As they say, "All good things must come to an end." It's sad when I think about how I always imagined it would last "forever."
It’s been a privilege to chronicle history’s greatest Credit Bubble on a weekly basis going back to 1999. I very much want to see this thing through. The CBB lives. A heart-felt “Thank You” to readers over the years. I also invite all to join me next week – the day after my beloved Oregon Ducks play in the Rose Bowl – at my new blog. I'm really excited for my next chapter.
For the Week:
The S&P500 gained 0.9% (up 13.0% y-t-d), and the Dow jumped 1.4% (up 8.9%). The Utilities surged 3.5% (up 27.8%). The Banks rose 1.3% (up 8.1%), and the Broker/Dealers gained 1.3% (up 16.3%). The Transports rose 2.3% (up 24.3%). The S&P 400 Midcaps advanced 1.3% (up 9.3%), and the small cap Russell 2000 jumped 1.6% (up 4.4%). The Nasdaq100 added 0.8% (up 20.1%), and the Morgan Stanley High Tech index gained 1.5% (up 14.6%). The Semiconductors jumped 1.6% (up 30.3%). The Biotechs declined 1.7% (up 49.6%). Although bullion was unchanged, the HUI gold index dropped 1.6% (down 17.7%).
One- and three-month Treasury bill rates closed the week at one basis point. Two-year government yields jumped 10 bps to 0.74% (up 36bps y-t-d). Five-year T-note yields rose 11 bps to 1.76% (up 2bps). Ten-year Treasury yields gained nine bps to 2.25% (down 78bps). Long bond yields increased six bps to 2.82% (down 115bps). Benchmark Fannie MBS yields were up seven bps to 2.89% (down 72bps). The spread between benchmark MBS and 10-year Treasury yields widened two to 64 bps. The implied yield on December 2015 eurodollar futures rose four bps to 0.96%. The two-year dollar swap spread dropped five to 18 bps, and the 10-year swap spread declined one to 12 bps. Corporate bond spreads mostly narrowed. An index of investment grade bond risk was little changed at 64 bps. An index of junk bond risk fell five bps to 342 bps. An index of emerging market (EM) debt risk dropped 11 bps to 344 bps.
Greek 10-year yields added seven bps to 8.50% (up 8bps y-t-d). Ten-year Portuguese yields slipped a basis point to 2.71% (down 342bps). Italian 10-yr yields gained three bps to 1.99% (down 214bps). Spain's 10-year yields increased two bps to 1.73% (down 242bps). German bund yields were unchanged at a record low 0.59% (down 134bps). French yields increased one basis point to 0.90% (down 166bps). The French to German 10-year bond spread widened one to 31 bps. U.K. 10-year gilt yields gained three bps to 1.88% (down 114bps).
Japan's Nikkei equities index gained 1.1% (up 9.4% y-t-d). Japanese 10-year "JGB" yields declined two bps to a record low 0.33% (down 41bps). The German DAX equities index gained 1.4% (up 3.8%). Spain's IBEX 35 equities index advanced 1.1% (up 5.7%). Italy's FTSE MIB index jumped 1.9% (up 2.0%). Emerging equities were mostly higher. Brazil's Bovespa index gained 1.0% (down 2.7%). Mexico's Bolsa rose 1.1% (up 0.6%). South Korea's Kospi index increased 0.9% (down 3.1%). India’s Sensex equities index declined 0.4% (up 28.7%). China’s Shanghai Exchange gained 1.6% to four-year high (up 49.2%). Turkey's Borsa Istanbul National 100 index rose 1.6% (up 25.3%). Russia's MICEX equities index dropped 2.2% (down 5.7%).
There was little debt issuance this week. I saw no investment-grade, convertible debt or international debt issues.
Junk issuers this week included Signature Group $305 million.
Freddie Mac 30-year fixed mortgage rates increased three bps to 3.83% (down 65bps y-o-y). Fifteen-year rates added a basis point to 3.10% (down 42bps). One-year ARM rates increased one basis point to 2.39% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up ten bps to 4.29% (down 34bps).
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $221bn y-o-y, or 1.9%, to an eight-month low $11.761 TN. Over two years, reserves were $914bn higher for 8% growth.
Money market fund assets jumped $20.6bn to $2.713 TN. Money Funds were down $5.2bn y-t-d, while increasing $19bn from a year ago, or 0.7%
Currency Watch:
The U.S. dollar index increased 0.5% to 90.03 (up 12.5% y-t-d). For the week on the upside, the South Korean won increased 0.3%. For the week on the downside, the Swedish krona declined 1.5%, the Norwegian krone 1.4%, the Taiwanese dollar 0.9%, the Mexican peso 0.8%, the Japanese yen 0.7%, the Singapore dollar 0.6%, the British pound 0.4%, the Danish krone 0.4%, the euro 0.4%, the Brazilian real 0.4%, the Swiss franc 0.3%, the Canadian dollar 0.2%, the South African rand 0.2% and the Australian dollar 0.1%.
Commodities Watch:
December 26 – Bloomberg (Millie Munshi and Phoebe Sedgman): “Investors in the world’s biggest exchange- traded product backed by bullion sold the most gold in 18 months as the U.S. economic recovery cut demand for a haven. Holdings in the SPDR Gold Trust fell 1.6% yesterday to 712.9 metric tons, the biggest drop since June 2013. Assets declined to the smallest since September 2008.”
The Goldman Sachs Commodities Index dropped 2.6% to a more than five-year low (down 32.1%). Spot Gold was about unchanged at $1,196 (down 0.8%). March Silver increased 0.7% to $16.15 (down 17%). February Crude fell $2.40 to $54.73 (down 44%). January Gasoline dropped 3.3% (down 46%), and January Natural Gas sank 13.2% (down 29%). March Copper declined 2.4% (down 17%). March Wheat fell 3.4% (up 1%). March Corn gained 1.0% (down 2%).
U.S. Fixed Income Bubble Watch:
December 24 – Bloomberg (Sarah Mulholland): “The boom in U.S. auto sales is transforming the market for asset-backed securities into one dominated by bonds tied to car loans. Sales of the debt will increase about $20 billion to $120 billion next year as the rest of the market, which includes securities tied to credit-card payments and student loans, remains stagnant, according to Citigroup Inc. That will boost the proportion of auto-linked offerings to 54% of the $224 billion in total issuance, from just under half this year. The auto industry has become the main catalyst for deals in the asset-backed bond market…”
December 23 – Bloomberg (Jody Shenn): “Remember when nobody wanted to touch U.S. subprime-mortgage debt? That’s just a distant memory as they deliver some of the bond market’s best returns. The securities that were created in the years leading before the financial crisis in 2008, the last time such notes were issued, have gained almost 12% this year, or six times more than junk-rated corporate debt, according to Barclays Plc. After contributing to the collapse of Lehman Brothers Holdings Inc., bonds tied to the riskiest home loans have returned 75% since 2010, topping speculative-grade corporate debt for three straight years. The rally in the U.S. home-loan securities stands in contrast to corporate-debt markets, which have buckled as oil prices plunged and the Federal Reserve moves toward raising benchmark interest rates from close to zero.”
Global Bubble Watch:
December 26 – Dow Jones (Maureen Farrell): “J.P. Morgan's… debt capital markets team is still on top in the bond world. For the fourth year in a row, J.P. Morgan topped the so-called league tables as the bank that advised on the most bond deals--both globally and in the U.S., according to Dealogic. And the $415 billion in bond offerings it advised on globally was also tops for the industry… With interest rates still hovering around record lows, 2014 has been one of the best years on record for bond issuance, with $6.2 trillion in debt issued in 2014. That trails only 2012, when $6.6 billion was issued, according to Dealogic… The data also shows that this was the best year on record for investment grade corporate bond issuance, with such companies issuing $1.8 trillion in bonds.”
December 23 – Dow Jones (Karen Damato): “Strong interest from investors and a surging stock market have pushed the assets of exchange-traded funds over $2 trillion for the first time, according to industry watchers ETF.com and ETFGI. ETF.com said a rush of almost $14 billion into U.S.-stock funds on Monday--with most of that going into the SPDR S&P 500--tipped industry assets over the milestone figure. Wrote ETF.com's Cinthia Murphy: It took ETFs 18 years to reach $1 trillion in assets, but only another four years to double those assets to $2 trillion. To put that figure into focus, hedge funds now command about $3 trillion in assets, and open-end mutual funds have $15 trillion… ETFGI… said this year has seen the U.S. ETF industry take in a record $232 billion in net new cash, beating the prior full-year record of S190 billion, set last year.”
December 23 – Financial Times (Arash Massoudi): “Corporate takeover deals surged to their highest levels since the financial crisis this year, with merger and acquisition volumes rising 47% to $3.34tn globally. In the busiest period since 2007, megadeals returned with a vengeance, as historically low borrowing rates, buoyant capital markets and inflated share prices prompted big transactions with the potential to remake industries — particularly in pharmaceuticals, technology and media."
December 23 – Financial Times (Arash Massoudi): “Corporate takeover deals surged to their highest levels since the financial crisis this year, with merger and acquisition volumes rising 47% to $3.34tn globally. In the busiest period since 2007, megadeals returned with a vengeance, as historically low borrowing rates, buoyant capital markets and inflated share prices prompted big transactions with the potential to remake industries — particularly in pharmaceuticals, technology and media. The thirst for deals is expected to pour into the new year, led by the US and UK… Wilhelm Schulz, head of M&A at Citigroup for Europe, Middle East and Africa, said: ‘A clear theme of this year has been the need for large European companies to make acquisitions outside their main markets. That outbound M&A is likely to persist in 2015.’”
December 23 – Bloomberg (Christopher Langner): “Bond sales in Asia are expected to trump this year’s record issuance in 2015 as Chinese companies look abroad for acquisitions and funding, according to UBS Group AG. China and Hong Kong represented 43% of the unprecedented $274.5 billion of debt denominated in dollars, euros and yen this year in Asia excluding Japan, a 33% increase from 2013… Corporations in the world’s second-largest economy made a record $316.9 billion in overseas acquisitions. China’s rise means Beijing is now home to two of the world’s top ten listed companies by revenue, China Petroleum & Chemical Corp. and PetroChina Co., and the largest bank by assets globally, Industrial & Commercial Bank of China Ltd. Giants like Alibaba Group Holding Ltd. will continue doing record-breaking transactions, driving up volumes and investment banking fees from Asia, UBS and HSBC Holdings Plc say.”
December 23 – Dow Jones (Ben Edwards): “With rate hikes looming in the developed world, frontier market countries have been rushing to sell bonds on the cheap this year. Such borrowers have raised $38.5 billion from dollar bond sales over the course of 2014, around 50% more than last year and the highest on record, according to Dealogic. …Countries from Jamaica to Vietnam were among frontier government borrowers to tap international bond markets this year, latching on to strong demand for higher yielding debt while global interest rates remain low. Jamaica, for example, which only last year restructured some if its existing debt, in July was able to borrow $800 million at a yield of 7.625%... Vietnam was able in November to borrow $1 billion for 10 years at a yield of 4.8%... Kenya in June sold $2 billion of bonds, one of the largest ever debut deals from an African country. It paid 5.875% for five-year cash…”
December 22 – Bloomberg (Glen Carey and Nafeesa Syeed): “The boom that adorned Gulf Arab monarchies with glittering towers, swelled their sovereign funds and kept unrest largely at bay may be over after oil prices dropped by almost 50% in the last six months. The sheikhdoms have used the oil wealth to remake their region. Landmarks include man-made islands on reclaimed land, as well as financial centers, airports and ports that turned the Arabian desert into a banking and travel hub. The money was also deployed to ward off social unrest that spread through the Middle East during the Arab Spring. ‘The region has had 10 years of abundance,’ said Simon Williams, HSBC Holdings Plc’s chief economist for central and eastern Europe, the Middle East and North Africa. ‘But that decade of plenty is done. The drop in oil prices will hurt performance in the near term, even if the Gulf’s buffers are powerful enough to ensure there’s no crisis.’”
U.S. Bubble Watch:
December 23 – Bloomberg (Michael B. Marois): “California, which has won the biggest gains in creditworthiness of any U.S. state since the recession ended in 2009, may find further improvement stymied by a $350 billion bill for municipal bonds and retiree costs. A growing economy, tax increases and a new rainy-day fund have prodded the three biggest rating companies to raise their rankings four times in the past two years. Yet California remains more indebted than any state, with $101 billion of gross tax-supported debt last year, according to Moody’s… That’s on top of about $249 billion of promises to retirees.”
ECB Watch:
December 22 – Bloomberg (Jana Randow and Alessandro Speciale): “Mario Draghi has one month to win consensus on quantitative easing by reassuring those worried the European Central Bank risks losing its own money. As officials prepare to consider sovereign-bond purchases on Jan. 22, the ECB president is working to get as many policy makers and as much of the public on his side as possible. One concession being debated is to require national central banks to be responsible for at least some of their own credit risk, according to people familiar with the talks… ‘In case of sovereign QE, it’ll be difficult to square the circle to make everybody happy,’ said Marco Valli, an economist at UniCredit SpA… ‘But they are trying to make it as consensual as possible, bringing on board some of the smaller states. It would be important for the credibility of any sovereign QE program to reduce dissent as much as possible.’ Weidmann has argued that aside from the question of whether government-bond purchases are legal, there’s no need for more action now.”
Russia/Ukraine Watch:
December 22 – Bloomberg: “Two Chinese ministers offered support for Russia as President Vladimir Putin seeks to shore up the ruble without depleting foreign-exchange reserves. China will provide help if needed and is confident Russia can overcome its economic difficulties, Foreign Minister Wang Yi was cited as saying… Commerce Minister Gao Hucheng said expanding a currency swap between the two nations and making increased use of yuan for bilateral trade would have the greatest impact in aiding Russia, according to the broadcaster.”
December 24 – Bloomberg (Olga Tanas, Anna Andrianova and Ye Xie): “Russia may lose its investment-grade credit rating for the first time in a decade after Standard & Poor’s said it’s considering a cut amid the country’s worst economic crisis since the 1998 debt default. There’s at least a 50% chance that Russia will be lowered to junk within 90 days, S&P said… The move ‘stems from what we view as a rapid deterioration of Russia’s monetary flexibility and the impact of the weakening economy on its financial system,’ S&P said.”
December 22 – Bloomberg (Yuliya Fedorinova): “Russia’s central bank pledged as much as 30 billion rubles ($531 million) to support National Bank Trust after the ruble plunged and liquidity tightened. The central bank is selecting an investor to help shore up the lender, and the Deposits Security Agency will take over its management, Bank of Russia said… Trust, once part of exiled former oil tycoon Mikhail Khodorkovsky’s business empire and later advertised in Russia by actor Bruce Willis, is one of the country’s top 15 lenders by retail savings… Faith between Russian lenders is strained, shown by the Mosprime overnight rate jumping to 27.3% on Dec. 18…”
December 26 – Bloomberg (Ye Xie and Elena Popina): “For all of the progress Russia has made over the past week in stabilizing the ruble and quelling its financial crisis, Standard & Poor’s delivered a reminder of just how precarious the situation remains. S&P said it’s considering cutting Russia’s credit-rating to junk… for the first time in a decade as the looming recession spurs concern that the nation’s banks will face mounting bad loans.”
Brazil Watch:
December 26 – Bloomberg (Julia Leite and Filipe Pacheco): “Underwriters of Brazil’s corporate bonds, including JPMorgan… and Citigroup Inc., are heading into 2015 with diminished expectations. Petroleo Brasileiro SA, the national oil company that accounted for 35% of corporate issuance out of Brazil in 2014, says it doesn’t plan to sell bonds next year. Some companies may be ensnared by a widening bribery investigation into the oil producer, according to JPMorgan. Borrowing costs that surged to a five-year high this month may also deter first- time issuers, Citigroup predicts. After a record $33 billion of first-half issuance in 2014, bond sales from Brazil all but stopped. In the last six months, companies raised just $5.8 billion, the least since the credit crisis.”
December 22 – Bloomberg (Mario Sergio Lima): “Brazil economists cut their gross domestic product forecast and raised their inflation estimate above the official target range as deteriorating confidence will present a challenge for the government’s new economic team. Analysts reduced to 0.55% their GDP estimate for 2015 from 0.69% the previous week… Analysts also cut to 0.13% the estimate for growth this year… Latin America’s largest economy is expected to record the slowest growth in five years as inflation hovers near the ceiling of the target range and the budget deficit remains at the highest in a decade.”
December 22 – Bloomberg (Paula Sambo): “Brazilian companies led by Grupo Virgolino de Oliveira SA and OAS SA are poised to saddle bond investors with the deepest losses in 18 months. The nation’s corporate notes have tumbled 4.8% in December, on pace for the biggest monthly drop since June 2013…, according to JPMorgan… Speculation that sugar producer GVO will default and an investigation into alleged bribery by construction companies including OAS have compounded losses for investors reeling from a global selloff spurred by a plunge in oil prices.”
December 23 – Bloomberg (Mario Sergio Lima and Raymond Colitt): “Brazil’s central bank forecasts inflation will remain above the center of the target range for two more years, reinforcing the chance of further rate increases. Inflation will end 2016 above target at 4.9% if the central bank raises the key rate to 12.5% next year, according to the central bank’s quarterly inflation report… A weaker real and increases in regulated prices are fueling inflation, which according to policy makers has a 37% probability of breaching the target range next year.”
EM Bubble Watch:
December 26 – Bloomberg (Selcuk Gokoluk): “Just when lira carry traders thought they had 2014 in the bag, along came the dollar. Borrowing dollars to buy lira debt earned 5.8% this year through last month, the fourth-biggest return in 23 emerging markets tracked by Bloomberg. By today, the gains had shrunk to 1.9% as a 4.3% slump in Turkey’s currency against the greenback this month ate into profits from holding the nation’s bonds. Like most riskier emerging-market assets, the lira is suffering as the strengthening U.S. economy pushes the Federal Reserve toward raising interest rates in 2015… Turkey’s currency has underperformed peers in December as the biggest current-account deficit in the developing world leaves it vulnerable to capital outflows.”
December 22 – Bloomberg (Neo Khanyile): “South African corporate bond sales slid to the lowest level since 2009 as African Bank Investments Ltd.’s failure drove up borrowing costs and spurred companies to cancel debt plans. Issuance this year fell 39% to $4.8 billion… Global corporate bond sales increased 8.5% to a record $4.08 trillion as companies lock in borrowing costs on the likelihood the Federal Reserve will raise interest rates next year.”
December 23 – Bloomberg (Ben Bain): “To Adrian Parra, the 436,375 peso ($30,000) mortgage he got in Mexico in 2008 is a burden he can’t shake. He says inflation-linked increases to the principal have helped push the amount he owes to more than 500,000 pesos after six years of payments. To investors, mortgages like Parra’s are an opportunity to seize in Mexico’s rebounding housing market. This must be ‘a very profitable business,’ said Parra, 37, a financial adviser in Mexico City. “But since I’m a homeowner, it’s really not.’ Foreign investors have poured into Mexico’s first mortgage real-estate investment trust, which is using some of the 8.625 billion pesos raised in a share sale last month to fund purchases of inflation-adjusted mortgages. Investors in the REIT, known as FHipo, benefit from an interest rate of at least 8.5% on the mortgages…”
Europe Watch:
December 24 – Bloomberg (Marcus Bensasson and Eleni Chrepa): “As Prime Minister Antonis Samaras’s political maneuvers to avoid early elections edge toward a dead end, his warning of turmoil risks falling on deaf ears among Greeks numbed by years of upheaval. After losing a second vote in parliament yesterday on his candidate for a new president, Samaras needs to win over a dozen lawmakers before a final ballot on Dec. 29. Should he fail, the constitution dictates that elections must be called, with opposition party Syriza leading opinion polls. ‘We’ve already been living through chaos for years now,’ said Kostas Grekas, a 23-year-old computer-technology student in Athens… ‘I’d prefer there to be elections now so that Syriza gets in, just to break up the old party system and to see something different.’”
December 24 – Bloomberg (Mark Deen): “French jobless claims rose to a record after President Francois Hollande failed to revive the nation’s economy in the first half of his mandate. The number of people actively looking for work in France increased by 27,400, or 0.8%, to 3.49 million in November… Jobless claims have risen in all except three months during Hollande’s first 2 1/2 years in office as the economy barely grew…”
Geopolitical Watch:
December 22 – Bloomberg (Ting Shi): “China’s military is building a large military base on islands about 300 kilometers (190 miles) from an islet chain at the center of a territorial row with Japan, Kyodo News reported… The base on the Nanji islands in Zhejiang Province is designed to enhance China’s readiness to respond to a potential military crisis and strengthen surveillance over an air defense identification zone it declared in the area in November last year, the news agency said.”
China Bubble Watch:
December 24 – Bloomberg (Shai Oster and Justina Lee): “UBS Group AG is flagging risks from China’s $1 trillion worth of unhedged foreign debt as forecasters see bets against the greenback unwinding in 2015. The world’s second-largest economy is exposed to shifts in currency and interest rates as never before because of expanding international trade and easing foreign-exchange regulations, said Stephen Andrews, head of Asia banks research… at UBS. Daiwa Capital Markets has a $1 trillion estimate for carry-trade inflows since 2008, bets on the difference between yields in China and overseas. It sees a 5.7% drop in the yuan next year. The renminbi is heading for a 2.8% loss in 2014… Capital controls and record foreign- exchange reserves will help the PBOC cope with any similar situation to 1997’s Asian financial crisis, when firms struggled to repay debt as currencies slumped, Andrews said. ‘This could get very uncomfortable very quickly,’ he said… ‘I boil it down to its basics. You’ve borrowed unhedged and leveraged: you’re at risk.’”
December 26 – Bloomberg: “China plans to temporarily waive a requirement for banks to set aside reserves for some deposits, people with knowledge of the matter said, highlighting efforts to boost lending amid a slowdown of the world’s second-largest economy. Commercial lenders won’t be required to set aside reserves for the savings that they hold for non-deposit-taking financial institutions, the people said… The waiver is seen as another move to replace a universal reserve-requirement ratio cut that the People’s Bank of China needs to boost credit and bolster the economy. Concerned that a broad reduction might send out a strong easing signal and bring turmoil to stock market, the PBOC has added liquidity by stealth at least four times in the past four months.”
December 24 – Bloomberg: “The People’s Bank of China is turning to a hidden hand as it seeks to stimulate the world’s second-largest economy without worsening debt risks. Contrary to the Federal Reserve’s forward guidance, the Bank of England’s increased transparency and a Group of 20 Nations vow to clearly communicate policies, China has added liquidity by stealth at least four times in the past four months. One proxy it has been using is China Development Bank Corp., the nation’s biggest policy lender. Balancing the need to buoy an economy set for its slowest full-year expansion since 1990 and efforts to contain a debt pile that’s almost doubled in six years, China’s leaders have sought a targeted monetary path that’s deviating from advanced economy peers. Problem is, by keeping in the shadows, speculators have jumped in, pushing the stock market up over 20% since the PBOC’s benchmark interest rate cut on Nov. 21… ‘It lacks both transparency and effectiveness,’ said Ding Shuang, senior China economist at Citigroup…, who used to work at the PBOC. ‘On this year’s policies, I can say I have no clue of their reasoning.’”
December 24 – Wall Street Journal (Shen Hong): “Following years of explosive growth, China’s shadow-banking industry is experiencing a sharp slowdown after Beijing tightened its grip on the sector, which has been a key source of funding for the economy but also has added to rising debt levels and other risks in the financial system. The industry, a mélange of informal lenders such as trust companies and leasing firms, takes in money from investors and lends it to often risky projects for which traditional bank lending is unavailable. Investors have flocked to the so-called wealth-management and trust products sold by shadow lenders in recent years because they typically promise returns ranging from 4% to more than 10%, much higher than a bank account. But the sector has been hit especially hard in the second half of this year. Investors have shifted their cash into the rallying stock market. The slowdown may become even more pronounced next year, with authorities set to increase efforts to rein in financial risks as the economy slows… The outstanding value of shadow-banking products stood at 21.87 trillion yuan ($3.52 trillion) at the end of November, up 14.2% from the level a year earlier, according to estimates by Nomura Securities… That growth is significantly slower than the 35.5% rise it registered for the whole of last year and the 33.1% gain in 2012.”
December 23 – Bloomberg (Billy Chan): “Citic Securities Co. has become the world’s fourth-largest securities firm by market value, as China’s stock rally lures new investors and bolsters trading fees. …Citic’s market value has about doubled in the past month to $55 billion as of Dec. 19, surpassing Credit Suisse Group AG and approaching UBS Group AG… Citic’s shares surged 153% in Shanghai this year as the benchmark index’s 47% climb prompted investors to open new trading accounts and almost tripled loans taken out to finance equity purchases… The profit outlook for Citic and its peers has brightened as individual investors opened almost 900,000 accounts to trade stocks in the week ended Dec. 12, the most since November 2007. The value of outstanding margin debt in China climbed to a record 987.9 billion yuan as of Dec. 18 from 335.9 billion yuan a year ago…”
December 23 – Bloomberg: “Chinese President Xi Jinping’s decision to investigate his predecessor’s top aide for corruption marks the downfall of the remaining ‘tiger’ in a group that Communist Party cadres termed the ‘New Gang of Four.’ Ling Jihua, former chief of staff to retired president Hu Jintao, was the last member of the quartet who had long been in Xi’s sights, analysts said… Removing Ling… emphasizes Xi’s iron grip on the party just two years after he became its chief, and may further strengthen his ability to mold the next generation of leaders. ‘Ling Jihua’s investigation suggests that it is likely we will see changes in the anticipated leadership lineup,’ at the next party congress in 2017, said Joseph Fewsmith, a political science professor at Boston University… ‘Xi is indeed emerging as the strongest leader in China since at least Deng Xiaoping.”
Japan Watch:
December 26 – Bloomberg (Keiko Ujikane and Toru Fujioka): “Japanese drew down savings for the first time on record while wages adjusted for inflation dropped the most in almost five years, highlighting challenges for Prime Minister Shinzo Abe as he tries to revive the world’s third- largest economy. The savings rate in the year through March was minus 1.3%, the first negative reading in data back to 1955… Real earnings fell 4.3% in November from a year earlier, a 17th straight decline and the steepest tumble since December 2009… A higher sales tax combined with the central bank’s record easing are driving up living costs, squeezing household budgets and damping consumption… ‘Households are suffering from a decline in real income,’ said Hiromichi Shirakawa, an economist at Credit Suisse Group AG who used to work at the Bank of Japan.”
December 26 – Bloomberg (Toru Fujioka): “Japan’s inflation slowed for a fourth month in November, and industrial production and retail sales unexpectedly dropped, pointing to further weakness in an economy Prime Minister Shinzo Abe is trying to revive from recession. Output fell 0.6% in November from a month earlier… Retail sales slid 0.3%, while consumer prices excluding fresh food rose 2.7% from a year earlier. Real wages fell the most since 2009.”
