Monday, December 15, 2014

12/05/2014 The Unavoidable Peril of Financial Sphere Bubbles *

Let’s begin with a brief update on the worsening travails at the Periphery. The Russian ruble sank another 6.5% this week, increasing y-t-d losses to 37.9%. Russian yields surged higher. Russian (ruble) 10-year yields jumped another 146 bps this week to 12.07%, with a nine-session jump of 188 bps. Russian yields are now up 425 bps in 2014 to the highest level since 2009.

Increasingly, EM contagion is enveloping Latin America. The Mexican peso was hit for 1.6% Friday, boosting this EM darling’s loss for the week to a notable 3.0%. This week saw the Colombian peso hit for 4.3%, the Peruvian new sol 1.1%, the Brazilian real 0.9% and the Chilean peso 0.6%. Venezuela CDS (Credit default swaps) surged 425 bps to a record 2,717 bps. Venezuela CDS traded near 1,000 in August. On the bond front, 10-year yields jumped 30 bps this week in Brazil, 24 bps in Mexico and 24 bps in Colombia. Brazilian stocks were slammed for 5% this week and Mexican equities fell 2.2%.

Eastern European currencies were also under pressure. The Ukrainian kryvnia dropped 2.9%, the Romanian leu 1.5%, the Bulgarian lev 1.3%, the Czech koruna 1.3%, the Hungarian forint 1.1% and the Polish zloty 0.7%. The Turkish lira was hit for 1.9%, as 10-year yields jumped 33 bps to 7.91%. The South African rand dropped 2.6% to a six-year low. In Asia, the Malaysian ringgit dropped 2.5%, the Singapore dollar fell 1.4% and the Indonesian rupiah declined 0.8%.

Declining 1.3%, the Goldman Sachs Commodities Index fell to the low since June 2010. Crude traded to a new five-year low. Sugar fell to a five-year low, with coffee, hogs and cattle prices all hit this week.

And a quick look at the bubbling Core: The Dow 18,000 party hats were ready, although they will have to wait until next week. The S&P500 traded Friday to another all-time record. Semiconductor (SOX) and Biotech (BTK) year-to-date gains increased to 31.4% and 48.1%, respectively. The week also saw $4.0 Trillion of year-to-date global corporate debt issuance, an all-time record. Italian (1.98%), Spanish (1.83%) and Portuguese (2.75%) yields traded to all-time record lows again this week.

December 4 – Bloomberg (Sree Vidya Bhaktavatsalam): “Bill Gross… recommended that investors reduce risk and prepare for asset prices to stop increasing… Gross… suggested that the creation of more debt by policy makers worldwide to solve the credit crisis will be judged by future generations much like smoking in public or discrimination against gays is viewed by people today… ‘Can a debt crisis be cured with more debt?,’ Gross wrote. ‘I suspect future generations will be asking current policy makers the same thing that many of us now ask about public smoking, or discrimination against gays, or any other wrong turn in the process of being righted… How could they? … How could policymakers have allowed so much debt to be created in the first place, and then failed to regulate their own system accordingly? How could they have thought that money printing and debt creation could create wealth instead of just more and more debt?”

I appreciate Bill Gross’ December commentary, “How Could They?” This period will be really difficult to explain to future generations. It’s rather challenging to explain in real time. I’ll dive deeper into the question, “Can a debt crisis be cured with more debt?”

The problem, as we’ve witnessed in the past, is that debt crises have been “cured.” So I would posit that the dilemma associated with reflations is that they do seem to work for a while – perhaps even for a long while – almost miraculously. This naturally bolsters policymaker self-confidence, market confidence in policymaking and confidence in “Keynesian” governmental management more generally. It becomes too easy for everyone to disregard Bubble risks.

The early-nineties debt crisis that followed late-eighties “decade of greed” excess? Well, inflated away with more debt. The S&L fiasco? Right. Inflated away with a major ramp-up of debt growth in the nineties. The 2001/02 debt crisis after the collapse of late-nineties (“technology Bubble”) excess? Melted away like magic through the great inflation of mortgage Credit. And the debt crisis subsequent to the collapse of the mortgage finance Bubble? Inflated away with protracted “global government finance Bubble” Credit excess.

Agreeing with Mr. Gross, I do believe we’re approaching the end of the reflation “miracle”. To build my case, I’ll focus again on Financial Sphere Versus Real Economy Sphere Analysis. It is fundamental to my Credit Bubble Thesis that the (desperate) global central bank reflationary push is mainly inflating the Financial Sphere. This reflation has unfolded primarily through central bank Credit, sovereign and corporate debt, and global securities markets. Especially over the past two years, there is support for the view that it's only a myth that central banks control and can readily manipulate a general price level (in the real economy).

A Bank of Japan (BOJ) board member, Takehiro Sato, Friday made a pertinent comment (quoted by WSJ): “Prices reflect the temperature of the economy, not a variable that can be directly controlled by a central bank.” Japan’s 25-year experience offers the best proof that even massive government fiscal and monetary stimulus does not ensure the ability to inflate out of debt problems.

Real economy pricing dynamics – especially in contemporary globalized economies – are highly complex. The massive increase in manufacturing capacity associated with globalization has placed downward pressure on many prices. Virtually unlimited cheap finance on a global basis has over recent years certainly spurred unprecedented capital investment. And, importantly, ongoing technological innovation and the “digital age” have played a momentous role in creating essentially limitless supplies of smart phones, tablets, computers, digital downloads, media and “technology” more generally. Throw in the growth in myriad “services,” including healthcare, and we have economic structures unlike anything in the past. History will look back and see this as all rather obvious. Today, central bankers ignore the reality that reflationary measures confront insurmountable headwinds in the Real Economy Sphere.

The Bernanke-inspired global central bank experiment is mindlessly fixated on dropping “helicopter money” directly into the Financial Sphere. The expectation has been that rising securities prices and “wealth” creation would feed through to the real economy – in the process spurring borrowing, spending and real investment sufficient to inflate the system out of its debt and structural woes.

