On the back of OPEC’s failure to cut production, crude sank $10.36, or 13.5% this week, to the lowest price since May 2010. The Goldman Sachs’ Commodities Index (GSCI) dropped 8.2%, to the low since September 2010. It’s worth noting that Copper dropped 6% this week to the lowest level since July 2010.
On the currency front, this week saw Russia’s ruble slammed for 7.3% to a record low. Brazil’s real dropped 1.9%, the Colombian peso 3.2%, and the Chilean peso 2.3%. The Mexican peso fell 1.9% to the lowest level since the tumultuous summer of 2012. The South African rand declined 1.1%. And despite losing a little ground to the euro this week, the U.S. dollar index traded to the highest level since June 2010.
At the troubled “Periphery of the Periphery,” Russia's 10-year yields jumped 43 bps to 10.53%. Ukraine 10-year yields surged 297 bps to a record 19.49% (Bloomberg: “worst week on record”). Venezuela CDS jumped 188 bps to 2,292. Greek 10-year yields surged 42 bps to 8.35%.
The melt-up in global “developed” bond markets is nothing short of incredible. German (0.70%), French (0.97%), Italian (2.03%), Spanish (1.90%), Portuguese (2.84%), Austrian (0.84%), Belgian (0.92%), Irish (1.38%) and Dutch (0.82%) yields all traded to record lows this week. With GDP surpassing 130% of GDP, Italian 10-year yields at 2%? French yields below 1% - with a huge debt load and big deficits as far as the eye can see? Japanese yields at a record low 0.41% (federal debt-to-GDP exceeding 250%)? What on earth have central bankers done to global markets? It’s worth noting that U.S. long-bond yields Friday fell below the October 15th “panic low” level, closing at a 19-month low 2.89%.
Market divergences have turned only more extreme. This week saw the S&P500 trade to another all-time high. The Dow Jones Transports jumped 1.1% this week to a record high. Gaining 2.0%, the Nasdaq 100 traded to the highest level since that fateful month, March 2000. Biotech stocks traded to a record high. The Morgan Stanley Retail Index jumped 2.0% this week to close at a record high. Standard & Poor’s Supercomposite Restaurants Index gained 1.3% to also close at an all-time high. In (“Core”) EM, the Shanghai Composite traded to a three-year high, while Indian stocks closed Friday at a record high.
It’s worth noting that the last time crude, the GSCI and copper traded at today’s levels the Fed’s balance sheet was about half its current size. Ditto for Bank of Japan assets. China’s International Reserve holdings have increased more than 70% since June 2010 (to $3.888 TN). Total Chinese system Credit has almost doubled in five years. Debt has exploded throughout EM, with too much denominated in dollars.
The world is now six years into history’s greatest concerted monetary inflation. Unprecedented policy measures have incited an unmatched global speculative Bubble. There is the ongoing global securities market Bubble that inflates on the back of central bank liquidity pumping and market backstops. This week, however, provided added confirmation of the ongoing deflation of the “Global Reflation Trade.” I believe history will look back on the crude, commodities and EM currency collapses as warnings that went unheeded in manic securities markets. In the worst-case scenario, the faltering of the global Bubble at the Periphery ensures that central bank liquidity stokes “Terminal Phase” excess at the Core. The global monetary experiment is failing spectacularly, though over-liquefied securities markets remain in denial.
November 28 – Financial Times (Jamil Anderlini): “ ‘Ghost cities’ lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers. In 2009 and 2013 alone, ‘ineffective investment’ came to nearly half the total invested in the Chinese economy in those years, according to research by Xu Ce of the National Development and Reform Commission, the state planning agency, and Wang Yuan from the Academy of Macroeconomic Research, a former arm of the NDRC. China is this year on track to grow at its slowest annual pace since 1990, and the report highlights growing concern in the Chinese leadership about the potential economic and social consequences if wasteful investment leaves projects abandoned and bad loans overloading the financial system. The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis… The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis…”
November 23 – Reuters (Kevin Yao): “China’s leadership and central bank are ready to cut interest rates again and also loosen lending restrictions, concerned that falling prices could trigger a surge in debt defaults, business failures and job losses, said sources involved in policy-making. Friday's surprise cut in rates, the first in more than two years, reflects a change of course by Beijing and the central bank… Economic growth has slowed to 7.3% in the third quarter and policymakers feared it was on the verge of dipping below 7% - a rate not seen since the global financial crisis. Producer prices, charged at the factory gate, have been falling for almost three years, piling pressure on manufacturers, and consumer inflation is also weak. ‘Top leaders have changed their views,’ said a senior economist at a government think-tank involved in internal policy discussions. The economist… said the People’s Bank of China had shifted its focus toward broad-based stimulus and were open to more rate cuts as well as a cut to the banking industry's reserve requirement ratio (RRR)…”
China has been somewhat off the markets’ radar of late. The People’s Bank of China has been injecting large amounts of liquidity and, last week, cut interest-rates. Chinese stimulus these days feeds the bullish imagination. Chinese equities have rallied sharply (short squeeze?), and the bulls view this as confirmation that China’s policymakers have everything under control.
At this point, I view China as a real near-term wildcard. Inarguably, both Chinese end demand and finance were integral to the “Global Reflation Trade.” Supposedly, the Chinese boom was to provide robust commodities demand for years to come. Chinese companies have scoured the world for commodities-related investment. At the same time, the Chinese financial system played a major role in global commodities financing. What does the commodities collapse mean for Chinese financial stability, especially with stability already challenged by serious domestic issues.
I find it intriguing that Chinese policymakers have apparently turned much more concerned about the economy (see Reuters excerpt above). And a report (see FT above) from government researchers has admitted that “government stimulus measures and hyperactive construction… have generated $6.8tn in wasted investment since 2009”? Wow. I’ll assume that Chinese officials are now in intense discussions as to how to respond to a bevy of pressing issues, including sinking commodities, heightened global disinflationary forces, king dollar, significant currency devaluation from the Japanese, Europeans, South Koreans and others, and overall mounting financial and economic risks.