Saturday, December 27, 2014
Weekly Commentary, December 19, 2014: "Bo, Bo"
It was an interesting week, including in the financial markets. We’ll focus on these extraordinary market gyrations. I’ll have nothing to say about the Federal Reserve, as I believe they actually had little to do with the markets.
The Russian ruble traded Tuesday at low as 79.17 to the dollar (after beginning the year at 33), before closing the week at 59.61. At Tuesday’s record low, the ruble was down 20% for the day, before a late-session rally cut the loss to 5.4%. The ruble was under pressure again early-Wednesday, until major buying pushed the ruble to a 10.3% session gain. By the time of Putin’s annual (three-hour) press conference on Thursday, the ruble and Russia bonds had miraculously stabilized. The world’s risk markets rejoiced the thought of the deep-pocket Chinese resolving Russia’s crisis: Bubble On.
If forced to venture a guess, I’d say the Chinese were actively supporting the ruble and Russian debt on Wednesday and Thursday. Early Thursday from Reuters: “China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall… Chinese Foreign Ministry spokesman Qin Gang, speaking at a later news conference, added that he believed Russia would overcome its problems. ‘Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,’ Qin said.”
And early Thursday from the South China Morning Post: “Russia May Seek China Help to Deal with Crisis: Russia could fall back on its 150 billion yuam currency swap agreement with China if the rouble continues to plunge… The deal was signed by the two central banks in October, when Premier Li Keqiang visited Russia. ‘Russia badly needs liquidity support and the swap line could be an ideal too,’ said Ban of Communications chief economist Lian Ping.”
The South China Morning Post came later with additional articles, including “Beijing May Spend Bigger in Russia,” and “Russia’s Currency Crisis Poses Risks to Other Emerging Markets.”
December 19 – Bloomberg: “China offered enhanced economic ties with Russia at a regional summit this week as its northern neighbor struggled to contain a currency crisis. ‘To help counteract an economic slowdown, China is ready to provide financial aid to develop cooperation,’ Premier Li Keqiang said… While the remark applied to any of the five other nations represented at the meeting of the Shanghai Cooperation Organization group, it was directed at Russia… Any rescue package for Russia would give China the opportunity of exercising the kind of great-power leadership the U.S. has demonstrated for a century -- sustaining other economies with its superior financial resources. President Xi Jinping last month called for China to adopt ‘big-country diplomacy’ as he laid out goals for elevating his nation’s status. ‘If the Kremlin decides to seek assistance from Beijing, it’s very unlikely for the Xi leadership to turn it down,’ said Cheng Yijun, senior researcher with the Institute of Russian, Eastern European, Central Asian Studies at the Chinese Academy of Social Sciences in Beijing. ‘This would be a perfect opportunity to demonstrate China is a friend indeed, and also its big power status.’”
I’ll speculate that the Chinese were becoming increasingly nervous – nervous about Russia, nervous about EM and nervous about China. Global markets on Tuesday again found themselves at the precipice. The ruble collapse was exacerbating a general flight out of EM currencies, bonds and stocks. Marketplace liquidity was evaporating – leading to brutal contagion at the Periphery and increasingly destabilizing de-risking/de-leveraging at the Core. In short, Bubble Off was taking over – in yet another market “critical juncture.” The ruble (miraculously) reversed course, EM rallied, global markets for the most part reversed and the “Core” U.S. equities market took flight. From Wednesday's lows to Friday’s highs, the Dow surged 800 points, or 4.7%. Bubble On. “Risk on” no longer does justice.
Most would likely challenge my view of the markets being at the “precipice” during Tuesday trading. Let me back up my claim. Tuesday trading saw a major Emerging Market CDS (Credit default swap) index jump to the highest level since the tumultuous summer of 2012. On Tuesday, the Brazilian real traded to a new nine-year low (trading down as much as 2.8% intraday). Interestingly, Brazil CDS surged to 268 intraday Tuesday, up from Friday’s close of 212 and 153 to start the month. Tuesday’s high actually surpassed the 2013, 2012 and 2011 spikes – to the highest level since 2009.
It’s worth noting that CDS traded to multi-year highs for the major Brazilian financial institutions. Banco do Brasil surged to over 420 on Tuesday before ending the week up 28 bps to 315 bps. BNDES (Brazil’s national development bank) CDS spiked higher Tuesday, before ending the week up 52 bps to 234. Banco Bradesco CDX traded to 300, before ending the week up 21 to 266 bps.
My thesis has been that the “global government finance Bubble” has burst at the Periphery. EM sovereign, corporate and financial debt is the global “system’s” weak link. Dollar-denominated EM debt in particular is the unfolding crisis’ “toxic” debt. Regrettably, Brazil is right in the thick of it.
Last week I wrote that the EM dollar-denominated debt dam had given way. This dynamic was clearly in play early in the week. Russia dollar bond yields traded as high at 7.88% Tuesday, up from the previous week’s closing 6.76%. Ukrainian dollar yields surpassed 32.5% Tuesday, before ending the week at 26.52%. Venezuela dollar bond yields jumped to 27.85% on Tuesday, up from Friday’s closing 24.28% - before ending the week at 22.29%. Brazilian 10-year dollar yields rose as high as 5.28%, up from the previous week’s 4.82%. Turkey dollar yields traded as high as 4.88% on Tuesday, up from last Friday’s 4.52%. Colombia yields jumped to 4.40%, up from the previous week’s 4.16%.
Turkey (lira) bond yields this week traded at high as 8.60%, up from 7.62% to begin the month. The lira traded to a record low Tuesday. Indonesia yields rose to 8.48%, up from 7.70% to start December. The rupiah Tuesday traded to the lowest level versus the dollar since 1998. South African yields this week traded as high as 8.12%, up from last Friday's 7.60%. Tuesday saw the rand trade to the lowest level since 2000. Eastern European currencies were under notable pressure. For the week, the Hungarian forint declined 4.3%, the Polish zloty 3.6%, the Czech koruna 2.5%, the Bulgarian lev 1.8% and the Romanian leu 1.7%. Iceland’s krona fell 2.5% this week.
It wasn’t just EM under pressure earlier in the week. Greek five-year yields traded to 9.80% Tuesday, up from the previous Friday’s 9.65% close - to the highest level since the 2012 European crisis. Greek CDS traded as high at 1,178 – before closing the week at 1,025. Italian CDS traded to 165 bps Tuesday (10-month high), before ending the week about unchanged at 142. There’s been an interesting divergence of late between declining sovereign yields and rising CDS prices in Italy, Spain and Portugal.
Part of my thesis back in 2012 was that a crisis of confidence in Italian debt was about to provoke a crisis of confidence in the European banking system and the euro. I believed a loss of confidence in European banks risked a major global crisis involving derivatives, counter-party issues and funding of leveraged speculation. A Bloomberg headline from Wednesday caught my attention: “SocGen [French bank Society Generale Default Swaps Jump to One-Year High on Russia Turmoil.”
SocGen (subordinated debt) CDS traded to 225 bps on Wednesday (closed week at 200), after beginning the month at 171. An index of European (subordinated) bank CDS traded Tuesday almost back to the highs from the October market tumult. An index of European high-yield corporate debt also spiked Tuesday back to October Tumult levels. Basically, CDS has been rising just about everywhere. Japan CDS traded to 75 on Tuesday, now more than double the level from September lows (to an 18-month high).
Here at home, 10-year Treasury yields traded to 2.01% Tuesday, the low going back to May 2013. The week saw more all-time record low yields in Germany (0.59%), France (0.87%), Spain (1.70%), Netherlands (0.74%) and Austria (0.75%), among others.
December 19 – Financial Times (Tracy Alloway): “Big investors have been buying hundreds of billions of dollars worth of exotic credit derivatives to protect themselves against the possibility that growing numbers of corporate bond issuers will default. Options that give investors the right to buy insurance against bond defaults have exploded in popularity this year as asset managers and hedge funds seek to affordably offset the risk of a big blow-up in credit. Trading volumes of the instruments — known as credit index options or 'swaptions' — have jumped 148% in the past 12 months, with about $1.4tn of the instruments exchanging hands in 2014 compared with $573bn in 2013. ‘You can buy a very leveraged bet that the market will collapse using credit index options,’ said Andrew Jackson, chief investment officer at Cairn Capital. He added: ‘That is definitely the hedge of choice for real money investors who don’t really care that much about the level of volatility, but care about the amount of dollars they’re paying to hedge against Armageddon risk.’ Credit indices, such as Markit’s iTraxx or CDX series, are credit default swaps (CDS) written on baskets of corporate credits that investors and traders may use to hedge, or offset, their exposure to corporate debt or to make bets on the way the underlying companies will perform. Credit index options act in a similar way to options on other assets, such as stocks, by giving the holder the right to enter into a CDS contract at a certain time in the future. According to Citigroup research, asset managers account for a quarter of the total credit index options volume, compared with 15% just a year ago.”
Early-week instability evoked talk of the 1998 market crisis. A Bloomberg headline: “Memories of 1998 Rekindled in Routs From Russia to Venezuela.” I was convinced in early-1998 that Russia was the likely next big domino to drop after the brutal 1997 collapse of the “Asian Tiger miracle economies.” And I recall an FT article that highlighted the spectacular growth in derivatives to protect against a ruble decline. The knowledge that huge derivative “insurance” positions had accumulated convinced me that collapse was inevitable.
It’s time to ponder the ramifications of accumulating hedges against “Armageddon risk,” positions with potentially highly leveraged options and “swaptions” derivative instruments. This has become an important market issue. And it’s troubling to see that the trading of these types of instruments has exploded right along with trading options on equity volatility indices (i.e. VIX, VXX, etc.). Coincidently, I was listening to a conversation this week that went something like this: “Everyone is hedged (against market risk). Who is on the other side of these trades?”
Long-time readers know I am no fan of Credit and market “insurance.” Cheap insurance invariably fuels excess on the upside of the boom, only later to ensure dislocation when the Bubble burst. Basically, Credit and market risks are uninsurable – they are neither random nor independent events (such as auto accidents and house fires). I won’t this week dive back into this fascinating theoretical topic.
I believe options and swaptions on corporate Credit are exceptionally dangerous. I also believe they likely help to explain some of this year’s (and this week’s!) unusual market trading dynamics. Again, think “Bubble On, Bubble Off.” Who is on the other side of the explosion of Credit and market insurance? Computers and models. If a customer buys an option on a CDS contract – a computerized trading system will dictate how much of the underlying instrument that must be either bought or sold to “hedge” the contract sold. And as market prices change, “dynamic" trading strategies will adjust trading positions accordingly. If prices move little, there will be little to do on the trading/hedging side. If prices move a lot, there will be a major trading effort involved. Big price changes ensure a trend-following bias.
The embedded leverage in “Armageddon” trading strategies generally causes little issue. Think, for example, if you go out and purchase a 25% out-of-the-money put option on the equity market (crash protection). For the most part, the (derivative counter-) party that wrote this market insurance has little to do or worry about - so long as the market is quiescent. But if the market suddenly is on a downward spiral, the computerized trading model will dictate that a short position be established as a partial hedge against the “insurance” written. If the market continues to decline, more selling will be required to ensure a trading position that will generate sufficient cash-flow (trading gain) to pay on the insurance contract. And as this “out of the money” option gets closer to the “strike” price, the amount of (“delta”) trading necessary to hedge rises exponentially. But if the market then abruptly recovers, loss avoidance will require that this short position market hedge be unwound into a rising market.
The Fed and global central bankers have had a profound role on derivatives markets. I would argue that many of these key financial “insurance” markets are viable only because of central bank assurances of “liquid and continuous” markets. Certainly, the proliferation of these types of products would not be possible if not for the view that central banks will protect against market crisis. Who would write market and Credit insurance if they lacked confidence in central banks underpinning the markets?
The proliferation of Credit “insurance” over recent years is an especially fascinating issue. With unlimited central bank “money” printing, why not book easy profits by insuring against Credit losses? Why not write “flood insurance” when central bankers are ensuring drought? Why not write CDS (default protection) contracts for easy returns? And those on the other side of the derivative trade can simply buy corporate debt (on leverage, of course), to provide the cash-flows to pay on the contracts sold. And with CDS “insurance” so cheap and liquid, it’s perfectly rational for others to position aggressively long corporate Credit, while purchasing option protection just in case of “Armageddon.” This dynamic has had a profound impact on Credit Availability and loose financial conditions more generally. It's also pro-"Bo, Bo."
Actually, I think “do whatever it takes” central bank "money" printing coupled with zero rates has spurred risk-taking and a resulting historic Bubble throughout high-yield debt. CDS and derivatives more generally have played a profound role – creating significant unappreciated leverage on the upside of the boom. Now, with the global Bubble bursting, this “insurance” marketplace holds the potential to incite an abrupt tightening of Credit conditions (has it already commenced?) On the one hand, a widening of spreads and higher CDS prices will lead to some unwinding of derivative-related leverage. Worse yet, the proliferation of “out-of-the-money” option “Armageddon” protection will dictate that those that have written these derivatives short securities as market and Credit backdrops deteriorate.
I believe that the Trillions of Credit “insurance” derivatives in the marketplace help to explain volatile and now generally unstable markets. It helps explain why high-yield CDS has gyrated over the past year – beginning the year just over 300 – jumping to 360 in February – sinking to about 290 in July, only to spike to 355 in August - to fall back to 310 bps in early September. Things turned only more interesting over recent months. CDS spiked to almost 370 in late-September and then dropped back to 330 bps in early October. High-yield CDS then traded to 400 during the October Tumult, before again sinking back below 330 in late-November. CDS closed Tuesday at 406 bps.
When the Russia currency and bond collapse unfolded in October 1998, derivative trading strategies played a significant role. Hedging and speculation created overwhelming market selling pressure and resulting illiquidity. In the end, Russian banks that had written ruble insurance collapsed right along with the ruble and the Russian debt market. I have no doubt that derivatives and associated “dynamic” trading strategies will play a major destabilizing role in the unfolding global financial crisis.
And more from the FT: “The surge in trading of credit index options stands in stark contrast to the CDS market itself, which has been shrinking dramatically since the financial crisis. The derivatives were widely blamed for exacerbating the crisis and have since come under tighter regulatory scrutiny and control, including a requirement that they be ‘cleared’ through exchange-like central counter-parties. Unlike CDS, options on CDS indices are not yet required to be centrally cleared. ‘Every single month in 2014 experienced volume growth compared to the same period in 2013, which suggests the growth was not seasonal, or in response to one-off events in 2014,’ the Citi analysts said. “Credit options are currently one of the fastest growing areas in credit derivatives.”
There’s a fascinating aspect of Periphery to Core dynamics that I believe today underpins “Bo, Bo.” I’ve written extensively on how cracks (and even a bursting Bubble) at the Periphery work initially to funnel “hot money” flows to the bubbling Core. Importantly, this dynamic also promotes the accumulation of derivative risk “insurance” positions. First, trouble at the Periphery provides impetus for the discerning to hedge mounting systemic risk. Second, an over-liquefied Core ensures readily available inexpensive insurance – cheap insurance that spurs late-cycle risk-taking along with general complacency.
Indeed, this dynamic now plays a critical role in prolonged “blow off” excesses. Importantly, when the Core begins to succumb to the faltering Bubble this massive derivatives (hedging/speculating) trade will overhang system stability. The market cannot hedge market risk. There’s no one with the wherewithal to “take the other side of the trade.” The “other side” is instead a computer model, programmed to dump sell orders into declining markets. Liquidity will inevitably become a critical problem.
A year ago this week I was invited to participate in a company event – a bull vs. bear debate. I presented my Bubble thesis, arguing against the bullish “house” view. I posed what I am convinced is a fundamental question: “Is the underlying money and Credit sound or unsound?” I also included the following: “I do not sit around worrying about my reputation or my career prospects. I am driven by two things: analytical integrity and the quality of my analysis.” I would have it no other way.
For the Week:
The S&P500 rallied 3.4% (up 12.0% y-t-d), and the Dow gained 3.0% (up 7.4%). The Utilities jumped 2.8% (up 23.4%). The Banks rose 2.9% (up 6.7%), and the Broker/Dealers surged 3.9% (up 14.8%). Transports gained 1.7% (up 21.5%). The S&P 400 Midcaps advanced 3.4% (up 8.0%), and the small cap Russell 2000 jumped 3.8% (up 2.8%). The Nasdaq100 gained 2.0% (up 19.2%), and the Morgan Stanley High Tech index jumped 3.9% (up 13.0%). The Semiconductors rose 2.2% (up 28.2%). The Biotechs surged 3.7% (up 52.1%). Although bullion dropped $26.20, the HUI gold index was little changed (down 16.4%).
One-month Treasury bill rates closed the week at one basis point and three-month rates ended at three bps. Two-year government yields jumped 10 bps to 0.64% (up 26bps y-t-d). Five-year T-note yields rose 14 bps to 1.65% (down 10bps). Ten-year Treasury yields gained eight bps to 2.16% (down 87bps). Long bond yields added two bps to 2.76% (down 121bps). Benchmark Fannie MBS yields were up three bps to 2.83% (down 78bps). The spread between benchmark MBS and 10-year Treasury yields narrowed five to 67 bps. The implied yield on December 2015 eurodollar futures rose nine bps to 0.92%. The two-year dollar swap spread was little changed at 23 bps, and the 10-year swap spread was about unchanged at 13 bps. Corporate bond spreads reversed sharply narrower. An index of investment grade bond risk dropped seven to 65 bps. An index of junk bond risk sank 48 bps to 348 bps. An index of emerging market (EM) debt risk fell 28 bps to 355 bps.
Greek 10-year yields dropped 71 bps to 8.43% (up one basis point y-t-d). Ten-year Portuguese yields sank 25 bps to 2.73% (down 341bps). Italian 10-yr yields fell 11 bps to 1.95% (down 217bps). Spain's 10-year yields dropped 18 bps to 1.70% (down 245bps). German bund yields declined three bps to a record low 0.59% (down 134bps). French yields sank 11 bps to a record low 0.89% (down 167bps). The French to German 10-year bond spread narrowed eight to 30 bps. U.K. 10-year gilt yields rose five bps to 1.85% (down 117bps).
Japan's Nikkei equities index gained 1.4% (up 8.2% y-t-d). Japanese 10-year "JGB" yields dropped four bps to a record low 0.35% (down 39bps). The German DAX equities index rallied 2.0% (up 2.5%). Spain's IBEX 35 equities index gained 1.2% (up 4.5%). Italy's FTSE MIB index was up 2.1% (unchanged). Emerging equities were again wildly volatile. Brazil's Bovespa index recovered 3.4% (down 3.6%). Mexico's Bolsa gained 2.0% (down 0.5%). South Korea's Kospi index added 0.4% (down 4.1%). India’s Sensex equities index was little changed (up 29.3%). China’s Shanghai Exchange surged another 5.8% (up 46.9%). Turkey's Borsa Istanbul National 100 index increased 0.4% (up 23.3%). Russia's MICEX equities index slipped 0.7% (down 3.7%).
Debt issuance has slowed to a drip. I saw no investment-grade or convertible debt issues.
Junk funds saw outflows jump to $3.08bn (from Lipper), the largest outflows since August. Junk issuers this week included Global Cash Access $700 million.
International dollar debt issuers included Alliance Bank $237 million and Energia Eolica $204 million.
Freddie Mac 30-year fixed mortgage rates dropped 13 bps to 3.80% (down 67bps y-o-y). Fifteen-year rates fell 11 bps to 3.09% (down 42bps). One-year ARM rates declined two bps to 2.38% (down 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.19% (down 44bps).
Federal Reserve Credit last week expanded $16.1bn to a record $4.464 TN. During the past year, Fed Credit inflated $505bn, or 12.8%. Fed Credit inflated $1.653 TN, or 59%, over the past 110 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $3.9bn last week to $3.328 TN. "Custody holdings" were down $25.7bn year-to-date and fell $51.5bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $237bn y-o-y, or 2.1%, to $11.774 TN. Over two years, reserves were $929bn higher for 9% growth.
M2 (narrow) "money" supply expanded $5.3bn to a record $11.608 TN. "Narrow money" expanded $635bn, or 5.79%, over the past year. For the week, Currency increased $2.5bn. Total Checkable Deposits jumped $33bn, while Savings Deposits fell $28.7bn. Small Time Deposits declined $1.7bn. Retail Money Funds were little changed.
Money market fund assets declined $13.4bn to $2.693 TN. Money Funds were down $25.7bn y-t-d, while increasing $17.7bn from a year ago, or 0.7%.
Total Commercial Paper dropped $12.5bn to $1.074 TN. CP expanded $28.5bn year-to-date, while declining $11.3bn over the past year, or 1.0%.
Currency Watch:
December 18 – Bloomberg (Justina Lee): “Yuan forwards fell to a two-year low after the central bank reduced the currency’s fixing by the most in six weeks amid dollar demand on bets the U.S. will increase interest rates next year.”
The U.S. dollar index gained 1.4% to 89.60 (up 11.9% y-t-d). For the week on the upside, the Mexican peso increased 1.1%, the South Korean won 0.1% and the South African rand 0.1%. For the week on the downside, Swedish krona declined 2.4%, the Swiss franc 2.1%, the euro 1.9%, the Danish krone 1.9%, the Australian dollar 1.4%, the Japanese yen 0.6%, the British pound 0.6%, the Taiwanese dollar 0.5%, the New Zealand dollar 0.2%, the Brazilian real 0.2%, the Norwegian krone 0.2%, the Canadian dollar 0.2% and the Singapore dollar 0.1%.
Commodities Watch:
The Goldman Sachs Commodities Index declined another 1.6% to a more than five-year low (down 30.3%). Spot Gold fell 2.1% to $1,196 (down 0.8%). March Silver sank 6.0% to $16.03 (down 17%). January Crude declined 95 cents to $57.13 (down 42%). January Gasoline fell 2.4% (down 44%), and January Natural Gas dropped 6.7% (down 18%). March Copper lost 1.7% (down 15%). March Wheat jumped 4.2% (up 5%). March Corn increased 0.7% (down 3%).
U.S. Fixed Income Bubble Watch:
December 17 – Bloomberg (Kristen Haunss and Luca Casiraghi): “Wall Street dealers are bracing for a steep drop in issuance of collateralized loan obligations after a record amount of the debt was raised this year, threatening to boost borrowing costs for the neediest companies. Rules designed to limit risk-taking may mean CLO sales will be at least 41% less than the unprecedented $119.2 billion issued so far in 2014, according to the most pessimistic forecast by JPMorgan… CLOs helped finance some of the biggest leveraged buyouts in history, and the outlook for a drop in issuance comes as prices in the more-than $800 billion market for high-yield, high-risk loans are already near a two-year low and the debt is on track to deliver annual losses for the first time since 2008.”
U.S. Bubble Watch:
December 15 – Bloomberg (Bradley Olson and Tim Loh): “Autry Stephens knows the look and feel of an oil boom going bust, and he’s starting to get ready. The West Texas wildcatter, 76, has weathered four such cycles in his 52 years draining crude from the Permian basin… Though the collapse in prices since June doesn’t yet have him in a panic, Stephens recognizes the signs of another downturn on the horizon. And like many bust-hardened veterans in this region -- which has made and broken the fortunes of thousands -- he’s talking about it like a gathering storm. The ups and downs of oil are a way of life in Midland and Odessa, Texas, dating all the way back to the Great Depression… ‘We’re going to hunker down and go into survival mode,’ Stephens, founder of Endeavor Energy Resources LP, said… ‘Stay alive is our mantra, until the price recovers.’ Go about 1,300 miles due north and you get a very different take from the rookie oil barons in North Dakota, where crude output from the Bakken formation went from 200,000 barrels a day in 2008 to about 1.2 million today. They’re not seeing any need to take shelter, and it shows in their swagger.”
Federal Reserve Watch:
December 19 – Bloomberg (Craig Torres): Federal Reserve officials see the federal funds rate rising less by the end of 2015 than they projected three months ago, according to the median estimate of new forecasts released today. They also forecast the economy will be at full employment by the end of next year. The benchmark rate will be 1.125% at the end of next year, compared with a 1.375% median estimate in September… The rate will be 2.5% at the end of 2016, and 3.625% at the end of 2017, according to the median. Federal Open Market Committee participants said they don’t expect to reach their 2% target for inflation until 2016…”
ECB Watch:
December 16 – Bloomberg (Jeff Black and Jana Randow): “Jens Weidmann said there’s no need for the European Central Bank to expand monetary stimulus, and argued that sovereign-debt purchases are problematic even if slumping oil prices cause deflation. ‘Such a development initially requires no monetary policy response, as long as no second round effects are to be seen,’ the Bundesbank president said… ‘There’s a whole row of economic reasons that speak against government-bond purchases, even before you consider the legal question of whether they’re compatible with the ban on monetary financing.’ …Weidmann, and up to five other Governing Council members, are against pre-announcing government-bond buying before the effects of existing programs can be judged. ‘We have already acted, pre-emptively, in the expectation of a worsening of the economic situation,’ Weidmann said. ‘But this plays only a minor role in the discussion. Instead, it’s only ever asked, ‘what is coming next?’ And then mostly the question, ‘when will you finally buy government bonds?’ That raises the expectations for this measure to such a level that they can only be disappointed.’”
Central Bank Watch:
December 18 – Bloomberg (Zoe Schneeweiss and Jan Schwalbe): “The Swiss National Bank imposed the country’s first negative deposit rate since the 1970s as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. A charge of 0.25% on sight deposits… will apply as of Jan. 22… The SNB move follows Russia’s surprise interest-rate increase this week and hints at the investment pressures that resulted after that decision failed to stem a run on the ruble. Swiss officials acted as the turmoil, along with the imminent threat of quantitative easing from the ECB, kept the franc too close to its 1.20 per euro ceiling for comfort.”
Russia/Ukraine Watch:
December 19 – Financial Times (Courtney Weaver and Jack Farchy): “A defiant Vladimir Putin said Russia should brace itself for two years of recession, as he blamed economic woes on a western plot to defang the Russian bear. The president was speaking at a three-hour press conference during which he addressed this week’s market turmoil in public for the first time. He claimed that a period of economic hardship was the price Russia would have to pay to maintain its independence in the face of western aggression, repeatedly blaming the rouble’s plunge and a looming recession on ‘external factors’. In a metaphor that summed up his entire performance, he compared Russia to a bear which the west was trying to weaken by stripping it of its nuclear weapons and taking its natural resources. ‘They will always try to put it on a chain,’ he said. ‘As soon as they succeed in doing so they will tear out its fangs and claws.’ That, he said, would leave it nothing but a ‘stuffed animal’.”
December 17 – Wall Street Journal (Chiara Albanese and David Enrich): “Global banks are curtailing the flow of cash to Russian entities, a response to the ruble’s sharpest selloff since the 1998 financial crisis. Such banks as Goldman Sachs… this week started rejecting requests from institutional clients to engage in certain ruble-denominated repurchase agreements and other transactions designed to raise cash… Bankers and traders say the moves to restrict some ruble transactions have become increasingly widespread among major Western financial institutions this week… The moves, which the banks are deploying to protect themselves against further swings in the currency, have the potential to add to the strain on Russia’s financial system.”
