Friday, January 30, 2015

My Weekly Commentary: Dangerous Games of Chicken

It’s difficult to imagine more challenging analysis.  The global nature of the current Credit Bubble creates dynamics and complexities dissimilar to previous Bubble cycles.  There are extraordinary uncertainties – in hyper-speculative global markets, in experimental policymaking, in unsettled societies and unstable geopolitics.  Never have market perceptions mattered as much.  And never before has global activist monetary management so impacted market sentiment and prices – well, at least going back to the late-twenties.

I have written that I am these days more worried than in 2007, and back then I was quite apprehensive.  And while today’s global risks dwarf those of 2007, complacency and faith in central bankers have become so deeply embedded in securities and derivative prices.  Never has there been such extreme divergence between inflating securities markets and deflating future prospects.  As an analyst of Bubbles, I contend with the inevitable “chicken little” issue.

This week offered important confirmation of my global macro thesis.  Greece, a eurozone member, has a democratically elected radical party now controlling parliament and a leftist government led by a charismatic radical prime minister.  A deeply disillusioned people have spoken, and they’re fed up with Greek affairs being dictated from Brussels and Berlin.  Post-Bubble dislocation and ongoing policy-induced wealth redistribution finally reached the breaking point.  Sunday’s Greek election has left wing, right wing, anti-euro and antiestablishment parties throughout Europe further emboldened.  Greece is now moving rapidly toward a conflict with the EU, with potentially profound consequences for global markets.  A “Game of Chicken” has officially commenced.

January 30 – Bloomberg (Nikolaos ChrysolorasMarcus BensassonEleni Chrepa): “Finance Minister Yanis Varoufakis said Greece won’t seek an extension of its bailout agreement, setting the government on course to enter March without a financial backstop for the first time in five years. Greece won’t engage with officials from the troika of official creditors who have been policing the conditions of its rescue since 2010. It’s five-day-old government wants a new deal with the European Union that allows for more spending, Varoufakis said at a joint press conference with Eurogroup Chief Jeroen Dijsselbloem in Athens, Friday. ‘We don’t plan to cooperate with that committee,’ Varoufakis said. ‘The Greek state has a future, but what we won’t accept has a future is the self-perpetuating crisis of deflation and unsustainable debt.’ The standoff could see Greek banks effectively excluded from European Central Bank liquidity operations and the government with no source of funding, having rejected EU aid while still shut out of international markets.”

It’s worth noting that Putin and the Russian government have courted Syriza as well as anti-euro parties throughout Europe.  As strange as it sounds here in the U.S., Putin is idolized by many of Europe’s so-called “fringe” politicians – leading political movements that are rapidly gaining power and influence across the continent.

Thursday’s headline from the FT (Sam Jones, Kerin Hope and Courtney Weaver):  “Alarm Bells Ring Over Syriza’s Russian Links: Soon after Syriza, the Greek radical leftwing party swept to power this week, alarm bells began ringing in the capitals of Europe. But it was not finance officials who were rattled but Europe’s defence and security chiefs. The day after his election as Greece’s new prime minister, Alexis Tsipras threw a grenade in the direction of Brussels: he objected to calls for fresh sanctions against Russia as a result of rising violence in Ukraine. On Wednesday, Athens went further: ‘We are against the embargo that has been imposed against Russia,’ said Panagiotis Lafazanis, the energy minister and leader of Syriza’s far left faction… ‘We have no differences with Russia and the Russian people.’ The Greek rebuff has elicited an angry — and, behind closed doors, indignant — response. EU powers led by the UK, Germany and France, have lately trodden a careful path in trying to keep the EU’s 28 member states unified on the need to impose a financial and economic cost on Russia for its destabilising actions inside Ukrainian territory. While some diplomats and analysts see Mr Tsipras’ intervention against more sanctions as an opening gambit in forthcoming negotiations over Greece’s international bailout and debt burden, others point to it as another example of spreading Russian influence in southeastern Europe.”

I am again reminded of Adam Fergusson’s classic, “When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany.”  In reading a brilliant account of the German monetary breakdown, it was incredible how German central bankers remained oblivious to the reality that their printing operations were at the root of an unfolding catastrophe. Like today’s central banks, German bankers at the time believed their actions were a necessary response to outside forces.

These days it goes unappreciated that crises - ongoing and unfolding alike - emanate from an unprecedented period of unsound global money and Credit.  To be sure, financial, economic, social and political turmoil in Greece has been a direct consequence of years of unsound finance.  The euro monetary experiment, hatched during a period of optimism, integration and cohesion, is now a slow motion train wreck in today’s backdrop of growing discontent, disenchantment, hostility and disintegration. Greece, of course, must shoulder much of the responsibility.  Yet the euro currency coupled with unfettered global finance provided the noose for the Greeks to hang themselves.  Runaway global monetary inflation has ensured an abundance of nooses.

