.0% (down 1.2%). The Utilities added 0.4% (up 12.7%). The Banks fell 3.1% (down 3.5%), while the Broker/Dealer recovered 1.0% (up 0.7%). Transports jumped 3.2% (up 10.1%). The S&P 400 Midcaps rallied 1.3% (down 1.5%), and the small cap Russell 2000 surged 2.8% (down 7.0%). The Nasdaq100 lost 1.4% (up 6.2%), and the Morgan Stanley High Tech index fell 1.0% (up 0.1%). The Semiconductors rallied 2.5% (up 7.5%). The Biotechs added 0.2% (up 29.5%). Although bullion gained $15, the HUI gold index was down 1.0% (down 5.4%).

One- and three-month Treasury bill rates closed the week at two bps. Two-year government yields declined five bps to 0.37% (down one basis point y-t-d). Five-year T-note yields sank 12 bps to 1.42% (down 33bps). Ten-year Treasury yields fell nine bps to 2.19% (down 84bps). Long bond yields declined four bps to 2.97% (down 100bps). Benchmark Fannie MBS yields dropped nine bps to 2.89% (down 72bps). The spread between benchmark MBS and 10-year Treasury yields was little changed at 70 bps. The implied yield on December 2015 eurodollar futures dropped a notable 12.5 bps to 0.77%. The two-year dollar swap spread was little changed at 26 bps, while the 10-year swap spread rose two to 16 bps. Corporate bond spreads were wildly volatile. An index of investment grade bond risk declined one to 71 bps. An index of junk bond risk ended the week down 11 bps to 373 bps. An index of emerging market (EM) debt risk rose six bps to a seven-month high 319 bps.

Greek 10-year yields surged 147 bps to 8.07% (down 35bps y-t-d). Ten-year Portuguese yields jumped 35 bps to 3.30% (down 283bps). Italian 10-yr yields rose 17 bps to 2.50% (down 163bps). Spain's 10-year yields were up 10 bps to 2.17% (down 198bps). German bund yields declined three bps to 0.86% (down 107bps). French yields were up five bps to 1.30% (down 126bps). The French to German 10-year bond spread widened six to 44 bps. U.K. 10-year gilt yields declined three bps to 2.19% (down 83bps).

Japan's Nikkei equities index sank 5.0% (down 10.8% y-t-d). Japanese 10-year "JGB" yields fell three bps to a record low 0.47% (down 28bps). The German DAX equities index recovered 0.7% (down 7.4%). Spain's IBEX 35 equities index fell 1.9% (up 0.4%). Italy's FTSE MIB index was hit for 2.6% (down 1.4%). Emerging equities were highly unstable. A big Friday rally saw Brazil's volatile Bovespa index end the week up 0.8% (up 8.2%). Mexico's Bolsa slipped 0.4% (up 1.3%). South Korea's Kospi index was down 2.1% (down 2.1%). India’s Sensex equities index slipped 0.7% (up 23.3%). China’s Shanghai Exchange declined 1.4% (up 10.6%). Turkey's Borsa Istanbul National 100 index jumped 2.8% (up 11.4%). Russia's MICEX equities index rallied 1.5% (down 7.9%).

Debt issuance slowed to a trickle. Investment-grade issuers included JPMorgan $2.0bn, Bank of America $2.0bn, General Mills $1.0bn and PepsiCo $500 million.

Junk funds saw outflows of $549 million (from Lipper). I saw no junk issuers this week.

Convertible debt issuers included Monster Worldwide $125 million.

The notably short list of international dollar debt issuers included Kommunalbanken $1.0bn and Nova Chemicals $500 million.

Freddie Mac 30-year fixed mortgage rates dropped 15 bps to a 16-month low 3.97% (down 31bps y-o-y). Fifteen-year rates were down 12 bps to 3.18% (down 15bps). One-year ARM rates fell four bps to 2.38% (down 25bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 29 bps to 4.51% (up 6bps).

Federal Reserve Credit last week expanded $9.8bn to a record $4.421 TN. During the past year, Fed Credit inflated $659bn, or 17.5%. Fed Credit inflated $1.611 TN, or 57%, over the past 101 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $18.6bn last week to $3.318 TN. "Custody holdings" were down $36bn year-to-date, while gaining $10bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $438bn y-o-y, or 3.8%, to $11,853 TN. Over two years, reserves were $1.101 TN higher for 10% growth.

