Alan Greenspan, interviewed by the Financial Times’ Gillian Tett at the Council on Foreign Relations, October 29, 2014:
Greenspan: “One of the things that I used this book (“The Map and the Territory”) to write was to develop a concept of how do you shift from a system where everybody is acting rationally – which is what all our models basically said – to one where reality is where people are acting intuitively, various different types of forms. Irrationality is in many respects systematic – you can model it. And indeed I show in many cases why for example fear is demonstrably a much stronger force than euphoria… This is the type of thing that I think we’ve got to understand. And one of the reasons why I say, as a conclusion in this book, that the non-financial parts of our economy behave very well. They are highly capitalized, and essentially it is a financial system which is totally divorced – a different function than the type of things we do in the non-financial area. One (the financial sector) has to do with the allocation of savings into investment. That is where “animal spirits” really run wild.”
I am compelled this week to return to Greenspan’s comments. They provide a good opportunity to take a deeper dive into my favorite “Financial Sphere vs. Real Economy Sphere” analytical framework. There’s no more important subject matter – anywhere.
It’s nebulous. Yet let’s attempt to put some broad parameters around the concept of “Financial Sphere.” It broadly comprises the “Credit system” and “financial markets.” It encompasses “financial assets” – certainly including all securities (equities and fixed-income) and Credit instruments more generally. Importantly, “financial markets” includes myriad types of financial obligations and derivatives.
The “Financial Sphere” includes the financial liabilities of the household, corporate and government sectors. It includes the assets and liabilities of the financial sector, including the banks, securities broker/dealers, finance companies and insurance companies. These include liabilities traditionally viewed as the “money supply”, including currency, bank deposits and money fund assets. It includes the assets and liabilities (debt and MBS) of the GSEs. The Financial Sphere encompasses the assets and liabilities of the “leveraged speculating community.” Importantly, especially over recent years, the Financial Sphere also includes Federal Reserve liabilities.
The “Financial Sphere” is tasked with critical functions. Through lending, it provides the purchasing power necessary to drive both spending in the Real Economy and purchases throughout the assets markets (real and financial). Financial Sphere includes various forms of risk intermediation, including intermediating interest-rate, Credit, market and, perhaps most importantly, liquidity risks.
This crucial risk intermediation function can be viewed prominently in the asset/liability structure of the banking system, along with GSE, securities broker/dealer and securitization (“trust”) balance sheets. Money funds, mutual funds and exchange-traded funds (ETFs) play a prominent intermediation role. The expansive global derivatives marketplace has come to provide a profound intermediation function within the Financial Sphere. The hedge funds and global speculator community, with their heavy use of securities-based leverage and their short-term trading focus, have also come to operate as integral “Financial Sphere” participants - providers of the marginal source of securities marketplace liquidity.
Let’s cut to the chase: it’s my view that Depressions and deflationary collapses are primarily the consequence of a crisis of confidence in the soundness and viability of the Financial Sphere. Fortunately, they don’t happen often. Unfortunately, throughout history they’ve erupted on a recurring basis.
And I would argue Financial Spheres collapse only after prolonged periods of Bubble excess - protracted excess invariably made possible because of active governmental interventions, manipulations and inflations. Basically, the issue centers around a general loss of confidence – a loss of faith in the Financial Sphere’s capacity to expand sufficient system Credit, to sustain speculative leverage and/or to effectively intermediate risk – a lack of confidence in the underlying Credit and financial structure – a loss of confidence/trust in policymaking.
Similar to the Real Economy Sphere, the degree of dislocation wrought from a Financial Sphere bust is proportional to preceding boom-time excesses. The scope of cumulative boom-time Financial Sphere expansion, risk intermediation, speculative leveraging and resulting financial and economic system distortions chiefly determines the degree of systemic fragility (i.e. the risks of a crisis of confidence and financial collapse).
The contemporary Financial Sphere is unrecognizable from those of the past. Traditionally, there would be a supply of money available in the system along with a Credit apparatus largely dominated by bank lending and government debt issuance. The conventional view holds that gold standard regimes ensured that gold backing limited the issuance of a country’s currency. That’s fine. Yet I tend to think more in terms that a commitment to maintaining a gold standard regime cultivated norms, behaviors and standards that worked to keep the general Financial Sphere in check. Importantly, there were mechanisms that fostered self-correction and adjustment.
Traditionally, the Financial and Real Economy Spheres expanded/inflated in tandem. After all, the chief function of the financial sector was to provide Credit and finance for economic enterprise. Even in the event of overheated conditions in finance and the real economy, Financial Sphere ballooning would translate into a synchronized economic boom with generally rising price levels.
It’s fair to say that things really changed heading into and subsequent to the U.S. dropping dollar convertibility to gold in the early-1970s. Yet the most profound Financial Sphere transformation unfolded during the nineties. Monetary policy evolved (i.e. rate and yield curve manipulation, market backstopping) that incentivized financial leveraging and asset market speculation. The GSEs, with their implicit federal backing, became a major force spurring explosive Financial Sphere inflation, both from a Credit expansion and risk intermediation perspective. “Activism” on the part of both the Fed and GSEs nurtured unprecedented growth in “Wall Street finance” – including securitizations and derivatives. Readily available cheap funding; reliable market liquidity backstops; and a general inflationary bias spurred incredible growth in the hedge fund community and global leveraged speculation more generally.
There’s a couple of key points: First, unique from a historical perspective, the contemporary Financial Sphere operates completely unhinged from gold backing, as well as from restraints imposed by currency regimes and bank reserve and capital requirements. Traditional central bank angst for rapid Credit expansion, Current Account imbalances and speculative excess was tossed out the window. Instead, central bankers became proponents for Credit expansion, aggressive risk intermediation and inflating securities markets.