“Greek” and “Ukraine” crises this week seemed to merge into a potential geopolitical quagmire, with Russia supplying the muck.  It’s been my view that Russia’s invasion of Ukraine likely marked a historic inflection point.  The optimistic consensus view has been that Putin misjudged Western reaction to his Ukraine gambit – and that punishing sanctions would spur his retreat.  The disconcerting view, one I subscribe to, holds that the U.S. and the “West” on various fronts crossed Putin’s red line, provoking a fundamental change in the geopolitical landscape.  Not only would Western sanctions fail to alter Putin’s course, they would ensure a tit-for-tat escalation with the potential to spiral out of control.  The Ukraine conflict has again escalated.  Putin will not miss an opportunity to fracture Europe and split the “West” more generally.

For the week, Greek five-year yields surged an astounding 598 bps (to 15.00%), the high since the 2012 crisis.  Greek bank stocks collapsed.  As the markets prepare again for default, Greek CDS jump 560 bps this week to 1,732. The Russian ruble was slammed for 8.3% this week.  Russian 10-year dollar yields jumped 60 bps to 7.42%, the high since mid-December.

Greece now provides a clear and present danger to already weakened global markets.  From a more general market analysis framework, I’m watching for burst Bubble EM contagion.  To begin the year, EM has generally benefited from the perception of ongoing (“do whatever it takes”) liquidity abundance.  Yet the short-squeeze rally faltered this week.  I'm monitoring Brazil and Turkey closely.

On the back of the Brazilian real’s 2.9% Friday decline, the real fell 3.8% for the week.  Brazilian (real) yields jumped 24 bps this week (to 11.96%) with dollar yields up 28 bps to a four-week high 4.30%.  Petrobras bonds dropped a record 5% in Friday trade after a Moody’s downgrade.  Brazil these days faces an ugly mix of inflation, corruption investigations, government deficits and financial fragility.  They’ve had way too much government-directed lending and similar amounts of dollar-denominated borrowing.  Their central bank has written a huge amount of currency swaps.

The Turkish lira was slammed 3.8% this week to a new record low against the dollar.  Turkey certainly has its own corruption issues.  The Turkish central bank is now under intense pressure from the Erdogan government to aggressively slash interest rates.  Loose financial conditions have to this point sustained rapid Credit growth in Turkey, with attendant trade deficits and imbalances.  Similar to many EM economies, Turkey has issued significant amounts of dollar-denominated debt (government, corporate and financial).

On the EM currency front, this week saw the Mexican peso hit for 2.1%, the South African rand 2.1%, the Colombian peso 2.1%, the Indonesian rupiah 1.7%, the Peruvian sol 1.3%, the Chilean peso 1.4%, the South Korean won 0.9% and the Malaysian ringgit 0.8%.  It’s worth mentioning that the (offshore) Chinese renminbi lost 50 bps, trading to its lowest level versus the dollar since 2012.

Key EM equities markets were also under pressure.  Stocks in Brazil and Mexico were both down about 4%.  China’s Shanghai Composite fell 4.2%.  Turkish stocks were hit for 2.0%.

Let’s get back to Europe.  From my perspective, European crisis risk has elevated to the highest level since the summer of 2012.  Yet we’re at the phase of the cycle where disregarding risk comes naturally.  Complacency has been repeatedly well rewarded, especially back in 2012.  The bullish assumption is that the EU will flinch – that the Germans will back down as they’ve repeatedly done.  Surely Tsipras and Syriza don’t have a death wish - thus will eventually fall in line to remain in the euro.

Yet this is not 2012 – and Alexis Tsipras is a different character.  I don’t see Merkel and Schaeuble offering concessions to the firebrand Greek PM.  The German public stance against further accommodations for Greece has hardened significantly.  Germany now has its own anti-euro movement enjoying solid momentum.  German and EU leadership will be tougher negotiators now than in 2012, wary to not further invigorate rising anti-euro parties and sentiments throughout the eurozone.  At the same time, Tsipras is a man with a mandate and clearly on a mission.  He’ll relish a Game of Chicken with major global ramifications.  “Grexit” – and all the havoc that would entail - would be blamed on the EU and Germans.

And there’s that other Game of Chicken.  Putin is a real wild card here.  Do hostilities continue to ratchet up in Ukraine?  Does Putin see the Greece situation as an opportunity to stick the EU in the eye?  Does he relish the opportunity to destabilize “Western” financial markets – payback time for the sanctions and collapse in crude prices?  Could the Russians see the current backdrop as an opportune time to ratchet up the new “Cold War”?

There is a potentially quite important downside to “do whatever it takes” “money” printing and market manipulation.  At this point, Draghi has ensured that European markets would be especially vulnerable to a destabilizing shift in market perceptions and/or crisis of confidence.  European equities have begun the year with strong gains, while historic bond market mispricing runs unabated.  To this point, mounting risks – financial, economic, geopolitical and the like – have been viewed as guaranteeing only greater injections of central bank liquidity.    