“Can a debt crisis be cured with more debt?” Well, I would strongly suggest that if policy-induced debt expansion unfolds predominantly in the realm of the Financial Sphere, there’s a major, major problem. If prevailing effects include rampant speculative leveraging, it will work too well to inflate Bubbles only to later return to haunt system financial and economic stability. I would further argue that an expansion of non-productive debt, while short-term stimulatory, is also deleterious for financial and economic systems. Trillions of new government borrowings financing consumption – debt expansion unlikely to be reversed - is asking for long-term problems. I also believe strongly that Financial Sphere inflations are essentially wealth redistributions, ensuring that daunting economic and social problems come to create powerful headwinds for real economies.

What differentiates today’s reflation from those that “worked” in the past? The current reflation has overwhelming manifested within the Financial Sphere. And that’s the essence of why I believe the Bubble is now running on borrowed time. It’s a critical issue that goes completely unrecognized these days: In the end, Financial Sphere inflations are unsustainable.

The crucial vulnerability lies within the murky world of Risk Intermediation. Financial Sphere expansions inflate myriad market risks – including price, Credit, interest-rate, liquidity and, more generally, Bubble risks. From my perspective, the global government finance Bubble is in the late stages because of the acute fragility associated with mounting Financial Sphere risks. Especially since the summer of 2012, global central bankers have been in a desperate struggle to sustain Financial Sphere Bubbles. Yet the most significant consequence has been the widening divergence between deteriorating global economic prospects and escalating securities market risks.

Aggressive/reckless Risk Intermediation played a fundamental role throughout the fateful post-tech Bubble reflation. The GSE’s, the securitization marketplace and derivatives were instrumental to the “Wall Street Alchemy” that transformed Trillions of risky mortgage Credit into perceived safe and liquid “money-like” instruments. The “Moneyness of Credit” was essential for the doubling of mortgage Credit in just over six years. It amounted to a historic episode of risk and market distortions. Moreover, as the cycle lengthened and risk escalated, the Risk Intermediation task fell increasingly to the toxic combination of CDO/derivatives markets and leveraged speculation.

Credit, speculation and (financial and economic) resource misallocation facets of the Bubble guaranteed that collapse was unavoidable. The widening gulf between the perception of “moneyness” and the deteriorating quality of the underlying instruments was unsustainable. Importantly, policy stimulus only prolonged the “Terminal Phase” parabolic rise of systemic risk. Late-cycle Financial Sphere distortions ensured a misallocation of resources in the real economy that came back to undermine system stability when the Bubble burst. When waning confidence in the underlying Credit finally impinged Credit Availability, the system’s inability to sustain rapid Credit growth ushered in the cycle’s downside.

Today, the “Moneyness of Risk Assets” is the critical Bubble and Risk Intermediation issue. To be sure, Fed and global central bank liquidity injections, backstops and assurances have created epic market distortions that dwarf those from the mortgage finance Bubble. The entire world believes central bankers will support stock, bond and asset prices. Everyone believes central bankers will ensure liquid markets. Most believe global policymakers will forestall financial and economic crisis for years to come. And it is these beliefs that account for record securities prices in the face of a disconcerting world.

There are all kinds of serious issues related to a six-year period of near zero rates, massive liquidity injections and central bank market support (all on a global basis). I would argue that global fixed income has undergone historic risk mispricing – which is especially problematic considering the record $4.0 TN of global corporate debt issued this year. Tens of Trillions of suspect sovereign debt have been grossly mispriced. And especially with an increasingly disinflationary backdrop taking hold throughout the global Real Economy Sphere, there is (unappreciated) parabolic growth in Credit risk way beyond even the late-stage of the mortgage finance Bubble.

To be sure, the gulf between the perceptions of “Moneyness” and mounting global Credit risk grows by the week. It’s worth noting that debt from Argentina, Venezuela, Ukraine, Russia, Brazil and the energy-sector provide a reminder of how abruptly market adjustments can unfold. There are ominous parallels between this year’s faltering Periphery and subprime 2007.

I worry a lot about global Credit risk. I worry more about illiquidity. Financial Sphere inflation, heavy risk intermediation and the “Moneyness of Risk Assets” combine to nurture historic market liquidity risks. To be sure, six years of zero rates (along with repeated market interventions) ensured that Trillions flowed into various funds and products perceived as highly liquid stores of wealth (“money-like”). Wall Street – and especially the ETF complex – has fashioned scores of perceived liquid low-risk products that invest in illiquid underlying instruments (stocks, corporate debt, municipal debt, EM, etc.). “Money” continues to flood into stock index funds and products, with the perception that these types of vehicles are low-risk and highly liquid (courtesy of the Fed).

This serious marketplace liquidity risk problem began to manifest in 2012, then again in the spring of 2013 and once more this past October. Each episode was met quickly by aggressive central bank liquidity measures and assurances. Each market rescue further emboldened risk-taking and leveraging. In the process, the gulf between the perception of “moneyness” and escalating liquidity risk grew only wider.

Right here we can identify a key systemic weak link: Market pricing and bullish perceptions have diverged profoundly both from underlying risk (i.e. Credit, liquidity, market pricing, policymaking, etc.) and diminishing Real Economy prospects. And now, with a full-fledged securities market mania inflating the Financial Sphere, it has become impossible for central banks to narrow the gap between the financial Bubbles and (disinflationary) real economies. More stimulus measures only feed the Bubble and prolong parabolic (“Terminal Phase”) increases in systemic risk. In short, central bankers these days are trapped in policies that primarily inflate risk. The old reflation game no longer works.

It’s also worth noting that Friday’s jobs data confirm that the Fed has fallen far behind the curve. Benefiting much of the U.S. economy short-term, trouble at the Periphery of the global Bubble has seen financial conditions loosen at the Core (rising securities prices, lower mortgage and corporate borrowing costs, etc.). King dollar is increasingly destabilizing, spurring “hot money” away from the faltering Periphery and to the inflating U.S. Bubble. Bubble excess beckons for Fed tightening, though they will surely be fearful of further elevating king dollar and upsetting highly unstable markets.

There are reasons why central bankers and central banks have a long history of conservatism. Risks are much too great for experimentation – experiments in “money,” loose Credit and aggressive stimulus. History has shown unequivocally that you don’t want to monkey with money and Credit. Central banks monkey with securities and asset markets at all of our peril.