The second key point is related to the first - and is just as critical: The unrestrained Financial Sphere became increasingly divorced from the real economy. In particular, Fed and GSE-related market distortions incentivized asset-based lending, leveraging and speculation. Not surprisingly, this newfangled Credit system dominated by asset-based lending and speculating became increasingly unstable. A period of serial asset Bubbles took hold, domestically and internationally.
A book (or two) could – should – be written documenting and explaining the momentous consequences of Bubble Dynamics overwhelming the Financial Sphere of the world’s reserve currency. In short, beginning back in the nineties, massive U.S. Current Account Deficits and unfettered speculative finance flooded the world with dollar-based liquidity. By late in the decade, spectacular bursting EM Bubble contagion coupled with a (Fed-induced) runaway U.S. securities boom fueled a destabilizing king dollar dynamic. Later, post-“Tech” Bubble (“helicopter money”) reflationary measures spurred dollar devaluation, in the process unleashing powerful Credit booms throughout the Eurozone, Asia and more generally around the globe.
Meanwhile, increasingly unstable global finance and extreme economic imbalances ensured that global central banks adopted similar Federal Reserve policy activism. This process took a giant leap with the 2008 crisis. The Bernanke Fed’s adoption of unprecedented monetary measures unleashed global central bankers to pursue experimental “do whatever it takes” policies completely outside the realm of traditional central bank doctrine. Fed policies and resulting dollar devaluation provided EM and China unprecedented capacity to inflate Credit and fuel financial and economic booms: the “global government finance Bubble.”
Bernanke presided over further momentous Financial Sphere developments. For one, the Financial Sphere became more of a global phenomenon, spurred on by concerted reflationary monetary policy measures. Furthermore, a globalized Financial Sphere was the product of closely interlinked securities and derivatives markets; the proliferation of cross-border financial flows; readily accessible cheap securities-based lending on a globalized basis; and, more generally, by the vast and inflating pool of speculative finance that tied together global financial markets.
If globalized finance dominated by policy “activism” and distortions wasn’t enough, the Global Financial Sphere Bubble became only further divorced from real economies. And it is here that I believe future historians will see the catastrophic flaw in Bernanke’s policy doctrine: the belief that “money” printing and zero rates would inflate the general price level and reflate the economy out of debt problems; that the so-called “wealth effect” from inflating securities prices would spur spending, risk-taking and sustainable economic recovery.
From the perspective of my “Financial Sphere vs. Real Economy Sphere” analytical framework, inflating the contemporary Financial Sphere in hope of spurring sustainable economic recovery is an absolute fool’s errand. It’s nothing short of reckless. To inflate Financial Sphere excess based on Real Economy Sphere indicators (i.e. GDP, the unemployment rate or CPI) is lunacy. After all, we have ample historical evidence of Financial Sphere dynamics detached from real economies. And especially after the past two years, we have witnessed how the separate Spheres have price dynamics completely divorced from each other (wild securities price inflation vs. disinflationary forces commanding consumer price aggregates).
As I’ve repeated on numerous occasions, there is no general price level for the Fed or global central bankers to manipulate and control. The domain of their reflationary policies is within the Financial Sphere and with financial asset prices. And we’ve already seen how aggressive Global Financial Sphere inflationary measures can actually promote disinflationary forces in real economies.
Financial Sphere inflation is little more than wealth redistribution. Moreover, the inequitable distribution of wealth (from most to a fortunate few) is a major force behind underperforming economies (“insufficient demand”) around the globe. I would further contend that Financial Sphere inflation spurs resource misallocation, certainly including mal- and over-investment around the globe. The Global Financial Sphere Bubble has certainly been instrumental in stoking a protracted capital investment Bubble in China and throughout Asia, increasingly at the expense of pricing power and profits.
I’m sick of hearing the sympathetic “central banks are only game in town.” It’s just hard to believe at this point that flawed central banking is not held accountable for the mess it’s made of things. Greenspan and Bernanke argue that it’s not the responsibility of central banks to prick Bubbles. The Bernanke doctrine held that Bubbles could be allowed to run, with enlightened post-Bubble “mopping up” measures waiting to reflate markets, price levels and economies. But bursting Bubbles and the resulting realization of gross wealth redistribution and economic stagnation leave politicians in a major bind. To be sure, massive “mopping up” monetization and deficit spending are dangerously divisive issues. Central banks become the “only game” because they operate largely outside the political process; enjoy the unique capacity to create rules as they go along; and dictate policies in an area that so few understand. Regrettably, this era's sophisticated inflationism is even more seductive than its predecessors.
When the Financial Sphere runs amuck, things can really run amuck. Over relatively short periods of time, market prices can become precariously detached from real economy fundamentals. After all, pricing dynamics are quite divergent between the Financial Sphere and the Economic Sphere. In the real economy, supply and demand interact in determining price. Additional supply leads to lower prices. Lower prices lead to more demand. The Financial Sphere, however, is a different animal. More supply of finance leads to higher prices for financial assets. Inflating financial asset prices spur greater demand. As such, central bank intervention to spur Credit growth and asset price inflation will incite speculative Bubbles. And aggressive post-Bubble “mopping up” ensures only bigger Bubbles.
The Fed and global central bankers gambled that Financial Sphere intervention, manipulation and inflation would spur real economy reflation. It’s clear they’re now playing a losing hand – it's also apparent that they are unwilling to admit their flaws, failings or predicaments. The harsh reality is that central bankers cannot escape Financial Sphere fragility.
When Global Financial Sphere fragility turned acute back in the summer of 2012 (i.e. Italy, European banks and the euro), Draghi, Bernanke and Kuroda adopted unprecedented inflationary measures. They ended up buying some time, but at major costs including a U.S. securities Bubble, a Bubble in European sovereign debt and unprecedented global leveraged speculation (how big is the “yen carry trade”?). Several weeks back there were indications that Global Financial Sphere fragility was resurfacing. In response, there were indications from Fed officials that more QE could be forthcoming, while Draghi and Kuroda came with more shock and awe monetary stimulus.