The euro closed Friday trading at about 1.13 to the dollar.  The euro traded below 1.22 only briefly during the tumultuous summer of 2012.  Draghi has successfully collapsed sovereign yields.  He has also taken a battering ram to confidence in the euro currency.  The expectation is that a weak euro will help grease the inflationary wheels.  But if the markets begin to fear a Greece euro exit, the wheels could come off the weakened euro currency.  King dollar wasn’t an issue in 2012.  And if the reality begins to sink in that the ECB and others are sitting on near-worthless Greek debt, the public outrage over further ECB bond purchases in Germany and elsewhere could be further inflamed.  At this point, “money” must be flying out of the Greek banking system.  The ECB’s job just became even more difficult.  It’s that age-old illiquidity vs. insolvency issue – throwing good “money” after bad.

At this point, U.S. equity bulls aren’t losing any sleep over Greece.  Not with U.S. economic growth the envy of the world.  The consensus bullish view holds that the system is sound – now six years into a healing recovery.  To the bulls, the strong dollar and buoyant securities markets confirms their optimistic view.

I’ll provide a counter argument.  The global Credit “system” is quite vulnerable – and king dollar is increasingly destabilizing.  “Hot money” is on the move - out of EM, Europe and, increasingly, China.  Global currencies are unstable - making "carry trade" leverage problematic.  The ongoing collapse in commodities and EM currencies is creating enormous amounts of impaired global Credit.  China remains a Credit accident in the making.  The global leveraged speculating community is susceptible to de-risking/de-leveraging.

This week at home, market participants were awakened to the reality that American multinationals have major earnings exposure to both dollar strength and global economic weakness.   And the significant tightening in Credit Availability in the energy sector this week manifested into meaningful reductions in capital expenditure budgets (and job cuts).  The U.S. economy is not immune to global forces.  Yet the greatest exposure is within the financial markets.  There were certainly indications this week that contagion at the “periphery” gained important momentum.  There were as well signs that the deflating Bubble at the “periphery” is increasingly impinging the “core.”  For inflated and over-confident markets, it’s an inopportune time for Games of Chicken with really high stakes.

For the Week:

The S&P500 sank 2.8% (down 3.1% y-t-d), and the Dow fell 2.9% (down 3.7%). The Utilities declined 1.8% (up 2.5%). The Banks dropped 2.8% (down 10.1%), and the Broker/Dealers lost 2.6% (down 10.2%). The Transports were hit for 3.7% (down 5.4%). The S&P 400 Midcaps declined 1.4% (down 1.2%), and the small cap Russell 2000 fell 2.0% (down 3.3%). The Nasdaq100 sank 3.0% (down 2.1%), and the Morgan Stanley High Tech index was clobbered for 3.9% (down 4.3%). The Semiconductors were hammered for 4.0% (down 4.9%). The Biotechs added 0.4% (up 7.8%). Although bullion declined $10, the HUI gold index gained 2.8% (up 23.0%).

One- and three-month Treasury bills rates ended the week at one basis point. Two-year government yields declined four bps to 0.45% (down 22bps y-t-d). Five-year T-note yields dropped 15 bps to 1.16% (down 50bps). Ten-year Treasury yields fell 15 bps to 1.64% (down 53bps). Long bond yields declined 15 bps to 2.22% (down 53bps). Benchmark Fannie MBS yields declined 13 bps to 2.43% (down 40bps). The spread between benchmark MBS and 10-year Treasury yields widened two to 79 bps. The implied yield on December 2015 eurodollar futures dropped five bps to 0.665%. Corporate bond spreads widened. An index of investment grade bond risk increased three to 70 bps. An index of junk bond risk jumped 14 bps to 371 bps. An index of EM debt risk surged 18 bps to 398 bps.

Greek 10-year yields surged 269 bps to 10.98% (up 237bps y-o-y). Ten-year Portuguese yields jumped 19 bps to 2.62% (down 238bps). Italian 10-yr yields gained seven bps to 1.59% (down 218bps). Spain's 10-year yields rose five bps to 1.42% (down 224bps). German bund yields fell six bps to yet a another record low 0.30% (down 136bps). French yields slipped about a basis point to a record low 0.535% (down 169bps). The French to German 10-year bond spread widened five bps to about 24 bps. U.K. 10-year gilt yields dropped 15 bps to 1.33% (down 138bps).

Japan's Nikkei equities index gained 0.9% (up 1.3% y-t-d). Japanese 10-year "JGB" yields increased four bps to 0.27% (down 34bps y-o-y). The German DAX equities index added 0.4% (up 9.1%). Spain's IBEX 35 equities index fell 1.7% (up 1.2%). Italy's FTSE MIB index was little changed (up 7.8%). Emerging equities were mostly lower. Brazil's Bovespa index sank 3.8% (down 6.2%). Mexico's Bolsa fell 4.0% (down 5.1%). South Korea's Kospi index added 0.7% (up 1.8%). India’s Sensex equities index slipped 0.3% (up 6.1%). China’s volatile Shanghai Exchange sank 4.2% (down 0.8%). Turkey's Borsa Istanbul National 100 index was hit for 2.0% (up 3.8%). Russia's MICEX equities index declined 1.4% (up 18.0%).