December 19 – Bloomberg (Vladimir Kuznetsov): “Trust between Russian lenders is breaking down after the biggest ruble rout since the country’s 1998 default, sending interbank rates to the highest in eight years. The Mosprime overnight rate jumped to 27.3% yesterday, the highest since Bloomberg started compiling the data in 2006. It declined to 25% today compared with from 11.85% a week ago… ‘Banks are either demanding additional collateral, or asking to close deals and then reducing limits on the counterparty,’ Oleg Kouzmin, an analyst at Renaissance Capital in Moscow, said… ‘Gradually, the situation is getting worse, the market is shrinking.’”
December 19 – Bloomberg (Daryna Krasnolutska): “Ukraine’s credit rating was cut by Standard & Poor’s, which said a default could become inevitable as central bank reserves are melting and a bailout is being held up as fighting in the country’s easternmost regions continues. S&P lowered the long-term sovereign rating one level to CCC-… ‘A default could become inevitable in the next few months if circumstances do not change, for instance if additional international financial support is not forthcoming,’ S&P analysts led by Ana Jelenkovic said…”
Brazil Watch:
December 17 – Bloomberg (Julia Leite): “Petroleo Brasileiro SA, Brazil’s state- controlled oil producer, would be a junk-rated company if it weren’t for the government’s support, Standard & Poor’s said. Petrobras’s so-called stand-alone credit rating was lowered two steps to BB, S&P said…, citing a corruption investigation… The company’s benchmark bonds due 2021 have slumped to a record low of about 88 cents on the dollar after Petrobras delayed reporting its financial results amid Brazil’s largest- ever money laundering probe.”
December 16 – Bloomberg (Sabrina Valle and Leonardo Silva): “Petroleo Brasileiro SA, the biggest oil producer in ultra-deep waters, is curbing refining and exploration spending in response to the collapse in prices and difficulties tapping debt markets during a corruption probe, said two people with direct knowledge of the matter. The state-run oil company known as Petrobras plans to freeze investments in the Premium I and Premium II refineries in northeastern Brazil and sell assets to protect its cash position…”
EM Bubble Watch:
December 15 – Bloomberg (Boris Korby): “Emerging markets are ending the year much like how they began it -- in freefall. From Russia to Venezuela, Thailand to Brazil, stocks, bonds and currencies across the developing world are plunging. The Russian ruble tumbled past 60 for the first time on record today while Venezuelan bonds sank below 40 cents on the dollar and Thai stocks fell the most in 11 months. Brazil’s corporate debt market is reeling as a graft probe of state oil producer Petroleo Brasileiro SA infects the market. All of this has something of a familiar feel to it, dating back to 1998, when, just like now, oil was tumbling and driving crude exporters Russia and Venezuela into financial crisis.”
December 15 – Bloomberg (Ken Kohn and Minh Bui): “Investors withdrew more than $2.5 billion from U.S. exchange-traded funds that buy emerging-market stocks and bonds last week, the biggest outflow since January… The last time outflows were greater was in the week of Jan. 27, when they reached $4.46 billion, the most this year. All 24 of the emerging markets tracked by ETFs saw withdrawals…”
December 17 – Bloomberg (Benjamin Harvey): “President Recep Tayyip Erdogan is reviving a political battle that helped drive the Turkish lira to a record low in January, and again yesterday. The currency weakened to an all-time low and two-year note yields rose the most in emerging markets after Russia yesterday, as police detained at least 20 people at media groups linked to a U.S.-based cleric accused by Erdogan of plotting against the government… ‘Political risk draws attention to Turkey’s domestic and external weaknesses -- particularly at a time when sentiment towards risk assets is deteriorating markedly,’ Nicholas Spiro, managing director of Spiro Sovereign Strategy…said… ‘What’s patently clear is that the lira remains one of the most vulnerable emerging market currencies.’”
Europe Watch:
December 18 – Financial Times (Kerin Hope): “Greek lawmakers failed to elect Stavros Dimas as the country’s next president in Wednesday’s first-round vote, but the result indicated he could still scrape a win in the final ballot on Dec 29 and avert a snap general election. Mr Dimas captured 155 votes from the governing coalition and another five from independent deputies. He needs 180 votes to secure victory in the third and final round… Mr Samaras’s decision to bring forward the presidential election by two months has sparked turmoil on financial markets and prompted fears that prolonged political instability could even put at risk Greece’s membership of the eurozone. Opinion polls suggest that the radical leftwing Syriza party, which wants to restructure Greece’s sovereign debt while boosting public spending in defiance of the country’s bailout agreement, would come first in a general election. Mr Samaras has warned that this would threaten a fragile economic recovery following an unprecedented six-year recession.”
Global Bubble Watch:
December 17 – New York Times (Neil Irwin): “It has been a hairy 24 hours in global financial markets, particularly for anyone who works in the oil business or has a stake in the health of Russia’s economy. But what is really going on, and what does it mean for the United States? With the Russian ruble in near free fall, the country’s central bank announced an emergency interest rate increase at 1 a.m. Moscow time on Tuesday, raising its main interest rate 6.5 percentage points to a whopping 17%. The idea was to make the ruble more attractive with the very high interest rates it might earn, and thus avert the outflow of capital that has driven the currency down since summer. The initial results were promising, with a brief uptick in the value of the ruble. But it didn’t last. After falling about 11% Monday, the ruble was down a further 10% against the dollar early Tuesday, before rebounding to be down 6%...”
December 18 – Reuters: “China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall. Wang Yungui, head of policy and regulations for the State Administration of Foreign Exchange (SAFE), told a news conference that China was paying attention considering the close economic relationship between the two. ‘We haven't seen a significant impact on our cross-border capital flows,’ he said. Chinese Foreign Ministry spokesman Qin Gang… added that he believed Russia would overcome its problems. ‘Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,’ Qin said. China's exports to Russia rose an on-year 10.5% and imports went up 2.9% in the first three quarters of the year, with total trade valued at $70.78 billion.”
December 19 – Bloomberg (Luca Casiraghi and Cordell Eddings): Junk-bond investors worldwide are forfeiting all the gains they’ve accumulated this year as a selloff triggered by plunging oil prices thrusts the debt toward its first loss since the financial crisis. The worst monthly performance in more than three years has eroded returns on speculative-grade debt, shrinking the year’s gain to 0.15% after ending November at 4.34%... That puts the debt on pace to hand investors their first annual loss since it gave up 27% in 2008… With energy-company bonds making up more than 10% of the global high-yield market, investors are shunning the debt on concern that oil prices below $60 a barrel will precipitate defaults. More than $80 billion has been wiped off the value of junk securities worldwide in the past month.”
December 17 – Bloomberg (John Glover): “The cost of insuring against losses on Societe Generale SA’s junior bonds jumped to the highest in more than a year amid concern it will be hurt by Russia’s financial crisis. The second-biggest French lender owns Moscow-based Rosbank and has about 25 billion euros ($31bn) of exposure to the Russian economy, according to Citigroup Inc. That’s equivalent to 62% of the bank’s equity and the largest amount for European institutions. ‘SocGen’s one of the banks that’s most exposed to Russia,’ said Robert Montague, an analyst at ECM Asset Management… Credit-default swaps insuring SocGen’s subordinated bonds rose 24 bps to 225.5 bps… That’s the highest since October 2013, the data show.”
December 16 – Financial Times (Christopher Adams): “Almost $1tn of spending on future oil projects is at risk after a brutal plunge in crude prices to nearly $60 a barrel, Goldman Sachs has warned. Any cancellation of these developments would deprive the world of 7.5m barrels a day of new output over the coming decade — or 8% of current global oil demand. The findings suggest the supply glut that has sent prices tumbling could soon vanish as the oil majors delay big-ticket production projects — the lifeblood of future petrol supplies, heating fuels and chemicals… The price plunge has shaken the energy industry, throwing some of the majors’ most ambitious plans into doubt and pummelling oil company shares. Projects in challenging frontier regions like the deep waters of the Gulf of Mexico are predicated on high oil prices and may not be economic with oil at $60 a barrel…”
Geopolitical Watch:
December 19 - South China Morning Post (Teddy Ng): “China is preparing to flex its financial strength amid the economic crisis in Russia as it closely watches how the slump of the Russian rouble affects cooperation between the two countries, mainland analysts have said. They said Beijing was unlikely to send aid to Moscow, but it would boost infrastructure and investment projects to stop the collapse of the Russian economy, a result that would hurt the two nations’ joint attempts to build influence in international affairs. China and Russia have both described their relationship as reaching a ‘new stage’ after the signing of massive cooperation deals in recent months… Companies have already started talks about building the necessary pipeline to deliver the gas. But a continued drop in the Russian economy could leave Moscow unable to complete the pipeline, and Chinese capital – possibly a concessionary loan – could be required, analysts said.”
December 18 – Bloomberg: “China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers, according to people familiar with the effort. The push comes after a test of domestic alternatives in the northeastern city of Siping that was deemed a success, said the people, who asked not to be named because the details aren’t public. Workers there replaced Microsoft Corp.’s Windows with a homegrown operating system called NeoKylin and swapped foreign servers for ones made by China’s Inspur Group Ltd., they said. The plan for changes in four segments of the economy is driven by national security concerns and marks an increasingly determined move away from foreign suppliers under President Xi Jinping, the people said.”
December 13 – Reuters (Jim Finkle): “The Federal Bureau of Investigation has warned U.S. businesses to be on the alert for a sophisticated Iranian hacking operation whose targets include defense contractors, energy firms and educational institutions, according to a confidential agency document. The operation is the same as one flagged last week by cyber security firm Cylance Inc as targeting critical infrastructure organizations worldwide, cyber security experts said. Cylance has said it uncovered more than 50 victims from what it dubbed Operation Cleaver, in 16 countries, including the United States… Cylance Chief Executive Stuart McClure said the FBI warning suggested that the Iranian hacking campaign may have been larger than its own research revealed. ‘It underscores Iran's determination and fixation on large-scale compromise of critical infrastructure,’ he said.”
China Bubble Watch:
December 15 – Bloomberg: “What if a central bank cut interest rates and borrowing costs rose? Since the People’s Bank of China surprised markets with the first benchmark rate reduction in two years on Nov. 21, the five-year sovereign bond yield climbed 15 bps, that for similar AAA corporate notes surged 35 and AA debt yields jumped 74. While finance companies did start charging less for mortgages, their funding costs rose as the one-week Shanghai interbank lending rate added 39 basis points. The PBOC move misfired as it triggered an 18% surge in the Shanghai Composite Index of shares… ‘Financing costs moved in the opposite way than the central bank wished,’ said Deng Haiqing, Beijing-based chief fixed-income analyst at Citic Securities Co., China’s biggest brokerage. ‘We don’t think the call for aggressive interest rate or reserve-requirement ratio cuts are well-grounded under current circumstances, as it could fuel bubbles in stocks.’”
December 17 – Bloomberg: “Two local governments in China pulled support for bond sales by their financing vehicles in the space of a week, throwing the market into disarray. On Dec. 12, Changzhou Tianning Construction Development Co. in the eastern province of Jiangsu said it wouldn’t go ahead with a 1.2 billion yuan ($194 million) planned offering after city authorities said they wouldn’t support the debt… This week, officials in Urumqi in the northwestern province of Xinjiang withdrew backing for a planned 1 billion yuan sale, another U-turn. The shakeup was signaled in October when China’s cabinet said that governments have no obligation to repay debt not raised for public works, raising the risk of mothballed construction and defaults in the world’s second-largest economy. While a national audit showed regional liabilities swelled to 17.9 trillion yuan as of June 2013, the actual amount may be greater, China Business News reported… ‘The two local governments’ statements shocked investors,’ said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai.”
December 18 – Bloomberg: “China’s central bank offered short-term loans to commercial lenders as the benchmark money-market rate jumped the most in 11 months. The amount of money made available by the People’s Bank of China wasn’t clear… Policy makers are adding funds to the financial system to address a cash crunch as subscriptions for the biggest new share sales of the year lock up funds. Twelve initial public offerings from today through Dec. 25 will draw orders of as much as 3 trillion yuan ($483 billion), Shenyin & Wanguo Securities Co. estimated. The seven-day repurchase rate, a gauge of interbank funding availability in the banking system, surged 139 bps… to a 10-month high of 5.28%...”
December 16 – Financial Times (Gabriel Wildau): “China’s once high-flying trust industry has seen its fortunes reverse this year as a slowing economy and competition for investor funds curb growth. Trust loans outstanding increased for 33 straight months through June this year, helping China’s trust sector surpass the insurance industry as the largest category of financial institution by assets, behind commercial banks. But figures released on Friday showed trust loans falling for a fifth straight month, the longest run of declines since 2010. Overall trust assets, which include loans, publicly traded securities and private equity-style investments, rose at their slowest pace in over two years in the third quarter… Just a year ago, trust companies were riding a wave of growth. In 2010, as regulators tried to rein in the explosion in bank credit resulting from the country’s Rmb4tn ($645bn) economic stimulus plan, banks turned to trusts to help them comply with lending controls. Trust companies bought loans from banks and packaged them into high-yielding wealth management products, which they marketed to bank clients as a higher yielding substitute for traditional savings deposits. Trust assets surged to Rmb10.3tn at the end of 2013, from just Rmb2.9tn in 2011.”
December 18 – Bloomberg: “New-home prices fell in fewer Chinese cities last month after the government eased property curbs and cut interest rates for the first time since 2012, boosting demand. Prices dropped in 67 cities of the 70… Prices fell in 69 cities in October… New-home prices in the first-tier cities of Beijing, Shanghai, Shenzhen and Guangzhou all declined last month from the same period last year. ‘New-home prices are dropping because the supply is much larger than the demand,’ said Liu Yuan, a Shanghai-based research director for Centaline Group, China’s biggest property agency. ‘The market sentiment and fundamentals are not good enough to drive price up.’ Property developers offering discounts to boost sales to meet year-end targets is also weighing on prices, Liu said.”
December 17 – Bloomberg: “Chinese billionaire Li Shufu’s Geely Automobile Holdings Ltd. said it expects full-year net income to fall about 50% from 2013 because of the slumping Russian currency and declining sales. Depreciation of the ruble resulted an unrealized foreign-exchange loss from operations in Russia, Geely said… Sales volume dropped 26% in the first 11 months of the year, led by a 49% decline in export markets…”
The Russian ruble traded Tuesday at low as 79.17 to the dollar (after beginning the year at 33), before closing the week at 59.61. At Tuesday’s record low, the ruble was down 20% for the day, before a late-session rally cut the loss to 5.4%. The ruble was under pressure again early-Wednesday, until major buying pushed the ruble to a 10.3% session gain. By the time of Putin’s annual (three-hour) press conference on Thursday, the ruble and Russia bonds had miraculously stabilized. The world’s risk markets rejoiced the thought of the deep-pocket Chinese resolving Russia’s crisis: Bubble On.
If forced to venture a guess, I’d say the Chinese were actively supporting the ruble and Russian debt on Wednesday and Thursday. Early Thursday from Reuters: “China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall… Chinese Foreign Ministry spokesman Qin Gang, speaking at a later news conference, added that he believed Russia would overcome its problems. ‘Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,’ Qin said.”
And early Thursday from the South China Morning Post: “Russia May Seek China Help to Deal with Crisis: Russia could fall back on its 150 billion yuam currency swap agreement with China if the rouble continues to plunge… The deal was signed by the two central banks in October, when Premier Li Keqiang visited Russia. ‘Russia badly needs liquidity support and the swap line could be an ideal too,’ said Ban of Communications chief economist Lian Ping.”
The South China Morning Post came later with additional articles, including “Beijing May Spend Bigger in Russia,” and “Russia’s Currency Crisis Poses Risks to Other Emerging Markets.”
December 19 – Bloomberg: “China offered enhanced economic ties with Russia at a regional summit this week as its northern neighbor struggled to contain a currency crisis. ‘To help counteract an economic slowdown, China is ready to provide financial aid to develop cooperation,’ Premier Li Keqiang said… While the remark applied to any of the five other nations represented at the meeting of the Shanghai Cooperation Organization group, it was directed at Russia… Any rescue package for Russia would give China the opportunity of exercising the kind of great-power leadership the U.S. has demonstrated for a century -- sustaining other economies with its superior financial resources. President Xi Jinping last month called for China to adopt ‘big-country diplomacy’ as he laid out goals for elevating his nation’s status. ‘If the Kremlin decides to seek assistance from Beijing, it’s very unlikely for the Xi leadership to turn it down,’ said Cheng Yijun, senior researcher with the Institute of Russian, Eastern European, Central Asian Studies at the Chinese Academy of Social Sciences in Beijing. ‘This would be a perfect opportunity to demonstrate China is a friend indeed, and also its big power status.’”
I’ll speculate that the Chinese were becoming increasingly nervous – nervous about Russia, nervous about EM and nervous about China. Global markets on Tuesday again found themselves at the precipice. The ruble collapse was exacerbating a general flight out of EM currencies, bonds and stocks. Marketplace liquidity was evaporating – leading to brutal contagion at the Periphery and increasingly destabilizing de-risking/de-leveraging at the Core. In short, Bubble Off was taking over – in yet another market “critical juncture.” The ruble (miraculously) reversed course, EM rallied, global markets for the most part reversed and the “Core” U.S. equities market took flight. From Wednesday's lows to Friday’s highs, the Dow surged 800 points, or 4.7%. Bubble On. “Risk on” no longer does justice.
Most would likely challenge my view of the markets being at the “precipice” during Tuesday trading. Let me back up my claim. Tuesday trading saw a major Emerging Market CDS (Credit default swap) index jump to the highest level since the tumultuous summer of 2012. On Tuesday, the Brazilian real traded to a new nine-year low (trading down as much as 2.8% intraday). Interestingly, Brazil CDS surged to 268 intraday Tuesday, up from Friday’s close of 212 and 153 to start the month. Tuesday’s high actually surpassed the 2013, 2012 and 2011 spikes – to the highest level since 2009.
It’s worth noting that CDS traded to multi-year highs for the major Brazilian financial institutions. Banco do Brasil surged to over 420 on Tuesday before ending the week up 28 bps to 315 bps. BNDES (Brazil’s national development bank) CDS spiked higher Tuesday, before ending the week up 52 bps to 234. Banco Bradesco CDX traded to 300, before ending the week up 21 to 266 bps.
My thesis has been that the “global government finance Bubble” has burst at the Periphery. EM sovereign, corporate and financial debt is the global “system’s” weak link. Dollar-denominated EM debt in particular is the unfolding crisis’ “toxic” debt. Regrettably, Brazil is right in the thick of it.
Last week I wrote that the EM dollar-denominated debt dam had given way. This dynamic was clearly in play early in the week. Russia dollar bond yields traded as high at 7.88% Tuesday, up from the previous week’s closing 6.76%. Ukrainian dollar yields surpassed 32.5% Tuesday, before ending the week at 26.52%. Venezuela dollar bond yields jumped to 27.85% on Tuesday, up from Friday’s closing 24.28% - before ending the week at 22.29%. Brazilian 10-year dollar yields rose as high as 5.28%, up from the previous week’s 4.82%. Turkey dollar yields traded as high as 4.88% on Tuesday, up from last Friday’s 4.52%. Colombia yields jumped to 4.40%, up from the previous week’s 4.16%.
Turkey (lira) bond yields this week traded at high as 8.60%, up from 7.62% to begin the month. The lira traded to a record low Tuesday. Indonesia yields rose to 8.48%, up from 7.70% to start December. The rupiah Tuesday traded to the lowest level versus the dollar since 1998. South African yields this week traded as high as 8.12%, up from last Friday's 7.60%. Tuesday saw the rand trade to the lowest level since 2000. Eastern European currencies were under notable pressure. For the week, the Hungarian forint declined 4.3%, the Polish zloty 3.6%, the Czech koruna 2.5%, the Bulgarian lev 1.8% and the Romanian leu 1.7%. Iceland’s krona fell 2.5% this week.
It wasn’t just EM under pressure earlier in the week. Greek five-year yields traded to 9.80% Tuesday, up from the previous Friday’s 9.65% close - to the highest level since the 2012 European crisis. Greek CDS traded as high at 1,178 – before closing the week at 1,025. Italian CDS traded to 165 bps Tuesday (10-month high), before ending the week about unchanged at 142. There’s been an interesting divergence of late between declining sovereign yields and rising CDS prices in Italy, Spain and Portugal.
Part of my thesis back in 2012 was that a crisis of confidence in Italian debt was about to provoke a crisis of confidence in the European banking system and the euro. I believed a loss of confidence in European banks risked a major global crisis involving derivatives, counter-party issues and funding of leveraged speculation. A Bloomberg headline from Wednesday caught my attention: “SocGen [French bank Society Generale Default Swaps Jump to One-Year High on Russia Turmoil.”
SocGen (subordinated debt) CDS traded to 225 bps on Wednesday (closed week at 200), after beginning the month at 171. An index of European (subordinated) bank CDS traded Tuesday almost back to the highs from the October market tumult. An index of European high-yield corporate debt also spiked Tuesday back to October Tumult levels. Basically, CDS has been rising just about everywhere. Japan CDS traded to 75 on Tuesday, now more than double the level from September lows (to an 18-month high).
Here at home, 10-year Treasury yields traded to 2.01% Tuesday, the low going back to May 2013. The week saw more all-time record low yields in Germany (0.59%), France (0.87%), Spain (1.70%), Netherlands (0.74%) and Austria (0.75%), among others.
December 19 – Financial Times (Tracy Alloway): “Big investors have been buying hundreds of billions of dollars worth of exotic credit derivatives to protect themselves against the possibility that growing numbers of corporate bond issuers will default. Options that give investors the right to buy insurance against bond defaults have exploded in popularity this year as asset managers and hedge funds seek to affordably offset the risk of a big blow-up in credit. Trading volumes of the instruments — known as credit index options or 'swaptions' — have jumped 148% in the past 12 months, with about $1.4tn of the instruments exchanging hands in 2014 compared with $573bn in 2013. ‘You can buy a very leveraged bet that the market will collapse using credit index options,’ said Andrew Jackson, chief investment officer at Cairn Capital. He added: ‘That is definitely the hedge of choice for real money investors who don’t really care that much about the level of volatility, but care about the amount of dollars they’re paying to hedge against Armageddon risk.’ Credit indices, such as Markit’s iTraxx or CDX series, are credit default swaps (CDS) written on baskets of corporate credits that investors and traders may use to hedge, or offset, their exposure to corporate debt or to make bets on the way the underlying companies will perform. Credit index options act in a similar way to options on other assets, such as stocks, by giving the holder the right to enter into a CDS contract at a certain time in the future. According to Citigroup research, asset managers account for a quarter of the total credit index options volume, compared with 15% just a year ago.”
Early-week instability evoked talk of the 1998 market crisis. A Bloomberg headline: “Memories of 1998 Rekindled in Routs From Russia to Venezuela.” I was convinced in early-1998 that Russia was the likely next big domino to drop after the brutal 1997 collapse of the “Asian Tiger miracle economies.” And I recall an FT article that highlighted the spectacular growth in derivatives to protect against a ruble decline. The knowledge that huge derivative “insurance” positions had accumulated convinced me that collapse was inevitable.
It’s time to ponder the ramifications of accumulating hedges against “Armageddon risk,” positions with potentially highly leveraged options and “swaptions” derivative instruments. This has become an important market issue. And it’s troubling to see that the trading of these types of instruments has exploded right along with trading options on equity volatility indices (i.e. VIX, VXX, etc.). Coincidently, I was listening to a conversation this week that went something like this: “Everyone is hedged (against market risk). Who is on the other side of these trades?”
Long-time readers know I am no fan of Credit and market “insurance.” Cheap insurance invariably fuels excess on the upside of the boom, only later to ensure dislocation when the Bubble burst. Basically, Credit and market risks are uninsurable – they are neither random nor independent events (such as auto accidents and house fires). I won’t this week dive back into this fascinating theoretical topic.
I believe options and swaptions on corporate Credit are exceptionally dangerous. I also believe they likely help to explain some of this year’s (and this week’s!) unusual market trading dynamics. Again, think “Bubble On, Bubble Off.” Who is on the other side of the explosion of Credit and market insurance? Computers and models. If a customer buys an option on a CDS contract – a computerized trading system will dictate how much of the underlying instrument that must be either bought or sold to “hedge” the contract sold. And as market prices change, “dynamic" trading strategies will adjust trading positions accordingly. If prices move little, there will be little to do on the trading/hedging side. If prices move a lot, there will be a major trading effort involved. Big price changes ensure a trend-following bias.
The embedded leverage in “Armageddon” trading strategies generally causes little issue. Think, for example, if you go out and purchase a 25% out-of-the-money put option on the equity market (crash protection). For the most part, the (derivative counter-) party that wrote this market insurance has little to do or worry about - so long as the market is quiescent. But if the market suddenly is on a downward spiral, the computerized trading model will dictate that a short position be established as a partial hedge against the “insurance” written. If the market continues to decline, more selling will be required to ensure a trading position that will generate sufficient cash-flow (trading gain) to pay on the insurance contract. And as this “out of the money” option gets closer to the “strike” price, the amount of (“delta”) trading necessary to hedge rises exponentially. But if the market then abruptly recovers, loss avoidance will require that this short position market hedge be unwound into a rising market.
The Fed and global central bankers have had a profound role on derivatives markets. I would argue that many of these key financial “insurance” markets are viable only because of central bank assurances of “liquid and continuous” markets. Certainly, the proliferation of these types of products would not be possible if not for the view that central banks will protect against market crisis. Who would write market and Credit insurance if they lacked confidence in central banks underpinning the markets?
The proliferation of Credit “insurance” over recent years is an especially fascinating issue. With unlimited central bank “money” printing, why not book easy profits by insuring against Credit losses? Why not write “flood insurance” when central bankers are ensuring drought? Why not write CDS (default protection) contracts for easy returns? And those on the other side of the derivative trade can simply buy corporate debt (on leverage, of course), to provide the cash-flows to pay on the contracts sold. And with CDS “insurance” so cheap and liquid, it’s perfectly rational for others to position aggressively long corporate Credit, while purchasing option protection just in case of “Armageddon.” This dynamic has had a profound impact on Credit Availability and loose financial conditions more generally. It's also pro-"Bo, Bo."
Actually, I think “do whatever it takes” central bank "money" printing coupled with zero rates has spurred risk-taking and a resulting historic Bubble throughout high-yield debt. CDS and derivatives more generally have played a profound role – creating significant unappreciated leverage on the upside of the boom. Now, with the global Bubble bursting, this “insurance” marketplace holds the potential to incite an abrupt tightening of Credit conditions (has it already commenced?) On the one hand, a widening of spreads and higher CDS prices will lead to some unwinding of derivative-related leverage. Worse yet, the proliferation of “out-of-the-money” option “Armageddon” protection will dictate that those that have written these derivatives short securities as market and Credit backdrops deteriorate.