The latest Fed, ECB and BOJ show (again) did wonders for U.S. and Japanese stock prices. Yet yen and euro devaluation bolstered king dollar, much to the expense of commodity-related companies, currencies and countries. Crude sank $2.83 to $75.82, with the Goldman Sachs Commodities Index down another 2.5%. Russia’s ruble was hit again this week, as geopolitics turned only more disconcerting. There was also further indication of acute fragility unfolding in Brazil. The Brazilian real dropped 1.65%, while 10-year (real) yields jumped another 36 bps to 12.92%. Venezuela 10-year bond yields surged 123 bps to 19.73%. It’s also worth noting that Mexican stocks were hit for 2.8%. All in all, evidence mounts of serious EM vulnerability. I’m sticking with the view that the global Bubble has been pierced and that contagion risks are mounting. As for U.S. equities, the level of bullishness and complacency is just incredible. Apparently, nothing can get in the way of the mighty year-end rally.
For the Week:
The S&P500 added 0.4% (up 10.4% y-t-d), and the Dow gained 0.4% (up 6.4%). The Utilities sank 2.9% (up 17.1%). The Banks slipped 0.6% (up 5.0%), while the Broker/Dealers rose 0.8% (up 10.3%). Transports advanced 1.3% (up 22.4%). The S&P 400 Midcaps were little changed (up 6.6%), and the small cap Russell 2000 was about unchanged (up 0.9%). The Nasdaq100 jumped 1.6% (up 17.6%), and the Morgan Stanley High Tech index rose 1.6% (up 10.1%). The Semiconductors gained 1.3% (up 20.7%). The Biotechs declined 0.8% (up 39.7%). With bullion recovering $11, the HUI gold index rallied 2.4% (down 14.7%).
One-month Treasury bill rates closed the week at four bps and two-month rates ended at one basis point. Two-year government yields added a basis point to 0.51% (up 13bps y-t-d). Five-year T-note yields gained two bps to 1.61% (down 14bps). Ten-year Treasury yields were up two bps to 2.32% (down 71bps). Long bond yields added two bps to 3.05% (down 92bps). Benchmark Fannie MBS yields declined a basis point to 2.99% (down 62bps). The spread between benchmark MBS and 10-year Treasury yields narrowed three to 67 bps. The implied yield on December 2015 eurodollar futures slipped a basis point to 0.825%. The two-year dollar swap spread was little changed at 22 bps, while the 10-year swap spread declined one to 13 bps. Corporate bond spreads were little changed. An index of investment grade bond risk was unchanged at 65 bps. An index of junk bond risk ended the week two higher to 344 bps. An index of emerging market (EM) debt risk increased one to 310 bps.
Greek 10-year yields increased three bps to 8.10% (down 32bps y-t-d). Ten-year Portuguese yields dropped nine bps to 3.19% (down 294bps). Italian 10-yr yields slipped three bps to 2.35% (down 178bps). Spain's 10-year yields declined three bps to 2.13% (down 203bps). German bund yields fell three bps to a record low 0.78% (down 114bps). French yields were down four bps to a new low 1.14% (down 142bps). The French to German 10-year bond spread narrowed one to 36 bps. U.K. 10-year gilt yields fell eight bps to 2.12% (down 90bps).
Japan's Nikkei equities index surged 3.6% to the high since June 2007 (up 7.4% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.48% (down 26bps). The German DAX equities index slipped 0.4% (down 3.1%). Spain's IBEX 35 equities index recovered 0.2% (up 2.3%). Italy's FTSE MIB index lost another 0.7% (unchanged). Emerging equities were mostly lower. Brazil's Bovespa index ended the week down 2.7% (up 0.5%). Mexico's Bolsa was slammed for 2.8% (up 1.5%). South Korea's Kospi index added 0.3% (down 3.3%). India’s Sensex equities index gained 0.6% to another record (up 32.5%). China’s Shanghai Exchange jumped 2.5% (up 17.2%). Turkey's Borsa Istanbul National 100 index jumped 4.2% (up 19.8%). Russia's MICEX equities index increased 0.2% (down 0.2%).
Debt issuance was strong. Investment-grade issuers included Chevron $4.0bn, Gilead Sciences $4.0bn, Freeport-McMoRan $3.0bn, Eastman Chemical $2.5bn, Phillips 66 $2.0bn, Volkswagen Group America $2.0bn, Roche $1.65bn, Altria Group $1.0bn, Sunoco Logistics Partners Operation LP $1.3bn, Newell Rubbermaid $850 million, E-Trade Financial $540 million, First Tennessee Bank $400 million, PACCAR Financial $300 million, AvalonBay Communities $300 million, Duke Realty LP $300 million, Ethiopian Leasing $288 million, Federal Realty Investment Trust $250 million, Tanger Properties LP $250 million and Fulton Financial $100 million.
Junk funds saw inflows of $890 million (from Lipper). Junk issuers this week included Scientific Games $3.125bn, Audatex North America $2.255bn, Rio Oil $1.1bn, Ally Financial $800 million, Kennedy-Wilson $650 million, SM Energy $600 million, HC2 Holdings $500 million, Supervalu $350 million, Realogy Group $300 million and Greystar Real Estate Partners $250 million.
Convertible debt issuers included ISIS Pharmaceuticals $425 million.
International dollar debt issuers included Canadian National Resources $1.2bn, Asian Development Bank $1.0bn, Golden Legacy PTE $270 million, Canbriam Energy $250 million and Alpha Bank $250 million.