Debt issuance was decent. Investment-grade issuers included Wells Fargo $2.65bn, Citigroup $2.0bn, Union Pacific $1.15bn, Praxair $1.125bn, Penske Truck Leasing $900 million, New York and Presbyterian Hospital $750 million, Synchrony Financial $750 million, SVB Financial Group $350 million, TTX $350 million, Select Income REIT $1.45bn, The Met $250 million and Colby College $100 million.

Convertible debt issuers included Xenoport $100 million.

Junk funds saw notable inflows of $2.77bn (from Lipper). Junk issuers included HJ Heinz $2.0bn, PSPC $2.1bn, Micron Technology $1.0bn, Calpine $650 million and Kindred Healthcare $500 million.

International debt issuers included Credit Suisse $2.75bn, European Bank of Reconstruction & Development $3.1bn, Altice $5.0bn, Royal Bank of Canada $2.0bn, Banque Centrale de Tunisie $1.0bn, Caisse Centrale Desjardn $1.0bn, Canadian Pacific Railway $700 million, International Financial Corp $500 million, China Auto Rental $500 million, Turkiye Vakiflar Bankasi $500 million and Galileo RE $300 million.

Freddie Mac 30-year fixed mortgage rates increased three bps to 3.66% (down 66bps y-o-y). Fifteen-year rates gained five bps to 2.98% (down 42bps). One-year ARM rates were up a basis point to 2.38% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 4.25% (down 26bps).

Federal Reserve Credit last week expanded $1.1bn to $4.469 TN. During the past year, Fed Credit inflated $410bn, or 10.1%. Fed Credit inflated $1.658 TN, or 59%, over the past 116 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week dropped another $13.6bn to a nine-month low $3.271 TN. "Custody holdings" were down $63.7bn over the past year, or 1.9%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were down $25bn y-o-y, or 0.2%, to $11.668 TN. Over two years, reserves were $729bn higher for 7% growth.

M2 (narrow) "money" supply expanded $6.9bn to a record $11.702 TN. "Narrow money" expanded $672bn, or 6.1%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits dropped $20.4bn, while Savings Deposits jumped $30.4bn. Small Time Deposits slipped $1.1bn. Retail Money Funds declined $3.5bn.

Money market fund assets declined $2.5bn to $2.702 TN. Money Funds were down $4.1bn over the past year, or 0.2%.

Total Commercial Paper declined $2.4bn to $1.008 TN. CP contracted $7bn over the past year, or 0.6%.

Currency Watch:

The U.S. dollar index was little changed at 94.80 (up 5.0% y-t-d). For the week on the downside, the Swiss franc declined 4.4%, the Brazilian real 3.8%, the New Zealand dollar 2.5%, the Canadian dollar 2.5%, the Mexican peso 2.1%, the South African rand 2.1%, the Australian dollar 1.9%, the South Korean won 0.9%, the Singapore dollar 0.7% and the Taiwanese dollar 0.6%. For the week on the upside, the Danish krone increased 0.8%, the euro 0.8%, the Swedish krona 0.6%, the British pound 0.5%, the Norwegian krone 0.5% and the Japanese yen 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index rallied 2.6% (down 6.8% y-t-d). Spot Gold slipped 0.8% to $1,284 (up 8.3%). March Silver dropped 6.0% to $17.21 (up 10%). March Crude recovered $2.65 to $48.24 (down 9%). March Gasoline increased 0.3% (unchanged), and March Natural Gas sank 9.0% (down 7%). March Copper slipped 0.3% (down 12%). March Wheat sank 5.1% (down 15%). March Corn fell 4.3% (down 7%).

U.S. Fixed Income Bubble Watch:

January 27 – Bloomberg (Christine Idzelis): “Junk-debt investors, reeling from the impact of a 58% drop in oil, aren’t ready to swallow the $25 billion of loans that bankers are selling to back mergers and leveraged buyouts. Leon Black’s Apollo Global Management LLC postponed a $400 million bond deal on Monday backing its purchase of information technology firm Presidio Holdings Inc., after sweetening terms to attract investors for the $600 million loan portion of its leveraged buyout financing… Centerbridge Partners LP and Madison Dearborn Partners LLC boosted yields on around $1.05 billion of debt backing LBOs. The concessions show that high-yield investors haven’t regained their appetite for risk after the drop in oil from its June peak caused their energy bond holdings to lose more than 17%. Average borrowing costs in the loan market have climbed to the highest since October, and diminished demand is making it more difficult to fund buyouts… ‘Anything with a little bit of hair on it is more challenged,’ Jason Rosiak, head of portfolio management at…Pacific Asset Management, said… ‘People are being more selective.’ Outflows that began about nine months ago from U.S. loan mutual funds and exchange-traded funds accelerated last week to $738 million, bringing this year’s net redemptions to $1.7 billion, according to… Lipper.”