We now see all the world’s major central banks trapped in a monetary experiment run amuck. Not surprisingly, especially considering the length and results from prolonged monetary stimulus, deep divisions have developed within the central banker ranks. This week saw more public policy criticism from past and present members of the Bank of Japan. There is also this deepening rift between Draghi and the Germans. Draghi continues to talk tough and assure the markets he’s ready for QE, with or without German consent, surely believing they will have no choice but to come around. The Germans believe “monetary financing” is illegal. Draghi counters that it would be “illegal” if the ECB did not pursue its 2% inflation mandate. How this plays out has major ramifications for the global Bubble.

I’ll conclude with more wisdom from Bill Gross: “Markets are reaching the point of low return and diminishing liquidity.” I’ll add that it’s really important to Bubble analysis that the ability for central bankers to inflate bond prices has essentially run its course. Low returns on fixed income and virtually no return on savings foster Bubble-inflating flows to equities. But it also ensures that when this Bubble bursts – a global Bubble, in stocks, bonds and asset prices generally, that has made it to the heart of contemporary “money” – there will be limited scope for Financial Sphere reflationary measures. And it’s when confidence falters in “money,” perceived “money-like” instruments and policymaking more generally, that we will come to see clearly that you can’t cure a debt crisis with more debt.

For the Week:

The S&P500 added 0.4% (up 12.3% y-t-d), and the Dow rose 0.7% (up 8.3%). The Utilities slipped 0.3% (up 19.5%). The Banks jumped 2.6% (up 7.7%), and the Broker/Dealers surged 4.0% (up 14.5%). Transports slipped 0.5% (up 23.7%). The S&P 400 Midcaps added 0.1% (up 7.6%), and the small cap Russell 2000 increased 0.6% (up 7.1%). The Nasdaq100 declined 0.6% (up 20.0%), and the Morgan Stanley High Tech index slipped 0.1% (up 12.6%). The Semiconductors jumped 2.5% (up 31.4%). The Biotechs added 0.4% (up 48.1%). With bullion surging $25, the HUI gold index recovered 2.0% (down 16.0%).

One-month Treasury bill rates closed the week at two bps and one-month rates ended at one basis point. Two-year government yields surged 18 bps to a three and one-half year high 0.645% (up 26 bps y-t-d). Five-year T-note yields jumped 20 bps to 1.685% (down 6bps). Ten-year Treasury yields rose 14 bps to 2.31% (down 72bps). Long bond yields increased eight bps to 2.98% (down 100bps). Benchmark Fannie MBS yields were up 13 bps to 2.96% (down 65bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 65 bps. The implied yield on December 2015 eurodollar futures surged 18.5 bps to 0.935%. The two-year dollar swap spread declined one to 22 bps, and the 10-year swap spread declined two to 11 bps. Corporate bond spreads widened. An index of investment grade bond risk increased one to 62 bps. An index of junk bond risk jumped nine bps to end the week at 344 bps. An index of emerging market (EM) debt risk rose six to 316 bps.

Greek 10-year yields collapsed 112 bps to 7.23% (down 119bps y-t-d). Ten-year Portuguese yields fell 10 bps to a record low 2.75% (down 338bps). Italian 10-yr yields declined six bps to a record low 1.98% (down 215bps). Spain's 10-year yields dropped six bps to a record low 1.83% (down 232bps). German bund yields rose eight bps to 0.78% (down 115bps). French yields gained six bps 1.03% (down 153bps). The French to German 10-year bond spread narrowed two to a more than four-year low 25 bps. U.K. 10-year gilt yields jumped nine bps to 2.02% (down 100bps).

Japan's Nikkei equities index jumped 2.6% to a more than seven-year high (up 10% y-t-d). Japanese 10-year "JGB" yields were unchanged at a record low 0.416% (down 33bps). The German DAX equities index gained 1.1% (up 5.6%). Spain's IBEX 35 equities index rose 1.2% (up 9.9%). Italy's FTSE MIB index added 0.4% (up 5.9%). Emerging equities were mixed. Brazil's Bovespa index sank 5.0% (up 0.9%). Mexico's Bolsa fell 2.2% (up 1.2%). South Korea's Kospi index increased 0.3% (down 1.2%). India’s Sensex equities index slipped 0.8% (up 34.4%). China’s Shanghai Exchange surged 9.5% (up 38.8%). Turkey's Borsa Istanbul National 100 index declined 1.1% (up 25.7%). Russia's MICEX equities index slipped 0.3% (up 1.7%).

Debt issuance picked up. Investment-grade issuers included Medtronic $17bn, Amazon $6.0bn, Becton Dickinson $5.45bn, Morgan Stanley $2.25bn, UnitedHealth Group $2.0bn, JPMorgan Chase $2.0bn, Berkshire Hathaway $1.5bn, BB&T $1.5bn, Dominion Gas $1.4bn, Cox Communications $1.35bn, DIRECTV $1.2bn, Plains All American Pipeline LP $1.15bn, Viacom $1.0bn, Citizens Bank $1.5bn, American Express $600 million, Clorox $500 million, Ameren Illinois $300 million, BGC Partners $300 million, Church & Dwight $300 million, Freddie Mac $250 million, Entergy Arkansas $250 million and Mizuho Securities USA $118 million.

Junk funds saw outflows jump to $859 million (from Lipper). Junk issuers this week included Cott Beverages $625 million, Dana Holding $425 million, ADT $300 million, Spectrum Brands $250 million and Tenneco $225 million.

Convertible debt issuers included Quidel $150 million, ANI Pharmaceuticals $125 million and PROS Holdings $125 million.

International dollar debt issuers included Industrial and Commercial Bank of China $1.94bn, National Australia Bank $1.25bn, Chile $1.06bn, Ethiopia $1.0bn, Unitymedia Hessen $550 million, Constellium $400 million, Tradewynd RE $400 million and Tramline RE $200 million.

Freddie Mac 30-year fixed mortgage rates dropped eight bps to an 18-month low 3.89% (down 57bps y-o-y). Fifteen-year rates were down seven bps to 3.10% (down 37bps). One-year ARM rates declined three bps to 2.41% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down one basis point to 4.41% (down 41bps).

Federal Reserve Credit last week declined $7.8bn to $4.446 TN. During the past year, Fed Credit inflated $562bn, or 14.5%. Fed Credit inflated $1.635 TN, or 58%, over the past 108 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $7.8bn last week to $3.322 TN. "Custody holdings" were down $32.1bn year-to-date and fell $39.4bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $239bn y-o-y, or 2.1%, to a new seven-month low $11.775 TN. Over two years, reserves were $936bn higher for 9% growth.