M2 (narrow) "money" supply surged $55.5bn to $11.517 TN. "Narrow money" expanded $613bn, or 5.6%, over the past year. For the week, Currency declined $2.0bn. Total Checkable Deposits added $1.1bn, and Savings Deposits jumped $55.2bn. Small Time Deposits slipped $1.0bn. Retail Money Funds gained $2.3bn.

Money market fund assets gained $17.0bn to a six-month high $2.609 TN. Money Fund assets were down $110bn y-t-d and dropped $4bn from a year ago, or 0.2%.

Total Commercial Paper dropped $22.6bn to $1.061 TN. CP was up $15bn year-to-date and $27bn, or 2.6%, over the past year.

Currency Watch:

The U.S. dollar index declined 0.9% to 85.11 (up 6.3% y-t-d). For the week on the upside, the New Zealand dollar increased 1.4%, the Swiss franc 1.1%, the euro 1.1%, the Danish krone 1.0%, the Swedish krona 0.8%, the Japanese yen 0.7%, the Australian dollar 0.7%, the South Korean won 0.4%, the South African rand 0.4%, the British pound 0.1% and the Singapore dollar 0.1%. For the week on the downside, the Canadian dollar declined 0.7% and the Norwegian krone 0.5%.

Commodities Watch:

The CRB index declined 1.1% this week (down 2.7% y-t-d). The Goldman Sachs Commodities Index sank 2.5% to a four-year low (down 14.6%). Spot Gold gained 1.2% to $1,238 (up 2.7%). December Silver added 0.2% to $17.33 (down 11%). November Crude sank another $3.07 to a 28-month low $82.75 (down 16%). November Gasoline fell 1.1% (down 20%), and November Natural Gas dropped 2.4% (down 11%). December Copper lost 1.0% (down 12%). December Wheat rallied 3.5% (down 15%). December Corn recovered 4.2% (down 18%).

U.S. Fixed Income Bubble Watch:

October 15 – Bloomberg (Katherine Chiglinsky, Christine Idzelis and Nabila Ahmed): “Junk bonds in the U.S. extended declines that are handing buyers their biggest losses in more than a year, all but shuttering the market where speculative- grade companies borrow. The largest exchange-traded fund that buys the debt reached the lowest level since June 2013. Demand surged for credit- default swaps that investors use to hedge against losses, fueling trading that was almost four times the daily average. The turmoil stopped junk-bond issuance for a second day… After gobbling up a record $294 billion of high-yield, high-risk debt this year, bond buyers are facing losses of 2.6% since the end of August as signs of a global economic slowdown and plunging commodity prices raise concerns that the riskiest companies will struggle under the weight of their debt. ‘You’re really seeing some real credit fears,’ Peter Tchir, head of macro strategy at Brean Capital… said… ‘There’s real concern that people have been sloppy and lazy and mispricing assets.’”

October 15 – Bloomberg (Nabila Ahmed and Matt Robinson): “Gobbling up $50 billion of high-yielding U.S. junk-bond offerings by energy companies this year may have seemed like a good idea when oil was above $100 a barrel and yields were at record lows. With prices now falling toward $80, bond buyers have instead been saddled with $1.8 billion of lost market value and growing concern that too much credit has been extended too fast amid America’s shale boom… Because the borrowing capacity of oil and gas producers is directly tied to the value of their reserves, the falling commodity prices are increasing the risk that companies will face funding constraints should the selloff persist. Junk bonds issued by energy companies, which have made up a record 17% of the $294 billion of high-yield debt sold in the U.S. this year, have on average lost almost 4% of their market value since issuance…”

October 14 – Bloomberg (Lisa Abramowicz): “If you’re wondering why junk bonds keep selling off, consider this: Oil prices are tanking and energy companies now account for a record proportion of the below investment-grade market. Debt of high-yield energy companies has tumbled 4.6% since August, leading the market down as the price of brent crude futures plummeted to the lowest in about four years. Some securities have fared much worse, like the 19% plunge in oil and gas producer Samson Investment Co.’s bonds. ‘It’s been a pretty sharp move,’ said Matt Eagan, a fund manager at Loomis Sayles & Co. in Boston. ‘This is the first time in a long time where a sector has seen a big setback.’ Every time the U.S. junk-bond market has faltered since 2008, it’s been rescued by record monetary stimulus that’s fueled demand for the higher-yielding debt.”