Freddie Mac 30-year fixed mortgage rates slipped a basis point to 4.01% (down 34bps y-o-y). Fifteen-year rates declined one basis point to 3.20% (down 18bps). One-year ARM rates were down two bps to 2.43% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down seven bps to 4.18% (down 34bps).
Federal Reserve Credit last week increased $2.4bn to $4.448 TN. During the past year, Fed Credit inflated $625bn, or 16.4%. Fed Credit inflated $1.637 TN, or 58%, over the past 105 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $6.7bn last week to $3.310 TN. "Custody holdings" were down $44.3bn year-to-date, and fell $14.8bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $296bn y-o-y, or 2.6%, to a new seven-month low $11.789 TN. Over two years, reserves were $994bn higher for 9% growth.
M2 (narrow) "money" supply fell $65.7bn to $11.488 TN. "Narrow money" expanded $586bn, or 5.4%, over the past year. For the week, Currency increased $1.1bn. Total Checkable Deposits jumped $51.8bn, while Savings Deposits sank $108.5bn. Small Time Deposits were about unchanged. Retail Money Funds dropped $9.7bn.
Money market fund assets gained $9.1bn to $2.644 TN. Money Funds were down $74.6bn y-t-d and dropped $24.4bn from a year ago, or 0.9%.
Total Commercial Paper rose another $6.5bn to $1.080 TN. CP expanded $34bn year-to-date and was up $13bn over the past year.
The U.S. dollar index slipped 0.1% to 87.525 (up 9.4% y-t-d). For the week on the upside, the New Zealand dollar increased 2.0%, the South African rand 1.7%, the Australian dollar 1.3%, the Norwegian krone 1.0%, the euro 0.6%, the Danish krone 0.5%, the Canadian dollar 0.4%, the Swedish krona 0.3% and the Mexican peso 0.1%. For the week on the downside, the Brazilian real declined 1.7%, the Japanese yen 1.5%, the Singapore dollar 0.7%, the South Korean won 0.7% and the Taiwanese dollar 0.1%.
November 11 – Bloomberg (Juan Pablo Spinetto): “Iron-ore market is being ‘flooded’ by ‘super-supply’ from big miners seeking to gain market share, Eduardo Costa de Faria, commercial general manager at Usiminas’s mining venture MUSA, says… Smaller producers suffering from lack of logistics, scale, need to cut costs. Iron-ore prices seen trading at around $80/ton in 2015… Iron ore plunged 44% this yr to 5-yr low as rising supplies from BHP, Rio Tinto in Australia created glut as China’s economy slowed…”
The Goldman Sachs Commodities Index dropped 2.5% (down 17.6%). Spot Gold recovered 0.9% to $1,189 (down 1.4%). December Silver rallied 3.8% to $16.31 (down 16%). December Crude sank another $2.83 to $75.82 (down 23%). December Gasoline fell 4.3% (down 27%), and December Natural Gas sank 8.9% (down 5%). December Copper was little changed (down 11%). December Wheat surged 8.9% (down 7%). December Corn jumped 3.9% (down 10%).
U.S. Fixed Income Bubble Watch:
November 12 – Bloomberg (Matt Robinson and Katherine Chiglinsky): “The riskiest corporate debtors in the U.S. aren’t growing fast enough to pay down their borrowings, increasing the risk for bond investors at a time when valuations are already at about record highs. That’s the conclusion of Deutsche Bank AG, which estimates that the biggest jump in earnings in almost three years may be coming too late for speculative-grade borrowers as the amount of debt on balance sheets climbs back to levels seen in early 2008 before the financial crisis. To make matters worse, their ability to make interest payments is about where it was in 2007, even as the Federal Reserve has held its benchmark rate close to zero. ‘We expect the next restructuring cycle will be dominated by companies with good operations but not able to grow into their balance sheets or refinance maturing debt,’ Kenneth Buckfire, president of… restructuring firm Miller Buckfire & Co., said… Investors have piled into junk bonds for their relatively high yields amid the suppressed rates. That has allowed the least creditworthy borrowers to raise $1.64 trillion in the bond market since the end of 2008…”
Federal Reserve Watch:
November 14 – Wall Street Journal (Michael S. Derby): “Paul Volcker, the man who broke the back of inflation in the opening years of the 1980s, is a man at odds with what Federal Reserve policy making has become. A 2% inflation target? Long-term, detailed forecasts of activity? Pledges to keep rates very low well into the future? For Mr. Volcker, who led the Fed from 1979 to 1987, these are all overly precise policy choices that promise more than any central bank can deliver. What’s worse, the policies that have come to define modern Fed policy can even be counterproductive, making central bank goals harder to achieve. Mr. Volcker, 87, weighed in on monetary policy while participating at a conference held at the Federal Reserve Bank of Philadelphia on Thursday. The former central banker occupies a hallowed place in the institution’s history… His blunt-force approach to central bank policy making stands in sharp relief to the increasingly complex web of communications and tools that have come to define the Ben Bernanke and Janet Yellen eras of central bank leadership… Mr. Volcker also said the Fed’s decision to provide long-term forecasts for key economic variables is simply folly.”
November 11 – MarketNews International: “Philadelphia Federal Reserve Bank President Charles Plosser said… that central banks must know and accept their limitations, adding that financial markets often fail to understand those limits. Speaking to CNBC…, Plosser said ‘I do think that central banks have to understand what their limitations are and financial markets sometimes I don't believe really appreciate the limitations of the central bank.’ Plosser said he still felt central banks - including the Federal Reserve - were best served following the single mandate of achieving price stability. ‘I have argued in the past for a single mandate and I would still make that argument, I think it is the right argument, but that doesn't mean you are going to hit that mandate month after month or even year after year.’ But even following a single mandate does not guarantee central bank success. ‘There are going to be discrepancies, there's going to be shocks that hit the system and we have to recognize that and make appropriate policy when and where we can,’ he added. The Federal Reserve Act currently says the Fed must ‘maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.’ This is often referred to as the dual mandate.”