M2 (narrow) "money" supply expanded $3.5bn to a record $11.567 TN. "Narrow money" expanded $595bn, or 6.0%, over the past year. For the week, Currency slipped $0.2bn. Total Checkable Deposits declined $4.3bn, while Savings Deposits expanded $11.6bn. Small Time Deposits were little changed. Retail Money Funds declined $3.4bn.

Money market fund assets jumped $25.6bn to $2.688 TN. Money Funds were down $31bn y-t-d and dropped $14bn from a year ago, or 0.5%.

Total Commercial Paper gained $4.4bn to a 2014 high $1.096 TN. CP expanded $50bn year-to-date and was up $46bn over the past year, or 4.4%.

Currency Watch:

December 4 – Bloomberg (Ksenia Galouchko, Evgenia Pismennaya and Vladimir Kuznetsov): “Russia is urging exporters such as OAO Rosneft to convert more of their foreign revenue into rubles, a move that Sputnik Asset Management and Bank of America Corp. say is tantamount to capital controls. The government is appealing to state-controlled exporters to help limit the ruble’s tumble, Finance Minister Anton Siluanov told reporters… ‘This is definitely an introduction of capital controls, although in a different sense than the one we’re used to,’ Alexander Losev, the… chief executive officer of Sputnik, said… ‘The sale of foreign-exchange revenue is recommended for those companies whose business depends on or is controlled by the state. Siluanov’s proposal is a classic example of the ‘kind word and pistol’ method.’”

The U.S. dollar index jumped 1.1% to 89.334 (up 11.6% y-t-d). For the week on the downside, the Mexican peso declined 3.0%, the South African rand 2.6%, the Japanese yen 2.3%, the Australian dollar 2.2%, the Norwegian krone 1.8%, the New Zealand dollar 1.7%, the Swedish krona 1.4%, the Singapore dollar 1.4%, the Swiss franc 1.4%, the euro 1.4%, the Danish krone 1.3%, the Brazilian real 0.9%, the Taiwanese dollar 0.6%, the South African rand 0.5%, the British pound 0.4% and the Canadian dollar 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index dropped 1.3% to a new four and one-half year low (down 24.7%). Spot Gold rallied 2.2% to $1,193 (down 1.1%). March Silver jumped 4.5% to $16.26 (down 16%). January Crude slipped another 31 cents to $65.84 (down 33%). January Gasoline dropped 3.0% (down 36%), and January Natural Gas sank 7.0% (down 10%). March Copper gained 2.0% (down 15%). December Wheat surged 5.5% (up 1%). December Corn rose 1.5% (down 10%).

U.S. Fixed Income Bubble Watch:

December 2 – Wall Street Journal (Ryan Tracy): “The U.S. financial system is growing more vulnerable to debilitating shocks as new regulations and market forces change trading habits and make some market participants less willing to smooth out volatility, a government watchdog warned. The Office of Financial Research, a new arm of the Treasury Department created by the 2010 Dodd-Frank law, said the system is vulnerable to repeats of what occurred in October, when tumult in the trading of U.S. Treasury securities spread broadly to futures, swaps and options markets. ‘Although the dislocation that peaked in mid-October was fleeting, we believe there is a risk of a repeat occurrence,’ the office said…, adding that such volatility ‘raises a host of financial stability concerns.’ …The report said such swings could be exacerbated by computerized trading and algorithms, as high volumes of transactions are executed automatically, deepening instability.”

December 3 – Bloomberg (Lisa Abramowicz): “Banks may have gotten safer since the 2008 credit crisis, but risk is migrating to bond buyers. That’s worrying analysts and policy makers alike, who see investors plowing into infrequently-traded debt while Wall Street reduces its role in making markets. The combination has ‘resulted in a new world for investors,’ one that’s fraught with pockets of less trading and bigger price swings, Royal Bank of Scotland Group Plc analysts wrote… The U.S. Treasury Department has taken note, too, saying this week that investors pose a growing threat to financial stability. ‘Markets have become more brittle because liquidity may be less available in a downturn,’ according to the annual report by the Treasury’s Office of Financial Research. ‘Recent volatility in financial markets focused attention on some of the vulnerabilities that have been growing over the past several years.’”

December 2 – Bloomberg (Katherine Chiglinsky): “U.S. corporate bond sales swelled to an annual record as a late-year rush by borrowers to lock in low interest rates pushed offerings for 2014 pass $1.5 trillion… Internet commerce company Alibaba Group Holding Ltd. sold $8 billion last month, helping propel this year’s volume past the previous high of $1.494 trillion set last year. Companies have offered $1.168 trillion of investment-grade notes in 2014 and $344 billion of junk bonds… That outpaces the $1.146 trillion of high-grade notes and $348 billion of junk notes issued last year…”

December 2 – Bloomberg (Nabila Ahmed and Sridhar Natarajan): “Bond investors who helped finance America’s shale boom are facing potential losses of $8.5 billion as oil prices plummet by the most since the financial crisis. The $90 billion of debt issued by junk-rated energy producers in the past three years has fallen almost 10% since crude oil peaked in June… The oil selloff is deepening concern among bond investors that the least-creditworthy oil explorers will struggle to pay their obligations and prompt bankers to rein in credit lines as revenue slumps.”

December 2 – Bloomberg (Darrell Preston): “The agency that financed stadiums for three of Houston’s professional sports teams is selling debt to extricate itself from municipal-bond deals that backfired with the financial crisis. The Harris County-Houston Sports Authority plans to borrow about $689 million starting this week to restructure some of its $1 billion of obligations. The debt, mostly backed by tourism- related taxes, was sold to pay for facilities in the fourth- most-populous U.S. city for Major League Baseball’s Astros, the National Basketball Association’s Rockets and the National Football League’s Texans. Localities are still dealing with financing structures sold by Wall Street banks more than a decade ago with the promise of cutting borrowing costs.”

U.S. Bubble Watch:

December 3 – Reuters (Kristen Hays): “Plunging oil prices sparked a drop of almost 40% in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007. Data provided exclusively to Reuters… by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October. The pullback was a ‘very quick response’ to U.S. crude prices…, said Allen Gilmer, chief executive officer of Drilling Info. New permits, which indicate what drilling rigs will be doing 60-90 days in the future, showed steep declines for the first time this year across the top three U.S. onshore fields: the Permian Basin and Eagle Ford in Texas and North Dakota's Bakken shale.”