October 17 – Bloomberg (Michelle Kaske): “Puerto Rico securities are poised for their longest skid since July as hedge funds and other distressed investors sell the junk-rated island’s debt, which has outperformed the municipal market for most of 2014. The U.S. territory’s bonds are on pace to decline for a fifth straight week… With stocks sliding this month, some funds may be shifting money elsewhere or exiting Puerto Rico to compensate for losses… The sales underscore the fickle nature of hedge funds’ approach to the island, after they bolstered its liquidity by buying most of a $3.5 billion March general-obligation deal.”

Federal Reserve Watch:

October 17 – Bloomberg (Steve Matthews and Rich Miller): “Federal Reserve Bank of St. Louis President James Bullard challenged his fellow central bankers to honor pledges to adjust bond purchases in response to incoming economic data and to keep inflation stable. Bullard said the Fed should consider delaying plans to end its bond-buying program at the end of this month to halt a decline in expected inflation. The Fed has tapered purchases to $15 billion a month from $85 billion in December 2012. ‘We said the taper was data dependent,’ he said… The Fed’s message should be that ‘we are watching and we’re ready and we are willing to do things to defend our inflation target.’”

October 14 – Reuters (Ann Saphir and Jonathan Spicer): “A bellwether Federal Reserve policymaker on Tuesday downplayed concerns about weakness in the global economy, saying the U.S. central bank should only delay an interest rate hike next year if inflation or wages fail to perk up. John Williams, president of the San Francisco Fed, said in an interview with Reuters that the first line of defense at the central bank, if needed, would be to telegraph that U.S. rates would stay near zero for longer than mid-2015, when he currently expects them to rise. If the outlook changes ‘significantly,’ with inflation showing little sign of returning to the central bank's 2% target, he said he would even be open to another round of asset purchases.”

October 13 – Bloomberg (Christopher Condon, Jeff Kearns and Ian Katz): “Federal Reserve policy makers said a slowdown in the world economy could undermine the U.S. expansion and prompt them to delay raising interest rates. ‘If foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise,’ Vice Chairman Stanley Fischer said in a weekend speech at the International Monetary Fund’s annual meetings…”

U.S. Bubble Watch:

October 17 – Bloomberg (Clea Benson): “Fannie Mae, Freddie Mac and their regulator are nearing agreement with mortgage issuers on efforts to boost lending and ease banks’ concerns that they will get stuck with bad loans when borrowers default. The initiatives include a consensus on when defaulted loans are so flawed that lenders must buy them back from the two mortgage-finance companies, a key sticking point in efforts to unlock credit… The steps are part of a broader push to increase lending after banks had to repurchase billions of dollars of mortgages that were issued during the housing bubble.”

October 12 – Reuters (Peter Rudegeair): “U.S. regulators are asking banks for more detail on their autos financing exposure, as rapid growth in the lending has prompted officials to seek to better assess the risks, according to a person familiar with the matter. Balances remaining on auto loans have risen by about a third since April 2011, reaching an all-time high of $924.2 billion in August, according to… Equifax. About a fifth of the loans are subprime. Banking regulators fear that reckless lending may be at least helping to fuel that growth, and there are early signs that delinquencies are increasing in the sector.”

October 14 – Reuters (Michelle Conlin): “Many thousands of Americans who lost their homes in the housing bust, but have since begun to rebuild their finances, are suddenly facing a new foreclosure nightmare: debt collectors are chasing them down for the money they still owe by freezing their bank accounts, garnishing their wages and seizing their assets. By now, banks have usually sold the houses. But the proceeds of those sales were often not enough to cover the amount of the loan, plus penalties, legal bills and fees. The two big government-controlled housing finance companies, Fannie Mae and Freddie Mac, as well as other mortgage players, are increasingly pressing borrowers to pay whatever they still owe on mortgages they defaulted on years ago.”

Central Bank Watch:

October 17 – Telegraph (Denise Roland): “Bundesbank president says eurozone is being hampered by structural barriers, not monetary policy Germany's Jens Weidmann has claimed that the European Central Bank's (ECB) plan to purchase asset-backed securities (ABS), a form of quantitative easing, will do little to help the ailing eurozone economy. He insisted that the eurozone's economic stagnation was due to structural factors rather than monetary policy. ‘The biggest bottleneck for growth in the euro area is not monetary policy, nor is it the lack of fiscal stimulus: it is the structural barriers that impede competition, innovation and productivity,’ he said. The Bundesbank president also warned that the ECB's plan would only serve to transfer risks from banks to the taxpayer. ‘This would run counter to everything we have strived to achieve in banking regulation over the last years,’ he said.”