Over the past six years, respective U.S. and Chinese Credit Bubbles have been engaged in somewhat of a mirror image dynamic. With U.S. federal debt up 150% in six years and the Fed’s balance sheet inflating 400%, surfeit dollar balances flooded into the PBOC. In the process, the People’s Bank of China accommodated a historic expansion of Chinese domestic Credit. This Credit fueled historic booms in manufacturing capacity and Chinese housing (apartments). This Credit Bubble was also fundamental to the greater EM Bubble that saw virtually unlimited cheap finance spur booms throughout the commodity-related economies.
Importantly, this powerful self-reinforcing U.S. to China to EM (“global government finance Bubble”) dynamic was possible because of the Chinese currency’s tight link to the U.S. dollar. This “peg” ensured that when finance flowed into China it would be easily converted into local currency balances at the PBOC, and then immediately recycled back to U.S. securities markets. The King of Dollar Pegs also created a powerful magnet for speculative flows. Why not borrow cheap and invest in higher-yielding securities (or finance commodities) in a currency tied to the dollar? Better yet, between June 2010 and January of this year the Chinese steadily revalued the renminbi higher against the dollar. In the past I referred to the renminbi/dollar as a “currency peg on steroids.” It made the SE Asian currency pegs from the nineties look tiny and feeble in comparison.
I all too clearly remember the bloody havoc unleashed when currency peg regimes collapsed back in the nineties. Part of the current bull case is that the world has largely moved to free-floating currencies, with EM central bankers sitting on huge treasure troves of International Reserves. And China’s massive $3.8 Trillion of Reserves has the world believing they have ample “money” to spend their way out of any predicament, certainly including pressure that might befall its currency.
I just believe we’ve reached the point where the renminbi peg to king dollar has turned quite problematic for the Chinese. Actually, it’s my view they have recognized this for a while now, and actually decided early this year to begin an orderly currency devaluation. And between late-January and into early-May, the renminbi was devalued about 3.5% versus the dollar (to about 6.25 per $). Yet they then reversed course, with the remninbi trading back down to 6.11 this month. I’ve pondered whether policymakers turned timid after renminbi devaluation prompted a problematic reversal of “hot money” flows and heightened stress in their huge commodities financing complex.
Over recent weeks, increasingly desperate measures from Draghi and Kuroda spurred king dollar, in the process pushing crude, commodities and EM currency markets over the edge. While U.S. equities investors are salivating over the thought of sinking energy prices, a deflating commodities complex has myriad negative ramifications. For one, the “hot money” exit from commodities and commodities-related economies has accelerated. This ensures serious Credit issues after years of financial and investment excess, with negative economic effects for EM generally.
These dynamics now place China in a real bind. Already suffering from massive overcapacity, slim profits and heightened financial stress, Chinese manufactures are now exposed to a severe global slowdown and acute pricing/competitive pressures. The bloated Chinese financial sector could be even more vulnerable. Keep in mind that Chinese bank assets are projected (Autonomous Research’s Charlene Chu) to end 2014 with assets of $28 Trillion – an astounding triple the level from 2008. And don’t forget the now substantial Chinese “shadow banking” sector that has apparently been a bastion of high-risk lending.
God only knows the mess that’s been created. Chinese finance was already facing the downside of both a historic housing Bubble and an unprecedented over-/mal-investment throughout the manufacturing complex. Throw in a global collapse in commodities and the bursting of the EM Credit Bubble, and one is left fearing for Chinese financial and economic instability.
I believe Chinese policymakers have major decisions to make. Do they stick with the peg to king dollar? Increasingly, it doesn’t seem tenable. With the way global dynamics are now playing out, divergent U.S. and Chinese economic structures are inconsistent with a stable currency peg. The (consumption and services) U.S. economy, with its relatively small export sector, is less sensitive to the global commodities downturn and economic slowdown. The U.S. financial sector is less directly exposed to global commodities and EM instability. Perceived economic and financial stability – in the face of a now deflating global Bubble – throws gas on the king dollar fire.
Meanwhile, the Chinese economy and financial sector appear more vulnerable by the week. To this point, sticking with The Peg has likely held financial instability at bay. At some point, however, I would expect priority to be given to China’s massive export sector and the challenge of maintaining full employment (and social stability). I believe it will prove difficult for the Chinese not to devalue. This week saw the renminbi decline 0.33%, the largest weekly drop since April.
Curiously, Chinese International Reserves dropped $81bn in September – and are now down $106bn from June highs. How much “hot money” flowed into China over recent years, enticed by the Chinese “miracle economy,” by high yields, by global liquidity excess and a currency tightly linked to the U.S. dollar? But with the China story turning sour and the temptation to devalue on the rise, why would “hot money” not be looking to exit? Has an important reversal in speculative finance already commenced? Might this have marked a momentous inflection point for the Chinese and global Bubbles? How stable is The King of Dollar Pegs? What are the ramifications if it falters - for Chinese financial stability, for commodities, for EM, for the global economy and global Credit? Could the escalating risk of a destabilizing unwind help explain the simultaneous collapse in global commodities prices and “developed” sovereign yields?
With global “hot money” now on the move in major fashion, it’s time to start paying close attention to happenings in China. It’s also time for U.S. equities bulls to wake up from their dream world. There are Trillions of problematic debts in the world, including some in the U.S. energy patch. There are surely Trillions more engaged in leveraged securities speculation. Our markets are not immune to a full-fledged global “risk off” dynamic. And this week saw fragility at the Global Bubble’s Periphery attain some significant momentum. Global currency and commodities markets are dislocating, portending global instability in prices, financial flows, Credit and economies.
For the Week:
The S&P500 added 0.2% (up 11.9% y-t-d), and the Dow gained 0.1% (up 7.6%). The Utilities rose 0.5% (up 19.8%). The Banks were unchanged (up 4.9%), while the Broker/Dealers added 0.6% (up 10.1%). Transports jumped 1.1% (up 24.3%). The S&P 400 Midcaps slipped 0.1% (up 7.5%), while the small cap Russell 2000 added 0.1% (up 0.8%). The Nasdaq100 surged 2.0% (up 20.8%), and the Morgan Stanley High Tech index jumped 2.2% (up 12.8%). The Semiconductors advanced 3.4% (up 28.2%). The Biotechs jumped 2.8% (up 47.5%). With bullion down $34, the HUI gold index sank 7.2% (down 17.7%).