I believe that the Trillions of Credit “insurance” derivatives in the marketplace help to explain volatile and now generally unstable markets. It helps explain why high-yield CDS has gyrated over the past year – beginning the year just over 300 – jumping to 360 in February – sinking to about 290 in July, only to spike to 355 in August - to fall back to 310 bps in early September. Things turned only more interesting over recent months. CDS spiked to almost 370 in late-September and then dropped back to 330 bps in early October. High-yield CDS then traded to 400 during the October Tumult, before again sinking back below 330 in late-November. CDS closed Tuesday at 406 bps.
When the Russia currency and bond collapse unfolded in October 1998, derivative trading strategies played a significant role. Hedging and speculation created overwhelming market selling pressure and resulting illiquidity. In the end, Russian banks that had written ruble insurance collapsed right along with the ruble and the Russian debt market. I have no doubt that derivatives and associated “dynamic” trading strategies will play a major destabilizing role in the unfolding global financial crisis.
And more from the FT: “The surge in trading of credit index options stands in stark contrast to the CDS market itself, which has been shrinking dramatically since the financial crisis. The derivatives were widely blamed for exacerbating the crisis and have since come under tighter regulatory scrutiny and control, including a requirement that they be ‘cleared’ through exchange-like central counter-parties. Unlike CDS, options on CDS indices are not yet required to be centrally cleared. ‘Every single month in 2014 experienced volume growth compared to the same period in 2013, which suggests the growth was not seasonal, or in response to one-off events in 2014,’ the Citi analysts said. “Credit options are currently one of the fastest growing areas in credit derivatives.”
There’s a fascinating aspect of Periphery to Core dynamics that I believe today underpins “Bo, Bo.” I’ve written extensively on how cracks (and even a bursting Bubble) at the Periphery work initially to funnel “hot money” flows to the bubbling Core. Importantly, this dynamic also promotes the accumulation of derivative risk “insurance” positions. First, trouble at the Periphery provides impetus for the discerning to hedge mounting systemic risk. Second, an over-liquefied Core ensures readily available inexpensive insurance – cheap insurance that spurs late-cycle risk-taking along with general complacency.
Indeed, this dynamic now plays a critical role in prolonged “blow off” excesses. Importantly, when the Core begins to succumb to the faltering Bubble this massive derivatives (hedging/speculating) trade will overhang system stability. The market cannot hedge market risk. There’s no one with the wherewithal to “take the other side of the trade.” The “other side” is instead a computer model, programmed to dump sell orders into declining markets. Liquidity will inevitably become a critical problem.
A year ago this week I was invited to participate in a company event – a bull vs. bear debate. I presented my Bubble thesis, arguing against the bullish “house” view. I posed what I am convinced is a fundamental question: “Is the underlying money and Credit sound or unsound?” I also included the following: “I do not sit around worrying about my reputation or my career prospects. I am driven by two things: analytical integrity and the quality of my analysis.” I would have it no other way.
For the Week:
The S&P500 rallied 3.4% (up 12.0% y-t-d), and the Dow gained 3.0% (up 7.4%). The Utilities jumped 2.8% (up 23.4%). The Banks rose 2.9% (up 6.7%), and the Broker/Dealers surged 3.9% (up 14.8%). Transports gained 1.7% (up 21.5%). The S&P 400 Midcaps advanced 3.4% (up 8.0%), and the small cap Russell 2000 jumped 3.8% (up 2.8%). The Nasdaq100 gained 2.0% (up 19.2%), and the Morgan Stanley High Tech index jumped 3.9% (up 13.0%). The Semiconductors rose 2.2% (up 28.2%). The Biotechs surged 3.7% (up 52.1%). Although bullion dropped $26.20, the HUI gold index was little changed (down 16.4%).
One-month Treasury bill rates closed the week at one basis point and three-month rates ended at three bps. Two-year government yields jumped 10 bps to 0.64% (up 26bps y-t-d). Five-year T-note yields rose 14 bps to 1.65% (down 10bps). Ten-year Treasury yields gained eight bps to 2.16% (down 87bps). Long bond yields added two bps to 2.76% (down 121bps). Benchmark Fannie MBS yields were up three bps to 2.83% (down 78bps). The spread between benchmark MBS and 10-year Treasury yields narrowed five to 67 bps. The implied yield on December 2015 eurodollar futures rose nine bps to 0.92%. The two-year dollar swap spread was little changed at 23 bps, and the 10-year swap spread was about unchanged at 13 bps. Corporate bond spreads reversed sharply narrower. An index of investment grade bond risk dropped seven to 65 bps. An index of junk bond risk sank 48 bps to 348 bps. An index of emerging market (EM) debt risk fell 28 bps to 355 bps.
Greek 10-year yields dropped 71 bps to 8.43% (up one basis point y-t-d). Ten-year Portuguese yields sank 25 bps to 2.73% (down 341bps). Italian 10-yr yields fell 11 bps to 1.95% (down 217bps). Spain's 10-year yields dropped 18 bps to 1.70% (down 245bps). German bund yields declined three bps to a record low 0.59% (down 134bps). French yields sank 11 bps to a record low 0.89% (down 167bps). The French to German 10-year bond spread narrowed eight to 30 bps. U.K. 10-year gilt yields rose five bps to 1.85% (down 117bps).
Japan's Nikkei equities index gained 1.4% (up 8.2% y-t-d). Japanese 10-year "JGB" yields dropped four bps to a record low 0.35% (down 39bps). The German DAX equities index rallied 2.0% (up 2.5%). Spain's IBEX 35 equities index gained 1.2% (up 4.5%). Italy's FTSE MIB index was up 2.1% (unchanged). Emerging equities were again wildly volatile. Brazil's Bovespa index recovered 3.4% (down 3.6%). Mexico's Bolsa gained 2.0% (down 0.5%). South Korea's Kospi index added 0.4% (down 4.1%). India’s Sensex equities index was little changed (up 29.3%). China’s Shanghai Exchange surged another 5.8% (up 46.9%). Turkey's Borsa Istanbul National 100 index increased 0.4% (up 23.3%). Russia's MICEX equities index slipped 0.7% (down 3.7%).
Debt issuance has slowed to a drip. I saw no investment-grade or convertible debt issues.
Junk funds saw outflows jump to $3.08bn (from Lipper), the largest outflows since August. Junk issuers this week included Global Cash Access $700 million.
International dollar debt issuers included Alliance Bank $237 million and Energia Eolica $204 million.
Freddie Mac 30-year fixed mortgage rates dropped 13 bps to 3.80% (down 67bps y-o-y). Fifteen-year rates fell 11 bps to 3.09% (down 42bps). One-year ARM rates declined two bps to 2.38% (down 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.19% (down 44bps).
Federal Reserve Credit last week expanded $16.1bn to a record $4.464 TN. During the past year, Fed Credit inflated $505bn, or 12.8%. Fed Credit inflated $1.653 TN, or 59%, over the past 110 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $3.9bn last week to $3.328 TN. "Custody holdings" were down $25.7bn year-to-date and fell $51.5bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $237bn y-o-y, or 2.1%, to $11.774 TN. Over two years, reserves were $929bn higher for 9% growth.
M2 (narrow) "money" supply expanded $5.3bn to a record $11.608 TN. "Narrow money" expanded $635bn, or 5.79%, over the past year. For the week, Currency increased $2.5bn. Total Checkable Deposits jumped $33bn, while Savings Deposits fell $28.7bn. Small Time Deposits declined $1.7bn. Retail Money Funds were little changed.
Money market fund assets declined $13.4bn to $2.693 TN. Money Funds were down $25.7bn y-t-d, while increasing $17.7bn from a year ago, or 0.7%.
Total Commercial Paper dropped $12.5bn to $1.074 TN. CP expanded $28.5bn year-to-date, while declining $11.3bn over the past year, or 1.0%.
Currency Watch:
December 18 – Bloomberg (Justina Lee): “Yuan forwards fell to a two-year low after the central bank reduced the currency’s fixing by the most in six weeks amid dollar demand on bets the U.S. will increase interest rates next year.”
The U.S. dollar index gained 1.4% to 89.60 (up 11.9% y-t-d). For the week on the upside, the Mexican peso increased 1.1%, the South Korean won 0.1% and the South African rand 0.1%. For the week on the downside, Swedish krona declined 2.4%, the Swiss franc 2.1%, the euro 1.9%, the Danish krone 1.9%, the Australian dollar 1.4%, the Japanese yen 0.6%, the British pound 0.6%, the Taiwanese dollar 0.5%, the New Zealand dollar 0.2%, the Brazilian real 0.2%, the Norwegian krone 0.2%, the Canadian dollar 0.2% and the Singapore dollar 0.1%.
Commodities Watch:
The Goldman Sachs Commodities Index declined another 1.6% to a more than five-year low (down 30.3%). Spot Gold fell 2.1% to $1,196 (down 0.8%). March Silver sank 6.0% to $16.03 (down 17%). January Crude declined 95 cents to $57.13 (down 42%). January Gasoline fell 2.4% (down 44%), and January Natural Gas dropped 6.7% (down 18%). March Copper lost 1.7% (down 15%). March Wheat jumped 4.2% (up 5%). March Corn increased 0.7% (down 3%).
U.S. Fixed Income Bubble Watch:
December 17 – Bloomberg (Kristen Haunss and Luca Casiraghi): “Wall Street dealers are bracing for a steep drop in issuance of collateralized loan obligations after a record amount of the debt was raised this year, threatening to boost borrowing costs for the neediest companies. Rules designed to limit risk-taking may mean CLO sales will be at least 41% less than the unprecedented $119.2 billion issued so far in 2014, according to the most pessimistic forecast by JPMorgan… CLOs helped finance some of the biggest leveraged buyouts in history, and the outlook for a drop in issuance comes as prices in the more-than $800 billion market for high-yield, high-risk loans are already near a two-year low and the debt is on track to deliver annual losses for the first time since 2008.”
U.S. Bubble Watch:
December 15 – Bloomberg (Bradley Olson and Tim Loh): “Autry Stephens knows the look and feel of an oil boom going bust, and he’s starting to get ready. The West Texas wildcatter, 76, has weathered four such cycles in his 52 years draining crude from the Permian basin… Though the collapse in prices since June doesn’t yet have him in a panic, Stephens recognizes the signs of another downturn on the horizon. And like many bust-hardened veterans in this region -- which has made and broken the fortunes of thousands -- he’s talking about it like a gathering storm. The ups and downs of oil are a way of life in Midland and Odessa, Texas, dating all the way back to the Great Depression… ‘We’re going to hunker down and go into survival mode,’ Stephens, founder of Endeavor Energy Resources LP, said… ‘Stay alive is our mantra, until the price recovers.’ Go about 1,300 miles due north and you get a very different take from the rookie oil barons in North Dakota, where crude output from the Bakken formation went from 200,000 barrels a day in 2008 to about 1.2 million today. They’re not seeing any need to take shelter, and it shows in their swagger.”
Federal Reserve Watch:
December 19 – Bloomberg (Craig Torres): Federal Reserve officials see the federal funds rate rising less by the end of 2015 than they projected three months ago, according to the median estimate of new forecasts released today. They also forecast the economy will be at full employment by the end of next year. The benchmark rate will be 1.125% at the end of next year, compared with a 1.375% median estimate in September… The rate will be 2.5% at the end of 2016, and 3.625% at the end of 2017, according to the median. Federal Open Market Committee participants said they don’t expect to reach their 2% target for inflation until 2016…”
ECB Watch:
December 16 – Bloomberg (Jeff Black and Jana Randow): “Jens Weidmann said there’s no need for the European Central Bank to expand monetary stimulus, and argued that sovereign-debt purchases are problematic even if slumping oil prices cause deflation. ‘Such a development initially requires no monetary policy response, as long as no second round effects are to be seen,’ the Bundesbank president said… ‘There’s a whole row of economic reasons that speak against government-bond purchases, even before you consider the legal question of whether they’re compatible with the ban on monetary financing.’ …Weidmann, and up to five other Governing Council members, are against pre-announcing government-bond buying before the effects of existing programs can be judged. ‘We have already acted, pre-emptively, in the expectation of a worsening of the economic situation,’ Weidmann said. ‘But this plays only a minor role in the discussion. Instead, it’s only ever asked, ‘what is coming next?’ And then mostly the question, ‘when will you finally buy government bonds?’ That raises the expectations for this measure to such a level that they can only be disappointed.’”
Central Bank Watch:
December 18 – Bloomberg (Zoe Schneeweiss and Jan Schwalbe): “The Swiss National Bank imposed the country’s first negative deposit rate since the 1970s as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. A charge of 0.25% on sight deposits… will apply as of Jan. 22… The SNB move follows Russia’s surprise interest-rate increase this week and hints at the investment pressures that resulted after that decision failed to stem a run on the ruble. Swiss officials acted as the turmoil, along with the imminent threat of quantitative easing from the ECB, kept the franc too close to its 1.20 per euro ceiling for comfort.”
Russia/Ukraine Watch:
December 19 – Financial Times (Courtney Weaver and Jack Farchy): “A defiant Vladimir Putin said Russia should brace itself for two years of recession, as he blamed economic woes on a western plot to defang the Russian bear. The president was speaking at a three-hour press conference during which he addressed this week’s market turmoil in public for the first time. He claimed that a period of economic hardship was the price Russia would have to pay to maintain its independence in the face of western aggression, repeatedly blaming the rouble’s plunge and a looming recession on ‘external factors’. In a metaphor that summed up his entire performance, he compared Russia to a bear which the west was trying to weaken by stripping it of its nuclear weapons and taking its natural resources. ‘They will always try to put it on a chain,’ he said. ‘As soon as they succeed in doing so they will tear out its fangs and claws.’ That, he said, would leave it nothing but a ‘stuffed animal’.”
December 17 – Wall Street Journal (Chiara Albanese and David Enrich): “Global banks are curtailing the flow of cash to Russian entities, a response to the ruble’s sharpest selloff since the 1998 financial crisis. Such banks as Goldman Sachs… this week started rejecting requests from institutional clients to engage in certain ruble-denominated repurchase agreements and other transactions designed to raise cash… Bankers and traders say the moves to restrict some ruble transactions have become increasingly widespread among major Western financial institutions this week… The moves, which the banks are deploying to protect themselves against further swings in the currency, have the potential to add to the strain on Russia’s financial system.”
December 19 – Bloomberg (Vladimir Kuznetsov): “Trust between Russian lenders is breaking down after the biggest ruble rout since the country’s 1998 default, sending interbank rates to the highest in eight years. The Mosprime overnight rate jumped to 27.3% yesterday, the highest since Bloomberg started compiling the data in 2006. It declined to 25% today compared with from 11.85% a week ago… ‘Banks are either demanding additional collateral, or asking to close deals and then reducing limits on the counterparty,’ Oleg Kouzmin, an analyst at Renaissance Capital in Moscow, said… ‘Gradually, the situation is getting worse, the market is shrinking.’”
December 19 – Bloomberg (Daryna Krasnolutska): “Ukraine’s credit rating was cut by Standard & Poor’s, which said a default could become inevitable as central bank reserves are melting and a bailout is being held up as fighting in the country’s easternmost regions continues. S&P lowered the long-term sovereign rating one level to CCC-… ‘A default could become inevitable in the next few months if circumstances do not change, for instance if additional international financial support is not forthcoming,’ S&P analysts led by Ana Jelenkovic said…”
Brazil Watch:
December 17 – Bloomberg (Julia Leite): “Petroleo Brasileiro SA, Brazil’s state- controlled oil producer, would be a junk-rated company if it weren’t for the government’s support, Standard & Poor’s said. Petrobras’s so-called stand-alone credit rating was lowered two steps to BB, S&P said…, citing a corruption investigation… The company’s benchmark bonds due 2021 have slumped to a record low of about 88 cents on the dollar after Petrobras delayed reporting its financial results amid Brazil’s largest- ever money laundering probe.”
December 16 – Bloomberg (Sabrina Valle and Leonardo Silva): “Petroleo Brasileiro SA, the biggest oil producer in ultra-deep waters, is curbing refining and exploration spending in response to the collapse in prices and difficulties tapping debt markets during a corruption probe, said two people with direct knowledge of the matter. The state-run oil company known as Petrobras plans to freeze investments in the Premium I and Premium II refineries in northeastern Brazil and sell assets to protect its cash position…”
EM Bubble Watch:
December 15 – Bloomberg (Boris Korby): “Emerging markets are ending the year much like how they began it -- in freefall. From Russia to Venezuela, Thailand to Brazil, stocks, bonds and currencies across the developing world are plunging. The Russian ruble tumbled past 60 for the first time on record today while Venezuelan bonds sank below 40 cents on the dollar and Thai stocks fell the most in 11 months. Brazil’s corporate debt market is reeling as a graft probe of state oil producer Petroleo Brasileiro SA infects the market. All of this has something of a familiar feel to it, dating back to 1998, when, just like now, oil was tumbling and driving crude exporters Russia and Venezuela into financial crisis.”
December 15 – Bloomberg (Ken Kohn and Minh Bui): “Investors withdrew more than $2.5 billion from U.S. exchange-traded funds that buy emerging-market stocks and bonds last week, the biggest outflow since January… The last time outflows were greater was in the week of Jan. 27, when they reached $4.46 billion, the most this year. All 24 of the emerging markets tracked by ETFs saw withdrawals…”
December 17 – Bloomberg (Benjamin Harvey): “President Recep Tayyip Erdogan is reviving a political battle that helped drive the Turkish lira to a record low in January, and again yesterday. The currency weakened to an all-time low and two-year note yields rose the most in emerging markets after Russia yesterday, as police detained at least 20 people at media groups linked to a U.S.-based cleric accused by Erdogan of plotting against the government… ‘Political risk draws attention to Turkey’s domestic and external weaknesses -- particularly at a time when sentiment towards risk assets is deteriorating markedly,’ Nicholas Spiro, managing director of Spiro Sovereign Strategy…said… ‘What’s patently clear is that the lira remains one of the most vulnerable emerging market currencies.’”
Europe Watch:
December 18 – Financial Times (Kerin Hope): “Greek lawmakers failed to elect Stavros Dimas as the country’s next president in Wednesday’s first-round vote, but the result indicated he could still scrape a win in the final ballot on Dec 29 and avert a snap general election. Mr Dimas captured 155 votes from the governing coalition and another five from independent deputies. He needs 180 votes to secure victory in the third and final round… Mr Samaras’s decision to bring forward the presidential election by two months has sparked turmoil on financial markets and prompted fears that prolonged political instability could even put at risk Greece’s membership of the eurozone. Opinion polls suggest that the radical leftwing Syriza party, which wants to restructure Greece’s sovereign debt while boosting public spending in defiance of the country’s bailout agreement, would come first in a general election. Mr Samaras has warned that this would threaten a fragile economic recovery following an unprecedented six-year recession.”
Global Bubble Watch:
December 17 – New York Times (Neil Irwin): “It has been a hairy 24 hours in global financial markets, particularly for anyone who works in the oil business or has a stake in the health of Russia’s economy. But what is really going on, and what does it mean for the United States? With the Russian ruble in near free fall, the country’s central bank announced an emergency interest rate increase at 1 a.m. Moscow time on Tuesday, raising its main interest rate 6.5 percentage points to a whopping 17%. The idea was to make the ruble more attractive with the very high interest rates it might earn, and thus avert the outflow of capital that has driven the currency down since summer. The initial results were promising, with a brief uptick in the value of the ruble. But it didn’t last. After falling about 11% Monday, the ruble was down a further 10% against the dollar early Tuesday, before rebounding to be down 6%...”
December 18 – Reuters: “China is closely monitoring the slide in the Russian rouble, the foreign exchange regulator said on Thursday, as the currency of one of its major energy importers struggles to avoid a free-fall. Wang Yungui, head of policy and regulations for the State Administration of Foreign Exchange (SAFE), told a news conference that China was paying attention considering the close economic relationship between the two. ‘We haven't seen a significant impact on our cross-border capital flows,’ he said. Chinese Foreign Ministry spokesman Qin Gang… added that he believed Russia would overcome its problems. ‘Russia has rich resources, quite a good industrial base. We believe that Russia has the ability to overcome its temporary difficulties,’ Qin said. China's exports to Russia rose an on-year 10.5% and imports went up 2.9% in the first three quarters of the year, with total trade valued at $70.78 billion.”
December 19 – Bloomberg (Luca Casiraghi and Cordell Eddings): Junk-bond investors worldwide are forfeiting all the gains they’ve accumulated this year as a selloff triggered by plunging oil prices thrusts the debt toward its first loss since the financial crisis. The worst monthly performance in more than three years has eroded returns on speculative-grade debt, shrinking the year’s gain to 0.15% after ending November at 4.34%... That puts the debt on pace to hand investors their first annual loss since it gave up 27% in 2008… With energy-company bonds making up more than 10% of the global high-yield market, investors are shunning the debt on concern that oil prices below $60 a barrel will precipitate defaults. More than $80 billion has been wiped off the value of junk securities worldwide in the past month.”
December 17 – Bloomberg (John Glover): “The cost of insuring against losses on Societe Generale SA’s junior bonds jumped to the highest in more than a year amid concern it will be hurt by Russia’s financial crisis. The second-biggest French lender owns Moscow-based Rosbank and has about 25 billion euros ($31bn) of exposure to the Russian economy, according to Citigroup Inc. That’s equivalent to 62% of the bank’s equity and the largest amount for European institutions. ‘SocGen’s one of the banks that’s most exposed to Russia,’ said Robert Montague, an analyst at ECM Asset Management… Credit-default swaps insuring SocGen’s subordinated bonds rose 24 bps to 225.5 bps… That’s the highest since October 2013, the data show.”
December 16 – Financial Times (Christopher Adams): “Almost $1tn of spending on future oil projects is at risk after a brutal plunge in crude prices to nearly $60 a barrel, Goldman Sachs has warned. Any cancellation of these developments would deprive the world of 7.5m barrels a day of new output over the coming decade — or 8% of current global oil demand. The findings suggest the supply glut that has sent prices tumbling could soon vanish as the oil majors delay big-ticket production projects — the lifeblood of future petrol supplies, heating fuels and chemicals… The price plunge has shaken the energy industry, throwing some of the majors’ most ambitious plans into doubt and pummelling oil company shares. Projects in challenging frontier regions like the deep waters of the Gulf of Mexico are predicated on high oil prices and may not be economic with oil at $60 a barrel…”
Geopolitical Watch:
December 19 - South China Morning Post (Teddy Ng): “China is preparing to flex its financial strength amid the economic crisis in Russia as it closely watches how the slump of the Russian rouble affects cooperation between the two countries, mainland analysts have said. They said Beijing was unlikely to send aid to Moscow, but it would boost infrastructure and investment projects to stop the collapse of the Russian economy, a result that would hurt the two nations’ joint attempts to build influence in international affairs. China and Russia have both described their relationship as reaching a ‘new stage’ after the signing of massive cooperation deals in recent months… Companies have already started talks about building the necessary pipeline to deliver the gas. But a continued drop in the Russian economy could leave Moscow unable to complete the pipeline, and Chinese capital – possibly a concessionary loan – could be required, analysts said.”
December 18 – Bloomberg: “China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers, according to people familiar with the effort. The push comes after a test of domestic alternatives in the northeastern city of Siping that was deemed a success, said the people, who asked not to be named because the details aren’t public. Workers there replaced Microsoft Corp.’s Windows with a homegrown operating system called NeoKylin and swapped foreign servers for ones made by China’s Inspur Group Ltd., they said. The plan for changes in four segments of the economy is driven by national security concerns and marks an increasingly determined move away from foreign suppliers under President Xi Jinping, the people said.”
December 13 – Reuters (Jim Finkle): “The Federal Bureau of Investigation has warned U.S. businesses to be on the alert for a sophisticated Iranian hacking operation whose targets include defense contractors, energy firms and educational institutions, according to a confidential agency document. The operation is the same as one flagged last week by cyber security firm Cylance Inc as targeting critical infrastructure organizations worldwide, cyber security experts said. Cylance has said it uncovered more than 50 victims from what it dubbed Operation Cleaver, in 16 countries, including the United States… Cylance Chief Executive Stuart McClure said the FBI warning suggested that the Iranian hacking campaign may have been larger than its own research revealed. ‘It underscores Iran's determination and fixation on large-scale compromise of critical infrastructure,’ he said.”
China Bubble Watch:
December 15 – Bloomberg: “What if a central bank cut interest rates and borrowing costs rose? Since the People’s Bank of China surprised markets with the first benchmark rate reduction in two years on Nov. 21, the five-year sovereign bond yield climbed 15 bps, that for similar AAA corporate notes surged 35 and AA debt yields jumped 74. While finance companies did start charging less for mortgages, their funding costs rose as the one-week Shanghai interbank lending rate added 39 basis points. The PBOC move misfired as it triggered an 18% surge in the Shanghai Composite Index of shares… ‘Financing costs moved in the opposite way than the central bank wished,’ said Deng Haiqing, Beijing-based chief fixed-income analyst at Citic Securities Co., China’s biggest brokerage. ‘We don’t think the call for aggressive interest rate or reserve-requirement ratio cuts are well-grounded under current circumstances, as it could fuel bubbles in stocks.’”
December 17 – Bloomberg: “Two local governments in China pulled support for bond sales by their financing vehicles in the space of a week, throwing the market into disarray. On Dec. 12, Changzhou Tianning Construction Development Co. in the eastern province of Jiangsu said it wouldn’t go ahead with a 1.2 billion yuan ($194 million) planned offering after city authorities said they wouldn’t support the debt… This week, officials in Urumqi in the northwestern province of Xinjiang withdrew backing for a planned 1 billion yuan sale, another U-turn. The shakeup was signaled in October when China’s cabinet said that governments have no obligation to repay debt not raised for public works, raising the risk of mothballed construction and defaults in the world’s second-largest economy. While a national audit showed regional liabilities swelled to 17.9 trillion yuan as of June 2013, the actual amount may be greater, China Business News reported… ‘The two local governments’ statements shocked investors,’ said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai.”
December 18 – Bloomberg: “China’s central bank offered short-term loans to commercial lenders as the benchmark money-market rate jumped the most in 11 months. The amount of money made available by the People’s Bank of China wasn’t clear… Policy makers are adding funds to the financial system to address a cash crunch as subscriptions for the biggest new share sales of the year lock up funds. Twelve initial public offerings from today through Dec. 25 will draw orders of as much as 3 trillion yuan ($483 billion), Shenyin & Wanguo Securities Co. estimated. The seven-day repurchase rate, a gauge of interbank funding availability in the banking system, surged 139 bps… to a 10-month high of 5.28%...”