EM Bubble Watch:

October 17 – Bloomberg (Cara Moffat): “Russia Cut to Baa2 From Baa1 by Moody’s, Outlook Negative: Russia’s increasingly subdued growth prospects, exacerbated by the prolongation of the Ukraine crisis, including through the impact of expanded international sanctions is key driver, Moody’s says. Key driver: Gradual, but ongoing erosion of the country’s foreign-exchange buffers due to capital flight, Russian borrowers’ restricted international market access and low oil prices…”

October 17 – Bloomberg (Vladimir Kuznetsov and Ksenia Galouchko): “Russian currency-market interventions that have topped $13 billion are failing to stem the ruble’s slide to unprecedented lows as oil tumbles and investors shun riskier assets… Brent crude has tumbled 25% from a June peak, worsening the outlook for Russia, which derives more than half of its budget revenue from energy and is teetering on the brink of recession as sanctions over the Ukraine crisis spur a domestic dollar shortage.”

October 17 – Bloomberg (Benjamin Harvey): “Turkey’s improving current-account deficit is raising questions about the sources of financing that are shrinking the gap. While a report this week showed the shortfall narrowed 35% over the past year to $29.6 billion through August, yields on 10-year bonds have climbed 64 bps in the period amid concern the trend isn’t sustainable. The deficit has been buoyed in 2014 by $9.1 billion in unexplained income classified as ‘net errors and omissions’ by the central bank.”

October 13 – Bloomberg (Ken Kohn and Minh Bui): “Investors withdrew more than $1 billion from U.S. exchange-traded funds that buy emerging-market stocks and bonds for a second straight week, led by Brazil.”

Europe Watch:

October 16 – Bloomberg (Nikos Chrysoloras and Eleni Chrepa): “Greece’s plan to escape the shackles of the biggest bailout in history is at risk of falling apart. A month of declines in stocks and bonds has pushed yields to a level that investors say threatens once again to cut Greece off from financial markets. ‘The selloff in Greek bonds is signaling that Greece has lost market access,’ Thanassis Drogossis, head of equities at Athens-based Pantelakis Securities SA, said… ‘Investors fear that an early exit from the bailout programs may prove that fiscal improvement so far is unsustainable.’ A rally in Greek government bonds earlier this year emboldened Prime Minister Antonis Samaras, who announced plans to sever the 240 billion-euro ($307bn) lifeline that has kept the country afloat since 2010.”

October 13 – Bloomberg (Sofia Horta e Costa): “Investors have had enough of Europe. Amid a global selloff that has sent the Standard & Poor’s 500 Index down 5.2% in three weeks, losses have been almost twice as big in the Euro Stoxx 50 Index, where last week’s 4.5% retreat was the largest since 2012. A record $1 billion was withdrawn from an exchange-traded fund tracking Europe in the period…”

October 13 – Telegraph (Ambrose Evans-Pritchard): “Italy's Five Star Movement has thrown down the gauntlet, calling for a euro referendum to end depression and save democracy…The die is cast in Italy. Beppe Grillo’s Five Star movement has launched a petition to drive for Italian withdrawal from Europe’s monetary union and for the restoration of economic sovereignty. ‘We must leave the euro as soon as possible,’ said Mr Grillo, speaking at a rally… ‘Tonight we are launching a consultative referendum. We will collect half a million signatures in six months – a million signatures – and we will take our case to parliament, and this time thanks to our 150 legislators, they will have to talk to us.’”

Germany Watch:

October 17 – Financial Times (Stefan Wagstyl in Berlin and James Politi): “German chancellor Angela Merkel… delivered a tough defence of the eurozone’s fiscal rules, raising tensions with France and Italy just a day after they submitted budgets to Brussels that challenge those limits. ‘All member states must accept in full the strengthened rules,’ she told the German parliament. As well as rebuffing French president François Hollande and Italian premier Matteo Renzi, who are demanding that Brussels allow them more budget flexibility, Ms Merkel seemed intent on calming the world’s financial markets, which saw some of their sharpest sell-offs of the week on Thursday… The chancellor said that only when the eurozone’s rules were seen as trustworthy could they fulfil their role as ‘the central anchor for stability and, above all, for trust in the eurozone’. But her comments brought a swift retort from the Italian and French leaders. ‘Europe needs to reflect a bit more: the crisis is not resolved, it’s international, it’s a matter of confidence,’ Mr Renzi said… ‘Europe needs to be capable of an economic response that invests in growth and not just rigour and austerity,” he said.”