One-month Treasury bill rates closed the week at four bps and one-month rates ended at one basis point. Two-year government yields declined three bps to 0.47% (up 9bps y-t-d). Five-year T-note yields dropped 13 bps to 1.48% (down 26bps). Ten-year Treasury yields fell 15 bps to 2.17% (down 86bps). Long bond yields dropped 13 bps to 2.89% (down 108bps). Benchmark Fannie MBS yields were down 13 bps to 2.83% (down 78bps). The spread between benchmark MBS and 10-year Treasury yields was unchanged at 66 bps. The implied yield on December 2015 eurodollar futures fell four bps to 0.75%. The two-year dollar swap spread was little changed at 22 bps, while the 10-year swap spread added one to 13 bps. Corporate bond spreads narrowed somewhat. An index of investment grade bond risk declined two to 62 bps. An index of junk bond risk ended the week down seven to 335 bps.
Greek 10-year yields jumped a notable 42 bps to 8.35% (down 7bps y-t-d). Ten-year Portuguese yields sank 16 bps to a record low 2.84% (down 329bps). Italian 10-yr yields sank 18 bps to a record low 2.03% (down 209bps). Spain's 10-year yields fell 12 bps to a record low 1.90% (down 21bps). German bund yields declined seven bps to a record low 0.70% (down 123bps). French yields sank 14 bps to a new low 0.97% (down 159bps). The French to German 10-year bond spread narrowed seven to a more than four-year low 27 bps. U.K. 10-year gilt yields declined 12 bps to 1.93% (down 109bps).
Japan's Nikkei equities index added 0.6% (up 7.2% y-t-d). Japanese 10-year "JGB" yields dropped four bps to a record low 0.416% (down 33bps). The German DAX equities index jumped 2.6% (up 4.5%). Spain's IBEX 35 equities index rose 2.4% (up 8.6%). Italy's FTSE MIB index increased 0.3% (up 5.5%). Emerging equities were all over the place. Brazil's Bovespa index ended the week down 2.5% (up 6.1%). Mexico's Bolsa fell 1.0% (up 3.4%). South Korea's Kospi index gained 0.8% (down 1.5%). India’s Sensex equities index rose 1.3% to another record (up 35.5%). China’s Shanghai Exchange surged 7.9% (up 26.8%). Turkey's Borsa Istanbul National 100 index jumped 3.5% to a 2014 high (up 27.1%). Russia's MICEX equities index slipped 0.3% (up 2.0%).
Debt issuance slowed for the holiday week. Investment-grade issuers included Kinder Morgan $6.0bn, Perrigo $1.6bn, PNC Bank $1.25bn, Raytheon $600 million, FS Investment Corporation $325 million and El Paso Electric $150 million.
Junk issuers this week included TIBCO Software $1.9bn, MGM Resorts International $1.25bn, Springleaf Finance $700 million and CDW $575 million.
Convertible debt issuers included NXP Semiconductors $1.0bn.
International dollar debt issuers included Kenya $2.75bn, Pakistan $1.0bn, Export Development Canada $1.0bn, Korea East-West Power $500 million, Seagate Hdd Cayman $500 million and Swedish Export Credit $253 million.
Freddie Mac 30-year fixed mortgage rates slipped two bps to 3.97% (down 32bps y-o-y). Fifteen-year rates were unchanged at 3.17% (down 13bps). One-year ARM rates were unchanged at 2.44% (down 16bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down six bps to 4.15% (down 30bps).
Federal Reserve Credit last week declined $8.8bn to $4.454 TN. During the past year, Fed Credit inflated $571bn, or 14.7%. Fed Credit inflated $1.643 TN, or 58%, over the past 107 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $6.3bn last week to $3.314 TN. "Custody holdings" were down $39.9bn year-to-date, and fell $35.4bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $263bn y-o-y, or 2.3%, to a seven-month low $11.776 TN. Over two years, reserves were $945bn higher for 9% growth.
M2 (narrow) "money" supply expanded $11.9bn to a record $11.564 TN. "Narrow money" expanded $591bn, or 6.1%, over the past year. For the week, Currency increased $2.6bn. Total Checkable Deposits fell $17.2bn, while Savings Deposits jumped $30.3bn. Small Time Deposits were down $1.9bn. Retail Money Funds slipped $1.8bn.
Money market fund assets increased $8.4bn to $2.662 TN. Money Funds were down $56.4bn y-t-d and dropped $15.7bn from a year ago, or 0.6%.
Total Commercial Paper added $0.4bn to a 2014 high $1.091 TN. CP expanded $45.4bn year-to-date and was up $31.9bn over the past year, or 3.0%.
Currency Watch:
The U.S. dollar index added 0.1% to 88.356 (up 10.4% y-t-d). For the week on the upside, the South Korean won increased 0.5%, the euro 0.5%, the Danish krone 0.5%, the Swiss franc 0.5% and the Swedish krona 0.2%. For the week on the downside, the Norwegian krone declined 3.2%, the Mexican peso 2.2%, the Brazilian real 1.9%, the Australian dollar 1.9%, the Canadian dollar 1.6%, the South African rand 1.1%, the Japanese yen 0.7%, the New Zealand dollar 0.6%, the Singapore dollar 0.4%, the Taiwanese dollar 0.1% and the British pound 0.1%.
Commodities Watch:
November 28 – Bloomberg (Wael Mahdi, Golnar Motevalli and Grant Smith): “OPEC took no action to ease a global oil-supply glut, resisting calls from Venezuela that the group needs to stem the rout in prices. Futures slumped the most in more than three years. The group maintained its collective production ceiling of 30 million barrels a day, Ali Al-Naimi, Saudi Arabia’s oil minister, said… Brent crude dropped as much as 8.4% in London, extending this year’s decline to 34%.”
November 28 – Bloomberg (Chanyaporn Chanjaroen and Alessandro Vitelli): “Commodities retreated to a five-year low as crude oil tumbled after OPEC refrained from cutting output to ease a global glut. Gold and copper also declined. The Bloomberg Commodity Index of 22 raw materials dropped as much as 2.3% to 114.8341, the lowest since July 2009… The index resumed trading today after the U.S. Thanksgiving holiday yesterday, when Brent crude plunged 6.7% after a meeting of the Organization of Petroleum Exporting Countries in Vienna took no action to relieve the supply excess. Commodities are poised for a fourth straight year of losses as West Texas Intermediate oil futures are set for the biggest slump since the 2008 financial crisis.”