December 16 – Financial Times (Gabriel Wildau): “China’s once high-flying trust industry has seen its fortunes reverse this year as a slowing economy and competition for investor funds curb growth. Trust loans outstanding increased for 33 straight months through June this year, helping China’s trust sector surpass the insurance industry as the largest category of financial institution by assets, behind commercial banks. But figures released on Friday showed trust loans falling for a fifth straight month, the longest run of declines since 2010. Overall trust assets, which include loans, publicly traded securities and private equity-style investments, rose at their slowest pace in over two years in the third quarter… Just a year ago, trust companies were riding a wave of growth. In 2010, as regulators tried to rein in the explosion in bank credit resulting from the country’s Rmb4tn ($645bn) economic stimulus plan, banks turned to trusts to help them comply with lending controls. Trust companies bought loans from banks and packaged them into high-yielding wealth management products, which they marketed to bank clients as a higher yielding substitute for traditional savings deposits. Trust assets surged to Rmb10.3tn at the end of 2013, from just Rmb2.9tn in 2011.”
December 18 – Bloomberg: “New-home prices fell in fewer Chinese cities last month after the government eased property curbs and cut interest rates for the first time since 2012, boosting demand. Prices dropped in 67 cities of the 70… Prices fell in 69 cities in October… New-home prices in the first-tier cities of Beijing, Shanghai, Shenzhen and Guangzhou all declined last month from the same period last year. ‘New-home prices are dropping because the supply is much larger than the demand,’ said Liu Yuan, a Shanghai-based research director for Centaline Group, China’s biggest property agency. ‘The market sentiment and fundamentals are not good enough to drive price up.’ Property developers offering discounts to boost sales to meet year-end targets is also weighing on prices, Liu said.”
December 17 – Bloomberg: “Chinese billionaire Li Shufu’s Geely Automobile Holdings Ltd. said it expects full-year net income to fall about 50% from 2013 because of the slumping Russian currency and declining sales. Depreciation of the ruble resulted an unrealized foreign-exchange loss from operations in Russia, Geely said… Sales volume dropped 26% in the first 11 months of the year, led by a 49% decline in export markets…”
Monday, December 15, 2014
Weekly Commentary, December 12, 2014: The Collapsing Periphery
This week saw things take a turn for the worse for the faltering Periphery Bubble. On the back of crude's $8.03 collapse (to five-year lows), Venezuela CDS surged another 1,402 bps to 4,151 bps. Ukrainian bond yields surged 517 bps this week to 28.63%. Russian ruble yields jumped another 95 bps to 12.82%. On the currency front, the Russian ruble was slammed for another 9.25% (down 43.6% y-t-d). The Colombian peso fell 3.7%, the South African rand 2.1%, Indonesia rupiah 1.4%, Chilean peso 1.1% and Indian rupee declined 0.8%. The Chinese renminbi declined a not insignificant 0.6% against the dollar this week.
Importantly, the Periphery’s core has fallen under major duress. The Mexican peso was hit for another 2.7% (down 11.7%) this week, while the Brazilian real was down 2.5% (down 11%) and the Turkish lira 1.7% (down 6.5%). Brazilian CDS (Credit default swap) surged 48 bps to a one-year high 212 bps. Mexican CDS jumped 22 bps to a one-year high 112 bps. Brazilian stocks sank 7.7%. Turkey CDS rose 36 bps to 185 (high since October). Indonesian rupiah bond yields jumped 34 bps to 8.11%.
As EM currencies have faltered, local-currency denominated debt has been under pressure. Yet for the most part, dollar-denominated EM debt has performed well – that is, until this week. Importantly, the EM dollar-denominated bond dam has given way. Russia dollar bond yields surged 59 bps to 6.62% this week. Brazil dollar yields jumped 47 bps to 4.56%. Turkey dollar yields rose 45 bps to 4.45%; Mexico 18 bps to 3.53%; Peru 22 bps to 3.80%; and Colombia 28 bps to 3.94%. Venezuela dollar-denominated yields jumped 381 bps this week to 24.28%.
Interesting dynamics at the Core. German stocks were hit for 4.9%, Spanish stocks fell 6.9% and Italian stocks dropped 7.4%. Greek stocks collapsed 20%. Greece five-year bond yields surged 332 bps to 9.15% - “worst week since the euro crisis.” Italian to German bond spreads widened 25 bps, and Portugal to German spreads widened 38 bps. Here at home, the S&P500 fell 3.5%. Yet the Morgan Stanley Retail index gained 0.8%. Healthcare, pharmaceuticals and the airlines advanced. Treasury bond yields sank below closing levels from tumultuous October 15th trading. Corporate bond spreads blew out to the widest level since the October market tumult.
U.S. equities bulls are clinging to a sanguine view of collapsing oil and commodities prices. A well-known strategist was on CNBC late Friday afternoon espousing the bullish thesis, comparing the current backdrop to 1997, when the U.S. expansion soldiered on impervious to EM debacles and sinking commodities. Yet EM debt was minuscule then compared to now. Global debt was a fraction of today’s level. U.S. debt was about a third the current level. And, importantly, the amount of global leveraged speculation was a small fraction of that which surely inflates speculative markets these days. That said, the Russian collapse and LTCM debacle almost brought the global financial system down in October 1998.
Especially these days, “Core vs Periphery” analysis is as fascinating as it is challenging. As always, it’s as much an “art” as it is a “science.” Importantly, initial stress at the Periphery only tends to spur financial flows to the Core. Serious unfolding issues can go so far as to rejuvenate Core Bubble Dynamics. At some point, however, a profoundly consequential transformation begins to unfold: De-risking/de-leveraging (liquidity “vaporization”) actually begins to suck liquidity from even Core markets. Progressively more powerful contagion momentum at the Periphery is apt to jump what had seemed an impermeable fire wall (between Periphery and Core). This will manifest first, often subtly, at the Core’s periphery. Still, with bullishness having become so engrained throughout the Core marketplace, critical warning signals will be readily dismissed.
I believe Collapsing Bubbles at the Periphery have at this point attained irreversible momentum. And the further that crude, commodities and EM currencies fall, the less likely EM countries, corporations and financial institutions will have the wherewithal to service huge amounts of dollar-denominated debt. A critical issue to ponder today is to what extent higher-yielding dollar-denominated debt has been used as fodder for leveraged speculation – for so-called “carry trades” as well as in the proliferation of high-return derivative structures and products. This debt has also found a home in scores of funds that ballooned in size courtesy of central bank measures and an unmatched global yield chase. The amount of dollar-denominated EM debt and its widespread distribution are unprecedented. The associated risks (especially Credit and liquidity) seemed this week to begin resonating.
Back in the late-nineties, the emerging markets were referred to as “roach motels.” It’s always the case that funds flow so smoothly into EM markets and economies. And as long as flows spur domestic lending, booming securities markets, generally loose financial conditions and economic expansion, the dream can persist that EM policymakers and economic players have learned from previous fiascos. At the same time, I do sympathize with EM. Developed world policy ineptness helped to really, really bury them this time around.
It’s a harsh fact of life that “loose money” and attendant Credit and speculative Bubbles provide fertile breeding grounds for fraud and corruption (not even mentioning resource misallocation). Throw trillions of cheap finance at “developing” financial and economic systems and you’ll at some point be dealing with major problems. And this is fundamental to the “global government finance Bubble” thesis: it’s been six years of history’s greatest and by far most dangerous Bubble. Now that Bubbles are Collapsing and the days of endless “hot money” inflows have turned to a rush for rapidly closing exits, some of the chicanery is coming into clearer view (i.e. Russia, Venezuela, Turkey, Brazil, Mexico, etc.). Just you wait for China.
It is also fundamental to my current analysis that central bank reflationary measures have rapidly lost their capacity to hold the global Bubble together. The wheels almost came off in October. Yet the efforts of Bullard, Draghi and Kuroda turned things around and incited yet another destabilizing speculative run. The market viewed that a Trillion from Draghi and another Trillion from Kuroda would more than offset the end of Federal Reserve liquidity creation. The game would continue.
The game, however, has changed. Flagrant euro and yen devaluation propelled king dollar, in the process giving a powerful bear hug to already deflating Periphery Bubbles. King dollar placed further downside pressure on crude and commodities markets. Collapsing oil and commodities impaired financial and economic stability for scores of countries and companies – too many that had ballooned debt (much dollar-denominated) throughout the previous boom. Huge amounts of global debt have rather suddenly turned suspect, inciting a self-reinforcing flight out of currencies, debt markets and commodities. And the more flows reverse out of the Periphery and head to the bubbling Core, the more destabilizing the unfolding king dollar dynamic for the global financial “system” and economy.
I’m sticking with my view of the existence of a massive “yen carry trade” (short a devaluing yen to leverage in higher-yielding instruments elsewhere). As was experienced during October’s bout of market instability - and as we saw at times again this week - any yen rally almost immediately fosters problematic de-risking/de-leveraging. And the assumption has been that as long as Kuroda remained at the helm, ongoing yen devaluation could be taken to the bank. This is reasonable and it may still play out this way. Indeed, the assumption of ongoing yen devaluation has been key to the resilient Bubble at the Core.
Yet, from the game aspect of it all, trading dynamics have undergone some subtle yet important changes. Nowadays, yen weakness powers king dollar – at the expense of Collapsing Periphery Bubbles. In a world where the Periphery and Core Bubble Dynamics have so profoundly diverged, no longer does yen devaluation keep the global Bubble afloat. And I think it’s reached the point where yen weakness has actually become destabilizing for the overall global Bubble. Yen devaluation works to sustain huge amounts of speculative leverage, but at the same time resulting dollar strength has pushed the unfolding EM collapse to the breaking point. This new dynamic provides a real policy quandary. Throwing more liquidity at the problem isn’t going to help.
The Fed released its Q3 2014 Z.1 “flow of funds” report this week. I won’t take as deep a dive as usual. From my perspective, what appears on the surface as a relatively benign Credit backdrop is in reality one with extraordinary vulnerability. I look out to 2015 and it is not clear how the system achieves ample Credit growth to sustain elevated securities markets, profit expectations and bullish optimism for the markets and real economy more generally - especially with ominous global storm clouds now gathering on the horizon.
Total Non-Financial Debt (TNFD) expanded at a 4.4% rate during Q3, up from Q2’s 3.4% and compared to Q3 2013’s 3.5%. Total Household debt expanded at a 2.7% rate, down from Q2’s 3.4%. And while Household Mortgage debt posted its first expansion in four quarters (0.7%), non-mortgage Consumer Credit slowed to a 6.4% pace, down from Q2’s 8.2% and Q1’s 6.6%. Total Business borrowings expanded at a 5.2% pace, up slightly from Q2’s 5.0% - but weaker than Q1’s 6.0%. State & Local government borrowing contracted at a 2.8% pace during Q3, more than reversing Q2’s 1.2% increase (which was the first positive number in five quarters). The star for the quarter, federal borrowings, expanded at a 7.2% annual pace, up significantly from Q2’s 2.5%.
In seasonally-adjusted and annualized rates (SAAR), TNFD expanded $1.801 TN, up from Q3’s $1.370 and Q1’s $1.688 TN. It was actually the strongest SAAR Credit growth since Q4 2012 ($1.962 TN). It is certainly worth noting that at SAAR $913bn, federal borrowings accounted for about half of TNFD. Household Debt expanded SAAR $366bn (mortgage $67bn and Consumer $206bn). Total Business borrowings expanded SAAR $605bn. State & Local contracted SAAR $84bn.
With equities under a little pressure during the period, Total Household Assets declined slightly in Q3 to $95.410 TN. And with Household Liabilities increasing $121bn (3.5% rate), Household Net Worth declined $141bn during the quarter to $81.349 TN. Over the past year, Household Assets increased $5.467 TN, with Net Worth inflating $5.140 TN. Net Worth was up a staggering $11.823 TN in two years and $26.664 TN in four years. As a percentage of GDP, Household Net Worth has increased from 331% to 463% in four years - to return almost to the record level from the end of 2007 (476%). There would be significant economic impact if Household Net Worth were to give back a few years of inflated gains.
I am fond of analysis that combines Treasury Securities, Municipal debt, GSE Securities, Corporate Bonds and Equities as a proxy for Total Marketable Securities (TMS). After beginning 1990 near $10 TN, TMS ended the nineties at about $33 TN. By the end of 2007, TMS had inflated to $52 TN. As a percentage of GDP, 2007’s 371% compared to 1990’s 178% (and 1999’s bubbly 355%).
TMS ended Q3 2014 at $70.79 TN, or 403% of GDP (both down slightly from Q2). TMS is now up $27 TN, or 62%, from the end of 2008. It is also worth noting that Equities at 200% of GDP surpasses 2007 (182%) and is almost back to 1999’s record 209%. And despite talk of system “deleveraging,” Total Debt Securities-to-GDP ended Q3 at 203%, up from 2007’s 182%, 1999’s 147% and 1989’s 114%.
One doesn’t have to go too crazy in search of cause and effect. The Federal Reserve’s Balance Sheet expanded SAAR $291bn during the quarter to a record $4.508 TN. Fed holdings jumped $720bn over the past year, or 19%. This puts the two-year open-ended QE operation (announced in the summer of 2012) at a staggering $1.700 TN, for 58.8% growth. It’s also worth noting that Security Credit jumped $189bn, or 16%, over the past year to a record $1.373 TN. Throughout the financial sector, no expansion is even remotely comparable to Federal Reserve and Security Credit.
Home mortgage borrowings expanded SAAR $77bn during Q3. This compares to 2005’s $1.128 TN, 2006’s $1.080 TN and 2007’s $771bn. Amazingly, six-years of ultra-loose monetary policy have done little to spur mortgage Credit expansion. And with Fed Credit growth supposedly ending and corporate Credit increasingly vulnerable to the forces of risk-aversion, mortgage Credit becomes only more critical to overall system Credit expansion. A strong case can be made that lowering market yields (and declining mortgage rates) no longer has much impact on mortgage borrowing (Household mortgage borrowings up 1.3% over the past two years!).
It is worth noting that GSE Securities expanded SAAR $225bn during Q3 (to $7.834 TN), up from Q2’s SAAR $185bn expansion. GSE Securities increased $240bn in 2013, the first growth since 2008. And with Fannie and Freddie now moving to lower lending standards, Washington appears ready for another push of GSE-induced Credit growth. As difficult as it is to believe, we’ll have to again keep close tabs on the GSE over coming quarters.
But the winner of the Q3 Z.1 Credit Sweepstakes goes to, once again, the U.S. Treasury. Treasury Securities expanded SAAR $914bn during the quarter to a record $12.756 TN. Over the past year, Treasury Securities increased $799bn, or 6.7%, with a two-year gain of $1.500 TN, or 13.3%. Since the end of 2007, outstanding Treasury Securities has increased $7.656 TN, or 150%. Over this period, total Household Debt declined about $420bn (to $13.414 TN). Tough to call this “deleveraging.”
Expanding upon comments made earlier, I think “ominous” when analyzing this Z.1. There is very little to indicate that an unprecedented expansion of Federal Reserve and Treasury Credit has resuscitated a private-sector Credit cycle. Corporate debt has expanded briskly over recent years, but even this important source of system Credit is now susceptible to both global and domestic forces.
My analytical hunch is that “hot money” flowing freely into our booming securities markets helps explain the robust asset price inflation backdrop in the face of lackluster underlying Credit dynamics. Thus far, troubles at the Global Bubble’s Periphery have ensured that king dollar flows inundate Core U.S. markets. But, again, there will be a point when Global de-risking/de-leveraging leads to waning risk-taking and liquidity – even at the susceptible Core.
I’ve argued for awhile now that the maladjusted U.S. economic structure requires in the neighborhood of $2.0 TN of annual non-financial Credit growth. The number for Q3 came in at $1.801 TN. System Credit has remained meaningfully below the $2.0 TN bogey since 2012. Yet I would argue strongly that the Fed’s massive QE program short-circuited typical dynamics. Miraculously, QE provided “money” for inflating securities prices, for ensuring ultra-loose corporate Credit conditions, for federal and state receipts, for corporate cash-flows and earnings, for record stock buybacks, for record M&A and for lots of spending (especially by the wealthy!). QE incited leveraged speculation and booming “hot money” flows. But QE has ended (for now).
I expect the post-QE landscape to be one of disappointing market performance, weakening corporate profits, less financial engineering and waning growth in government revenues (resurgent deficits!). I look out to 2015 and it’s not clear how we get anywhere near the $2.0 TN system Credit growth bogey. “Hot money” is the big wildcard. King dollar flows could help to sustain inflated securities markets, in the process inflating Household Net Worth (perceived wealth) and spending. But with my view that the global Bubble has burst, the probability for a problematic Risk-Off dynamic impacting the world has increased significantly. In that scenario, I don’t see the sources of sufficient liquidity and system Credit expansion to keep the U.S. Bubble markets and Bubble Economy levitated.
To summarize, six-years of unprecedented fiscal and monetary stimulus have ensured that everyone is today fully dressed up, liquored up, and silly eager for The Big Party. “Anybody seen the punchbowl?” “Where is it, and I mean now!” “Oh crap, where on earth did it go!!” “Who took it away!!” “I’m telling you to bring it back right now or there’s going to be some serious trouble!!!” What a fiasco.
For the Week:
The S&P500 sank 3.5% (up 8.3% y-t-d), and the Dow fell 3.8% (up 4.3%). The Utilities added 0.5% (up 20.1%). The Banks were hit for 3.8% (up 3.6%), and the Broker/Dealers sank 3.5% (up 10.5%). Transports declined 3.4% (up 19.4%). The S&P 400 Midcaps lost 2.9% (up 4.5%), and the small cap Russell 2000 dropped 2.5% (down 1.0%). The Nasdaq100 declined 2.6% (up 16.9%), and the Morgan Stanley High Tech index sank 3.6% (up 8.7%). The Semiconductors were slammed for 4.5% (up 25.5%). The Biotechs slipped 0.9% (up 46.8%). Although bullion rallied $30, the HUI gold index declined 0.4% (down 16.3%).
One-month Treasury bill rates closed the week at one basis point and three-month rates ended at two bps. Two-year government yields dropped 10 bps to 0.54% (up 16 bps y-t-d). Five-year T-note yields fell 17 bps to 1.51% (down 23bps). Ten-year Treasury yields sank 22 bps to 2.08% (down 95bps). Long bond yields fell 23 bps to 2.74% (down 123bps). Benchmark Fannie MBS yields were down 16 bps to 2.79% (down 82bps). The spread between benchmark MBS and 10-year Treasury yields widened six to 71 bps. The implied yield on December 2015 eurodollar futures dropped 10.5 bps to 0.83%. The two-year dollar swap spread increased three to 24 bps, and the 10-year swap spread gained two to 13 bps. Corporate bond spreads widened significantly. An index of investment grade bond risk jumped 10 to 72 bps. An index of junk bond risk surged 52 bps to 396 bps. An index of emerging market (EM) debt risk jumped 67 to 383 bps (high since June 2012).
Greek 10-year yields surged 192 bps to 9.15% (up 73bps y-t-d). Greek five-year yields jumped 332 bps to 9.15%. Ten-year Portuguese yields rose 22 bps to 2.97% (down 316bps). Italian 10-yr yields gained nine bps to 2.06% (down 206bps). Spain's 10-year yields rose five bps to 1.88% (down 227bps). German bund yields sank 16 bps to a record low 0.62% (down 131bps). French yields dropped 13 bps 0.90% (down 166bps). The French to German 10-year bond spread increased three to 28 bps. U.K. 10-year gilt yields fell 22 bps to 1.80% (down 122bps).
Japan's Nikkei equities index dropped 3.1% (up 6.6% y-t-d). Japanese 10-year "JGB" yields were down three bps to a record low 0.39% (down 35bps). The German DAX equities index sank 4.9% (up 0.5%). Spain's IBEX 35 equities index was clobbered for 6.9% (up 2.3%). Italy's FTSE MIB index was hammered for 7.4% (down 1.9%). Emerging equities were for the most part under significant pressure. Brazil's Bovespa index collapsed 7.7% (down 6.8%). Mexico's Bolsa fell 3.5% (down 2.4%). South Korea's Kospi index fell 3.3% (down 4.5%). India’s Sensex equities index was slammed for 3.9% (up 29.2%). China’s Shanghai Exchange was unchanged (up 38.9%). Turkey's Borsa Istanbul National 100 index declined 2.4% (up 22.8%). Russia's MICEX equities index fell 4.6% (down 3.0%).
Debt issuance slowed. Investment-grade issuers included American Honda $1.5bn, State Street $1.0bn, Goldman Sachs $1.0bn, New York Life Global $650 million, Trans-Allegheny Interstate Line $550 million, Penske Truck Leasing $500 million, Ingram Micro $500 million, AIG Global Funding $450 million and Overseas Primate Investment Corp $240 million.
Junk funds saw outflows surge to $1.89bn (from Lipper), the largest outflows since October. Junk issuers this week included OneMain Financial Holdings $1.5bn, Kindred Healthcare $1.35bn, CBRE Services $425 million, Westmoreland Coal $350 million and WGL Holdings $150 million.
Convertible debt issuers included Envestnet $150 million and IGI Laboratories $125 million.
International dollar debt sales dropped sharply. Issuers included Neder Waterschapsbank $1.5bn, Nakama RE $375 million and Asian Development Bank $300 million.
Freddie Mac 30-year fixed mortgage rates increased four bps to 3.93% (down 49bps y-o-y). Fifteen-year rates jumped 10 bps to 3.20% (down 23bps). One-year ARM rates slipped one basis point to 2.40% (down 11bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 4.14% (down 40bps).
Federal Reserve Credit last week expanded $1.8bn to $4.448 TN. During the past year, Fed Credit inflated $542bn, or 13.9%. Fed Credit inflated $1.637 TN, or 58%, over the past 109 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.5bn last week to $3.324 TN. "Custody holdings" were down $30bn year-to-date and fell $43bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $233bn y-o-y, or 2.0%, to another seven-month low $11.771 TN. Over two years, reserves were $924bn higher for 9% growth.
M2 (narrow) "money" supply expanded $35.6bn to a record $11.603 TN. "Narrow money" expanded $630bn, or 6.2%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits jumped $18.2bn, and Savings Deposits gained $18.4bn. Small Time Deposits slipped $0.8bn. Retail Money Funds fell $2.5bn.
Money market fund assets rose $18.5bn to $2.706 TN. Money Funds were down $12.3bn y-t-d and $3.3bn from a year ago, or 0.1%.
Total Commercial Paper dropped $9.0bn to $1.087 TN. CP expanded $40.8bn year-to-date and was up $5.1bn over the past year, or 0.5%.
Currency Watch:
December 10 – Bloomberg (Fion Li): “Don’t fight the central bank is an old adage on Wall Street. In China, currency traders are doing the opposite. Traders pushed the yuan’s onshore exchange rate to a five- month low even as the People’s Bank of China raised the official rate to the highest since March. The 1% discount between the market and central bank rates is the widest gap since June. That’s a turnaround from the first four months of the year, when weaker fixings by the PBOC prompted speculators to reverse bets on yuan appreciation and sent the spot rate lower.”
The U.S. dollar index declined 1.1% to 88.36 (up 10.4% y-t-d). For the week on the upside, the Japanese yen increased 2.3%, the Swiss franc 1.6%, the Danish krone 1.5%, the euro 1.5%, the South Korean won 1.0%, the British pound 0.9%, the New Zealand dollar 0.9%, the Singapore dollar 0.7% and the Swedish krona 0.2%. For the week on the downside, the Mexican peso declined 2.7%, the Norwegian krone 2.6%, the Brazilian real 2.5%, the South African rand 2.1%, the Canadian dollar 1.3%, the Australian dollar 0.8% and the Taiwanese dollar 0.6%.
Commodities Watch:
December 10 – Bloomberg (Grant Smith): “OPEC cut the forecast for how much crude oil it will need to provide in 2015 to the lowest in 12 years amid surging U.S. shale supplies and reduced estimates for global consumption… The impact of this year’s 40% price collapse on supply and demand remains unclear, OPEC said.”
The Goldman Sachs Commodities Index sank 5.9% to a more than five-year low (down 29%). Spot Gold rallied 2.5% to $1,223 (up 1.4%). March Silver recovered 4.9% to $17.057 (down 12%). January Crude collapsed $8.03 to $57.81 (down 41%). January Gasoline sank 9.9% (down 43%), and January Natural Gas slipped 0.2% (down 10%). March Copper gained 1.1% (down 14%). March Wheat increased 2.1% (up 1%). March Corn jumped 3.2% (down 3%).
U.S. Fixed Income Bubble Watch:
December 11 – Bloomberg (Christine Idzelis and Craig Torres): “The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt. Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to 8% next year. ‘Anything that becomes a mania -- it ends badly,’ said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of… Peritus Asset Management. ‘And this is a mania.’ The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s… this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.”
December 12 – Bloomberg (Cordell Eddings and Nabila Ahmed): “The market for new junk bonds has all but shut as plunging oil prices and borrowing costs at an 18-month high deter issuers. Even as sales of high-yield, high-risk notes in the U.S. reached a record $353.1 billion this year, offerings have stalled this month with the slowest pace for a December since 2011. Junk is on track to deliver its second straight quarterly loss, the first time that’s happened since 2008, and trimming gains for the year to 1.47%... After six years of easy monetary policies by the Federal Reserve boosted the ability of the least-creditworthy companies to borrow on favorable terms, investors are becoming more discriminating. The average yield on speculative-grade debt climbed to 7.11% yesterday from an all-time low of 5.69% in June…”
December 9 – Bloomberg (Sridhar Natarajan): “BlackRock Inc. Chief Executive Office Laurence D. Fink said moments of severe volatility will continue to plague the corporate bond market unless regulators enforce a push toward more electronic trading. ‘Regulators need to admit that we have changed the ecosystem of bonds and yet we are not seeing regulatory pressure to transform the bond market into more electronic trading,’ Fink said… ‘I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market. It’s going to create some sort of panic, create uncertainty again.’”
U.S. Bubble Watch:
December 12 – Bloomberg (Lisa Abramowicz): “Credit investors are preparing for the worst. They’re cleaning up their portfolios, selling riskier debt that’s harder to trade in bad times and hoarding longer-term government bonds that do best in souring markets. While investors have pruned energy-related holdings in particular as oil prices plunge, they’re also getting rid of other types of corporate bonds, causing yields to surge to the highest in more than a year. ‘We believe the pervasive nature of the sell-off is more reflective of overall liquidity concerns in the cash market than of fundamental deterioration,’ Barclays Plc analysts Jeffrey Meli and Bradley Rogoff wrote… ‘The weakness, while certainly most pronounced in the energy sector, has been broad based.’”
December 11 – Bloomberg (Lisa Abramowicz): “Perhaps 2014 will go down in history as the year that junk bonds sent a warning signal as oil plummeted and stocks just kept rallying. Prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as U.S. equities have climbed to new highs. The dollar-denominated debt is now yielding the most relative to a comparable measure on the Standard & Poor’s 500 index since 2011.”