October 15 – Bloomberg (Catherine Bosley): “German investor confidence fell to the weakest level in almost two years in the latest sign that the economy is struggling to find its footing even as the European Central Bank adds stimulus to the euro area.”

Global Bubble Watch:

October 15 – Reuters: “Global central bankers, eager to see the economy stand on its own feet, faced the rude reality this week of market turmoil threatening already faltering growth and prolonging world reliance on easy money. Stocks slumped again on Wednesday pushing S&P 500 losses to almost 8% since mid-September. The dollar fell and U.S. bond prices soared after weak Chinese inflation and U.S. producer price and retail sales data fanned fears the world economy could be even weaker than thought. When stock markets turned south last week after rallying for much of this year, many policymakers initially played that down. In fact, the sell-off could be seen bringing some healthy volatility back to markets that officials worried had become too complacent to risks ranging from tensions surrounding the conflict in Ukraine to the Ebola outbreak.”

October 16 – Financial Times (Stephen Foley): “Hedge funds are on course for their worst year since 2011, as several of their biggest and most popular trades turned sour and some managers were forced to cut their losses. Wednesday’s new and sudden fall in US Treasury yields wrongfooted numerous funds that had positioned themselves for rising interest rates and an improving macroeconomy. Hedge fund bets on tax-driven mergers and on US housing finance giants Fannie Mae and Freddie Mac have also unravelled this month.”

October 16 – Wall Street Journal (Liz Hoffman, Rob Copeland and Gregory Zuckerman): “A rough year for hedge funds turned more perilous as investors sold broad swaths of stock, including shares tied to pending takeover deals, after a closely watched merger hit the skids. Hedge funds have spent much of the past year and a half playing catch-up to the overall market. Adding to their troubles, the past few weeks have seen several of their most popular investments, including bets on oil-services and technology shares, turn sour… Traders and brokers said the latest trouble started Tuesday evening, when U.S. pharmaceutical company AbbVie Inc. signaled it might abandon its planned $54 billion acquisition of Irish drug maker Shire PLC… The sudden shift—one trader called it ‘a complete 180’—sent a shudder through trading desks, particularly at a handful of hedge funds that have poured billions of dollars into Shire shares, hoping the deal, the largest corporate tie-up planned this year, would go through."

October 14 – Telegraph (Ambrose Evans-Pritchard): “Investors take zero-rates for granted and unwisely believe that central banks will protect them, says the capital markets chief of the Bank of International Settlements. The global financial markets are dangerously stretched and may unwind with shock force as liquidity dries up, the Bank of International Settlements has warned. Guy Debelle, head of the BIS’s market committee, said investors have become far too complacent, wrongly believing that central banks can protect them, many staking bets that are bound to “blow up” as the first sign of stress. In a speech… Mr Debelle said: ‘The sell-off, particularly in fixed income, could be relatively violent when it comes. There are a number of investors buying assets on the presumption of a level of liquidity which is not there. This is not evident when positions are being put on, but will become readily apparent when investors attempt to exit their positions. ‘The exits tend to get jammed unexpectedly and rapidly.’”

October 17 – Bloomberg (Karl Lester M. Yap): “International Monetary Fund Chief Christine Lagarde lamented last week that the world has ‘too little economic risk taking, and too much financial risk taking.’ In the Philippines, there might be both. Companies in the Southeast Asian nation eager to make acquisitions and capital investments are piling on foreign debt, in the process leaving the economy vulnerable should emerging- market currencies get roiled again. By year-end, Philippine companies would take as long as a record four years to repay debt using operating earnings, said Xavier Jean, the Singapore-based director of corporate ratings at Standard & Poor’s.”

October 15 – Bloomberg (John Glover and Jim Brunsden): “Too big to fail is likely to prove a costly epithet for the world’s biggest banks as regulators demand they increase debt securities to cover losses should they collapse. The shortfall facing lenders from JPMorgan… to HSBC Holdings Plc could be as much as $870 billion, according to estimates from AllianceBernstein Ltd., or as little as $237 billion forecast by Barclays Plc. The range is so wide because proposals from the Basel-based Financial Stability Board outline various possibilities for the amount lenders need to have available as a portion of risk- weighted assets. With those holdings in excess of $21 trillion at the lenders most directly affected, small changes to assumptions translate into big numbers.”