The Goldman Sachs Commodities Index sank 8.2% (down 23.8%). Spot Gold fell 2.8% to $1,167 (down 3.2%). March Silver dropped 5.5% to $15.556 (down 20%). January Crude collapsed $10.36 to $66.15 (down 33%). January Gasoline sank 10.6% (down 34%), and January Natural Gas fell 7.4% (down 3%). March Copper lost 6.0% (down 16%). December Wheat jumped 5.5% (down 5%). December Corn increased 0.8% (down 11%).
U.S. Fixed Income Bubble Watch:
November 26 – Bloomberg (Christine Idzelis): “Leveraged loan issuance plummeted in the U.S. this month as investors punished borrowers in an increasingly volatile market for high-yield, high-risk debt. Borrowers… have sold $6.5 billion of U.S leveraged loans to institutional investors in what’s poised to be the slowest November since 2008… Volume was almost $30 billion in October. Fewer deals are getting done after loan prices plunged more than 3% last month from a July peak and yields rose to 6.2%, the highest in more than two years… The loans have returned 2.4% this year, down from 4.6% in the similar period of 2013 and underperforming 4.1% gains from U.S. junk bonds… Banks have arranged $473 billion of U.S. institutional loans this year, compared with a record of about $700 billion in all of 2013… ‘The loan market is still suffering from cash flowing out from mutual funds,’ said Peter Toal, Barclays Plc’s… head of global leveraged finance syndicate. Investors have pulled a net $15.5 billion from U.S. mutual funds and exchange-traded funds that buy leveraged loans this year, according to Lipper… In April, they snapped 95 straight weeks of inflows that included a record $62.9 billion of deposits last year… Leveraged loan issuance in Europe fell to 2.1 billion euros ($2.6bn) this month, the lowest for any period in almost four years… That compares with a seven-year high of 19.7 billion euros in June, the data show.”
November 25 – Bloomberg (Brian Chappatta and Tim Jones): “Illinois bonds are set to weaken after a judge struck down a plan to shrink a $111 billion pension shortfall, threatening to strain the finances of the lowest-rated U.S. state. Illinois 10-year obligations yield 3.68%, or about 1.4 percentage points above top-rated municipal debt… At that spread, the smallest since July, the bonds aren’t worth buying given the legal developments, said Robert Miller, who helps oversee $35 billion of munis at Wells Capital Management.”
November 25 – Bloomberg (Sarah Mulholland): “A $40 million penalty wasn’t enough to keep the owner of San Francisco’s Parkmerced apartment complex from the chance to lock in record-low interest rates and take advantage of the property’s $1.5 billion value. While a landlord willing to pay almost 63 times the average fee to refinance early is a bullish sign for commercial real estate, it’s less so for bond investors facing $295 billion of mortgages that come due during the next three years. That’s because the securities are increasingly tied to the market’s weakest properties, many of them financed during the peak of the real-estate boom in 2007, as the strongest are paid off. More property owners are jumping on a drop in financing costs and loosening terms to pay off their mortgages. That helped shrink the amount of debt maturing before the end of 2017 from $332 billion at the start of 2014…”
U.S. Bubble Watch:
November 24 – Los Angeles Times (Tim Logan): “By most measures, the housing market these days is a bit sluggish. Prices are flat. Sales are drooping. A lot of people are priced out. But not everyone. The high end is hopping. Luxury home sales in Southern California are hitting levels not seen in decades. The number of homes bought for $2 million or more in recent months is the highest on record. Sales worth $10 million or more are on pace this year to double their number from the heights of the housing bubble. ‘It's pretty mind-blowing, to be honest,’ said Cindy Ambuehl, an agent with the Partners Trust… ‘The luxury market has been completely on fire.’ …A record 1,436 homes worth $2 million or more were sold in the six-county Southland in the second quarter, according to… DataQuick. In the more recent third quarter, 1,431 were sold. That was up 14% from the third quarter of 2013, and well ahead of any three-month period in the housing bubble years of the mid-2000s. This comes even as the broader market has plateaued, with prices in the Southland still about one-fifth below their pre-crash highs and sales at less than two-thirds their 2005 pace. It reflects a housing market that is now moving at two speeds, said Selma Hepp, senior economist for the California Assn. of Realtors. Fast for the high end, sluggish for the rest. ‘It's just a completely different story between the two segments of the market,’ she said. ‘Those who are doing well are doing really well.’”
November 25 – Bloomberg (Alister Bull): “Americans took out the most auto loans in nine years during the third quarter, according to the Federal Reserve Bank of New York’s quarterly Household Debt and Credit Report. Auto loan origination was $105 billion, the highest amount since the third quarter of 2005… Auto loan balances have now risen for 14 straight quarters… ‘Outstanding household debt, led by increases in auto loans, student loans and credit card balances, has steadily trended upward in recent quarters,’ said Wilbert van der Klaauw, senior vice president and economist at the New York Fed.”
November 26 – Bloomberg (Tim Higgins, Joseph Ciolli and Callie Bost): “Apple Inc., already the world’s largest company by market capitalization, hit a new record value: $700 billion.”
November 26 – Bloomberg (Serena Saitto): “Uber Technologies Inc. is close to raising a round of financing that would value the mobile car- booking company at $35 billion to $40 billion… T. Rowe Price Group Inc. is in discussions to be a new investor, said the people, who asked not to be identified… Uber is raising at least $1 billion, the people said.”
November 25 – Bloomberg (Richard Clough, Laura Marcinek and Brandon Kochkodin): “Louis Chenevert, who retired as chief executive officer of United Technologies Corp. in a surprise move on Sunday, will leave with a nest egg of about $172 million. That sum includes $109 million of vesting option awards and $32 million of vesting performance-based restricted-stock awards, based on yesterday’s closing price, and a pension worth $31 million as of Dec. 31…”
ECB Watch:
November 28 – Wall Street Journal (Andrea Thomas): “Bundesbank President Jens Weidmann Friday rejected calls for a German stimulus plan, saying only structural reforms and more competitiveness would kick-start eurozone economies. ‘Calls for a public fiscal stimulus plan in Germany to boost the eurozone economy are amiss,’ said Mr. Weidmann in a speech… ‘Investment rates that are above the growth potential of a developed economy aren't likely to boost prosperity—this applies to both public and private investments.’ The German government shares Mr. Weidmann’s view. It says public investment can’t solve the eurozone’s growth problem as structural reforms are needed… Mr. Weidmann stressed that it is also wrong to believe central bank monetary policy would be able to solve the bloc’s economic problems. ‘It is an illusion to believe that monetary policy means can raise economies’ growth potential permanently, or create lasting jobs,’ Mr. Weidmann said. ‘In the end, this can only be achieved by structural reforms, because growth and employment occur in innovative companies and competitive products, and well-educated and highly motivated employees.’”