January 27 – New York Times (Michael Corkery and Jessica Silver-Greenberg): “The loans were for used Dodges, Nissans and Chevrolets, many with tens of thousands of miles on the odometer, some more than a decade old. They were also one of the hottest investments around. So many asset managers clamored for a piece of a September bond deal made up of these loans that the size of the offering was increased 35%, to $1.35 billion. Even then, Santander Consumer USA received more than $1 billion in investor demand that it could not accommodate. Across the country, there is a booming business in lending to the working poor — those Americans with impaired credit who need cars to get to work. But this market is as much about Wall Street’s perpetual demand for high returns as it is about used cars. An influx of investor money is making more loans possible, but all that money may also be enabling excessive risk-taking that could have repercussions throughout the financial system, analysts and regulators caution. In a kind of alchemy that Wall Street has previously performed with mortgages, thousands of subprime auto loans are bundled together and sold as securities to investors, including mutual funds, insurance companies and hedge funds.”

Global Bubble Watch:

January 29 – Bloomberg (Catherline Bosley): “Thomas Jordan’s move to scrap the Swiss currency ceiling has left him working out what to do with the half-a-trillion-dollar legacy in its wake. As the dust settles two weeks after the market earthquake unleashed by that decision, the Swiss National Bank president and his officials face a choice on how to manage a mass of reserves accumulated during years of market interventions. The total is about 495 billion francs ($546bn), including a sizable chunk in euro-area sovereign debt. For Jordan, the least costly option all round may be to accept a burden of negative yields on that hoard of euro-denominated bonds as existing holdings mature. The alternative is even tougher: selling out or moving into other currencies and exposing the SNB to a loss, potentially boosting the franc at an uncertain time for the economy and risking a backlash in a country where the central bank has previously found itself in the crossfire of party politics.”

January 29 – Bloomberg (Kelly Bit): “The outlook for hedge funds, already closing at the fastest pace since the financial crisis, is about to worsen, according to Citigroup Inc. Industrywide profits in 2014 declined 30% from a year earlier to $21.9 billion because of poor performance, the bank estimated… Hedge funds returned an average of 1.4% in 2014, their sixth straight year of underperforming U.S. stocks, according to data compiled by Bloomberg, and the worst since 2011. ‘Poor performance will be most acutely felt by small hedge fund firms,’ Sandy Kaul, global head of business advisory services at the… company, said… ‘These funds simply did not generate enough performance-fee revenues in 2014 to cover their gap.’”

Europe Watch:

January 28 – Bloomberg (Nikolaos Chrysoloras, Christos Ziotis and Marcus Bensasson): “Greek bank deposit outflows last week accelerated to record levels amid concern about lenders’ liquidity and the outcome of the nation’s negotiations with creditors, according to a person familiar with the matter. Withdrawals from Greek banks exceeded 14 billion euros ($15.9bn) in the run-up to the snap elections that catapulted the anti-bailout Syriza party to power, including 11 billion euros that were taken out in January, the person said. Between Jan. 19 and Jan. 23 outflows were greater than in May 2012, when Greece was on the brink of exiting the euro area.”

January 27 – Financial Times (Christopher Thompson): “Greek banks suffered a second day of double digit share price declines as the country’s biggest lenders are set to tap emergency central bank lending to mitigate the effects of accelerating deposit flight. The country’s four biggest lenders — Piraeus, Alpha Bank, Eurobank and National Bank of Greece — have each seen more than a fifth of their market capitalisation wiped out this week as the banking sector continues to bear the brunt of an electoral fallout dragging down the rest of the Athens bourse... ‘This is a massacre,’ said one senior Athens-based banker. ‘Markets are panicking . . . They’re trying to pre-empt a crisis on banks’ liquidity. They know the crisis will be centred around the banks… ‘International banks are looking to minimise their exposure to Greece through the interbank lending market,’ said Nondas Nicolaides, a senior credit officer at Moody’s.”

January 26 – UK Guardian (Ashifa Kassam): “‘Syriza, Podemos – venceremos,’ chanted Podemos’s Pablo Iglesias into the microphone on Sunday, his voice rising as he hit the last word: we will win. In the packed bleachers of this rally of the party faithful in Valencia, a Greek flag waved as thousands joined in his chant. Few followed the elections in Greece as closely as Spaniards, many of whom saw in the electoral race a preview of looming elections in Spain. As news broke on Sunday that Syriza had ousted the establishment to become the first anti-austerity party to gain power in the eurozone, Iglesias revelled in the news. ‘I think that the victory of Syriza will provoke something that’s new in the political panorama of Greece – they’re going to have a real Greek president, not a delegate of Angela Merkel whose interests will rank above those of the country and its people,’ he told La Sexta… Austerity had been dealt a blow by democracy, he said, giving his nascent movement in Spain a foothold that could prove crucial in the coming year as municipal, regional and general elections pit Podemos against the bipartisan political system that has ruled Spain since the death of Franco. Since its creation one year ago, Podemos has emerged as a top contender…”

January 28 – UK Telegraph (Evans-Pritchard): “A top German body has called for a clear mechanism to force Greece out of the euro if the left-wing Syriza government repudiates the terms of the country’s €245bn rescue. ‘Financial support must be cut off if Greece does not comply with its reform commitments,’ said the Institute of German Economic Research (IW). ‘If Greece is going to take a tough line, then Europe will take a tough line as well.’ IW is the second German institute in two days to issue a blunt warning to the new Greek premier, Alexis Tsipras, who has vowed to halt debt payments and reverse austerity measures imposed by the EU-IMF Troika. The ZEW research group said… that the EU authorities should order an immediate stress test of banks linked to Greece, and drive home the threat that they are willing to let a Greek default run its course rather than cave to pressure. ‘Europe should clearly signal that it is not susceptible to blackmail,’ it said. Germany’s finance minister, Wolfgang Schäuble, said… that debt forgiveness for Greece is out of the question. ‘Anybody discussing a haircut just shows they don’t know what they are talking about.’”