December 5 – Financial Times (Eric Platt): “Bullish equity investors have company. With stocks loitering in record territory, corporate America remains a major buyer of shares. One of the primary drivers of the ageing US bull market — share buybacks and dividend payouts — has hit the accelerator during the third quarter… Management teams have dedicated nearly $900bn to both forms of returns over the past 12 months, estimates from S&P Dow Jones Indices show… Companies have been a key source of support in recent years as investors have stepped back from buying equities. Since the start of 2010, companies have spent $3.3tn on share buybacks and dividends… During the third quarter, companies spent roughly $238bn on dividends and buybacks, with the latter making up nearly 63% of the total. The preliminary figure ranks second only to the first quarter of 2014, when company expenditures on the two reached $241.2bn.”

Federal Reserve Watch:

December 1 – Reuters (Jonathan Spicer and Ann Saphir): “With the U.S. economy humming along at its fastest clip in more than a decade, the Federal Reserve should be confident about its ability to weather a global slowdown and start lifting interest rates around the middle of next year. But then there is inflation. Interviews with Fed officials and those familiar with its thinking show the mood inside is more somber than the central bank's reassuring statements and evidence of robust economic health would suggest. The reason is the central bank's failure to nudge price growth up to its 2% target and, more importantly, signs that investors and consumers are losing faith it can get there any time soon… Barring a turnaround, Fed officials would hesitate to raise interest rates as soon as mid-2015 even as gradually as their forecasts now suggest… ‘The primary concern at the moment is whether you can get back to 2% in a way that keeps expectations anchored, and maintains the credibility of the Fed as an institution that can achieve its goal,’ said Jeffrey Fuhrer, the Boston Fed's senior policy advisor.”

December 1 – Bloomberg (Craig Torres): “Alarms went off inside the Federal Reserve: the Fed’s innermost secrets had leaked to Wall Street. Confidential deliberations of the Federal Open Market Committee made their way into a research note circulated among traders. The report -- a fly-on-the-wall account of the FOMC’s September 2012 meeting, with hints of Fed action to come that December -- prompted a mole hunt that reached the highest levels of the central bank. The story of the FOMC leak underscores the lengths to which outsiders will go to penetrate the inner workings of the Fed, and how valuable access can be. The Fed has never disclosed the investigation or its findings. Public pronouncements by Fed leaders routinely move markets, and officials must walk a delicate line when discussing information. They are allowed to air their own views but are forbidden from disclosing non-public information about committee decisions.”

ECB Watch:

December 4 – Reuters (John O’Donnell and Reinhard Becker): “The European Central Bank will decide early next year whether to take further action to revive the euro zone's economy, its president said on Thursday, signalling that he would not allow opposition from Germany or anyone else to stop it. In his clearest language yet, Mario Draghi underlined the central bank's commitment to supporting the ailing economy of the 18-country bloc, and argued the case for printing fresh money to buy assets such as state bonds. But his remarks, which came within minutes of a meeting where he clashed with German officials over his ambitions, set him on a possible collision course with the euro zone's biggest and single most important country.”

December 5 – Financial Times (Claire Jones): “Mario Draghi, European Central Bank president, has maintained he can deliver a fresh package of measures to stave off economic stagnation in the eurozone next year, despite renewed signs of tensions between policy makers at the central bank. Old wounds between governing council members were reopened on Thursday, after splits emerged over a slight toughening up of the language on plans to swell the ECB’s balance sheet by around €1tn… The ECB strengthened its forward guidance by saying the central bank ‘intends’ to expand its balance sheet to around €3tn to boost inflation, rather than simply ‘expecting’ to meet this objective. But the semantic change was not unanimous, with dissent coming from members of the executive board of top ECB officials, as well as some national central bank governors.”

December 5 – Reuters (Paul Carrel and John O'Donnell): “The head of Germany's Bundesbank warned the European Central Bank on Friday against copying the money printing used in the United States and Japan, saying that it would not have the same impact in Europe. Speaking a day after ECB President Mario Draghi signalled further action to shore up the euro zone economy as soon as early next year, Jens Weidmann cautioned that so-called quantitative easing may not work in Europe. ‘You cannot simply apply the same formula in Europe that has enjoyed success in the U.S.  or in Japan,’ Weidmann told a conference… Weidmann and fellow German ECB policymaker Sabine Lautenschlaeger opposed Thursday's ECB decision to firm up language on the expansion of the bank's balance sheet, central bank sources said. Weidman's comments on Friday followed German Finance Minister Wolfgang Schaeuble saying expansive monetary and fiscal policies were a cause of economic problems, not a solution to them. Commenting on the idea that economic weakness required an expansive monetary and fiscal policy, Schaeuble said: "I am not convinced of this. Rather, I am of the view that this approach is not the solution, rather the cause (of economic woes).’”

December 4 – Bloomberg (Jana Randow and Jeff Black): “The European Central Bank’s Governing Council expects to consider a package of broad-based asset purchases including sovereign debt next month… While the proposal is envisaged to include various types of bonds, it won’t encompass equities, said the officials, who asked not to be identified… They said no decision on implementing quantitative easing has been taken yet, and the composition of the program may be influenced by incoming data… ECB President Mario Draghi said… that policy makers ‘won’t tolerate’ a prolonged period of low inflation, and that officials discussed ‘all assets but gold’ as potential targets for purchases.”

Russia/Ukraine Watch:

December 6 – Bloomberg (Ye Xie and Krystof Chamonikolas): “Russia’s currency and bond rout is spreading to former Soviet states. Currencies are tumbling after holding steady since President Vladimir Putin annexed Crimea in March. Russia’s deepening crisis and the ruble’s 34% slump over the past six months hurt economies that rely on remittances and imports from the country. Georgia’s lari lost 10% against the dollar last week… The Armenian dram slumped 2.8%, the sixth weekly drop, the longest slump since March 2010. Kazakhstan’s dollar-denominated notes due in 2024 slid, sending yields up 57 bps… to 4.76%.”