November 24 – Bloomberg (Stefan Riecher and Ben Sills): “Purchasing government debt comes with legal obstacles and it is no panacea for the euro-area economy, European Central Bank Governing Council member Jens Weidmann said. ‘There is a prohibition of monetary financing in the treaties that puts up high legal hurdles, and for good reason,’ Weidmann said… The debate about quantitative easing ‘is distracting our attention from the true problems,’ he said. Weidmann’s comments come after ECB president Mario Draghi last week explicitly cited government bond-buying as a possible policy tool and said that officials will do what they must to raise inflation expectations as quickly as possible.”
November 25 – Financial Times (Elaine Moore): “Another hint of government bond buying by the European Central Bank, another set of records smashed for low government bond yields. Moments after ECB president Mario Draghi on Friday declared the bank would ‘do what we must to raise inflation and inflation expectations as fast as possible . . .’ prices across the eurozone’s sovereign bond market jumped. As Mr Draghi went on to clarify that the ECB was prepared to ‘step up the pressure and broaden even more the channels through which we intervene’ investors did a quick translation: eurozone sovereign bond buying was on the table. The market rally that began with Friday’s speech was still going strong on Monday. For the first time, Spain’s benchmark borrowing costs dropped below 2%, while Italian, French, Irish, Austrian and Belgian 10-year bond yields all hit record lows."
November 25 – Bloomberg (Mark Deen): “Euro-area financial institutions should consider creating securities that combine sovereign bonds to give the European Central Bank more assets to buy, the Organization for Economic Cooperation and Development said. The asset-backed securities, bundles of government debt from the countries in the currency bloc, would make it easier for the ECB to expand its asset-purchase program if needed, OECD Chief Economist Catherine Mann told reporters… ‘The idea is to create a package of individual sovereign bonds already issued,’ she said.”
Russia/Ukraine Watch:
November 26 – Associated Press (Peter Leonard): “Russia still has enough troops along Ukraine's border to mount a major incursion, NATO's top commander said…, and Moscow is using its military might to affect political developments inside Ukraine. U.S. Gen. Philip Breedlove said a large number of Russian troops are also active inside Ukraine, training and advising separatist rebels… Breedlove spoke during a brief visit to Kiev, where he met with top officials to discuss continued NATO assistance for Ukraine in its fight against Russian-backed separatists in the east. ‘We are going to help Ukraine's military to increase its capacities and capabilities through interaction with U.S. and European command,’ he said, adding that it ‘will make them ever more interoperable with our forces.’”
November 26 – Reuters (Noah Barkin and Andreas Rinke): “After nine months of non-stop German diplomacy to defuse the crisis in Ukraine, Chancellor Angela Merkel decided in mid-November that a change of tack was needed. Ahead of a summit of G20 leaders in Australia, Merkel resolved to confront Vladimir Putin alone… Instead of challenging him on what she saw as a string of broken promises, she would ask the Russian president to spell out exactly what he wanted in Ukraine and other former Soviet satellites the Kremlin had started bombarding with propaganda. On Nov. 15 at 10 p.m., a world away from the escalating violence in eastern Ukraine, the two met on the eighth floor of the Brisbane Hilton. The meeting did not go as hoped. For nearly four hours, Merkel… tried to get the former KGB agent, a fluent German speaker, to let down his guard and clearly state his intentions. But all the chancellor got from Putin, officials briefed on the conversation told Reuters, were the same denials and dodges she had been hearing for months. ‘He radiated coldness,’ one official said of the encounter. ‘Putin has dug himself in and he can't get out.’”
November 23 – Bloomberg (Tino Andresen and Aliaksandr Kudrytski): “Germany’s foreign minister expressed concerns that Russia is seeking to split up Ukraine by supporting separatists in the east and urged further dialogue with President Vladimir Putin’s government. ‘I’m taking Russia at its word that it doesn’t want to destroy the unity of Ukraine,’ Der Spiegel magazine cited the minister, Frank-Walter Steinmeier, as saying… ‘The reality, however, is speaking a different language.’ …The European Union and the U.S. accuse Russia of not abiding by a September truce signed in Minsk, Belarus, and Ukraine says Russian troops and vehicles continue to cross the frontier. Russia denies it’s fomenting the war.”
Brazil Watch:
November 27 – Bloomberg (Josue Leonel and Anna Edgerton): “Brazil’s central bank president Alexandre Tombini said the the country’s currency swaps program is ‘fully’ meeting its goals and doesn’t represent a threat to the foreign reserves. ‘The volume offered corresponds to less than 30% of our international reserves and do not compromise those assets,’ Tombini told reporters… ‘This situation doesn’t force us to revert those positions in the short and medium terms.’ The central bank adopted the swap program in August of 2013 to reduce currency volatility and protect investors, Tombini… The comments signal that the bank won’t increase the $100 billion it has in swaps, according to Jankiel Santos, chief economist at Banco Espirito Santo de Investimento SA. ‘This means that there is only one direction, that is down,’ Santos said…”
November 28 – Bloomberg (Raymond Colitt and David Biller): “Brazil’s Finance Minister-designate Joaquim Levy pledged to adopt more rigorous fiscal discipline without providing details on how he will reduce the country’s debt levels… Levy, a former Banco Bradesco SA executive and Treasury secretary, was named by President Dilma Rousseff yesterday to restore investor confidence… The University of Chicago-trained economist said he will narrow the widest budget gap in a decade enough to reduce the country’s debt as a percentage of gross domestic product.”