China Bubble Watch:

January 26 – Bloomberg (Justina Lee): “Managing the yuan is turning into a different game for China’s policy makers these days. After more than a decade of curbing the currency’s gains to help turn the nation into a manufacturing colossus, there are signs the People’s Bank of China is now propping up the yuan to stem an exodus of capital that’s threatening the economy. A gauge of capital flows on the PBOC’s balance sheet fell by the most since 2003 last month in a sign it’s selling foreign currency, while the yuan’s reference rate set daily by policy makers is at its strongest-ever level compared with the market price. ‘Everyone thought the movie would never end, and suddenly it ended, so everyone is hurrying to leave,’ Kevin Lai, an economist at Daiwa Capital Markets… said… ‘The authorities need to think of a way to keep the audience in the theater’ as the economy slows, he said.”

January 27 – Bloomberg: “The Shanghai branch of the China Banking Regulatory Commission asked local lenders to conduct their widest-ever stress tests on exposure to the real-estate industry, according to people familiar with the matter. The CBRC for the first time required the tests to include all property-related industries and lending outside Shanghai, said the people… Rapid increases in property loans and trust funding to places outside the city have concerned local regulators, they said. The move reflects concern that credit risks may mount for lenders after their bad-loan ratio jumped the most in at least a decade in the fourth quarter. Lenders… have sought to freeze assets of Shenzhen-based developer Kaisa Group Holdings Ltd., which missed bond and trust payments this month, people with knowledge of the matter have said.”

January 27 – Bloomberg: “China’s private bond market is facing increased scrutiny after a local-government financing vehicle in the eastern province of Jiangsu said it has no obligation to guarantee notes sold by a manufacturer. Dongfei Mazuoli Textile Machinery Co… can’t pay principal and interest on the securities… The LGFV had signed a contract with the manufacturer in 2012 to guarantee its bond credit ratings, but doesn’t guarantee the note payments themselves, according to a statement from the financing unit… Suqian Chief Leather Co., a leather maker also based in Jiangsu, has said it won’t be able to pay noteholders who exercise a Feb. 5 sell option on its 150 million yuan ($24 million) of three-year private securities due to a cash shortage… ‘Onshore investors have become more sensitive to credit risk these days as they are noticing the continued slowdown in the economy,’ said Liang Zhong, sovereign and international public finance ratings analyst at Standard & Poor’s. ‘The incident shows the relationship between LGFV guarantors and issuers can be quite opaque and lacking in clarity, which increases the uncertainties for bondholders regarding repayments.’”

January 29 – Reuters (Engen Tham and Pete Sweeney): “Chinese banks seeking to profit from the country's stock market frenzy have bought into the recent surge in margin finance, foiling regulatory efforts to reduce debt-fueled speculation and amplifying the risk if the rally turns into a rout. Although regulators are cracking down on credit flows into the stock market, financial industry insiders say they still have not closed loopholes that allow banks to channel credit into the stock market via brokerages. That exposes China's banking system to greater risks, even as lenders struggle with an economic slowdown that has pushed up bad loans, but market watchers say it is not time to panic yet. ‘I estimate that around 18 to 20% of margin finance loans end up with banks, but it varies from brokerage to brokerage,’ said a senior brokerage auditor at one of the big-four accounting firms in China. ‘It is definitely growing.’”

January 27 – Reuters (Kevin Yao): “China plans to cut its growth target to around 7% in 2015, its lowest goal in 11 years, sources said, as policymakers try to manage slowing growth, job creation and pursuing reforms intended to make the economy more driven by market forces… The target, which is in line with market expectations, has not been previously reported. ‘This year's economic growth target will be around 7%, but the 7% should be the bottom line,’ said one of the sources, an influential economist who advises the government. ‘The government will have to balance economic growth, employment and structural reforms this year," said the economist, who requested anonymity due to the sensitivity of the matter.”

January 27 – Financial Times (Gabriel Wildau): “Chinese industrial profits slumped by a record 8% last month, as Beijing’s targeted stimulus efforts failed to arrest a slowdown in the key driver of China’s economy. The fall in profits in December highlights the challenges facing an industrial sector racked by overcapacity and falling prices, adding to pressure on authorities to loosen monetary policy and boost infrastructure spending to cushion the slowdown… While falling prices for oil and other inputs have supported profit margins, the positive impact has been outweighed by falling prices for finished goods, He Ping, a statistician at the bureau’s industrial department, said in a statement accompanying the data. ‘The impact of lower prices on the slide in profits is worsening,’ he said.”