October 15 – Bloomberg (Jim Brunsden): “Traders are facing new global rules on how they determine the value of collateral in repo transactions as regulators seek to prevent panic writedowns that are seen fueling future financial crises. The Financial Stability Board, a global group that brings together central bankers and government officials from the Group of 20 nations, today published a set of guidelines on discounts applied to collateral handed over as part of repurchase-agreement trades and other securities-financing transactions that aren’t processed through clearing houses… Global regulators are targeting so-called shadow banks with tougher rules to prevent a repeat of the turmoil that followed the 2008 collapse of Lehman Brothers Holdings Inc., which was driven in part by difficulties determining the value of securities. The European repo market is worth 5.8 trillion euros ($7.4 trillion)…”

October 12 – New York Times (Landon Thomas Jr): “As global leaders sounded the alarm about a slowing world economy, a more immediate concern drew the attention of policy makers at the International Monetary Fund’s semiannual meetings last week: inflated asset prices and increasing levels of debt overseas. Bond markets in the eurozone are booming, debt in China is at historic highs and the United States stock market, even with its sharp fall last week, has been on a tear. As economists and politicians heap pressure on global central banks to continue, and even escalate, their unusually loose monetary policies in order to spur global demand, the fear that these measures could provoke another market convulsion is spreading. ‘A major lesson of the last crisis is that accommodative monetary policy contributed to financial excesses,’ said Lucas Papademos, a former vice president of the European Central Bank. ‘We are pursuing a similar policy for good reason. But there are limits — if you do this for too long, risks in the financial markets will materialize.”

October 13 – Financial Times (Andrew Bolger): “Demand for European high-yield corporate bonds has slumped as investors have become warier of holding risky assets amid mounting concerns over the global economy and the outlook for the eurozone. The yield on such ‘junk’ bonds has jumped from 4.27% to 4.85% since the end of August, according to JPMorgan’s Euro High Yield Index… Euro-domiciled high-yield bond funds last week suffered their sixth successive week of outflows…”

October 13 – Financial Times (Jude Webber in Mexico City, Gregory Meyer in New York and Neil Hume): “Falling crude prices have disrupted Mexico’s annual oil hedging programme – the largest of its kind in commodity markets – and raised fears the government may have to trim spending just as the economy starts to pick up steam. Luis Videgaray, the finance minister, took the extraordinary step this month of confirming that the highly secretive programme had kicked off… Since then oil prices have dropped to nearly four-year lows, pushing the sale price of Mexico’s main crude stream well below the $83 level that is the basis for next year’s budget. One-third of Mexico’s budget is funded by oil revenue… ‘They have a dilemma: do they recalculate their balances with a lower price, which is a highly politically charged move, or do they sit tight and hope for the better?’ said Pierre Lacaze of LCM Commodities…”

October 16 – Bloomberg (Mary Romano): “Phillips tallied a less-than- expected 14.9 million pounds ($23.8 million) at its contemporary art sale coinciding with London’s Frieze week as major works by Andy Warhol and Gerhard Richter failed to sell. The evening auction at Phillips, which took place yesterday in its new London home on Berkeley Square in the wealthy Mayfair neighborhood, fell short of the company’s low estimate of 15.5 million pounds as 37 of the 46 offered lots found buyers.”

Geopolitical Watch:

October 15 – Reuters (Alexei Anishchuk): “President Vladimir Putin warned Washington that a spat between nuclear powers over the Ukraine crisis could threaten global stability and said in remarks published on Wednesday that Russia would not be 'blackmailed' by sanctions. Taking a tough line on the eve of talks with Ukrainian President Petro Poroshenko in Milan, Putin said the sanctions imposed by the United States and the European Union over Moscow's role in the crisis were hindering peace moves. ‘We hope that our partners will realise the recklessness of attempts to blackmail Russia, will remember the risks that a spat between major nuclear powers incurs for strategic stability…’”

October 14 – Reuters (Jim Finkle and Alastair Macdonald): “Russian hackers exploited a bug in Microsoft Windows and other software to spy on computers used by NATO, the European Union, Ukraine and companies in the energy and telecommunications sectors, according to cyber intelligence firm iSight Partners. ISight said it did not know what data had been found by the hackers, though it suspected they were seeking information on the Ukraine crisis, as well as diplomatic, energy and telecom issues, based on the targets and the contents of phishing emails used to infect computers with tainted files. The five-year cyber espionage campaign is still going on, according to iSight…”