EM Bubble Watch:
November 25 – Bloomberg (Anoop Agrawal and Anto Antony): “Fitch Ratings says India’s banking system will come under strain as the highest borrowing costs in Asia prompt lenders to recast an unprecedented amount of loans… Restructured loans will rise by 1 trillion rupees ($16.2bn) from end-September to a record 4.7 trillion rupees by March… That will take lenders’ stressed assets, including soured debt, to 14% of advances, the highest since 2000… ‘With credit metrics for many companies at a decade low, we expect a record amount of restructuring in the next four months,’ Deep Narayan Mukherjee, a senior director at India Ratings… said… ‘Margins at many of these firms are barely enough to service the interest.’ …Higher interest rates amid an economic slowdown led to an increase in funding costs. The yield on five-year AAA corporate bonds averaged 9.40% so far in 2014, compared with 9.23% in all of 2013… Loans grew 11.2% from a year earlier as of Oct. 31…, about half the 21.8% average for the decade through 2013. Soured and restructured debt accounted for 9.8% of outstanding loans as of March 31.”
November 28 – Bloomberg (Rene Vollgraaff): “South Africa’s trade deficit widened to the highest in at least four years as oil importers increased purchases to benefit from lower prices. The trade gap swelled to 21.3 billion rand ($1.9bn) from a revised 3.05 billion rand in September…”
Europe Watch:
November 28 – Bloomberg (Chiara Vasarri): “Italy’s unemployment rate unexpectedly rose above 13% in October, setting a new record as businesses refrain from hiring amid the country’s longest recession since World War II. The unemployment rate rose to 13.2% from a revised 12.9% the previous month… Youth unemployment rate for those aged 15 to 24 rose to 43.3% last month from 42.7% in September…”
November 27 – Bloomberg (Stefan Riecher and Alex Webb): “German unemployment fell and the jobless rate reached a record low… The adjusted jobless rate was 6.6%...”
November 27 – Reuters (Robin Emmott): “The European Commission will tell France, Italy and Belgium on Friday that their 2015 budgets risk breaking EU rules, but it but will defer decisions on any action until early March. Draft documents seen by Reuters show the three countries are part of a group also comprising Spain, Portugal, Austria, and Malta at risk of busting budget limits.”
November 28 – Bloomberg (Alessandro Speciale): “Euro-area inflation slowed in November to match a five-year low, prodding the European Central Bank toward expanding its unprecedented stimulus program. Consumer prices rose 0.3% from a year earlier… Unemployment held at 11.5% in October…”
November 25 – Dow Jones (David Román): “Germany's central bank president, Jens Weidmann, Monday expressed doubt that a potential government bond-buying program would increase growth in eurozone countries. Speaking in Madrid, Mr. Weidmann… said that monetary policy alone can't create growth, and must be based on higher productivity and policy reforms. ‘Central banks are not able to deliver growth,’ Mr. Weidmann said. ‘Whenever we meet, this is always the first question, there is the conception that there is this silver bullet and this is distracting our attention from the main problem.’ Mr. Weidmann's comments follow remarks made Friday by ECB President Mario Draghi, who sent a strong signal that the bank is ready to ‘step up the pressure’ and expand its stimulus programs. This may happen, Mr. Draghi explained, if eurozone inflation fails to show signs of quickly returning to the bank's target of just below 2%.”
Global Bubble Watch:
November 25 – Financial Times (Andrew Bolger): “A meltdown in global credit markets is inevitable and the only questions concern the timing and catalyst, say traders and investors in European corporate bonds involved in a recent study. That is one of the stark conclusions of a report published by the International Capital Market Association based on discussions with European bond market participants. ‘Virtually every participant sees a correction lurking over the horizon,” said the report. It said the expected correction could be triggered by the unwinding of quantitative easing, heightened geopolitical risks, or some combination. ‘While market cycles are nothing new, the common concern is that, largely because of regulation, financial markets have never been worse placed to deal with a sharp correction.’ Andy Hill, author of the report, said a combination of larger bond markets, with fewer, larger investment firms, and a weakened capacity for bank intermediation, ‘all make for the perfect storm’. Since 2009, he said there had been a spectacular and unequalled rally in credit markets, largely fuelled by a wave of cheap central bank money and the unquenchable thirst for yield. ‘Corporates have taken full advantage of cheaper funding, and issuance has soared in the past few years. Similarly, fund and money managers have become more diverse and less risk-averse in their investments, and in a bid to beat the indices have targeted less and less liquid debt products … Effectively, a low-interest rate, low-volatility environment has driven investors away from liquidity.’”
November 24 – Financial Times (Tracy Alloway): “James Carville, in his time as adviser to former president Bill Clinton, was clear on how he would like to be reincarnated – as the bond market itself. ‘You can intimidate everybody’ he would quip, in a measured Louisiana drawl… Two decades later and the power of the market in which governments and companies sell their debt is once again reaching intimidating levels. The growth of bond fund managers over the past six years has been nothing short of extraordinary, with net assets of the world’s bond investment funds estimated to stand at $7.3tn, up almost 74% since the depths of the financial crisis in 2008… The BIS estimates bond holdings of the 20 biggest asset managers jumped $4tn in the four years immediately following the crisis. By 2012 the top 20 managers accounted for more than 60% of the assets under management of the 300 biggest groups in 2012, up from 50% in 2002. In other words, while asset managers are increasingly concentrated in bonds, the asset management industry, in turn, appears to be increasingly dominated by a select group of elite managers.”