January 27 – Financial Times (Tom Mitchell and Gabriel Wildau): “One of China’s richest men is suing six local governments for late payments on infrastructure contracts, in a rare legal action that highlights the risks of unpaid debts cascading through the country’s economy. Local government borrowing has risen steeply in recent years, with much new credit used to service existing debt, raising fears that local defaults could spark a full-blown financial crisis. Yan Jiehe, founder of China Pacific Construction Group, said… that his company’s legal actions were the first such suits launched against local governments. ‘We will appeal all the way to the Supreme Court if necessary,’ Mr Yan told the Financial Times… ‘We will surely win this case. The records and evidence are clear.’ CPCG is China’s largest private sector infrastructure company in an industry traditionally dominated by state-owned enterprises. Last year it was ranked 166th on the Forbes 500 list of the world’s largest companies, with $60bn in annual revenues. Mr Yan was listed as China’s seventh-richest person by last year’s Hurun report, with a fortune estimated at $14.2bn.”

U.S. Bubble Watch:

January 30 – Bloomberg (Y-Sing Liau): “Investors have a message for suffering U.S. oil drillers: We feel your pain. They’ve pumped more than $1.4 trillion into the oil and gas industry the past five years as oil prices averaged more than $91 a barrel. The cash infusion helped push U.S. crude production to the highest in more than 30 years, according to data compiled by Bloomberg. Now that oil prices have fallen below $45, any euphoria over cheaper energy will be tempered by losses that are starting to show up in investment funds, retirement accounts and bank balance sheets. The bear market has wiped out a total of $393 billion since June -- $353 billion from the shares of 76 companies in the Bloomberg Intelligence North America Exploration & Production index, and almost $40 billion from high-yield energy bonds, issued by many shale drillers, according to a Bloomberg index.”

January 28 – Reuters: “A slew of U.S. multinational companies, from DuPont to Procter & Gamble, showed that a strong U.S. dollar hurt their earnings, and several blue-chip exporters said the situation will get worse if the greenback holds its strength. All told, the resurgent U.S. currency could shave up to $12 billion off U.S. companies' fourth-quarter 2014 revenue alone, according to currency expert Wolfgang Koester, chief executive of FireApps, a data analytics company… that examines quarterly reports for currency-related losses. The pain is hitting multiple sectors, including industrial companies…, technology companies…, airlines…, healthcare companies…, and consumer firms… - which all garner a large portion of their sales from outside the United States. ‘This is a slow-motion crash,’ said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group… It could take a couple of quarters for currency conversion losses to show up, she said.”

January 29 – Bloomberg (Todd Shields): “A U.S. airwaves auction ended with record bids of almost $44.9 billion paid by companies eager for frequencies needed to meet growing demand from data-hungry smartphones and other wireless devices.”

January 29 – Bloomberg (Oshrat Carmiel): “Home prices in New York’s Hamptons jumped to a seven-year high in the fourth quarter, with sales of more than $1 million surging as wealthy buyers bolster demand… The median price of all homes sold in the quarter was $975,000, a 27% increase from a year earlier and the highest since 2007, according to.. Douglas Elliman Real Estate and appraiser Miller Samuel Inc. The number of transactions jumped 48% to 734. ‘It’s reflective of a second-home market that is skewing toward wealthier purchasers,’ said Jonathan Miller… ‘There are more of them coming back into the market.’”

ECB Watch:

January 30 – Reuters: “Greece's government will not cooperate with the EU and IMF mission bankrolling the country and will not seek an extension to the bailout programme, its finance minister said on Friday. Jeroen Dijsselbloem, head of the euro zone finance ministers' group who is in Athens for talks with the new government, said the two sides would decide what would happen next before the programme ends on Feb. 28. ‘This platform enabled us to win the confidence of the Greek people,’ Finance Minister Yanis Varoufakis told reporters after their meeting. ‘Our first action as a government will not be to reject the rationale of questioning this programme through a request to extend it.’”

January 29 – Reuters (John Geddie): “Nearly a quarter of all euro zone government bonds now have yields below zero, data from Tradeweb shows, a consequence of ECB schemes designed to channel money into the most credit-starved corners of the bloc's weak economy. This means investors are effectively paying to lend to countries, exposing them to potential losses… ‘Up until recently we've just been extending maturities slightly along the curve, but now it's such a large proportion of negative-yielding bonds that we have to have slightly different conversations with our clients,’ said Gareth Colesmith, senior portfolio management at Insight Investment.”

Global Central Banker Watch:

January 29 – Reuters (Ole Mikkelsen and Teis Jensen): “The Danish central bank cut its key interest rate for the third time in two weeks to another historic low after intervening in the market to keep the crown within a tight range against the euro. The central bank cut its certificate of deposit rate to -0.5% from -0.35%, making a reduction of 45 bps since Monday last week.”

January 29 – Reuters (David Ljunggren): “Canada's economy unexpectedly shrank by 0.2% in November, prompting market talk that the Bank of Canada will cut interest rates in March for the second time in six weeks.”