December 5 – Bloomberg (Ilya Arkhipov): “The U.S. and its allies are seeking to change the regime in Moscow through sanctions and attacks on the ruble and the oil price, Russia’s spy chief said. A decline of more than 30% in the oil price this year is caused partly by U.S. actions, Mikhail Fradkov, the head of the Foreign Intelligence Service, said after President Vladimir Putin’s annual address to parliament. Foreign investment funds are ‘taking part’ in ruble speculation via intermediaries, Fradkov, a former prime minister, said… ‘Any speculation has specific schemes and the schemes have a number of participants,’ he said… The U.S. and its allies want to oust Putin from power and achieve regime change, Fradkov said. ‘Such a desire has been noticed, it’s a small secret’ he also told reporters. ‘No one wants to see a strong and independent Russia.’”

December 3 – Bloomberg (Jason Corcoran, Lyubov Pronina and Natasha Doff): “State-controlled VTB Bank bonds sank below 72 cents on the dollar on concern that falling oil and a weakening ruble are straining Russian lenders’ finances. Sergey Dubinin, chairman of VTB’s supervisory council, underscored the anxiety by saying Russia’s banking system is experiencing ‘some panic.’ The ruble drop and four interest-rate increases this year are a ‘bad combination’ for growth and lenders, he said…”

December 2 – Bloomberg (Olga Tanas): “Russia is entering its first recession since 2009 as sanctions over the Ukraine conflict combine with plunging oil prices and the weakening ruble to hammer the economy and force the government to prop up banks. Gross domestic product may shrink 0.8% next year, compared with an earlier estimate of 1.2% growth, Deputy Economy Minister Alexei Vedev told reporters…”

Brazil Watch:

December 3 – Bloomberg (Sabrina Valle): “Brazil’s biggest money laundering and corruption scandal just got bigger with a high-level executive’s pledge to return $100 million and testify against colleagues including his former boss at state-run Petroleo Brasileiro SA. Pedro Barusco, a third-tier executive who reported to the head of the engineering division until 2010, contacted prosecutors and confessed he took bribes from construction companies… The testimony from Barusco threatens to implicate more people in the scandal as prosecutors probe the origins of his allegedly ill-gotten fortune. Petrobras management has been dealing with the crisis as it struggles to meet output targets and the industry adjusts to the lowest crude prices since 2009. It has put President Dilma Rousseff, who was Petrobras chairwoman from 2003 to 2010, on the defensive after she narrowly won re-election in October.”

December 4 – Wall Street Journal (Will Conners): “Moody’s… said Wednesday it downgraded the baseline credit of Petroleo Brasileiro SA, the second downgrade of Brazil’s state-controlled oil company in two months and the latest in a series of setbacks for the company as it grapples with a corruption scandal.”

December 3 – Bloomberg (Raymond Colitt and David Biller): “A 30 billion-real ($11.7bn) credit from Brazil’s Treasury to the national development bank, BNDES, raises doubts over the government’s fiscal policy objectives, Banco Mizuho’s chief Brazil strategist said. The government authorized the Treasury to transfer the amount to the… lender to finance the purchase of equipment and machinery, outgoing Finance Minister Guido Mantega told reporters… The transfer comes a week after incoming Finance Minister Joaquim Levy cautioned that an increase in funding to the BNDES could jeopardize his plans to reduce gross debt as a percentage of gross domestic product. Today’s credit announcement sends the wrong sign to investors hoping for a cut in government spending…, said Luciano Rostagno, chief strategist at Banco Mizuho do Brasil SA. ‘It raises doubts about the government’s willingness to do a serious fiscal adjustment,’ Rostagno said… ‘It’s definitely not a good sign.’”

December 4 – Bloomberg (Mario Sergio Lima and Raymond Colitt): “Brazil’s central bank doubled the pace of its interest rate increase as the government seeks to persuade investors it’s committed to containing inflation that has exceeded its target for more than four years. The bank’s board… raised the benchmark Selic by half a point to 11.75% after a 25 bps increase Oct. 29… Policy makers said future rate increases will probably be conducted with ‘parsimony.’”

December 1 – Bloomberg (Julia Leite and Paula Sambo): “Companies in Brazil are missing out on a global surge in bond sales as a stalled economy and a growing corruption investigation push up borrowing costs. Corporate borrowers have raised $5.8 billion selling bonds internationally since June, 43% less than the same period last year. That compares with a 10% increase for dollar issuance in all emerging markets. For the second half of the year, Brazilian companies are poised to issue the fewest bonds since the financial crisis of 2008. Yields on the nation’s corporate bonds are rising more than twice as fast as those in developing countries as analysts forecast growth will lag behind the average for Latin America for a fourth straight year.”

EM Bubble Watch:

December 2 – Bloomberg (David Yong): “Losses in emerging market distressed debt have mounted to the worst since the global financial crisis led by Indonesian coal miner PT Bumi Resources and ZAO Russian Standard Bank. Bank of America Merrill Lynch’s distressed emerging markets corporate index tumbled 2.7% yesterday after a 5.6% drop in November. The gauge, which tracks 108 dollar-and euro-denominated debentures from Russia to China and Brazil, has retreated 9.8% this year, the most since a 36.8% slide in 2008. A glut in coal and iron ore, plunging oil prices and sanctions against Russia are pushing more companies to the brink of default. Hedge funds are shutting at a rate not seen since the credit crunch amid disappointing returns… ‘It’s a very bloody environment for most of the small- and mid-sized commodity players,’ Heo Joon Hyuk, the… head of global fixed income at Mirae Asset Global Investments Co., said… ‘And Russian corporates have one more burden above falling commodities -- funding restrictions.’”

December 2 – Bloomberg (Sebastian Boyd and Christine Jenkins): “OPEC’s refusal to cut oil production is increasing the chances Venezuela will have to devalue its currency and sell its U.S.-based oil unit to avoid a default, according to EMSO Partners Ltd. and EM Quest Capital. The country’s benchmark notes due 2027 sank to a five-year low of 51.6 cents on the dollar… as the decision of the Organization of Petroleum Exporting Countries on Nov. 27 to maintain output deepened a collapse in the price of oil, which accounts for 95% Venezuela’s export revenue.”