November 24 – Bloomberg (Susanne Walker): “Even in the $100 trillion market for bonds worldwide, one of the most persistent dilemmas facing potential buyers is a dearth of supply. Demand for debt securities has surpassed issuance five times in the past seven years, according to… JPMorgan… The shortfall is set to continue into 2015, with the… firm predicting demand globally will outstrip supply by about $400 billion as central banks in Japan and Europe step up their own debt purchases. The mismatch helps to explain why bond yields worldwide have fallen by more than half since the financial crisis in 2008 to a record-low…, even as borrowing by governments, businesses and consumers added $30 trillion to the market for debt securities… Potential bond buyers are poised to spend $2.4 trillion next year on a net basis, while borrowers will issue an estimated $2 trillion of debt, according to JPMorgan… The Bank for International Settlements estimates the amount of bonds outstanding has surged more than 40% since 2007 as countries such as the U.S. increased deficits to pull their economies out of recession… JPMorgan predicts the European Central Bank and the Bank of Japan will boost purchases, offsetting the end of the Federal Reserve’s own quantitative easing that has added almost $4 trillion of Treasuries and mortgage-backed bonds to the central bank’s assets since 2008. The ECB will buy about $400 billion next year, while the BOJ will add at least $700 billion… Central banks in the U.S., Europe, Japan and the U.K., along with the major lenders and reserve managers in those regions, are on pace to amass $26 trillion of debt securities by the end of next year, according to JPMorgan… And it’s not only the central banks. Global bond funds will probably add $280 billion next year, while pensions and insurers in the U.S., Europe, Japan and the U.K. will buy an estimated $550 billion, according to JPMorgan…"
November 27 – Bloomberg (Kyoungwha Kim and Masaki Kondo): “Japanese investors are buying Asian assets like never before as Prime Minister Shinzo Abe’s policies make the yen a lucrative means to fund bets on regional growth. A net 1.82 trillion yen ($15.4bn) flowed into stocks and bonds in the rest of Asia in the first nine months of 2014, 76% more than the previous record in 2007… Borrowing in yen to invest in the 10 currencies that make up the Bloomberg-JPMorgan Asia Dollar Index returned an annualized 13% this year… That beat so-called carry trades funded in euros and dollars, which gained 11% and 0.3%, respectively.”
November 25 – Bloomberg (Jeff Black): “Low interest rates globally are prompting investors to take too many risks in some asset classes, the Bundesbank said. ‘Signs of an excessive search for yield are particularly evident in the corporate-bond and syndicated-loan markets,’ Bundesbank Vice President Claudia Buch said…, presenting the German central bank’s annual financial stability report. ‘The longer the period of low interest rates lasts, the greater the risk of exaggerations in certain market segments.’ While the U.S. Federal Reserve and Bank of England are considering when to begin raising rates as their economies grow, monetary policy in the euro area is still focused on keeping the cost of borrowing as low as possible as the recovery struggles. That’s causing financial-stability guardians to worry about asset-price bubbles, for example in German property.”
November 24 – Bloomberg (Michael P. Regan): “Dear spouses, children and parents of hedge-fund managers: forgive your loved one if the gifts aren’t so generous this holiday season. Managers are still pocketing their usual fee of 2% of investors’ assets for simply showing up, but the 20% of profits are proving harder to come by. As Goldman Sachs… pointed out in a Nov. 20 report, the average fund has lost 1% so far this year even as the Standard & Poor’s 500 Index returned more than 13% including dividends… Hedge funds’ long exposure to equities rose to a record high of 54% at the start of the fourth quarter, the report shows. Yet the stocks they focused on are proving problematic: They continued to favor companies that rely on discretionary consumer spending… The group is up 5% in 2014, the second-worst performing industry among nine in the index. Energy companies, the worst performing group so far this year with a 1.7% drop, are the second biggest hedge-fund weighting at 14% …Their big love of small companies is also taking a toll: The report said the typical fund has 35% of its assets in stocks from the Russell 2000 Index, which is only up 1.3% this year… The Goldman Sachs report was based on 782 hedge funds with $2 trillion of gross equity positions. Look, 2% of $2 trillion is still $40 billion.”
November 25 – Bloomberg: “China’s builders are selling more bonds and spurning shadow banking, boosting transparency in an industry flagged by regulators as the No. 1 risk to the economy. Property companies have raised a record $40 billion through international and domestic notes this year, up 31% from 2013… Funding of real estate projects by trusts, a less-regulated type of financing targeting wealthy individuals, dropped 33% to 197.4 billion yuan ($32.1bn)… Premier Li Keqiang is seeking to expand official fund channels after shadow lending surged more than 30% last year…”
Geopolitical Watch:
November 25 – Financial Times (Gideon Rachman): “For centuries European navies roamed the world’s seas – to explore, to trade, to establish empires and to wage war. So it will be quite a moment when the Chinese navy appears in the Mediterranean next spring, on joint exercises with the Russians. This plan to hold naval exercises was announced in Beijing last week, after a Russian-Chinese meeting devoted to military co-operation between the two countries. The Chinese will doubtless enjoy the symbolism of floating their boats in the traditional heartland of European civilisation. But, beyond symbolism, Russia and China are also making an important statement about world affairs. Both nations object to western military operations close to their borders. China complains about US naval patrols just off its coast; Russia rails against the expansion of Nato. By staging joint exercises in the Mediterranean, the Chinese and Russians would send a deliberate message: if Nato can patrol near their frontiers, they too can patrol in Nato’s heartland. Behind this muscle-flexing, however, the Russians and Chinese are pushing for a broader reordering of world affairs, based around the idea of ‘spheres of influence’. Both China and Russia believe that they should have veto rights about what goes on in their immediate neighbourhoods.”
November 28 – Bloomberg (Robert Hutton and Svenja O’Donnell): “David Cameron raised the prospect of Britain leaving the European Union unless fellow leaders agree to let him restrict access to welfare payments for migrants. …The prime minister demanded that Europeans arriving in the U.K. receive no welfare payments or state housing until they’ve been resident for four years… It’s the second time Cameron has been forced to make a speech in an attempt to counter the rise of the anti-EU U.K. Independence Party.”
November 24 – Bloomberg (Benjamin Harvey): “Turkish President Recep Tayyip Erdogan lashed out at the U.S. two days after meeting Vice President Joe Biden, suggesting scant progress in reconciling the two nations’ approaches to the war in Syria. ‘I’m always meeting with them but I stick to what I’ve said,’ Erdogan said… ‘They have only one sensitivity: oil.’”
China Bubble Watch:
November 23 – Reuters (Kevin Yao): “China’s leadership and central bank are ready to cut interest rates again and also loosen lending restrictions, concerned that falling prices could trigger a surge in debt defaults, business failures and job losses, said sources involved in policy-making. Friday's surprise cut in rates, the first in more than two years, reflects a change of course by Beijing and the central bank… Economic growth has slowed to 7.3% in the third quarter and policymakers feared it was on the verge of dipping below 7% - a rate not seen since the global financial crisis. Producer prices, charged at the factory gate, have been falling for almost three years, piling pressure on manufacturers, and consumer inflation is also weak. ‘Top leaders have changed their views,’ said a senior economist at a government think-tank involved in internal policy discussions. The economist… said the People's Bank of China had shifted its focus toward broad-based stimulus and were open to more rate cuts as well as a cut to the banking industry's reserve requirement ratio (RRR), which effectively restricts the amount of capital available to fund loans.”