U.S. Bubble Watch:
November 10 – Bloomberg (Boris Korby and Jackie Klauberg): “The race is on to give U.S. exchange-traded fund investors access to $9 trillion of stocks and bonds in mainland China. Money managers including BlackRock Inc. and CSOP Asset Management Ltd. have now registered almost 40 ETFs tracking the country’s domestic shares and debt with U.S. regulators, six times the number of existing funds. The products allow anyone with a U.S. brokerage account to gain exposure to Chinese securities that were previously off limits to all but a few qualified institutions.”
November 12 – Bloomberg (David Evans): “It’s a Saturday afternoon in March, and more than 500 people have tuned in for a two-hour webinar that tells them they can become rich trading foreign currencies. ‘Success in trading is not a fantasy; it’s a formula,’ Jared Martinez, founder of Market Traders Institute… tells his audience. ‘We have that formula.’ The Lake Mary, Florida, company that Martinez founded in 1994 says it has educated 30,000 amateur foreign-exchange investors. ‘How many people would like to learn a skill where, within two days, they could make a thousand dollars?’ Martinez asks that afternoon. ‘I’m here to tell you I can teach you how to trade consistently.’ He introduces Jose Tormos, his son-in-law, who echoes Martinez’s advice…‘It is the easiest, most predictable and safest way to invest,’ Tormos says. ‘Many of you are missing out on opportunities to build a retirement nest egg.’”
November 12 – Reuters (Andreas Framke): “The ECB would encourage euro zone states to pile up debt if it were to buy state bonds, the president of Germany's central bank has warned again, underlining resistance to such a move in the bloc's most influential country. …Jens Weidmann conceded that the overall outlook for the euro zone remained weak, referring to low price inflation, and that the European Central Bank had therefore been right to take a generous stance. ‘The expansionary monetary policy is fundamentally appropriate,’ he said. ‘And it is understandable that the ECB's governing council has discussed additional measures and will continue to discuss this.’ But whatever measures may be taken on top of ECB schemes to give banks cheap credit and buy rebundled loans, Weidmann cautioned against any buying of government debt. ‘As well as the legal limits, the buying of state bonds would create wrong incentives, in particular encouraging indebtedness of euro zone countries,’ he said.”
Nov 12 (Reuters) - The German government's panel of independent economic advisers criticised the European Central Bank's asset-buying programme on Wednesday and urged it to avoid a major increase in its balance sheet until clearer signs of deflation emerged. In its annual report, the panel known as the ‘wisemen’, although it now includes one woman, also cut its forecast for 2014 growth to 1.2% from a previous 1.9%... The ECB's cuts to the benchmark interest rate to combat falling inflation and its bond-buying programme carried dangers for the euro zone economy, the panel said. ‘On the one hand the financial sector is led into taking greater risks because of low interest rates, and on the other hand, due to the bond buying, the ECB could encourage governments to ease off on their reform and consolidation efforts.’”
November 11 – Bloomberg (Stefan Riecher): “European Central Bank Executive Board member Yves Mersch said policy makers will be ready to buy asset-backed securities next week as part of a stimulus plan. The ECB’s package of measures includes ‘a purchase program, which we started with covered bonds a few weeks ago and which we will continue in one week’ with asset-backed securities, Mersch said… They will help ‘to guarantee price stability in the euro area,’ he said. Since June, policy makers have cut interest rates twice, offered long-term loans to banks and committed to buy assets to boost the ECB’s balance sheet by as much as 1 trillion euros ($1.24 trillion)… ‘There hasn’t been a decision to buy government bonds,’ Mersch said. ‘It is a theoretical option if the situation deteriorates.’”
Central Bank Watch:
November 11 – Bloomberg Businessweek (Allison Schrager): “My first year of graduate school a professor offered my class a warning: ‘There is only one thing we know for certain in macroeconomics,’ he cautioned, ‘bad monetary policy can do a lot of damage, but we don’t know what good policy can really achieve.’ Fourteen years and $4.4 trillion later that advice sounds dated. Many agree the Fed’s extraordinary policies, like Quantitative Easing, pulled the American economy from the brink at the height of the recession. But my professor’s warning may explain why central Bankers are under fire today. My colleague Peter Coy worries a Republican congress may be out to curb Janet Yellen’s power. In Europe the national bankers, especially from Germany, are trying to block or discredit Mario Draghi. This could foretell the end of the Central Banker power bubble. A recent essay by Harvard economist Ken Rogoff warns that’s a risk. A compelling narrative has emerged since the Greenspan era, he writes, that casts the central banker as a powerful technocrat who can foresee where the economy is headed, keep it robust without risk, and buoy the stock market at the same time. The markets and media hang on the technocrat’s every word. Expectations of central bankers have heightened since the financial crisis because legislative bodies largely stayed away from fiscal stimulus.”
November 9 – Reuters (Alastair Macdonald): “Seeing its gold-spangled blue flag flown on the barricades of Kiev thrilled the European Union, reviving its self-image as a beacon of democracy at a time of growing doubt and economic gloom. But nearly a year on from the first ‘EuroMaidan’ protests that would topple the pro-Moscow president who had spurned an EU trade deal, some in Brussels are disillusioned by the experience of helping Ukraine. EU generosity in waiving import duties and funding gas supplies from Russia may be being abused, they say. Some in Ukraine's elite may be colluding with Russia, even as fighting in the east has begun to escalate again. ‘The Ukrainians are manipulating the EU,’ a senior EU official involved in negotiations told Reuters, saying the bloc was ‘waking up’ to a need to better defend its own interests. ‘There may be, in certain sections of the Ukrainian government, an interest in colluding with the Russians and instrumentalizing to a certain extent the EU,’ he added.”