December 1 – Bloomberg (Brendan Case and Eric Martin): “President Enrique Pena Nieto’s approval rating plunged to the lowest level since he took office two years ago, dragged down by drug-related violence and sluggish economic growth, according to two opinion polls. Thirty-nine percent of those polled approved of Pena Nieto’s performance, the least for any Mexican president since the mid-1990s and down 11 percentage points from August… On the economic front, the Finance Ministry and central bank cut their 2014 growth forecast ranges last month after Mexico’s expansion missed analysts’ estimates for the eighth time in 10 quarters.”

December 3 – Bloomberg (Selcan Hacaoglu): “Turkish consumer price inflation accelerated more than anticipated in November, giving the central bank leeway to resist government pressure to cut interest rates. The annual inflation rate rose to 9.2% from 9% in the previous month…”

December 3 – Bloomberg (Patrick Donahue): “China and Turkey are among countries that tumbled the most in a global corruption ranking as they displayed widespread or increased levels of bribery, graft and opacity, Transparency International said. China fell to 100th place on the list, down from 80th last year, the watchdog group said in its annual Corruption Perceptions Index. Turkey slid to 64th place from 53rd in 2013. Egypt and Afghanistan gained in the ranking, which places the least corrupt countries at the top.”

December 4 – Bloomberg (Herdaru Purnomo): “Indonesia’s capital is girding for a potential turnout of millions of protesters asking for a bigger increase in minimum wages in the world’s fourth most-populous nation, a test of President Joko Widodo’s pro-business image. The two-day national protest, starting Dec. 10, will involve four trade union groups… Workers have seven demands including renegotiating last month’s minimum-wage deal and scrapping outsourcing in state-owned companies, he said.”

December 4 – Bloomberg (Paul Wallace): “South Africa’s worsening government finances are pushing the nation’s credit rating closer to junk, Fitch Ratings Ltd. said… Moody’s… downgraded South Africa to Baa2, the second-lowest investment grade and a similar level to Fitch, on Nov. 6. Standard & Poor’s downgraded it to BBB-, the lowest investment grade, in June. ‘Public finances in South Africa, which used to be a relative rating strength, no longer are,’ Richard Fox, head of Middle East and Africa sovereign ratings at Fitch, said… The country was ‘barely keeping pace with the BBB peer group’ in terms of gross domestic product per person…”

Europe Watch:

November 28 – Financial Times (Steve Johnson): “The German fund industry has witnessed its strongest inflows for 14 years during the first nine months of 2014. The strong demand comes despite the backdrop of a sluggish economy, with growth virtually grinding to a halt in the third quarter of the year, although this has propelled the bond market to new highs as yields on 10-year sovereign debt have tumbled to just 0.7%, from 1.94% at the turn of the year. Net inflows reached €71.2bn in the nine months to end of September, the highest tally since the €76.1bn raised at the height of the technology bubble in 2000… The bulk of the money went into so-called spezialfonds, aimed at institutional investors, with insurance companies, in particular, putting more money to work.”

Global Bubble Watch:

December 4 – Financial Time (Anjli Raval): “The flow of Opec petrodollars into global financial markets is set to dry up as the collapse in the oil price delivers a $316bn hit to the cartel’s revenues. Big oil producers have pumped the windfall they enjoyed from soaring oil prices over the last decade into a huge range of global assets, from US Treasuries and high-grade corporate bonds to equities and real estate. Qatar, for example, bought the Harrods department store and Paris Saint-Germain, France’s top football club, while Abu Dhabi’s sovereign wealth fund bought a stake in the glitzy Time Warner building in New York. The flow of petrodollars into the global financial system boosted liquidity, spurred asset prices and helped to keep borrowing costs down. But the 40% fall in Brent crude since mid-June will reverse this trend, as the shrinkage of the oil producers’ cash pile removes a pillar of support for global markets. ‘This is the first time in 20 years that Opec nations will be sucking liquidity out of the market rather than adding to it through investments,’ David Spegel, global head of emerging market sovereign and corporate research at BNP Paribas.”

December 3 – Bloomberg (Katherine Chiglinsky and Sridhar Natarajan): “Corporate bond sales worldwide are poised to set an annual record as soon as this week as companies lock in borrowing costs that forecasters say are bound to rise. Amazon.com Inc., Volkswagen AG and Alibaba Group Holding Ltd. have propelled offerings to $3.96 trillion this year, about $7 billion short of the peak of $3.97 trillion in 2012… Company bond sales in the U.S. have already set annual records… Borrowers from the most-creditworthy to the neediest have benefited as corporate yields also declined. Globally, corporate bonds now yield just 2.7%, within 0.2 percentage point of its record low last year… Since 1996, yields have averaged about 4.7%. In the U.S., home to the world’s biggest corporate bond market, borrowers have issued $1.5 trillion of debt… Investment-grade companies have already sold a record $1.18 trillion of bonds. Corporate bond issuance is also booming in Europe, with sales of 846 billion euros ($1 trillion) this year, up from 760 billion euros in all of 2013 and the most since 2010… Average yields on investment-grade bonds in euros fell 0.9 percentage point this year to 1.2%, 0.04 percentage point from a record low reached last month… Those on junk-rated debt dropped 0.3 percentage point to 3.98% versus the five- year average of 7.2%.”

December 4 – Financial Times (Stephen Foley): “An annus horribilis for US active fund managers drove a further $21.3bn into Vanguard, the leading provider of low-cost index tracker funds, in November. The inflows, the mutual fund giant’s third-best monthly total, means the… company has brought in $185bn into its US mutual funds in 2014, an industry record… Vanguard has had some powerful additional tailwinds this year, because active managers are underperforming their benchmarks to a greater degree than for more than a decade… Vanguard… overtook Pimco last year to become the second-largest fund manager in the world, behind BlackRock, and the latest three months of inflows have taken its assets under management comfortably above $3tn.”

December 1 – Bloomberg (Katherine Burton): “Hedge funds are shutting at a rate not seen since the financial crisis, as many managers post disappointing returns and the largest players dominate money raising… In the first half of the year, 461 funds closed, …Hedge Fund Research Inc. said. If that pace continues, it will be the worst year for hedge fund closures since 2009, when there were 1,023 liquidations… Hedge funds, on average, have returned just 2% in 2014, their worst performance since 2011… Smaller funds have struggled to grow as institutional investors flocked to the biggest players. In the first half of 2014, 10 firms… accounted for about a third of the $57 billion that came into the industry.”