October 16 – Bloomberg (Chris Strohm): “Hackers affiliated with the Chinese government have heavily targeted makers of microchips, computer networking equipment and data storage services to steal company secrets, the Federal Bureau of Investigation said. The FBI sent a warning to companies yesterday, telling them that ‘these state-sponsored hackers are exceedingly stealthy and agile’ and have used customized malicious code that was undetected by security researchers and law enforcement. The warning hints at an increasingly public confrontation in which the U.S. claims the Chinese government is conducting a long-term, widespread campaign of economic espionage… In addition to technology companies, the latest FBI alert said the hackers have also targeted defense contractors in multiple countries and multinational corporations.”

October 15 – Washington Post (Loveday Morris): “Islamic State fighters on Monday seized control of an army base in western Iraq, the third to fall in three weeks, as Iraqi forces in the region appeared close to collapse despite U.S.-led airstrikes. Iraqi officials described the pullback from near Hit — a town in Anbar province about 115 miles west of Baghdad — as a ‘tactical retreat’… The loss of the base deals another psychological blow to beleaguered Iraqi forces that have been battling Islamic State militants in Anbar for 10 months… The instability in Anbar has stoked fears that Islamic State fighters could use their gains to push into areas closer to the capital, including the volatile Abu Ghraib district, which lies just west of Baghdad's international airport.”

October 13 – Dow Jones (Nathan Hodge And Margherita Stancati): “Afghan security officials say that Islamic State is beginning to seek a foothold here, potentially extending the extremist group's reach precisely at a time when foreign combat troops are leaving. Islamic State's operations have been limited so far to parts of Iraq and Syria although its recruitment efforts, including slick online videos and social media, have extended far and wide.”

October 13 – Financial Times (Barney Jopson): “The Ebola outbreak is threatening ‘state failure’ in west Africa, the World Health Organisation warned, as the US said it needed to overhaul its management of the virus following the infection of an American nurse. ‘I have never seen a health event threaten the very survival of societies and governments in already very poor countries,’ Margaret Chan, director-general of the WHO… ‘I have never seen an infectious disease contribute so strongly to potential state failure.’ …’The rich get the best care. The poor are left to die.’ She added: ‘Decades of neglect of fundamental health systems and services mean that a shock, like an extreme weather event in a changing climate, armed conflict, or a disease run wild, can bring a fragile country to its knees.’”

China Bubble Watch:

October 17 – Bloomberg: “China’s central bank is said to plan the injection of about 200 billion yuan ($32.7bn) into some national and regional lenders as Premier Li Keqiang steps up stimulus to support economic growth. The People’s Bank of China is providing funds to joint-stock banks to help them prepare for year-end liquidity needs… Joint-stock banks are mid-sized national banks with mixed ownership. The injection comes after the central bank provided 500 billion yuan of liquidity to China’s five biggest banks last month…”

October 16 – Bloomberg: “China’s broadest measure of new credit rose to a three-month high in September as the central bank’s targeted measures to boost liquidity helped spur lending. Aggregate financing was 1.05 trillion yuan ($171bnn)… compared with the 1.15 trillion yuan median estimate… New local-currency loans were 857.2 billion yuan, and M2 money supply grew 12.9% from a year earlier. Foreign reserves were $3.89 trillion at Sept. 30… Foreign reserves fell 2.6% from the previous quarter, the steepest drop according to records dating back to 1996 and only the fourth quarterly decline over that period.”

October 15 – Reuters (Koh Gui Qing and Brenda Goh): “Chinese companies are on a pace to cut capital spending by around 7% this year, the biggest annual reduction since the global financial crisis, deepening an economic chill. Slower spending by companies underscores the challenges that China faces this year in containing an economic slowdown that is set to be its worst in 24 years, and which has been aggravated by a sagging property market… A Reuters analysis of 335 Chinese companies, ranging from drug to machinery makers, shows investment is expected to fall 7.3% this year - or 74 billion yuan ($12.1bn) - from 2013 levels…”

October 13 – Bloomberg: “Rating companies say the risk of defaults in China has risen as Premier Li Keqiang pares implicit guarantees for local-government financing vehicles. The yield premium over the sovereign for three-year AA corporate bonds, the most common grade for LGFVs, widened 21 bps from last month’s four-year low to 198 bps on Oct. 9. The State Council said Oct. 2 that the finance arms can no longer raise funds for local authorities, and that the governments have no obligation to repay debt that wasn’t raised to fund public projects… ‘The market is entering a new era,’ said Chen Jianheng… analyst at CICC. ‘The time when everybody bought LGFV bonds for high returns without considering credit risks are gone. For any sales in the future, investors will apply a different set of criteria.’”