November 12 – Bloomberg (Krystof Chamonikolas): “Ukrainian bonds slumped, lifting the benchmark yield to a record, as reports that pro-Russian insurgents are preparing for a new wave of fighting sent the hryvnia to an all-time low. The rate on the dollar-denominated note maturing July 2017 jumped 150 bps to 17.63%... Bondholders are pulling out of Ukraine after the military said yesterday rebels are mobilizing forces across the war-torn eastern regions. The conflict will deepen the country’s recession, further deplete foreign-currency reserves and weaken the hryvnia, JPMorgan Chase & Co. said…”
November 14 – Bloomberg (Stepan Kravchenko and Henry Meyer): “Russia is preparing for a ‘catastrophic’ slump in oil prices, which it can weather thanks to a cushion of more than $400 billion in reserves, President Vladimir Putin said. ‘We’re considering all the scenarios, including the so- called catastrophic fall of prices for energy resources, which is entirely possible, and we admit it,’ Putin said… Russia, whose economy is forecast by the central bank to run zero growth next year, is struggling under the weight of a plummeting ruble and sanctions imposed over the conflict in Ukraine.”
November 10 – Bloomberg View (Mohamed El-Erian): “As the central bank of Russia appears to be losing control of its currency market, the global financial media is warning about a possible financial crisis there. Some experts have even drawn parallels to August 1998, when a Russian default caused global economic and financial disruptions. Against this background, here are the seven things to know about what’s going on in Russia now. Buffeted by Western sanctions and lower oil prices, Russia has suffered a significant decline in net foreign earnings. Capital is fleeing the country, and corporations and households are looking to switch out of rubles and into dollars and other ‘hard’ currencies. The result has been a sharp fall in both international reserves and the value of the ruble, contributing to a rising threat of domestic financial turmoil.”
November 14 – Bloomberg (Ksenia Galouchko and Anatoly Medetsky): “A company managing Russian train stations, part of state-owned Russian Railways, failed to redeem bonds this week, citing delays in third-party payments. OAO RZhD-Razvitie Vokzalov, 25% owned by a unit of Russian Railways, will repay 176.4 million rubles ($3.7 million) of notes later this month after missing a Nov. 10 deadline, it said…”
November 14 – Bloomberg (Filipe Pacheco and Paula Sambo): “Brazil’s real fell to a nine-year low as Petroleo Brasileiro SA delayed its earnings report as federal police investigated allegations of corruption and money laundering at the state-run oil producer. The currency fell 0.5% to… the weakest level… since April 2005… The Brazilian currency sank with shares of Petrobras as the company said it may adjust financial statements and internal controls before publishing results… ‘Many foreign investors -- and even Brazilians who have money abroad -- are selling Petrobras’s stock and converting reais into dollars, which puts pressure on the local currency...'"
November 11 – Bloomberg (Raymond Colitt and Arnaldo Galvao): “Brazil’s government is asking Congress for authorization to ease its fiscal target this year after posting the biggest budget deficit in more than a decade. The government today submitted a bill to increase the amount it can discount from the 2014 primary budget, which excludes payments on interest, to include all tax breaks and investments in infrastructure… The measure would help the government reach its budget target, even as an economic slowdown crimps fiscal revenue. The move is a disappointment to investors who say they want more not less fiscal discipline, Luciano Rostagno, the chief strategist at Banco Mizuho do Brasil SA…, said… ‘It goes against what the market is expecting,’ said Rostagno. ‘It’s a bad sign amid the possibility of a credit rating downgrade.’”
November 14 – Bloomberg (Sabrina Valle): “Petroleo Brasileiro SA investors probably will have to wait another month for quarterly earnings while investigations are carried out into the state-run producer’s alleged participation in a corruption scandal. The stock plummeted in European trading. The Rio de Janeiro-based company, known as Petrobras, expects to release unaudited third-quarter results on Dec. 12… Federal police are conducting search and arrest warrants for 27 people for alleged involvement in the money laundering scheme known as Car Wash and blocked 720 million reais ($278 million) in assets…”
EM Bubble Watch:
November 13 – Bloomberg (Marton Eder): “Almost one year after the Maidan Square demonstrations began in central Kiev, Ukraine’s record- high borrowing costs are showing how difficult the path toward Europe has become. The yield on Ukraine’s dollar-denominated note due in July 2017 rose three bps to a record 17.67% today, almost quadruple the average borrowing cost for emerging markets. The cost to insure the nation’s debt against non- payment shows a 62% probability of default within five years… The hryvnia weakened to a record yesterday as NATO accused Russia of sending troops and heavy weapons into Ukraine."
November 14 – Bloomberg (Anatoly Kurmanaev): “Venezuela lost 30% of its foreign exchange revenue in the last month because of a ‘tremendous’ drop in oil prices, President Nicolas Maduro said. Venezuela’s average oil-export price last week fell to $72.80 a barrel, the lowest in four years, pushing the yield on the country’s benchmark bonds to almost 19% for the first time since the global financial crisis. Oil accounts for 97% of foreign exchange income, which the country needs to pay about $28.5 billion of bond principal due in 2016.”
November 12 – Bloomber (Selcan Hacaoglu): “Construction work on two of Turkey’s biggest dam projects has ground to a halt, as the country pays a price for simmering tensions between Kurdish rebels and the government. Since August, Kurdish rebels have set ablaze cement trucks, bombed power lines and kidnapped workers, leading construction companies to suspend work on the $3 billion Ilisu Dam and hydroelectric plant and a $3.5 billion irrigation project near the town of Silvan… The violence erupted in response to faltering peace talks between Kurds and the Turkish government to end a 30-year struggle for autonomy, escalating further in October over Turkey’s perceived failure to intervene to help Syrian Kurds in Kobani against Islamic State. The halted work on the dams -- part of a $35.5 billion development project -- has led to hundreds of workers losing their jobs.”