Geopolitical Watch:

December 2 – Bloomberg (Michael Riley and Jordan Robertson): “Hackers working for Iran have targeted at least 50 companies and government organizations, including commercial airlines, looking for vulnerabilities that could be used in physical attacks, cyber-security firm Cylance Inc. said… The hackers infiltrated the computer systems of carriers and their contractors in Pakistan, the United Arab Emirates and South Korea, the Irvine, California-based firm said in a report outlining the results of a two-year investigation. They broke into the computers of suppliers responsible for aircraft maintenance, cargo loading and refueling, according to the report and Cylance analysts, and stole credentials that could be used to impersonate workers. In the U.S., computers belonging to chemical and energy companies, defense contractors, universities and transportation providers were hacked in what Cylance dubbed Operation Cleaver… The capabilities of Iranian cyberspies have advanced to the point that the country is quickly becoming a top-tier cyber power, according to the report.”

China Bubble Watch:

December 1 – Bloomberg: “A Chinese manufacturing gauge fell as factory shutdowns aggravated a pullback in the economy, raising pressure on the central bank to ease policy further after it lowered interest rates for the first time in two years. The government’s Purchasing Managers’ Index fell to an eight-month low of 50.3 in November, compared with… October’s 50.8… China’s central bank cut interest rates last month as the economy heads for its slowest full-year expansion since 1990.”

December 5 – Bloomberg: “Passenger-vehicle sales in China rose at a slower pace last month as inventory levels climbed in the world’s largest auto market. Retail deliveries of cars, multipurpose and sport utility vehicles climbed 5% to 1.71 million units in November… That compares with the 9.3% growth rate in October. Dealers are cutting prices to reach targets set by automakers to qualify for year-end bonuses… A measure of vehicle inventory rose to the highest level this year last month… ‘There are more and more auto dealers selling vehicles at losses as they struggle to keep afloat,’ said Wang Ji, a… director at the dealer chamber of commerce. ‘Overcapacity is the fundamental reason behind the production surplus and unless they fix it, there will be a reshuffle of auto dealers and automakers sooner or later.’”

December 2 – Bloomberg: “China is tightening checks on local bond sales in its latest bid to reduce risks as debt loads surge to a record amid slowing economic growth. Underwriters must provide audit reports on local government financing vehicles, or the region in which they’re located… China’s leaders are trying to limit risks at the fundraising units, which cities and towns rely on to bankroll construction projects, after they sold a record 1.5 trillion yuan ($244 billion) of notes this year. Authorities are considering requiring provincial governments shift toward direct municipal debt sales as they aim to cut reliance on LGFVs, a draft plan from the Ministry of Finance showed in October.”

December 5 – Bloomberg: “Investors must consider risks while putting money into stocks, China’s securities regulator warned today after a buying spree drove daily trading turnover to above 1 trillion yuan ($163bn) for the first time. Illegal activities including stock manipulation have recently been ‘raising their head’ and investors should invest rationally, Deng Ge, a spokesman for the China Securities Regulatory Commission, said…”

December 2 – Bloomberg: “Chinese banks’ lending numbers understate their exposure to the property market, where a downturn persisting for ‘at least’ one or two years will add to credit risks, Standard & Poor’s said. Loans to property development and construction were at least 8.2 trillion yuan ($1.3 trillion), or 13.8% of total advances, at the end of last year… That compared with the 7 trillion yuan reported by banks, the ratings agency said… Shadow banking, where lenders can move credit exposures off their balance sheets, has helped hold down reported property loans, Liao Qiang, a Beijing-based analyst for the company, said… About 30% to 40% of corporate loans in China are backed by property and land as collateral, S&P said, adding that flat or falling real-estate valuations can significantly hinder borrowers’ ability to renew funding.”

Japan Bubble Watch:

December 5 – Wall Street Journal (Takashi Nakamichi): “A Bank of Japan board member made clear Thursday that the split among the central bank’s decision makers runs deeper than the relatively unified front portrayed by Gov. Haruhiko Kuroda. Takehiro Sato expressed concerns over possible fallout from the central bank’s aggressive government debt purchases, and questioned Mr. Kuroda’s view that the central bank has the power to generate 2% inflation and must commit itself to achieving the goal by around next year. ‘Prices reflect the temperature of the economy, not a variable that can be directly controlled by a central bank,’ Mr. Sato told business leaders… ‘I have a feeling that it is unreasonable to rigidly think that it is necessary to aim at a specific inflation rate within a specific time frame,’ said Mr. Sato, one of the BOJ’s nine policy board members… Mr. Sato also called a weakening yen a ‘risk’ and ‘headwind’ against the Japanese economy, distancing himself from Mr. Kuroda’s generally positive assessment of the falling currency."

December 5 – Wall Street Journal (Tatsuo Ito): “Former senior officials of the Bank of Japan are expressing alarm over the Bank of Japan’s ratcheting up of easing measures, breaking the general silence on policy matters expected from officials who have left the central bank. The comments from the former officials indicate that concern among people with a link with the bank is not limited to the four board members who voted against the expansion of the BOJ’s asset-buying orchestrated by Gov. Haruhiko Kuroda at the end of October. ‘The current easing policy is like a car driving down the highway without brakes,’ said a former policy board member. ‘And that car has just been needlessly filled up with extra gas,’ the former member added… The former officials are becoming increasingly concerned about the potential danger of Mr. Kuroda’s whatever-it-takes approach to hit a 2% inflation target in a two-year time frame.


December 2 – Financial Times (Ben McLannahan): “The government of Japan is now a riskier borrower than either China or South Korea, according to Moody’s, which has put its sovereign credit rating on a par with Bermuda, Oman and Estonia. Monday’s single-notch downgrade for Japan from Aa3 to A1, the fifth-highest rating, represents the first reaction by a big credit rating agency to the decision last month by Prime Minister Shinzo Abe to call a snap election to push back a second scheduled increase in sales taxes… Last month the central bank bought Y11.2tn ($94bn) of government bonds… – more than the total net issuance of Y10.7tn by the finance ministry. This ‘unorthodox’ policy carries risks of a market malfunction, Mr Byrne of Moody’s said, citing fears expressed by BoJ board members as the bank prepared to ramp up annual bond purchases from Y50tn to Y80tn on October 31. ‘It is like any medical treatment. You expect the patient to recover, but there could be adverse side effects,’ he said.”