December 8 – CNBC (Phil LeBeau): “In the latest sign Americans are comfortable paying more for what they'll drive, the country is on the cusp of major milestone. This year, automakers are on pace to sell more than one million vehicles in the U.S. with transaction prices of at least $50,000 according to new data compiled by TrueCar… The growth in sales of higher priced models is stunning when compared with the auto industry overall. From January through November 931,064 vehicles were sold in the U.S. with average price above $50,000, a whopping 30.8% increase compared to the same period last year… Meanwhile, …sales of models with average transaction prices under $50,000 are up just 4.1% this year.”
December 8 – Bloomberg (Clea Benson): “Fannie Mae and Freddie Mac have set terms for letting borrowers put down as little as 3% of a home’s cost to get mortgages, a step criticized by Republican lawmakers as a return to risky lending. Starting on Dec. 13, Fannie Mae will allow the lower down payments for first-time homebuyers and permit refinancing borrowers to reduce equity to 3% to cover closing costs… Freddie Mac will begin a program in March giving breaks to lower-income buyers and first-time borrowers who get housing counseling.”
December 9 – Dow Jones (Jon Ostrower): “Boeing Co. will reduce monthly production of its 747-8 jetliner to 1.3 aircraft a month from 1.5, as demand continues to slow for the storied jumbo jet. The aerospace giant… said it would make the reduction, which will lower annual deliveries of the 747 to approximately 16 from 18, in September 2015. The planned cut enables ‘us to continue to run a healthy business,’ Boeing said… Boeing last year said it was cutting 747 output to 1.5 aircraft a month from 1.75.”
Federal Reserve Watch:
December 9 – Wall Street Journal (Jon Hilsenrath): “Federal Reserve officials are seriously considering an important shift in tone at their policy meeting next week: dropping an assurance that short-term interest rates will stay near zero for a ‘considerable time’ as they look more confidently toward rate increases around the middle of next year. Senior officials have hinted lately that they’re looking at dropping this closely watched interest-rate signal… ‘It’s clearer that we’re closer to getting rid of that than we were a few months ago,’ Fed Vice Chairman Stanley Fischer said… New York Fed President William Dudley has avoided using the ‘considerable time’ phrase in recent speeches and instead said the Fed should be ‘patient’ before raising rates.”
ECB Watch:
December 11 – Financial Times (Claire Jones): “The European Central Bank has injected €129.8bn through its second offer of cheap four-year loans, missing expectations of a higher take-up. Analysts polled by Bloomberg last week had forecast eurozone lenders to bid for €170bn of a possible €317bn. Banks took €82.6bn in the first of the auctions, which the ECB hopes will boost lending to the region’s credit-starved smaller businesses. The offer is part of a package of eight auctions, known as ‘Targeted Longer-Term Refinancing Operations’, allowing banks to borrow at ultra-low fixed rates if they agree to terms for lending to businesses and households in the region. The remaining six auctions will take place over the next two years. The result of the auction will weigh on the ECB’s decision-making in the months ahead, with weak demand supporting the case for doing more.”
Central Bank Watch:
December 11 – Bloomberg (Saleha Mohsin): “Norway’s central bank cut its main interest rate for the first time in more than two years and signaled it may ease again next year as plunging oil prices threaten growth in western Europe’s biggest crude exporter. The rate was lowered by 0.25 percentage point to 1.25%... The bank sees a ‘50-50 chance’ for another rate cut next year, Governor Oeystein Olsen said… The job now is to ‘prevent a severe downturn,’ he said…”
Russia/Ukraine Watch:
December 11 – Bloomberg (Olga Tanas, Anna Andrianova and Ksenia Galouchko): “Russia’s fifth interest-rate increase this year failed to stem the ruble’s worst rout in 16 years, risking further damage to an economy battered by sanctions and oil prices near the lowest since 2009. The Bank of Russia increased its key rate to 10.5% from 9.5%... ‘This is a spineless decision,’ Vadim Bit-Avragim, who helps oversee about $4 billion at Kapital Asset Management LLC in Moscow, said… ‘If the central bank’s goal was to defend the ruble, it would’ve raised rates by 2-3 percentage points.’”
December 10- Financial Times (Peter Spiegel in Brussels and Roman Olearchyk): “The International Monetary Fund has identified a $15bn shortfall in its bailout for war-torn Ukraine and warned western governments the gap will need to be filled within weeks to avoid financial collapse. The IMF’s calculations lay bare the perilous state of Ukraine’s economy and hint at the financial burden of propping up Kiev… The additional cash needed would come on top of the $17bn IMF rescue announced in April and due to last until 2016… ‘It’s not going to be easy,’ said one official involved in the talks. ‘There’s not that much money out there.’ …Without additional aid, Kiev would have to massively slash its budget or be forced to default on its sovereign debt obligations. Since the bailout programme began in April, Ukraine has received $8.2bn in funding from the IMF and other international creditors… Under IMF rules, the fund cannot distribute aid unless it has certainty a donor country can meet its financing obligations for the next 12 months, meaning the fund is unlikely to be able to send any additional cash to Kiev until the $15bn gap is closed. The scale of the problem became clearer last week after Ukraine’s central bank revealed its foreign currency reserves had dropped from $16.3bn in May to just $9bn in November. The data also showed the value of its gold reserves had dropped by nearly half over the same period.”
December 10 – Bloomberg (Lyubov Pronina and Natasha Doff): “Russian companies lost tens of billions of rubles on foreign-exchange derivatives amid a rout in the ruble, Interfax reported, citing Sergey Moiseev, the head of financial stability at the central bank. Companies were forced to close out the contracts after the central bank’s move to a free-floating currency exposed them to the world’s highest currency volatility amid a slump in oil prices, Moiseev said…”
December 11 – Bloomberg (Jason Corcoran, Ilya Khrennikov and Anna Baraulina): “Anatoly Ivanov, a 39-year-old software engineer who lives in a 53 square-meter (570 square-foot) St. Petersburg apartment with his wife and child, said he feels boxed in. The ruble’s collapse this year has caused a headache for Anatoly, who bought his Soviet-era home with a dollar mortgage in 2008… At the time, a dollar was 23 rubles and the interest rate on the mortgage was 4 percentage points lower than on loans in rubles. Yesterday, the rate was about 55 to the dollar, and Ivanov is considering paying a penalty to switch the mortgage into rubles. ‘Our $800 monthly payment has jumped to 38,000 rubles from 26,000 rubles since the start of the year,’ Ivanov, who is paid in rubles, said… Lured by foreign banks offering lower rates, Russians have taken 108.5 billion in non-ruble mortgage loans… While that represents 3% of total mortgages, 15% of the foreign currency home loans are delinquent, while 0.9% of ruble loans are overdue.”
Brazil Watch:
December 10 – Bloomberg (Filipe Pacheco): “Brazil’s plan to cut subsidized loans is coming at an inopportune time for corporate borrowers. Incoming Finance Minister Joaquim Levy pledged last month to scale back transfers to state development banks including BNDES, part of a strategy to trim debt levels after Standard & Poor’s lowered Brazil’s credit rating to the cusp of junk in March. While his plan reduced the nation’s funding costs in the bond market, it may also boost expenses for companies struggling to obtain overseas financing with yields at a 13-month high, Barclays Plc and Banco Mizuho do Brasil SA said. Levy’s strategy marks a shift after funding for BNDES doubled during President Dilma Rousseff’s first term, which benefited corporate borrowers including Petroleo Brasileiro SA, Norte Energia SA and Oi SA. Three Brazilian companies have pulled overseas bond offerings in the past month as economic growth stalls and a bribery probe into Petrobras prompts investors to shun sales.”
December 8 – Bloomberg (Julia Leite): “In 2011, Moody’s… rated Petroleo Brasileiro SA three levels above its owner, Brazil’s government. Today, the bond rater says the oil producer would merit a junk grade without state support and is proving a drag on the nation’s own creditworthiness. Mauro Leos, Moody’s lead analyst for Brazil, said… that a bribery probe into Petrobras is contributing to the negative outlook on Brazil’s rating, two days after Moody’s cut its so-called stand-alone rating for the oil producer to speculative grade. The comments came after the investigation took another turn last week when President Dilma Rousseff’s ruling party was alleged to have received donations from compans in exchange for securing contracts with Petrobras.”
December 8 – Bloomberg (Sabrina Valle): “AP Moeller-Maersk A/S is among foreign companies being investigated in Brazil over allegations they bribed Petroleo Brasileiro SA executives in exchange for contracts, widening the probe from local suppliers to companies working on oil projects around the globe. A prosecutor and a federal police agent said in interviews that they found evidence of international suppliers paying bribes through agents to Paulo Roberto Costa, the former Petrobras executive who is cooperating with authorities in exchange for a reduced sentence…”
December 11 – Bloomberg (Anna Edgerton and Rachel Gamarski): “Petroleo Brasileiro SA, the oil producer at the center of Brazil’s biggest-ever corruption scandal, plans to sell debt this year backed by the national treasury and state-run Centrais Eletricas Brasileiras SA. The transaction will be guaranteed by money that Eletrobras… owes Petrobras from the purchase of fuel for power plants, Energy Minister Edison Lobao told reporters…”
December 11 – Bloomberg (Francisco Marcelino, Gerson Freitas Jr. and Tariq Panja): “The boost that the World Cup was supposed to give Brazilian soccer hasn’t materialized as a sluggish economy and budget shortfalls leave the majority of top division clubs unable to pay salaries. Five of the league’s 20 clubs, including former FIFA world club champion Sao Paulo and Santos, where soccer star Pele spent the majority of his career, ended the season this month without major sponsors on their shirts. At least 17 clubs delayed players’ salaries this year, said a person with direct knowledge of the matter…”
EM Bubble Watch:
December 8 – Bloomberg (Srinivasan Sivabalan): “Foreign-debt levels of companies in emerging markets from China to India and Brazil are underestimated, threatening financial stability, the Bank for International Settlements said. Companies are raising more foreign funds through their offshore affiliates and accounting practices understate the currency risk in such transactions, the… institution said in its quarterly report. Almost half of the $554 billion that the firms raised in the five years through 2013 came from the affiliates, the BIS said. ‘Offshore subsidiaries of emerging-market non-financial corporates are increasingly acting as surrogate intermediaries,’ raising money abroad and transferring it to their parent companies, economists led by Stefan Avdjiev wrote. ‘This trend could have important financial-stability implications.”
December 11 – Financial Times (Pan Kwan): “Market fears over Venezuela’s creditworthiness are approaching panic levels as the price of oil plunges. The cost of insuring the South American country’s government debt against default surged to a new high on Wednesday… The five-year credit-default swap on Venezuelan government debt surged more than 832 bps — its biggest one-day jump on record — to 4019.57 bps. This makes Venezuelan debt the most expensive to insure in the world, surpassing even Argentina’s, which went into default for the eighth time in its history this year. The cost of insuring a portfolio of Venezuelan sovereign debt for five years against default has quadrupled since June, when oil began its downward spiral… With oil accounting for roughly 96 per cent of its export earnings and 48% of budget revenue, the slump in oil prices has taken a toll on the country’s already dire finances.”
December 9 – Bloomberg (Katia Porzecanski): “The scores of money managers and analysts who crowded into Cleary Gottlieb Steen & Hamilton LLP’s panel discussion on Venezuela last week are a testament to the deepening concern over whether President Nicolas Maduro can make good on the nation’s debt obligations. … Among the topics debated were whether the state oil company’s U.S. gasoline stations could be seized as collateral and whether it was legally possible for Venezuela to restructure the producer as an empty shell to avoid bondholder claims, they said. For a country that hasn’t missed a foreign bond payment in decades, the questions reflect growing speculation the socialist revolution that transformed Venezuela over the past 15 years under Hugo Chavez and now Maduro has finally pushed the nation to the brink of economic collapse.”
December 10 – Bloomberg (Onur Ant and Constantine Courcoulas): “Turkey’s economic growth slowed in the third quarter as falling borrowing costs failed to spur domestic demand and agricultural output contracted. Gross domestic product grew 1.7%, the slowest pace since 2012, compared with a revised 2.2% during the previous three months… Household consumption, which makes up two-thirds of the Turkish economy, grew 0.2% from a year ago compared with 0.5% during the previous quarter.”
December 12 – Bloomberg (Onur Ant): “Turkish central bank Governor Erdem Basci is sending monetary-policy signals that are upending a two-month government bond rally. Lira bonds have lost 3.8% in December after the biggest returns in emerging markets the previous two months… Further declines are in store after Basci indicated two days ago that he’s in no rush to cut interest rates further…”
December 9 – Bloomberg (Sandrine Rastello): “India’s current-account deficit widened more than estimated to the largest since the quarter through June 2013 as exports slowed and gold imports surged. The July-September shortfall in the broadest measure of trade widened to $10.1 billion from $7.8 billion the previous quarter… A recession in Japan and deteriorating outlook for the euro-area economy are keeping a lid on demand for Indian products as Prime Minister Narendra Modi seeks to revive manufacturing in Asia’s third-largest economy.”
December 9 – Bloomberg (Maciej Martewicz and Konrad Krasuski): “Poland’s real-estate developers are selling a record amount of debt this year to fund an office construction boom even as the central bank warns of a glut. Builders including Echo Investments SA and Ghelamco NV have issued about 1.7 billion zloty ($500 million) of bonds amid record low interest rates at home and in the neighboring euro region, according to Fitch… While the Polish central bank said last week that Warsaw vacancy rates at 14% signaled a ‘growing imbalance,’ no fewer than 46 office buildings, including the 48-story Warsaw Spire, are under construction.”
Europe Watch:
December 11 – Bloomberg (David Goodman): “Greece’s government bonds fell, pushing three- and five-year rates to the highest since the nation restructured its debt in 2012, amid speculation early presidential elections will spark renewed political turmoil. The nation’s 10-year yield exceeded 9% after Prime Minister Antonis Samaras said the markets fear a victory for anti-bailout party Syriza in potential elections next year.”
December 8 – Reuters (John O’Donnell and Paul Carrel): “The euro zone is experiencing a massive weakening in its economy not least due to a slowdown in its biggest member, Germany, a senior ECB policy maker said… ‘We see a massive weakening in the euro zone economy,’ Ewald Nowotny, a member of the ECB's Governing Council, told a conference… Nowotny said that the European Central Bank had struck a middle ground in its monetary policy, between extremes in the United States that called for full-blown money printing and others that wanted the ECB to take a less expansive path.”
December 10 – Reuters (James Mackenzie): “In a European political landscape increasingly populated with insurgent, anti-system parties, Italy's eurosceptic anti-immigrant Northern League is the latest to profit from a groundswell of hostility to the European Union. The League's 41-year-old leader, Matteo Salvini calls the euro a ‘criminal currency’ and wants to demolish the Brussels consensus that has dominated European politics since the end of World War Two. He is also, at odds with mainstream leaders, an admirer of Russian President Vladimir Putin. Salvini has become Italy's second-most popular leader since taking over the party, founded in the early 1990s as a separatist movement in the prosperous north of Italy.”
December 10 – Bloomberg (Sonia Sirletti): “Italian banks boosted their holdings of the country’s sovereign debt to a record high as Italy’s third recession in six years makes lending to companies and individuals risky. Italian banks increased Italian sovereign-debt holdings by almost 18.4 billion euros ($22.8bn) in October to a record 414.3 billion euros…”
December 8 – Bloomberg (David Goodman): “The drop in Italy’s 10-year bonds that followed a Standard & Poor’s downgrade of the nation lasted less than a morning, amid speculation the European Central Bank will start buying sovereign debt as soon as next month. Government bonds from Germany to Spain rose today after ECB President Mario Draghi said last week officials would act should current stimulus prove insufficient when it is reassessed early next year. A round of loans from the ECB to banks this week, part of stimulus plans intended to add as much as 1 trillion euros ($1.22 trillion) to the institution’s balance sheet, won’t even cover the repayments they owe from a previous program, according to a Bloomberg News survey…”
December 8 – Bloomberg (Ambereen Choudhury): “European banks will be weakened further by poor economic conditions and high litigation costs in 2015, according to Moody’s… Banks’ profits in the region, with the exception of the U.K. and Scandinavia, may be exposed to ‘economic tailwinds,’ hurting loan demand and the value of transactions, Moody’s said… ‘Weak macroeconomic conditions weigh on Europe’s banking sector, and low overall bottom lines implies that the European banking industry remains structurally vulnerable,’ Carola Schuler, Moody’s managing director…, said”
December 9 – Financial Times (John Plender): “France’s finance minister has called on the German establishment to watch its words when criticising his country’s economic policies, claiming barbs from Germany are fuelling the rise of anti-EU populists. Michel Sapin, who is under pressure from Brussels and Berlin to be more aggressive in cutting spending and in his reforms, said he was concerned by ‘certain extreme comments in Germany’. He called for mainstream parties to counter ‘outdated’ stereotypes.”
Global Bubble Watch:
December 8 – Financial Times (Claire Jones and Sam Fleming): “Global financial policy makers have sounded the alarm about the impact of a resurgent US dollar on emerging markets, where companies have racked up large debts denominated in the American currency. The Bank for International Settlements, known as the central bankers’ bank, warned… in its Quarterly Review that a prolonged rally in the dollar could expose financial vulnerabilities in emerging markets by damaging some companies’ creditworthiness. The… organisation added that there were increasing signs of fragility in financial markets, despite renewed hopes for economic growth, pointing to the recent stress in the $12.3tn US Treasury market that serves as the bedrock of the global financial system. ‘To my mind, these events underline the fragility — dare I say growing fragility — hidden beneath the markets’ buoyancy,’ said Claudio Borio, the head of the BIS’s monetary and economic department… However, companies in emerging markets have been borrowing heavily via the issuance of dollar securities in recent years… It said emerging market borrowers had issued a total of $2.6tn of international debt securities, of which three-quarters were denominated in dollars. International banks’ cross-border loans to emerging market economies amounted to $3.1tn in mid-2014, mainly in US dollars, the BIS added. Mr Borio said: ‘Should the US dollar, the dominant international currency, continue its ascent, this could expose currency and funding mismatches by raising debt burdens. The corresponding tightening of financial conditions could only worsen once interest rates in the US normalise.”
December 12 – Bloomberg (David Goodman): “The last time Greece’s bonds had this bad a week, the nation had just undergone the biggest debt restructuring in history, inconclusive elections had stoked concern it may exit the euro and Mario Draghi’s ‘whatever it takes’ pledge was more than two months away. The yield on Greek 10-year bonds has surged about 200 bps this week, the biggest leap since the height of the euro- area sovereign-debt crisis in May 2012. Worse still, the yield on three-year notes, issued in July as part of Greece’s emblematic return to capital markets, have jumped more than 450 bps, climbing above the longer-dated rates in a sign that investors are increasingly concerned the nation will be unable to pay its debt.”
December 8 – Reuters (Chris Vellacott): “China has become the largest emerging market destination for international bank lending, accounting for more than a quarter of cross-border claims on all emerging market economies, a central banking report shows. Cross-border claims on China increased by $65 billion in the second quarter of 2014 to $1.1 trillion, and were up nearly 50% in the year to the end of June, according to a quarterly report from the Bank for International Settlements… ‘China has become by far the largest (emerging market) borrower for BIS reporting banks. Outstanding cross-border claims on residents of China totaled $1.1 trillion at end-June 2014, compared with $311 billion on Brazil and slightly more than $200 billion each on India and Korea,’ the report says.”
Geopolitical Watch:
December 12 – Bloomberg (Diep Ngoc Pham and John Boudreau): “Tensions over the South China Sea were reignited after Vietnam said it had submitted its stance on the dispute to the international arbitration tribunal reviewing the Philippines’ challenge against China’s claims. Vietnam has asked the arbitration court to take into account its legal rights and interests in the disputed sea region, spokesman Le Hai Binh, said… The country also refuted China’s claims to the Paracel and Spratly islands in the statement, which provoked a Chinese response yesterday that its neighbor’s claims were unlawful. The renewed tensions are being sparked as the United Nations tribunal in the Hague considers Philippine’s challenge to China’s claim to much of the South China Sea as the island nation seeks to check Beijing’s bid for control of waters rich in oil, gas and fish. Vietnamese and Philippine leaders say they are determined to oppose China’s move to control the sea region…”
December 12 – Bloomberg (Alex Nussbaum and Alex Morales): “Envoys at the United Nations climate talks enter their final day in Lima divided on how to put teeth into a deal that the biggest polluters have turned into a package of mostly voluntary measures. Developing countries led by China and India want to pin down industrial nations on how they’ll meet a pledge for $100 billion a year in climate-related aid by 2020. The U.S. and its allies want to secure a way to ensure that all governments, rich and poor alike, will curb greenhouse gases. The differing goals underscore how quickly the problem about how to rein in emissions has shifted from an issue aimed mostly at rich polluters into one that needs to be answered by all nations.”
China Bubble Watch:
December 11 – Reuters: “China has told its banks to lend more in the final months of 2014 and relaxed enforcement of loan-to-deposit ratios to expand credit, sources told Reuters… Figures on inflation, imports and fiscal spending in November have already undershot expectations since the People's Bank of China (PBOC) sprang a surprise interest rate cut on Nov. 21… ‘I wouldn't be surprised by that at all,’ said Andrew Polk, resident economist for the Conference Board in Beijing. ‘It seems pretty clear activity is continuing to weaken throughout this fourth quarter.’ Two sources with knowledge of the matter said China's central bank increased the annual new loan target to 10 trillion yuan ($1.62 trillion) for 2014, up from what Chinese media have said was a previous target of 9.5 trillion yuan. Banks have disbursed 8.23 trillion yuan of loans between January and October, so they will have to quicken the pace in the last two months if they are to meet the new target.”
December 9 – Bloomberg: “China took one of its biggest steps yet to push local governments away from using opaque financing vehicles to raise money as policy makers seek to reduce leverage and develop a more transparent municipal bond market. The nation’s clearing agency for exchanges said yesterday it won’t allow bonds rated below AAA or sold by issuers graded lower than AA to be used as collateral for short-term loans obtained through repurchase agreements. The new rules sparked a retreat in lower-rated bonds of local government financing vehicles and contributed to a tumble in Shanghai shares as noteholders reassessed the appeal of owning such debt.”
December 12 – Bloomberg: “A local government financing vehicle in China’s eastern province of Jiangsu has delayed a bond sale after authorities ruled it wouldn’t be backed by the state. Changzhou Tianning Construction Development Co. said it won’t go ahead with a 1.2 billion yuan ($194 million) offering planned for Dec. 15 because of market volatility… The Finance Ministry has said local governments must detail all outstanding borrowings by Jan. 5 as it determines which of the thousands of financial entities set up by cities and provinces it may be willing to support.”
December 11 – Bloomberg: “The People’s Bank of China injected 400 billion yuan ($65bn) into the banking system, according to a person familiar with the matter, pressing ahead with targeted steps to add liquidity as the economy slows… The move comes as a previous PBOC injection of 500 billion yuan comes due this month. The PBOC had said it pumped that amount into the economy in September with a term of three months and a rate of 3.5%. Another 269.5 billion was added in October with the same terms, it said.”
December 10 – Bloomberg: “With $90 billion of bonds sold by local government financing vehicles coming due next year, China is walking a fine line between teaching investors a lesson and preventing widespread defaults. The nation’s clearing agency said this week that local bonds rated lower than the highest AAA grade are too risky to be used as collateral for short-term loans. That means about half of the outstanding 1 trillion yuan ($162bn) securities sold by local government financing vehicles, or LGFVs, in the exchange market can no longer be pledged to raise funds, according to Morgan Stanley. Warning that these securities aren’t risk free caused the yield spread on seven-year AA-rated local debt over Chinese government bonds to widen the most on record yesterday. Now investors will be looking for clues as to which of the thousands of financial entities set up by cities and provinces the government may be willing to support, and which it won’t. ‘We could see a further sell-off in LGFV and corporate bonds as investors are more aware of the credit and liquidity risks,’ said Ken Hu, the… chief investment officer for Asia-Pacific fixed income at Invesco… ‘The new rules are leading to some large-scale deleveraging.’”
December 11 – Bloomberg: “Loan defaults at China’s state-owned enterprises may increase as growth in the world’s second-biggest economy slows, according to Moody’s… Risks are greatest in industries with excess production capacity, Kai Hu, a senior credit officer at the rating company, said… Regulators stepped up efforts to curb local-government debt on Dec. 8, prompting borrowing costs to jump and companies to cancel or postpone at least 46.6 billion yuan ($7.5bn) of note sales this week… In the latest signs of concern in China’s credit markets, the extra yield companies rated AA must pay to sell bonds due in seven years over similar-maturity government notes has surged 51 bps this week to a two-month high of 263 bps. The seven-day repurchase rate, a gauge of interbank funding availability, rose as much as 17 bps today to a four- month high of 3.81%...”
December 6 – Financial Times (Jamil Anderlini): “China’s previously overheated property market has been in the doldrums for most of this year but things are likely to get a lot worse, because of demographic shifts that are about to reverse a main driver of the decades-long boom. According to newly published research, the size of China’s main property-buying population — people aged 25 to 49 — will peak next year and then start to decline, just as a huge glut of new apartments hits the market. This demographic will shrink drastically from 2018, with the number of urban homebuying Chinese falling much faster than contemporaries from the countryside, who are far less likely to have the means to buy expensive apartments, according to Ai Jingwei, an expert on Chinese real estate and author of the research… Moody’s Analytics estimates the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product last year.”
December 12 – Bloomberg: “China’s economy slowed in November as factory shutdowns exacerbated weaker demand, raising pressure on the central bank to add further stimulus. Bloomberg’s gross domestic product tracker came in at 6.78% year-on-year in November, down from 6.91% in October and a fourth month below 7%... Factory production rose 7.2% from a year earlier, retail sales gained 11.7%, and investment in fixed assets expanded 15.8% in January through November from a year earlier…”
December 10 - South China Morning Post (Phoenix Kwong): “Economic weakness continues to weigh on China auto sales growth, which slowed to 2.3% last month. Vehicles sales last month totalled 2.1 million units, with the year-on-year growth rate slowing from October’s 2.8%, the state-backed China Association of Automobile Manufacturers (CAAM) said… November’s growth rate was 7.4 percentage points lower than that of the same period of last year, it said.”
December 12 – Bloomberg: “China plans to establish a fund to support troubled trust firms as repayment risks accumulate in the 13 trillion yuan ($2.1 trillion) industry. Under rules jointly issued by China Banking Regulatory Commission and the Ministry of Finance, each trust firm is required to contribute 1% of their net assets to the fund, while each trust product will pay 1% of the money raised… Premier Li Keqiang is trying to sustain economic growth while containing financial stress after the nation’s loosely regulated shadow-banking system started swelling in 2010.”
December 9 – Bloomberg: “China’s residential building boom is petering out, with the effects seen from slumping steel and cement prices, to electricity use, rail-freight traffic and retail sales. The drag will be long lasting with home completions set to fall by 1 to 3% annually from next year to 2025 after almost tripling in 13 years, according to… Gavekal Dragonomics. A once-in-a-generation shift in demand for housing and an overhang of supply suggests policy makers can cushion the effect with interest-rate cuts such as the one announced Nov. 21, not reverse it. ‘The turning point has come,’ said Wang Tao, chief China economist at UBS… ‘Construction has to come down so that means growth has to slow, and therefore steel demand, cement demand, energy consumption, mining production, appliances, automobiles -- everything has to come down.’ …Increasing evidence the slowdown is structural, not cyclical, is playing out on commodity markets and leaves the U.S. shouldering prospects for a pickup in 2015 global growth.”