November 14 – Bloomberg (Lorenzo Totaro): “Italy’s economy shrank in the third quarter pushing the nation into a fourth year of a slump that has complicated Prime Minister Matteo Renzi’s efforts to revive growth and keep public finances in check. Gross domestic product fell 0.1% from the previous three months, when it declined 0.2%... Output was down by 0.4% from a year earlier.”
November 12 – Bloomberg (Sonia Sirletti): “Banca Monte dei Paschi di Siena SpA, which is seeking to raise 2.5 billion euros ($3.1bn) to plug a capital deficit that emerged in Europe’s bank health check, reported a 10th straight quarterly loss on higher bad- loan provisions and restructuring costs. The third-quarter net loss widened to 796.7 million euros from 138.6 million euros a year earlier… Results were affected by 318 million euros of one-time costs related to job cuts agreed with unions in August.”
November 14 – Bloomberg (Agnes Lovasz): “A recovery in the European Union’s eastern nations faltered in the third quarter, derailed by the euro region’s slowdown and deadly fighting in Ukraine. Poland’s $518 billion economy, the largest in the EU’s east, grew 2.7% from a year earlier, down from 3.3% in the previous three months, according to the median estimate… Hungary’s expansion slowed to 2.9% from 3.9%, a separate survey showed.”
Global Bubble Watch:
November 11 – Bloomberg (Christopher Langner): “The neediest companies in Asia are getting a warmer reception in the loan market than their European counterparts as banks flush with deposits support the fastest economic expansion in two years. Borrowers in the region rated below investment grade have obtained $27.7 billion of loans this year, almost twice the amount in all of 2013 and the most since $40.8 billion in 2007… Leveraged lending in Europe is down 6.8% versus the same period last year. Banks faced with scant growth in the West are heading East in search of better returns, according to HSBC Holdings Plc and Australia & New Zealand Banking Group Ltd. The result is that lenders in Asia are become more aggressive, helping to fund companies from resort operators to pig farmers.”
November 12 – Bloomberg (Scott Lanman): “Disinflation is becoming ‘entrenched’ throughout Asia, creating economic headwinds and making it tougher for governments to control debt, Morgan Stanley analysts said. China and South Korea are among seven of 10 major Asian economies excluding Japan that are experiencing producer-price deflation, reflecting a loss of corporate pricing power and weaker commodity prices, analysts led by Chetan Ahya in Hong Kong wrote… Persistent disinflation in Asia adds to global economic challenges including a euro area teetering on the edge of a recession, with the International Monetary Fund last month lowering its estimates of world expansion this year and next. Producer-price deflation is spurring weaker consumer-price gains, slowing nominal gross domestic product growth and pushing up inflation-adjusted interest rates, Morgan Stanley said. ‘Against this backdrop and in the context of a rapid increase in leverage almost all across the region over the past six years, this has added to the challenges for managing the debt dynamic in the region,’ Ahya and his team wrote.”
November 12 – Bloomberg (Julia Verlaine and Liam Vaughan): “Traders worked together to ‘whack’ the market, called themselves a ‘cartell’ and congratulated each other for a job well done, according to transcripts released by regulators… ‘Ok, i got a lot of euros,’ a currency trader at JPMorgan… said… to his counterpart at Citigroup Inc. A minute later he says, ‘tell you what, lets double team it.’ Dozens of chats spanning four years from 2008 were released by regulators as they reached the first settlements in the global probe into the manipulation of foreign-exchange benchmarks. Citigroup, JPMorgan, Royal Bank of Scotland Group Plc, HSBC Holdings Plc and UBS AG were ordered to pay about $3.3 billion… Traders discussed which of their counterparts to include in chats and openly disclosed their positions with dealers at other banks just before the 4 p.m. WM/Reuters fix. That’s one of the most popular benchmarks for asset managers, and a time of day that was especially volatile for currency trading, so knowing other firms’ client orders beforehand could be advantageous.”
November 12 – Wall Street Journal (John Revill): “The head of Switzerland’s central bank has warned that maintaining stable prices would be harder to achieve if the Alpine country votes to require the bank to keep a minimum amount of gold in its vaults. The adoption of the so-called ‘Save Our Swiss Gold’ initiative would be a ‘fatal error of judgment,’ Thomas Jordan, president of the Swiss National Bank , told Swiss newspaper 20 Minuten… On Nov. 30, the Swiss are scheduled to vote in a referendum on the initiative to make the Swiss National Bank to hold a fifth of its assets in gold, a level it would need to meet within five years. The SNB currently has assets of around $550 billion. The requirement, the campaign for which is led by members of the right-wing Swiss People’s Party, would also prohibit the bank from selling any of its gold in the future and repatriate gold held overseas. A recent poll showed the vote was too close to call with 44% of respondents in favor of the initiative, 39% against and 17% undecided.”
November 12 – New York Times (David M. Herszenhorn): “Tanks and other military vehicles towing heavy weapons pouring over the border from Russia into eastern Ukraine. Nightly artillery battles in the region’s biggest city, Donetsk, and reports of fighting around another regional capital. And now, sightings of the ‘green men,’ professional soldiers in green uniforms without insignia, the same type of forces that carried out the invasion of Crimea in the spring. A senior NATO official confirmed on Wednesday what Ukrainian military officials and monitors from the Organization for Security and Cooperation in Europe have been saying for days now: Russian troops and military equipment are crossing the border into Ukraine, seemingly preparing for renewed military action, though what exactly remains unclear.”