October 16 – Bloomberg: “Zhou Bingguo expected to find a few buyers for the 20 apartments for sale next to Beijing’s Central Business District in the first week of October, he said. It was the Golden Week holiday, traditionally a peak time for homes sales, and China had just eased mortgage restrictions. ‘Quite a few people visited, but nobody bought,’ said Zhou, a consultant in the asset management department of CBD Private Castle, a residential project… After four years of government restrictions to cool housing prices that had tripled since 2000, the central bank is reversing course, making it easier for homeowners to buy second properties. They are not likely to get back into the market, several analysts said… ‘The property downturn will continue as buyers stay on the sidelines in anticipation of further price declines,” said Bei Fu, a Hong Kong-based credit analyst at Standard & Poor’s.”

October 13 – Bloomberg: “Agile Property Holdings Ltd. tumbled to the lowest in more than five years after its billionaire founder and chairman Chen Zhuolin was placed under the control of Chinese prosecutors amid a money laundering allegation which it denied. Shares plunged as much as 31%, the most on record…”

October 16 – Telegraph (Tom Phillips): “Police surround a rural village in southwest China after violence leaves at least eight dead and 18 injured. Villagers in southwest China have vowed to ‘fight to the death’ after a long-running land dispute erupted into violence that left eight people dead and at least 18 injured… At least two villagers and six ‘attackers’ were killed in the skirmishes which appear to have been sparked by a row over a developer's attempts to evict farmers from their land… ‘Villagers are angry and sad,’ said Zhou Lihui, a 41-year-old resident, who witnessed the battle. ‘Two of our men were beaten to death. What crime did we commit? All we were doing was trying to protect our land.’ Clashes over land are an almost daily occurrence in a rapidly urbanising China, where villagers are often unfairly forced from their homes by cash-strapped or corrupt local officials who sell farmers' lands to developers in order to stay afloat. However, the violence that has gripped Fuyou village, near Kunming, Yunnan's provincial capital, has been shocking even by Chinese standards.”

October 13 – Bloomberg (Rudy Ruitenberg): “Eastern China may experience more ‘extreme warm’ summer weather similar to the 2013 heatwave in the coming years, researchers in China and Canada wrote in the journal Nature Climate Change. Within two decades, half the summers in eastern China are projected to be hotter than last year, the warmest on record, under a ‘moderate’ scenario for greenhouse-gas emissions…”

Latin America Watch:

October 16 – Bloomberg (Sebastian Boyd and Pietro D. Pitts): “Since becoming Venezuela’s president 18 months ago, Nicolas Maduro has contended with chronic shortages of everything from toothpaste to medicine, the world’s fastest inflation and sinking foreign reserves. His predicament is about to get worse. Prices for Venezuela’s oil, which accounts for 95% of the nation’s exports, are tumbling to a four-year low and threatening to choke off the export dollars the country needs to pay its debts. ‘It’s a direct hit on tax revenues,’ Lars Christensen, chief emerging-markets economist at Danske Bank A/S, said… ‘There is nothing good to say about the state of Venezuela’s economy, and this isn’t helping.’”

Japan Bubble Watch:

October 17 – Bloomberg (Mariko Ishikawa): “Japan’s two-year notes climbed, pushing yields to a record low, as a decline in domestic equities reinforced speculation the Bank of Japan will maintain its unprecedented debt purchases to sustain growth. The yield dropped three basis points to 0.005%, declining past the previous low of 0.01% set in August 2002… The central bank couldn’t buy all 3 trillion yen ($28bn) of bills it sought to purchase today, falling short of its goal for such an operation for the first time since at least April 2013.”


October 17 – Bloomberg (Takashi Amano): “Billionaire Masayoshi Son’s 300-year business plan for SoftBank Corp. sees no pause in acquisitions that saw him splurge $51 billion in five years. Higher interest rates in the U.S. and Japan may put the brakes on his debt- fueled ambitions. SoftBank is Japan’s biggest corporate bond issuer for the second year, raising 1.52 trillion yen ($14bn) to fund purchases… The Tokyo-based company paid 271.5 billion yen in interest last fiscal year, more than it made in the past three quarters, according to its earnings data.”