December 12 – Bloomberg: “Regulators in China are considering restricting individual investors from buying corporate bonds rated below the top grade as policy makers seek to shift away from a ‘too small to fail’ mentality, Fitch… said. China Securities Regulatory Commission is proposing to only allow so-called qualified investors or institutional funds to buy anything less than locally AAA rated exchange-traded domestic bonds, Ying Wang, a… director at Fitch, said…”
Japan Bubble Watch:
December 12 – Bloomberg (Toru Fujioka and Masahiro Hidaka): “The Bank of Japan rejects the idea that additional monetary stimulus is needed to prevent the decline in oil prices in recent months from pulling down inflation, according to people familiar with the discussions. For now, policy makers assess that while cheaper energy costs may weigh on consumer prices for a time, they ultimately will boost the economy -- spurring inflation, the people said… Less agreement is found on how much capacity the central bank has to expand its buying of government debt, some of the people said.”
Importantly, the Periphery’s core has fallen under major duress. The Mexican peso was hit for another 2.7% (down 11.7%) this week, while the Brazilian real was down 2.5% (down 11%) and the Turkish lira 1.7% (down 6.5%). Brazilian CDS (Credit default swap) surged 48 bps to a one-year high 212 bps. Mexican CDS jumped 22 bps to a one-year high 112 bps. Brazilian stocks sank 7.7%. Turkey CDS rose 36 bps to 185 (high since October). Indonesian rupiah bond yields jumped 34 bps to 8.11%.
As EM currencies have faltered, local-currency denominated debt has been under pressure. Yet for the most part, dollar-denominated EM debt has performed well – that is, until this week. Importantly, the EM dollar-denominated bond dam has given way. Russia dollar bond yields surged 59 bps to 6.62% this week. Brazil dollar yields jumped 47 bps to 4.56%. Turkey dollar yields rose 45 bps to 4.45%; Mexico 18 bps to 3.53%; Peru 22 bps to 3.80%; and Colombia 28 bps to 3.94%. Venezuela dollar-denominated yields jumped 381 bps this week to 24.28%.
Interesting dynamics at the Core. German stocks were hit for 4.9%, Spanish stocks fell 6.9% and Italian stocks dropped 7.4%. Greek stocks collapsed 20%. Greece five-year bond yields surged 332 bps to 9.15% - “worst week since the euro crisis.” Italian to German bond spreads widened 25 bps, and Portugal to German spreads widened 38 bps. Here at home, the S&P500 fell 3.5%. Yet the Morgan Stanley Retail index gained 0.8%. Healthcare, pharmaceuticals and the airlines advanced. Treasury bond yields sank below closing levels from tumultuous October 15th trading. Corporate bond spreads blew out to the widest level since the October market tumult.
U.S. equities bulls are clinging to a sanguine view of collapsing oil and commodities prices. A well-known strategist was on CNBC late Friday afternoon espousing the bullish thesis, comparing the current backdrop to 1997, when the U.S. expansion soldiered on impervious to EM debacles and sinking commodities. Yet EM debt was minuscule then compared to now. Global debt was a fraction of today’s level. U.S. debt was about a third the current level. And, importantly, the amount of global leveraged speculation was a small fraction of that which surely inflates speculative markets these days. That said, the Russian collapse and LTCM debacle almost brought the global financial system down in October 1998.
Especially these days, “Core vs Periphery” analysis is as fascinating as it is challenging. As always, it’s as much an “art” as it is a “science.” Importantly, initial stress at the Periphery only tends to spur financial flows to the Core. Serious unfolding issues can go so far as to rejuvenate Core Bubble Dynamics. At some point, however, a profoundly consequential transformation begins to unfold: De-risking/de-leveraging (liquidity “vaporization”) actually begins to suck liquidity from even Core markets. Progressively more powerful contagion momentum at the Periphery is apt to jump what had seemed an impermeable fire wall (between Periphery and Core). This will manifest first, often subtly, at the Core’s periphery. Still, with bullishness having become so engrained throughout the Core marketplace, critical warning signals will be readily dismissed.
I believe Collapsing Bubbles at the Periphery have at this point attained irreversible momentum. And the further that crude, commodities and EM currencies fall, the less likely EM countries, corporations and financial institutions will have the wherewithal to service huge amounts of dollar-denominated debt. A critical issue to ponder today is to what extent higher-yielding dollar-denominated debt has been used as fodder for leveraged speculation – for so-called “carry trades” as well as in the proliferation of high-return derivative structures and products. This debt has also found a home in scores of funds that ballooned in size courtesy of central bank measures and an unmatched global yield chase. The amount of dollar-denominated EM debt and its widespread distribution are unprecedented. The associated risks (especially Credit and liquidity) seemed this week to begin resonating.
Back in the late-nineties, the emerging markets were referred to as “roach motels.” It’s always the case that funds flow so smoothly into EM markets and economies. And as long as flows spur domestic lending, booming securities markets, generally loose financial conditions and economic expansion, the dream can persist that EM policymakers and economic players have learned from previous fiascos. At the same time, I do sympathize with EM. Developed world policy ineptness helped to really, really bury them this time around.
It’s a harsh fact of life that “loose money” and attendant Credit and speculative Bubbles provide fertile breeding grounds for fraud and corruption (not even mentioning resource misallocation). Throw trillions of cheap finance at “developing” financial and economic systems and you’ll at some point be dealing with major problems. And this is fundamental to the “global government finance Bubble” thesis: it’s been six years of history’s greatest and by far most dangerous Bubble. Now that Bubbles are Collapsing and the days of endless “hot money” inflows have turned to a rush for rapidly closing exits, some of the chicanery is coming into clearer view (i.e. Russia, Venezuela, Turkey, Brazil, Mexico, etc.). Just you wait for China.
It is also fundamental to my current analysis that central bank reflationary measures have rapidly lost their capacity to hold the global Bubble together. The wheels almost came off in October. Yet the efforts of Bullard, Draghi and Kuroda turned things around and incited yet another destabilizing speculative run. The market viewed that a Trillion from Draghi and another Trillion from Kuroda would more than offset the end of Federal Reserve liquidity creation. The game would continue.
The game, however, has changed. Flagrant euro and yen devaluation propelled king dollar, in the process giving a powerful bear hug to already deflating Periphery Bubbles. King dollar placed further downside pressure on crude and commodities markets. Collapsing oil and commodities impaired financial and economic stability for scores of countries and companies – too many that had ballooned debt (much dollar-denominated) throughout the previous boom. Huge amounts of global debt have rather suddenly turned suspect, inciting a self-reinforcing flight out of currencies, debt markets and commodities. And the more flows reverse out of the Periphery and head to the bubbling Core, the more destabilizing the unfolding king dollar dynamic for the global financial “system” and economy.
I’m sticking with my view of the existence of a massive “yen carry trade” (short a devaluing yen to leverage in higher-yielding instruments elsewhere). As was experienced during October’s bout of market instability - and as we saw at times again this week - any yen rally almost immediately fosters problematic de-risking/de-leveraging. And the assumption has been that as long as Kuroda remained at the helm, ongoing yen devaluation could be taken to the bank. This is reasonable and it may still play out this way. Indeed, the assumption of ongoing yen devaluation has been key to the resilient Bubble at the Core.
Yet, from the game aspect of it all, trading dynamics have undergone some subtle yet important changes. Nowadays, yen weakness powers king dollar – at the expense of Collapsing Periphery Bubbles. In a world where the Periphery and Core Bubble Dynamics have so profoundly diverged, no longer does yen devaluation keep the global Bubble afloat. And I think it’s reached the point where yen weakness has actually become destabilizing for the overall global Bubble. Yen devaluation works to sustain huge amounts of speculative leverage, but at the same time resulting dollar strength has pushed the unfolding EM collapse to the breaking point. This new dynamic provides a real policy quandary. Throwing more liquidity at the problem isn’t going to help.
The Fed released its Q3 2014 Z.1 “flow of funds” report this week. I won’t take as deep a dive as usual. From my perspective, what appears on the surface as a relatively benign Credit backdrop is in reality one with extraordinary vulnerability. I look out to 2015 and it is not clear how the system achieves ample Credit growth to sustain elevated securities markets, profit expectations and bullish optimism for the markets and real economy more generally - especially with ominous global storm clouds now gathering on the horizon.
Total Non-Financial Debt (TNFD) expanded at a 4.4% rate during Q3, up from Q2’s 3.4% and compared to Q3 2013’s 3.5%. Total Household debt expanded at a 2.7% rate, down from Q2’s 3.4%. And while Household Mortgage debt posted its first expansion in four quarters (0.7%), non-mortgage Consumer Credit slowed to a 6.4% pace, down from Q2’s 8.2% and Q1’s 6.6%. Total Business borrowings expanded at a 5.2% pace, up slightly from Q2’s 5.0% - but weaker than Q1’s 6.0%. State & Local government borrowing contracted at a 2.8% pace during Q3, more than reversing Q2’s 1.2% increase (which was the first positive number in five quarters). The star for the quarter, federal borrowings, expanded at a 7.2% annual pace, up significantly from Q2’s 2.5%.
In seasonally-adjusted and annualized rates (SAAR), TNFD expanded $1.801 TN, up from Q3’s $1.370 and Q1’s $1.688 TN. It was actually the strongest SAAR Credit growth since Q4 2012 ($1.962 TN). It is certainly worth noting that at SAAR $913bn, federal borrowings accounted for about half of TNFD. Household Debt expanded SAAR $366bn (mortgage $67bn and Consumer $206bn). Total Business borrowings expanded SAAR $605bn. State & Local contracted SAAR $84bn.
With equities under a little pressure during the period, Total Household Assets declined slightly in Q3 to $95.410 TN. And with Household Liabilities increasing $121bn (3.5% rate), Household Net Worth declined $141bn during the quarter to $81.349 TN. Over the past year, Household Assets increased $5.467 TN, with Net Worth inflating $5.140 TN. Net Worth was up a staggering $11.823 TN in two years and $26.664 TN in four years. As a percentage of GDP, Household Net Worth has increased from 331% to 463% in four years - to return almost to the record level from the end of 2007 (476%). There would be significant economic impact if Household Net Worth were to give back a few years of inflated gains.
I am fond of analysis that combines Treasury Securities, Municipal debt, GSE Securities, Corporate Bonds and Equities as a proxy for Total Marketable Securities (TMS). After beginning 1990 near $10 TN, TMS ended the nineties at about $33 TN. By the end of 2007, TMS had inflated to $52 TN. As a percentage of GDP, 2007’s 371% compared to 1990’s 178% (and 1999’s bubbly 355%).
TMS ended Q3 2014 at $70.79 TN, or 403% of GDP (both down slightly from Q2). TMS is now up $27 TN, or 62%, from the end of 2008. It is also worth noting that Equities at 200% of GDP surpasses 2007 (182%) and is almost back to 1999’s record 209%. And despite talk of system “deleveraging,” Total Debt Securities-to-GDP ended Q3 at 203%, up from 2007’s 182%, 1999’s 147% and 1989’s 114%.
One doesn’t have to go too crazy in search of cause and effect. The Federal Reserve’s Balance Sheet expanded SAAR $291bn during the quarter to a record $4.508 TN. Fed holdings jumped $720bn over the past year, or 19%. This puts the two-year open-ended QE operation (announced in the summer of 2012) at a staggering $1.700 TN, for 58.8% growth. It’s also worth noting that Security Credit jumped $189bn, or 16%, over the past year to a record $1.373 TN. Throughout the financial sector, no expansion is even remotely comparable to Federal Reserve and Security Credit.
Home mortgage borrowings expanded SAAR $77bn during Q3. This compares to 2005’s $1.128 TN, 2006’s $1.080 TN and 2007’s $771bn. Amazingly, six-years of ultra-loose monetary policy have done little to spur mortgage Credit expansion. And with Fed Credit growth supposedly ending and corporate Credit increasingly vulnerable to the forces of risk-aversion, mortgage Credit becomes only more critical to overall system Credit expansion. A strong case can be made that lowering market yields (and declining mortgage rates) no longer has much impact on mortgage borrowing (Household mortgage borrowings up 1.3% over the past two years!).
It is worth noting that GSE Securities expanded SAAR $225bn during Q3 (to $7.834 TN), up from Q2’s SAAR $185bn expansion. GSE Securities increased $240bn in 2013, the first growth since 2008. And with Fannie and Freddie now moving to lower lending standards, Washington appears ready for another push of GSE-induced Credit growth. As difficult as it is to believe, we’ll have to again keep close tabs on the GSE over coming quarters.
But the winner of the Q3 Z.1 Credit Sweepstakes goes to, once again, the U.S. Treasury. Treasury Securities expanded SAAR $914bn during the quarter to a record $12.756 TN. Over the past year, Treasury Securities increased $799bn, or 6.7%, with a two-year gain of $1.500 TN, or 13.3%. Since the end of 2007, outstanding Treasury Securities has increased $7.656 TN, or 150%. Over this period, total Household Debt declined about $420bn (to $13.414 TN). Tough to call this “deleveraging.”
Expanding upon comments made earlier, I think “ominous” when analyzing this Z.1. There is very little to indicate that an unprecedented expansion of Federal Reserve and Treasury Credit has resuscitated a private-sector Credit cycle. Corporate debt has expanded briskly over recent years, but even this important source of system Credit is now susceptible to both global and domestic forces.
My analytical hunch is that “hot money” flowing freely into our booming securities markets helps explain the robust asset price inflation backdrop in the face of lackluster underlying Credit dynamics. Thus far, troubles at the Global Bubble’s Periphery have ensured that king dollar flows inundate Core U.S. markets. But, again, there will be a point when Global de-risking/de-leveraging leads to waning risk-taking and liquidity – even at the susceptible Core.
I’ve argued for awhile now that the maladjusted U.S. economic structure requires in the neighborhood of $2.0 TN of annual non-financial Credit growth. The number for Q3 came in at $1.801 TN. System Credit has remained meaningfully below the $2.0 TN bogey since 2012. Yet I would argue strongly that the Fed’s massive QE program short-circuited typical dynamics. Miraculously, QE provided “money” for inflating securities prices, for ensuring ultra-loose corporate Credit conditions, for federal and state receipts, for corporate cash-flows and earnings, for record stock buybacks, for record M&A and for lots of spending (especially by the wealthy!). QE incited leveraged speculation and booming “hot money” flows. But QE has ended (for now).
I expect the post-QE landscape to be one of disappointing market performance, weakening corporate profits, less financial engineering and waning growth in government revenues (resurgent deficits!). I look out to 2015 and it’s not clear how we get anywhere near the $2.0 TN system Credit growth bogey. “Hot money” is the big wildcard. King dollar flows could help to sustain inflated securities markets, in the process inflating Household Net Worth (perceived wealth) and spending. But with my view that the global Bubble has burst, the probability for a problematic Risk-Off dynamic impacting the world has increased significantly. In that scenario, I don’t see the sources of sufficient liquidity and system Credit expansion to keep the U.S. Bubble markets and Bubble Economy levitated.
To summarize, six-years of unprecedented fiscal and monetary stimulus have ensured that everyone is today fully dressed up, liquored up, and silly eager for The Big Party. “Anybody seen the punchbowl?” “Where is it, and I mean now!” “Oh crap, where on earth did it go!!” “Who took it away!!” “I’m telling you to bring it back right now or there’s going to be some serious trouble!!!” What a fiasco.
For the Week:
The S&P500 sank 3.5% (up 8.3% y-t-d), and the Dow fell 3.8% (up 4.3%). The Utilities added 0.5% (up 20.1%). The Banks were hit for 3.8% (up 3.6%), and the Broker/Dealers sank 3.5% (up 10.5%). Transports declined 3.4% (up 19.4%). The S&P 400 Midcaps lost 2.9% (up 4.5%), and the small cap Russell 2000 dropped 2.5% (down 1.0%). The Nasdaq100 declined 2.6% (up 16.9%), and the Morgan Stanley High Tech index sank 3.6% (up 8.7%). The Semiconductors were slammed for 4.5% (up 25.5%). The Biotechs slipped 0.9% (up 46.8%). Although bullion rallied $30, the HUI gold index declined 0.4% (down 16.3%).
One-month Treasury bill rates closed the week at one basis point and three-month rates ended at two bps. Two-year government yields dropped 10 bps to 0.54% (up 16 bps y-t-d). Five-year T-note yields fell 17 bps to 1.51% (down 23bps). Ten-year Treasury yields sank 22 bps to 2.08% (down 95bps). Long bond yields fell 23 bps to 2.74% (down 123bps). Benchmark Fannie MBS yields were down 16 bps to 2.79% (down 82bps). The spread between benchmark MBS and 10-year Treasury yields widened six to 71 bps. The implied yield on December 2015 eurodollar futures dropped 10.5 bps to 0.83%. The two-year dollar swap spread increased three to 24 bps, and the 10-year swap spread gained two to 13 bps. Corporate bond spreads widened significantly. An index of investment grade bond risk jumped 10 to 72 bps. An index of junk bond risk surged 52 bps to 396 bps. An index of emerging market (EM) debt risk jumped 67 to 383 bps (high since June 2012).
Greek 10-year yields surged 192 bps to 9.15% (up 73bps y-t-d). Greek five-year yields jumped 332 bps to 9.15%. Ten-year Portuguese yields rose 22 bps to 2.97% (down 316bps). Italian 10-yr yields gained nine bps to 2.06% (down 206bps). Spain's 10-year yields rose five bps to 1.88% (down 227bps). German bund yields sank 16 bps to a record low 0.62% (down 131bps). French yields dropped 13 bps 0.90% (down 166bps). The French to German 10-year bond spread increased three to 28 bps. U.K. 10-year gilt yields fell 22 bps to 1.80% (down 122bps).
Japan's Nikkei equities index dropped 3.1% (up 6.6% y-t-d). Japanese 10-year "JGB" yields were down three bps to a record low 0.39% (down 35bps). The German DAX equities index sank 4.9% (up 0.5%). Spain's IBEX 35 equities index was clobbered for 6.9% (up 2.3%). Italy's FTSE MIB index was hammered for 7.4% (down 1.9%). Emerging equities were for the most part under significant pressure. Brazil's Bovespa index collapsed 7.7% (down 6.8%). Mexico's Bolsa fell 3.5% (down 2.4%). South Korea's Kospi index fell 3.3% (down 4.5%). India’s Sensex equities index was slammed for 3.9% (up 29.2%). China’s Shanghai Exchange was unchanged (up 38.9%). Turkey's Borsa Istanbul National 100 index declined 2.4% (up 22.8%). Russia's MICEX equities index fell 4.6% (down 3.0%).
Debt issuance slowed. Investment-grade issuers included American Honda $1.5bn, State Street $1.0bn, Goldman Sachs $1.0bn, New York Life Global $650 million, Trans-Allegheny Interstate Line $550 million, Penske Truck Leasing $500 million, Ingram Micro $500 million, AIG Global Funding $450 million and Overseas Primate Investment Corp $240 million.
Junk funds saw outflows surge to $1.89bn (from Lipper), the largest outflows since October. Junk issuers this week included OneMain Financial Holdings $1.5bn, Kindred Healthcare $1.35bn, CBRE Services $425 million, Westmoreland Coal $350 million and WGL Holdings $150 million.
Convertible debt issuers included Envestnet $150 million and IGI Laboratories $125 million.
International dollar debt sales dropped sharply. Issuers included Neder Waterschapsbank $1.5bn, Nakama RE $375 million and Asian Development Bank $300 million.
Freddie Mac 30-year fixed mortgage rates increased four bps to 3.93% (down 49bps y-o-y). Fifteen-year rates jumped 10 bps to 3.20% (down 23bps). One-year ARM rates slipped one basis point to 2.40% (down 11bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 4.14% (down 40bps).
Federal Reserve Credit last week expanded $1.8bn to $4.448 TN. During the past year, Fed Credit inflated $542bn, or 13.9%. Fed Credit inflated $1.637 TN, or 58%, over the past 109 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.5bn last week to $3.324 TN. "Custody holdings" were down $30bn year-to-date and fell $43bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $233bn y-o-y, or 2.0%, to another seven-month low $11.771 TN. Over two years, reserves were $924bn higher for 9% growth.
M2 (narrow) "money" supply expanded $35.6bn to a record $11.603 TN. "Narrow money" expanded $630bn, or 6.2%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits jumped $18.2bn, and Savings Deposits gained $18.4bn. Small Time Deposits slipped $0.8bn. Retail Money Funds fell $2.5bn.
Money market fund assets rose $18.5bn to $2.706 TN. Money Funds were down $12.3bn y-t-d and $3.3bn from a year ago, or 0.1%.
Total Commercial Paper dropped $9.0bn to $1.087 TN. CP expanded $40.8bn year-to-date and was up $5.1bn over the past year, or 0.5%.
Currency Watch:
December 10 – Bloomberg (Fion Li): “Don’t fight the central bank is an old adage on Wall Street. In China, currency traders are doing the opposite. Traders pushed the yuan’s onshore exchange rate to a five- month low even as the People’s Bank of China raised the official rate to the highest since March. The 1% discount between the market and central bank rates is the widest gap since June. That’s a turnaround from the first four months of the year, when weaker fixings by the PBOC prompted speculators to reverse bets on yuan appreciation and sent the spot rate lower.”
The U.S. dollar index declined 1.1% to 88.36 (up 10.4% y-t-d). For the week on the upside, the Japanese yen increased 2.3%, the Swiss franc 1.6%, the Danish krone 1.5%, the euro 1.5%, the South Korean won 1.0%, the British pound 0.9%, the New Zealand dollar 0.9%, the Singapore dollar 0.7% and the Swedish krona 0.2%. For the week on the downside, the Mexican peso declined 2.7%, the Norwegian krone 2.6%, the Brazilian real 2.5%, the South African rand 2.1%, the Canadian dollar 1.3%, the Australian dollar 0.8% and the Taiwanese dollar 0.6%.
Commodities Watch:
December 10 – Bloomberg (Grant Smith): “OPEC cut the forecast for how much crude oil it will need to provide in 2015 to the lowest in 12 years amid surging U.S. shale supplies and reduced estimates for global consumption… The impact of this year’s 40% price collapse on supply and demand remains unclear, OPEC said.”
The Goldman Sachs Commodities Index sank 5.9% to a more than five-year low (down 29%). Spot Gold rallied 2.5% to $1,223 (up 1.4%). March Silver recovered 4.9% to $17.057 (down 12%). January Crude collapsed $8.03 to $57.81 (down 41%). January Gasoline sank 9.9% (down 43%), and January Natural Gas slipped 0.2% (down 10%). March Copper gained 1.1% (down 14%). March Wheat increased 2.1% (up 1%). March Corn jumped 3.2% (down 3%).
U.S. Fixed Income Bubble Watch:
December 11 – Bloomberg (Christine Idzelis and Craig Torres): “The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt. Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to 8% next year. ‘Anything that becomes a mania -- it ends badly,’ said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of… Peritus Asset Management. ‘And this is a mania.’ The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s… this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.”
December 12 – Bloomberg (Cordell Eddings and Nabila Ahmed): “The market for new junk bonds has all but shut as plunging oil prices and borrowing costs at an 18-month high deter issuers. Even as sales of high-yield, high-risk notes in the U.S. reached a record $353.1 billion this year, offerings have stalled this month with the slowest pace for a December since 2011. Junk is on track to deliver its second straight quarterly loss, the first time that’s happened since 2008, and trimming gains for the year to 1.47%... After six years of easy monetary policies by the Federal Reserve boosted the ability of the least-creditworthy companies to borrow on favorable terms, investors are becoming more discriminating. The average yield on speculative-grade debt climbed to 7.11% yesterday from an all-time low of 5.69% in June…”
December 9 – Bloomberg (Sridhar Natarajan): “BlackRock Inc. Chief Executive Office Laurence D. Fink said moments of severe volatility will continue to plague the corporate bond market unless regulators enforce a push toward more electronic trading. ‘Regulators need to admit that we have changed the ecosystem of bonds and yet we are not seeing regulatory pressure to transform the bond market into more electronic trading,’ Fink said… ‘I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market. It’s going to create some sort of panic, create uncertainty again.’”
U.S. Bubble Watch:
December 12 – Bloomberg (Lisa Abramowicz): “Credit investors are preparing for the worst. They’re cleaning up their portfolios, selling riskier debt that’s harder to trade in bad times and hoarding longer-term government bonds that do best in souring markets. While investors have pruned energy-related holdings in particular as oil prices plunge, they’re also getting rid of other types of corporate bonds, causing yields to surge to the highest in more than a year. ‘We believe the pervasive nature of the sell-off is more reflective of overall liquidity concerns in the cash market than of fundamental deterioration,’ Barclays Plc analysts Jeffrey Meli and Bradley Rogoff wrote… ‘The weakness, while certainly most pronounced in the energy sector, has been broad based.’”
December 11 – Bloomberg (Lisa Abramowicz): “Perhaps 2014 will go down in history as the year that junk bonds sent a warning signal as oil plummeted and stocks just kept rallying. Prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as U.S. equities have climbed to new highs. The dollar-denominated debt is now yielding the most relative to a comparable measure on the Standard & Poor’s 500 index since 2011.”
December 8 – CNBC (Phil LeBeau): “In the latest sign Americans are comfortable paying more for what they'll drive, the country is on the cusp of major milestone. This year, automakers are on pace to sell more than one million vehicles in the U.S. with transaction prices of at least $50,000 according to new data compiled by TrueCar… The growth in sales of higher priced models is stunning when compared with the auto industry overall. From January through November 931,064 vehicles were sold in the U.S. with average price above $50,000, a whopping 30.8% increase compared to the same period last year… Meanwhile, …sales of models with average transaction prices under $50,000 are up just 4.1% this year.”
December 8 – Bloomberg (Clea Benson): “Fannie Mae and Freddie Mac have set terms for letting borrowers put down as little as 3% of a home’s cost to get mortgages, a step criticized by Republican lawmakers as a return to risky lending. Starting on Dec. 13, Fannie Mae will allow the lower down payments for first-time homebuyers and permit refinancing borrowers to reduce equity to 3% to cover closing costs… Freddie Mac will begin a program in March giving breaks to lower-income buyers and first-time borrowers who get housing counseling.”
December 9 – Dow Jones (Jon Ostrower): “Boeing Co. will reduce monthly production of its 747-8 jetliner to 1.3 aircraft a month from 1.5, as demand continues to slow for the storied jumbo jet. The aerospace giant… said it would make the reduction, which will lower annual deliveries of the 747 to approximately 16 from 18, in September 2015. The planned cut enables ‘us to continue to run a healthy business,’ Boeing said… Boeing last year said it was cutting 747 output to 1.5 aircraft a month from 1.75.”