November 12 – Bloomberg (Volodymyr Verbyany and Kateryna Choursina): “Russia is planning to extend its long-range bomber patrols as far as the Gulf of Mexico and the eastern Pacific Ocean, it said, as NATO accused Vladimir Putin’s government of sending more troops into eastern Ukraine. With Ukraine warning its conflict is close to returning to open war, Russian Defense Minister Sergey Shoigu said his country’s military will start conducting regular long-range bomber patrols along Russia’s borders and over the Arctic Ocean… ‘In this situation, we have to maintain a military presence in the western part of the Atlantic and the eastern part of the Arctic Ocean, in the Caribbean and in the Gulf of Mexico,’ Shoigu said, according to a statement on the Russian Defense Ministry website.”
November 12 – Bloomberg (Harry R. Weber): “U.S. power systems vulnerable to cyberattack from other nations as well, industry needs to keep assessing weaknesses, Michael Chertoff, former U.S. homeland security secretary, says at EEI Financial Conference… Politics, terrorism, would be reasons for power cyberattacks from other nations, Chertoff says…”
November 13 – Bloomberg (James G. Neuger): “European Union governments remain split over further sanctions on Russia, limiting any moves next week to asset freezes and travel bans on additional Ukrainian separatists, according to EU officials and a planning document. EU foreign-policy chief Federica Mogherini said a Nov. 17 meeting of national ministers will consider the blacklisting, while putting off a discussion of tougher economic measures until next month’s summit of leaders… Russian President Vladimir Putin is due to meet with fellow leaders from the Group of 20 nations in Australia this weekend amid evidence that Russian tanks, artillery and troops are entering Ukraine. British Prime Minister David Cameron cited the prospect of a new Cold War in a speech in London on Nov. 10, saying the U.K. will ‘keep upping the pressure.’”
China Bubble Watch:
November 14 – Bloomberg: “The People’s Bank of China’s targeted liquidity injections haven’t been enough to spur a pickup in lending, adding pressure for broader stimulus steps. Aggregate financing in October was 662.7 billion yuan ($108bn)…, down from 1.05 trillion yuan in September and lower than the 887.5 billion yuan median… The central bank has added liquidity and sought to lower the cost of funds while refraining from broad-based interest rate or reserve requirement ratio cuts. Data yesterday showing the second-weakest growth in industrial output since 2009 and the slowest investment in fixed assets since 2001 suggest bolder steps will be needed to spur a pickup in growth. ‘Sluggish domestic demand and risk-aversion among commercial banks dragged credit growth,’ said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd.”
November 13 – Bloomberg: “China’s slowdown deepened in October as policy makers refrained from economy-wide stimulus, with industrial output and investment trailing estimates. Factory production rose 7.7% from a year earlier, the second weakest pace since 2009… Investment in fixed assets such as machinery expanded the least since 2001 from January through October, and retail sales gains also missed economists’ forecasts last month. The government has kept to targeted steps to shore up the economy this year, rather than a broader response such as nationwide interest-rate cuts, to avert a repeat of a buildup in debt from the record 2008-2009 credit surge… Growth in retail sales of 11.5% in October compared with the 11.6% median projection of analysts… The expansion in January through October fixed-asset investment excluding rural households was 15.9% versus estimates for a 16% increase. Factory gate prices fell 2.2% in October, a record 32nd straight decline… Electricity output grew 1.9% from a year earlier in October, compared with September’s 4.1% increase…”
November 13 – Bloomberg : “China’s central bank is inviting selected city commercial banks in some provinces, including Jiangsu and Zhejiang, to apply for cash injections, according to an official with knowledge of the matter. The money will come from the PBOC and is earmarked to support loans to smaller enterprises… Final amount will be decided later and total size could be tens of billions of yuan: source. Collateral will need to be pledged by banks to secure funds, though the PBOC hasn’t determined yet which facility will be used to distribute the money…”
November 14 – Bloomberg: “When Lin Li, a consultant in Shanghai, bought a Mercedes Benz C260 and a Lexus ES250 for himself and his wife he borrowed half of the money at zero interest for one year. Car companies are competing to offer the sweetest deals for buyers like Lin, 35, and then reducing their own costs by selling bonds backed by automobile loans. Sales of such notes are set to more than double to at least 35 billion yuan ($5.7bn) in 2015 from 15.9 billion yuan this year, according to Citic Securities Co., the top underwriter of China’s asset- backed securities. ‘People would rather take loans than pay cash as long as the interest rate is lower than the yield on wealth-management products,’ said Lin, who borrowed 320,000 yuan, half of the purchase cost for the two cars.”
Japan Bubble Watch:
November 13 – Bloomberg (Andy Sharp): “Japanese Prime Minister Shinzo Abe is poised to gamble his political future on a plan to call a snap election next month, halfway into his current term. ‘It’s always risky to dissolve the house when you’re the prime minister,’ said Robert Dujarric, director of the Institute of Contemporary Asian Studies at Temple University in Tokyo. ‘Unless you win a crushing victory, you have nowhere to go but down.’ Abe is likely to go to the people on Dec. 14 after postponing an unpopular sales-tax increase slated for October 2015… Abe is less than two years into his four-year term and elections aren’t due until 2016.”
November 9 – Reuters (Linda Sieg and Yoshifumi Takemoto): “Officials from Japan's ruling coalition urged lawmakers on Tuesday to prepare for a possible early election, and a government source said Prime Minister Shinzo Abe was likely to delay a tax hike that could derail a promised economic recovery. A second government source said one option being considered was for Abe to call a snap poll before the end of the year if he decides to delay a planned but unpopular sales tax increase to 10% from next October. Abe said he had not decided on the timing of an election. ‘As for the timing of dissolving parliament, I haven't made any decision,’ he told a news conference… He added that he had never mentioned the possibility of a snap poll.”