November 25 – Reuters (Jake Spring): “China's central bank will wait until fourth-quarter economic data is out and monitor U.S. and Japanese monetary policy before considering any more rate cuts or easing, a central bank adviser said… The People's Bank of China surprised the markets by cutting rates last Friday for the first time in more than two years to help stabilize the world's second-largest economy… Regarding the next step, whether to cut rates again or take similar action, we still need to look at the fourth quarter's macroeconomic index,’ said Chen Yulu, who sits on the central bank's monetary policy committee… ‘It is also important to make decisions taking into account Japanese and U.S. monetary policy,’ Chen said.”
November 24 – Wall Street Journal (Dinny McMahon): “When a fabric company called Jiangyin Xueyuan Textile Co. collapsed, the troubles soon cascaded through other firms in this mill town. A machinery maker, paper producer, manufacturer of faux-wood flooring and textile maker had one thing in common. They had promised, in the event of default, to repay the loans taken on by Xueyuan. Court documents say the fabric company can’t pay what it owes. With China’s economic growth flagging, businesses such as Xueyuan are foundering. And these chains of guarantees, in which companies back loans to other firms, are causing pain for the wider Chinese economy… Guarantees played a large role in fueling China’s rapid debt expansion over the last six years. About a quarter of the $13 trillion in total outstanding loans as of the end of October was backed by promises from other companies, individuals and dedicated guarantee companies, often undercapitalized, to pay up if the borrower defaults. Lenders outside the traditional banking system—so-called shadow bankers—also embraced guarantees, seeing them as a way to assure nervous investors that their funds were secure and to circumvent government restrictions on lending to certain types of businesses. Reliance on these guarantees is now backfiring, regulators and analysts say, resulting in a surge of bad loans that banks had assumed were insured and threatening financial contagion. The China Banking Regulatory Commission said in a notice to banks in July that bankruptcies in these ‘guarantee chains’ could ‘trigger regional financial crises.’”
November 27 – Bloomberg: “Industrial profits in China fell the most in two years, underscoring the need for looser monetary conditions as the world’s second-largest economy slows. Total profits of China’s industrial enterprises fell 2.1% from a year earlier in October… That compares with September’s 0.4% increase and is the biggest drop since August 2012… Mired by a property slump, overcapacity and factory-gate deflation, China is headed for its slowest full-year economic expansion since 1990. Data released Nov. 13 showed the economy’s slowdown deepened in October. Factory production rose 7.7% from a year earlier, the second weakest pace since 2009, while investment in fixed assets such as machinery expanded the least since 2001 from January through October. Retail sales gains also missed economists’ forecasts last month.”
November 28 – Bloomberg: “Rating companies say defaults in China will spread as the central bank’s interest rate cut will do little to stop a wave of maturities from worsening record debt downgrades. Chinese credit assessors slashed grades on 83 firms this year, already matching the record number in all of 2013… Companies must repay 2.1 trillion yuan ($342bn) in the first six months of 2015, the most for any half… Slowing economic growth is adding to strains as average debt at listed companies has climbed to 94% of equity from 77% in 2007, Bloomberg-compiled data show.”
November 24 – Bloomberg: “China’s first interest-rate cut since 2012 is prompting investors to bet on further monetary easing as policy makers react to the biggest jump in bad loans in nine years. Non-performing loans surged 10% last quarter, the most since 2005, as the property market slumped and the economy slowed. New-home prices declined in October in 67 of 70 major cities, while housing sales slumped 10% in the first 10 months from a year earlier… The one-year swap rate, the fixed cost to receive the seven-day repurchase rate, slumped 20 bps today to 2.92%.”
November 24 – Bloomberg: “China’s companies scrapped or delayed at least 7.55 billion yuan ($1.2bn) of bond sales since Nov. 20 as borrowing costs jumped, flagging fundraising strains even as the central bank eased monetary policy. The yield on AAA rated corporate securities due in three years rose 17 bps last week, the most in a year, to 4.43%. The increase comes as investors held more cash ahead of planned new share sales this week, with initial public offerings to lock up at least 1 trillion yuan, according to Australia & New Zealand Banking Group Ltd…"
November 27 – Bloomberg: “China’s central bank refrained from selling repurchase agreements for the first time since July, loosening monetary policy further as a report showed industrial companies’ profits fell by the most in two years… It last suspended sales of repos, which drain funds from the banking system…”
Japan Bubble Watch:
November 25 – Financial Times (Ben McLannahan): “Bank of Japan board members warned last month that the benefits of extra monetary easing were not worth the costs, just before governor Haruhiko Kuroda stunned markets by unleashing a second round of stimulus. The surprise announcement on October 31 – approved by the narrowest majority, with five of nine board members in favour – caused the yen to drop sharply, pushing stocks higher. At his press conference after the policy board meeting that day, Mr Kuroda argued that a combination of a tax-hit economy and lower oil prices meant that more radical action from the BoJ – including stepping up annual government-bond purchases from Y50tn to Y80tn – was needed to rid Japan of its ‘deflation mindset’. The actions made it clear that the BoJ was competing in a ‘currency war’ to drive down the value of the yen, said Izuru Kato, chief market economist at Totan Research… Yet during that meeting, board members expressed a long list of concerns over the prospect of extra easing, according to minutes…”
November 25 – Bloomberg (Wes Goodman): “What started as a plan to reduce Japan’s debt is turning into a reason to issue more bonds. Prime Minister Shinzo Abe’s administration implemented a higher sales tax in April to boost revenue as government liabilities ballooned to 1 quadrillion yen ($8.5 trillion), more than double the nation’s yearly economic output. Consumption plunged and the economy fell into a recession, prompting companies including Mirae Asset Global Investments Co. and High Frequency Economics to predict even more sovereign debt sales to revive growth. ‘The government’s policies have failed,” Will Tseng, a money manager in Taipei at Mirae Asset…$62 billion, said… ‘They’re still issuing more debt and printing more money to try to help the economy. They’re in a really bad cycle.’ He said he’s staying away from Japanese bonds. The cost of protecting Japan’s debt from default surged for eight straight days and the yen tumbled to a seven-year low…”