Federal Reserve Watch:
December 9 – Wall Street Journal (Jon Hilsenrath): “Federal Reserve officials are seriously considering an important shift in tone at their policy meeting next week: dropping an assurance that short-term interest rates will stay near zero for a ‘considerable time’ as they look more confidently toward rate increases around the middle of next year. Senior officials have hinted lately that they’re looking at dropping this closely watched interest-rate signal… ‘It’s clearer that we’re closer to getting rid of that than we were a few months ago,’ Fed Vice Chairman Stanley Fischer said… New York Fed President William Dudley has avoided using the ‘considerable time’ phrase in recent speeches and instead said the Fed should be ‘patient’ before raising rates.”
ECB Watch:
December 11 – Financial Times (Claire Jones): “The European Central Bank has injected €129.8bn through its second offer of cheap four-year loans, missing expectations of a higher take-up. Analysts polled by Bloomberg last week had forecast eurozone lenders to bid for €170bn of a possible €317bn. Banks took €82.6bn in the first of the auctions, which the ECB hopes will boost lending to the region’s credit-starved smaller businesses. The offer is part of a package of eight auctions, known as ‘Targeted Longer-Term Refinancing Operations’, allowing banks to borrow at ultra-low fixed rates if they agree to terms for lending to businesses and households in the region. The remaining six auctions will take place over the next two years. The result of the auction will weigh on the ECB’s decision-making in the months ahead, with weak demand supporting the case for doing more.”
Central Bank Watch:
December 11 – Bloomberg (Saleha Mohsin): “Norway’s central bank cut its main interest rate for the first time in more than two years and signaled it may ease again next year as plunging oil prices threaten growth in western Europe’s biggest crude exporter. The rate was lowered by 0.25 percentage point to 1.25%... The bank sees a ‘50-50 chance’ for another rate cut next year, Governor Oeystein Olsen said… The job now is to ‘prevent a severe downturn,’ he said…”
Russia/Ukraine Watch:
December 11 – Bloomberg (Olga Tanas, Anna Andrianova and Ksenia Galouchko): “Russia’s fifth interest-rate increase this year failed to stem the ruble’s worst rout in 16 years, risking further damage to an economy battered by sanctions and oil prices near the lowest since 2009. The Bank of Russia increased its key rate to 10.5% from 9.5%... ‘This is a spineless decision,’ Vadim Bit-Avragim, who helps oversee about $4 billion at Kapital Asset Management LLC in Moscow, said… ‘If the central bank’s goal was to defend the ruble, it would’ve raised rates by 2-3 percentage points.’”
December 10- Financial Times (Peter Spiegel in Brussels and Roman Olearchyk): “The International Monetary Fund has identified a $15bn shortfall in its bailout for war-torn Ukraine and warned western governments the gap will need to be filled within weeks to avoid financial collapse. The IMF’s calculations lay bare the perilous state of Ukraine’s economy and hint at the financial burden of propping up Kiev… The additional cash needed would come on top of the $17bn IMF rescue announced in April and due to last until 2016… ‘It’s not going to be easy,’ said one official involved in the talks. ‘There’s not that much money out there.’ …Without additional aid, Kiev would have to massively slash its budget or be forced to default on its sovereign debt obligations. Since the bailout programme began in April, Ukraine has received $8.2bn in funding from the IMF and other international creditors… Under IMF rules, the fund cannot distribute aid unless it has certainty a donor country can meet its financing obligations for the next 12 months, meaning the fund is unlikely to be able to send any additional cash to Kiev until the $15bn gap is closed. The scale of the problem became clearer last week after Ukraine’s central bank revealed its foreign currency reserves had dropped from $16.3bn in May to just $9bn in November. The data also showed the value of its gold reserves had dropped by nearly half over the same period.”
December 10 – Bloomberg (Lyubov Pronina and Natasha Doff): “Russian companies lost tens of billions of rubles on foreign-exchange derivatives amid a rout in the ruble, Interfax reported, citing Sergey Moiseev, the head of financial stability at the central bank. Companies were forced to close out the contracts after the central bank’s move to a free-floating currency exposed them to the world’s highest currency volatility amid a slump in oil prices, Moiseev said…”
December 11 – Bloomberg (Jason Corcoran, Ilya Khrennikov and Anna Baraulina): “Anatoly Ivanov, a 39-year-old software engineer who lives in a 53 square-meter (570 square-foot) St. Petersburg apartment with his wife and child, said he feels boxed in. The ruble’s collapse this year has caused a headache for Anatoly, who bought his Soviet-era home with a dollar mortgage in 2008… At the time, a dollar was 23 rubles and the interest rate on the mortgage was 4 percentage points lower than on loans in rubles. Yesterday, the rate was about 55 to the dollar, and Ivanov is considering paying a penalty to switch the mortgage into rubles. ‘Our $800 monthly payment has jumped to 38,000 rubles from 26,000 rubles since the start of the year,’ Ivanov, who is paid in rubles, said… Lured by foreign banks offering lower rates, Russians have taken 108.5 billion in non-ruble mortgage loans… While that represents 3% of total mortgages, 15% of the foreign currency home loans are delinquent, while 0.9% of ruble loans are overdue.”
Brazil Watch:
December 10 – Bloomberg (Filipe Pacheco): “Brazil’s plan to cut subsidized loans is coming at an inopportune time for corporate borrowers. Incoming Finance Minister Joaquim Levy pledged last month to scale back transfers to state development banks including BNDES, part of a strategy to trim debt levels after Standard & Poor’s lowered Brazil’s credit rating to the cusp of junk in March. While his plan reduced the nation’s funding costs in the bond market, it may also boost expenses for companies struggling to obtain overseas financing with yields at a 13-month high, Barclays Plc and Banco Mizuho do Brasil SA said. Levy’s strategy marks a shift after funding for BNDES doubled during President Dilma Rousseff’s first term, which benefited corporate borrowers including Petroleo Brasileiro SA, Norte Energia SA and Oi SA. Three Brazilian companies have pulled overseas bond offerings in the past month as economic growth stalls and a bribery probe into Petrobras prompts investors to shun sales.”
December 8 – Bloomberg (Julia Leite): “In 2011, Moody’s… rated Petroleo Brasileiro SA three levels above its owner, Brazil’s government. Today, the bond rater says the oil producer would merit a junk grade without state support and is proving a drag on the nation’s own creditworthiness. Mauro Leos, Moody’s lead analyst for Brazil, said… that a bribery probe into Petrobras is contributing to the negative outlook on Brazil’s rating, two days after Moody’s cut its so-called stand-alone rating for the oil producer to speculative grade. The comments came after the investigation took another turn last week when President Dilma Rousseff’s ruling party was alleged to have received donations from compans in exchange for securing contracts with Petrobras.”
December 8 – Bloomberg (Sabrina Valle): “AP Moeller-Maersk A/S is among foreign companies being investigated in Brazil over allegations they bribed Petroleo Brasileiro SA executives in exchange for contracts, widening the probe from local suppliers to companies working on oil projects around the globe. A prosecutor and a federal police agent said in interviews that they found evidence of international suppliers paying bribes through agents to Paulo Roberto Costa, the former Petrobras executive who is cooperating with authorities in exchange for a reduced sentence…”
December 11 – Bloomberg (Anna Edgerton and Rachel Gamarski): “Petroleo Brasileiro SA, the oil producer at the center of Brazil’s biggest-ever corruption scandal, plans to sell debt this year backed by the national treasury and state-run Centrais Eletricas Brasileiras SA. The transaction will be guaranteed by money that Eletrobras… owes Petrobras from the purchase of fuel for power plants, Energy Minister Edison Lobao told reporters…”
December 11 – Bloomberg (Francisco Marcelino, Gerson Freitas Jr. and Tariq Panja): “The boost that the World Cup was supposed to give Brazilian soccer hasn’t materialized as a sluggish economy and budget shortfalls leave the majority of top division clubs unable to pay salaries. Five of the league’s 20 clubs, including former FIFA world club champion Sao Paulo and Santos, where soccer star Pele spent the majority of his career, ended the season this month without major sponsors on their shirts. At least 17 clubs delayed players’ salaries this year, said a person with direct knowledge of the matter…”
EM Bubble Watch:
December 8 – Bloomberg (Srinivasan Sivabalan): “Foreign-debt levels of companies in emerging markets from China to India and Brazil are underestimated, threatening financial stability, the Bank for International Settlements said. Companies are raising more foreign funds through their offshore affiliates and accounting practices understate the currency risk in such transactions, the… institution said in its quarterly report. Almost half of the $554 billion that the firms raised in the five years through 2013 came from the affiliates, the BIS said. ‘Offshore subsidiaries of emerging-market non-financial corporates are increasingly acting as surrogate intermediaries,’ raising money abroad and transferring it to their parent companies, economists led by Stefan Avdjiev wrote. ‘This trend could have important financial-stability implications.”
December 11 – Financial Times (Pan Kwan): “Market fears over Venezuela’s creditworthiness are approaching panic levels as the price of oil plunges. The cost of insuring the South American country’s government debt against default surged to a new high on Wednesday… The five-year credit-default swap on Venezuelan government debt surged more than 832 bps — its biggest one-day jump on record — to 4019.57 bps. This makes Venezuelan debt the most expensive to insure in the world, surpassing even Argentina’s, which went into default for the eighth time in its history this year. The cost of insuring a portfolio of Venezuelan sovereign debt for five years against default has quadrupled since June, when oil began its downward spiral… With oil accounting for roughly 96 per cent of its export earnings and 48% of budget revenue, the slump in oil prices has taken a toll on the country’s already dire finances.”
December 9 – Bloomberg (Katia Porzecanski): “The scores of money managers and analysts who crowded into Cleary Gottlieb Steen & Hamilton LLP’s panel discussion on Venezuela last week are a testament to the deepening concern over whether President Nicolas Maduro can make good on the nation’s debt obligations. … Among the topics debated were whether the state oil company’s U.S. gasoline stations could be seized as collateral and whether it was legally possible for Venezuela to restructure the producer as an empty shell to avoid bondholder claims, they said. For a country that hasn’t missed a foreign bond payment in decades, the questions reflect growing speculation the socialist revolution that transformed Venezuela over the past 15 years under Hugo Chavez and now Maduro has finally pushed the nation to the brink of economic collapse.”
December 10 – Bloomberg (Onur Ant and Constantine Courcoulas): “Turkey’s economic growth slowed in the third quarter as falling borrowing costs failed to spur domestic demand and agricultural output contracted. Gross domestic product grew 1.7%, the slowest pace since 2012, compared with a revised 2.2% during the previous three months… Household consumption, which makes up two-thirds of the Turkish economy, grew 0.2% from a year ago compared with 0.5% during the previous quarter.”
December 12 – Bloomberg (Onur Ant): “Turkish central bank Governor Erdem Basci is sending monetary-policy signals that are upending a two-month government bond rally. Lira bonds have lost 3.8% in December after the biggest returns in emerging markets the previous two months… Further declines are in store after Basci indicated two days ago that he’s in no rush to cut interest rates further…”
December 9 – Bloomberg (Sandrine Rastello): “India’s current-account deficit widened more than estimated to the largest since the quarter through June 2013 as exports slowed and gold imports surged. The July-September shortfall in the broadest measure of trade widened to $10.1 billion from $7.8 billion the previous quarter… A recession in Japan and deteriorating outlook for the euro-area economy are keeping a lid on demand for Indian products as Prime Minister Narendra Modi seeks to revive manufacturing in Asia’s third-largest economy.”
December 9 – Bloomberg (Maciej Martewicz and Konrad Krasuski): “Poland’s real-estate developers are selling a record amount of debt this year to fund an office construction boom even as the central bank warns of a glut. Builders including Echo Investments SA and Ghelamco NV have issued about 1.7 billion zloty ($500 million) of bonds amid record low interest rates at home and in the neighboring euro region, according to Fitch… While the Polish central bank said last week that Warsaw vacancy rates at 14% signaled a ‘growing imbalance,’ no fewer than 46 office buildings, including the 48-story Warsaw Spire, are under construction.”
Europe Watch:
December 11 – Bloomberg (David Goodman): “Greece’s government bonds fell, pushing three- and five-year rates to the highest since the nation restructured its debt in 2012, amid speculation early presidential elections will spark renewed political turmoil. The nation’s 10-year yield exceeded 9% after Prime Minister Antonis Samaras said the markets fear a victory for anti-bailout party Syriza in potential elections next year.”
December 8 – Reuters (John O’Donnell and Paul Carrel): “The euro zone is experiencing a massive weakening in its economy not least due to a slowdown in its biggest member, Germany, a senior ECB policy maker said… ‘We see a massive weakening in the euro zone economy,’ Ewald Nowotny, a member of the ECB's Governing Council, told a conference… Nowotny said that the European Central Bank had struck a middle ground in its monetary policy, between extremes in the United States that called for full-blown money printing and others that wanted the ECB to take a less expansive path.”
December 10 – Reuters (James Mackenzie): “In a European political landscape increasingly populated with insurgent, anti-system parties, Italy's eurosceptic anti-immigrant Northern League is the latest to profit from a groundswell of hostility to the European Union. The League's 41-year-old leader, Matteo Salvini calls the euro a ‘criminal currency’ and wants to demolish the Brussels consensus that has dominated European politics since the end of World War Two. He is also, at odds with mainstream leaders, an admirer of Russian President Vladimir Putin. Salvini has become Italy's second-most popular leader since taking over the party, founded in the early 1990s as a separatist movement in the prosperous north of Italy.”
December 10 – Bloomberg (Sonia Sirletti): “Italian banks boosted their holdings of the country’s sovereign debt to a record high as Italy’s third recession in six years makes lending to companies and individuals risky. Italian banks increased Italian sovereign-debt holdings by almost 18.4 billion euros ($22.8bn) in October to a record 414.3 billion euros…”
December 8 – Bloomberg (David Goodman): “The drop in Italy’s 10-year bonds that followed a Standard & Poor’s downgrade of the nation lasted less than a morning, amid speculation the European Central Bank will start buying sovereign debt as soon as next month. Government bonds from Germany to Spain rose today after ECB President Mario Draghi said last week officials would act should current stimulus prove insufficient when it is reassessed early next year. A round of loans from the ECB to banks this week, part of stimulus plans intended to add as much as 1 trillion euros ($1.22 trillion) to the institution’s balance sheet, won’t even cover the repayments they owe from a previous program, according to a Bloomberg News survey…”
December 8 – Bloomberg (Ambereen Choudhury): “European banks will be weakened further by poor economic conditions and high litigation costs in 2015, according to Moody’s… Banks’ profits in the region, with the exception of the U.K. and Scandinavia, may be exposed to ‘economic tailwinds,’ hurting loan demand and the value of transactions, Moody’s said… ‘Weak macroeconomic conditions weigh on Europe’s banking sector, and low overall bottom lines implies that the European banking industry remains structurally vulnerable,’ Carola Schuler, Moody’s managing director…, said”
December 9 – Financial Times (John Plender): “France’s finance minister has called on the German establishment to watch its words when criticising his country’s economic policies, claiming barbs from Germany are fuelling the rise of anti-EU populists. Michel Sapin, who is under pressure from Brussels and Berlin to be more aggressive in cutting spending and in his reforms, said he was concerned by ‘certain extreme comments in Germany’. He called for mainstream parties to counter ‘outdated’ stereotypes.”
Global Bubble Watch:
December 8 – Financial Times (Claire Jones and Sam Fleming): “Global financial policy makers have sounded the alarm about the impact of a resurgent US dollar on emerging markets, where companies have racked up large debts denominated in the American currency. The Bank for International Settlements, known as the central bankers’ bank, warned… in its Quarterly Review that a prolonged rally in the dollar could expose financial vulnerabilities in emerging markets by damaging some companies’ creditworthiness. The… organisation added that there were increasing signs of fragility in financial markets, despite renewed hopes for economic growth, pointing to the recent stress in the $12.3tn US Treasury market that serves as the bedrock of the global financial system. ‘To my mind, these events underline the fragility — dare I say growing fragility — hidden beneath the markets’ buoyancy,’ said Claudio Borio, the head of the BIS’s monetary and economic department… However, companies in emerging markets have been borrowing heavily via the issuance of dollar securities in recent years… It said emerging market borrowers had issued a total of $2.6tn of international debt securities, of which three-quarters were denominated in dollars. International banks’ cross-border loans to emerging market economies amounted to $3.1tn in mid-2014, mainly in US dollars, the BIS added. Mr Borio said: ‘Should the US dollar, the dominant international currency, continue its ascent, this could expose currency and funding mismatches by raising debt burdens. The corresponding tightening of financial conditions could only worsen once interest rates in the US normalise.”
December 12 – Bloomberg (David Goodman): “The last time Greece’s bonds had this bad a week, the nation had just undergone the biggest debt restructuring in history, inconclusive elections had stoked concern it may exit the euro and Mario Draghi’s ‘whatever it takes’ pledge was more than two months away. The yield on Greek 10-year bonds has surged about 200 bps this week, the biggest leap since the height of the euro- area sovereign-debt crisis in May 2012. Worse still, the yield on three-year notes, issued in July as part of Greece’s emblematic return to capital markets, have jumped more than 450 bps, climbing above the longer-dated rates in a sign that investors are increasingly concerned the nation will be unable to pay its debt.”
December 8 – Reuters (Chris Vellacott): “China has become the largest emerging market destination for international bank lending, accounting for more than a quarter of cross-border claims on all emerging market economies, a central banking report shows. Cross-border claims on China increased by $65 billion in the second quarter of 2014 to $1.1 trillion, and were up nearly 50% in the year to the end of June, according to a quarterly report from the Bank for International Settlements… ‘China has become by far the largest (emerging market) borrower for BIS reporting banks. Outstanding cross-border claims on residents of China totaled $1.1 trillion at end-June 2014, compared with $311 billion on Brazil and slightly more than $200 billion each on India and Korea,’ the report says.”
Geopolitical Watch:
December 12 – Bloomberg (Diep Ngoc Pham and John Boudreau): “Tensions over the South China Sea were reignited after Vietnam said it had submitted its stance on the dispute to the international arbitration tribunal reviewing the Philippines’ challenge against China’s claims. Vietnam has asked the arbitration court to take into account its legal rights and interests in the disputed sea region, spokesman Le Hai Binh, said… The country also refuted China’s claims to the Paracel and Spratly islands in the statement, which provoked a Chinese response yesterday that its neighbor’s claims were unlawful. The renewed tensions are being sparked as the United Nations tribunal in the Hague considers Philippine’s challenge to China’s claim to much of the South China Sea as the island nation seeks to check Beijing’s bid for control of waters rich in oil, gas and fish. Vietnamese and Philippine leaders say they are determined to oppose China’s move to control the sea region…”
December 12 – Bloomberg (Alex Nussbaum and Alex Morales): “Envoys at the United Nations climate talks enter their final day in Lima divided on how to put teeth into a deal that the biggest polluters have turned into a package of mostly voluntary measures. Developing countries led by China and India want to pin down industrial nations on how they’ll meet a pledge for $100 billion a year in climate-related aid by 2020. The U.S. and its allies want to secure a way to ensure that all governments, rich and poor alike, will curb greenhouse gases. The differing goals underscore how quickly the problem about how to rein in emissions has shifted from an issue aimed mostly at rich polluters into one that needs to be answered by all nations.”
China Bubble Watch:
December 11 – Reuters: “China has told its banks to lend more in the final months of 2014 and relaxed enforcement of loan-to-deposit ratios to expand credit, sources told Reuters… Figures on inflation, imports and fiscal spending in November have already undershot expectations since the People's Bank of China (PBOC) sprang a surprise interest rate cut on Nov. 21… ‘I wouldn't be surprised by that at all,’ said Andrew Polk, resident economist for the Conference Board in Beijing. ‘It seems pretty clear activity is continuing to weaken throughout this fourth quarter.’ Two sources with knowledge of the matter said China's central bank increased the annual new loan target to 10 trillion yuan ($1.62 trillion) for 2014, up from what Chinese media have said was a previous target of 9.5 trillion yuan. Banks have disbursed 8.23 trillion yuan of loans between January and October, so they will have to quicken the pace in the last two months if they are to meet the new target.”
December 9 – Bloomberg: “China took one of its biggest steps yet to push local governments away from using opaque financing vehicles to raise money as policy makers seek to reduce leverage and develop a more transparent municipal bond market. The nation’s clearing agency for exchanges said yesterday it won’t allow bonds rated below AAA or sold by issuers graded lower than AA to be used as collateral for short-term loans obtained through repurchase agreements. The new rules sparked a retreat in lower-rated bonds of local government financing vehicles and contributed to a tumble in Shanghai shares as noteholders reassessed the appeal of owning such debt.”
December 12 – Bloomberg: “A local government financing vehicle in China’s eastern province of Jiangsu has delayed a bond sale after authorities ruled it wouldn’t be backed by the state. Changzhou Tianning Construction Development Co. said it won’t go ahead with a 1.2 billion yuan ($194 million) offering planned for Dec. 15 because of market volatility… The Finance Ministry has said local governments must detail all outstanding borrowings by Jan. 5 as it determines which of the thousands of financial entities set up by cities and provinces it may be willing to support.”
December 11 – Bloomberg: “The People’s Bank of China injected 400 billion yuan ($65bn) into the banking system, according to a person familiar with the matter, pressing ahead with targeted steps to add liquidity as the economy slows… The move comes as a previous PBOC injection of 500 billion yuan comes due this month. The PBOC had said it pumped that amount into the economy in September with a term of three months and a rate of 3.5%. Another 269.5 billion was added in October with the same terms, it said.”
December 10 – Bloomberg: “With $90 billion of bonds sold by local government financing vehicles coming due next year, China is walking a fine line between teaching investors a lesson and preventing widespread defaults. The nation’s clearing agency said this week that local bonds rated lower than the highest AAA grade are too risky to be used as collateral for short-term loans. That means about half of the outstanding 1 trillion yuan ($162bn) securities sold by local government financing vehicles, or LGFVs, in the exchange market can no longer be pledged to raise funds, according to Morgan Stanley. Warning that these securities aren’t risk free caused the yield spread on seven-year AA-rated local debt over Chinese government bonds to widen the most on record yesterday. Now investors will be looking for clues as to which of the thousands of financial entities set up by cities and provinces the government may be willing to support, and which it won’t. ‘We could see a further sell-off in LGFV and corporate bonds as investors are more aware of the credit and liquidity risks,’ said Ken Hu, the… chief investment officer for Asia-Pacific fixed income at Invesco… ‘The new rules are leading to some large-scale deleveraging.’”
December 11 – Bloomberg: “Loan defaults at China’s state-owned enterprises may increase as growth in the world’s second-biggest economy slows, according to Moody’s… Risks are greatest in industries with excess production capacity, Kai Hu, a senior credit officer at the rating company, said… Regulators stepped up efforts to curb local-government debt on Dec. 8, prompting borrowing costs to jump and companies to cancel or postpone at least 46.6 billion yuan ($7.5bn) of note sales this week… In the latest signs of concern in China’s credit markets, the extra yield companies rated AA must pay to sell bonds due in seven years over similar-maturity government notes has surged 51 bps this week to a two-month high of 263 bps. The seven-day repurchase rate, a gauge of interbank funding availability, rose as much as 17 bps today to a four- month high of 3.81%...”
December 6 – Financial Times (Jamil Anderlini): “China’s previously overheated property market has been in the doldrums for most of this year but things are likely to get a lot worse, because of demographic shifts that are about to reverse a main driver of the decades-long boom. According to newly published research, the size of China’s main property-buying population — people aged 25 to 49 — will peak next year and then start to decline, just as a huge glut of new apartments hits the market. This demographic will shrink drastically from 2018, with the number of urban homebuying Chinese falling much faster than contemporaries from the countryside, who are far less likely to have the means to buy expensive apartments, according to Ai Jingwei, an expert on Chinese real estate and author of the research… Moody’s Analytics estimates the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product last year.”
December 12 – Bloomberg: “China’s economy slowed in November as factory shutdowns exacerbated weaker demand, raising pressure on the central bank to add further stimulus. Bloomberg’s gross domestic product tracker came in at 6.78% year-on-year in November, down from 6.91% in October and a fourth month below 7%... Factory production rose 7.2% from a year earlier, retail sales gained 11.7%, and investment in fixed assets expanded 15.8% in January through November from a year earlier…”
December 10 - South China Morning Post (Phoenix Kwong): “Economic weakness continues to weigh on China auto sales growth, which slowed to 2.3% last month. Vehicles sales last month totalled 2.1 million units, with the year-on-year growth rate slowing from October’s 2.8%, the state-backed China Association of Automobile Manufacturers (CAAM) said… November’s growth rate was 7.4 percentage points lower than that of the same period of last year, it said.”
December 12 – Bloomberg: “China plans to establish a fund to support troubled trust firms as repayment risks accumulate in the 13 trillion yuan ($2.1 trillion) industry. Under rules jointly issued by China Banking Regulatory Commission and the Ministry of Finance, each trust firm is required to contribute 1% of their net assets to the fund, while each trust product will pay 1% of the money raised… Premier Li Keqiang is trying to sustain economic growth while containing financial stress after the nation’s loosely regulated shadow-banking system started swelling in 2010.”
December 9 – Bloomberg: “China’s residential building boom is petering out, with the effects seen from slumping steel and cement prices, to electricity use, rail-freight traffic and retail sales. The drag will be long lasting with home completions set to fall by 1 to 3% annually from next year to 2025 after almost tripling in 13 years, according to… Gavekal Dragonomics. A once-in-a-generation shift in demand for housing and an overhang of supply suggests policy makers can cushion the effect with interest-rate cuts such as the one announced Nov. 21, not reverse it. ‘The turning point has come,’ said Wang Tao, chief China economist at UBS… ‘Construction has to come down so that means growth has to slow, and therefore steel demand, cement demand, energy consumption, mining production, appliances, automobiles -- everything has to come down.’ …Increasing evidence the slowdown is structural, not cyclical, is playing out on commodity markets and leaves the U.S. shouldering prospects for a pickup in 2015 global growth.”
December 12 – Bloomberg: “Regulators in China are considering restricting individual investors from buying corporate bonds rated below the top grade as policy makers seek to shift away from a ‘too small to fail’ mentality, Fitch… said. China Securities Regulatory Commission is proposing to only allow so-called qualified investors or institutional funds to buy anything less than locally AAA rated exchange-traded domestic bonds, Ying Wang, a… director at Fitch, said…”
Japan Bubble Watch:
December 12 – Bloomberg (Toru Fujioka and Masahiro Hidaka): “The Bank of Japan rejects the idea that additional monetary stimulus is needed to prevent the decline in oil prices in recent months from pulling down inflation, according to people familiar with the discussions. For now, policy makers assess that while cheaper energy costs may weigh on consumer prices for a time, they ultimately will boost the economy -- spurring inflation, the people said… Less agreement is found on how much capacity the central bank has to expand its buying of government debt, some of the people said.”
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