Russia/Ukraine Watch:

January 29 – Reuters (Thomas Grove): “Russia's envoy to the European security watchdog OSCE urged the United States and Europe on Thursday to stop supporting the ‘party of war’ in Ukraine and warned ‘catastrophe’ could result, Interfax news agency reported. ‘I would like to appeal to the states that have influence on Kiev's leadership, most of all to Washington. It's time to stop indulging Ukraine's party of war,’ said Russia's OSCE envoy, Andrei Kelin. ‘Only a big catastrophe can result from such developments.’ Russia has increasingly blamed the United States and NATO for the flare-up in violence in eastern Ukraine.”

January 26 – Washington Post (Karoun Demirijian): “As Western leaders mulled new punitive measures against Russia over its involvement in the latest violence in eastern Ukraine, Russian leaders lashed out Monday, blaming the West for using the events to incite anti-Russian hatred and of playing an on-the-ground role in furthering the fighting. The sharpened charges punctuated an increasingly tense standoff between Russia and the West as the two sides exchange accusations over who bears ultimate responsibility for the worsening situation in eastern Ukraine, a conflict that both Russian and Western leaders have accused their counterparts of manipulating for the sake of greater global ambitions. ‘Who is really out there fighting?’ Russian President Vladimir Putin said to a group of students in St. Petersburg…‘It is not even the army — it’s a foreign legion, in this case, a NATO foreign legion.’”

January 27 – Bloomberg (Anna Andrianova and Ksenia Galouchko): “Russia’s foreign-currency credit rating was cut to junk by Standard & Poor’s, putting it below investment grade for the first time in a decade as policy makers struggle to keep economic growth alive amid sanctions and falling oil prices. S&P… cut the sovereign one step to BB+ …, the same level as countries including Bulgaria and Indonesia. The ratings firm said the outlook is ‘negative.’ …The world’s biggest energy exporter is on the brink of a recession after oil prices fell to the lowest since 2009 and the U.S. and its allies imposed sanctions over President Vladimir Putin’s actions in Ukraine. The penalties have locked Russian corporate borrowers out of international debt markets and curbed investor appetite for the ruble, stocks and bonds.”

Brazil Watch:

January 30 – Bloomberg (Paula Sambo): “Petroleo Brasileiro SA bonds plunged the most on record after Moody’s… reduced its rating to the edge of junk amid a widening corruption probe. Moody’s lowered its grade on debt from the oil producer one step to Baa3, the lowest investment classification, and said the ratings remain on review for a further cut. Moody’s said in a statement that it was concerned the investigation into alleged bribery at state-controlled Petrobras will make it difficult for the Rio de Janeiro-based company to get financing. Petrobras’s $2.5 billion of bonds due 2024 slumped 4.4 cents to 89.69 cents on the dollar as of 8:25 a.m. in New York, reaching the lowest level since they were issued in March 2014. The shares sank 6.6%...”

January 29 – Bloomberg (Rachel GamarskiMario Sergio Lima): “Brazil’s central government posted its first year-end primary budget deficit on record after President Dilma Rousseff cut taxes and boosted spending in a failed attempt to revive growth. The budget, which excludes interest payments as well as municipalities, states and government-run companies, recorded a deficit of 17.2 billion reais ($6.6bn) in 2014, the first since the Treasury started its series in 1997.”

January 30 – Bloomberg (Mario Sergio Lima): “Brazil posted a budget deficit in December that was twice as big as economists forecast, after President Dilma Rousseff cut taxes and boosted spending last year in a failed attempt to revive growth. The budget gap in December widened to 60.1 billion reais ($22.6bn) from 41.6 billion reais a month earlier… For the year, Brazil had a budget gap of 343.9 billion reais.”

EM Bubble Watch:

January 29 – Bloomberg (Katia PorzecanskiCamila Russo): “Bond investors in Argentina have become accustomed to all sorts of political drama over the years. But even for a country that’s defaulted twice since 2001, the latest uproar engulfing President Cristina Fernandez de Kirchner is one that few could’ve ever imagined. Prosecutor Alberto Nisman was found dead in his home on Jan. 18, a day before he was due to appear before lawmakers to present evidence for his claim that Fernandez sought to cover up Iran’s involvement in a 1994 Buenos Aires bombing. Fernandez initially suggested Nisman may have committed suicide in a Facebook post. Then, she said in a letter on her official website that he’d been murdered as part of a plot against her. With Argentina plagued by runaway inflation and a deepening recession, the controversy is eroding public support for Fernandez’s party ahead of presidential elections this year.”

January 27 – Bloomberg (Onur Ant and Selcuk Gokoluk): “Central Bank Governor Erdem Basci said he may convene the monetary policy committee early next week, 20 days before the scheduled meeting, to review interest rates should inflation ease by one percentage point in January. The committee could meet on Feb. 4 instead of Feb. 24, Basci said… The remarks came after Basci cut the benchmark one-week repo rate by 50 bps to 7.75% on Jan. 20 in a move that was widely criticized by government officials including President Recep Tayyip Erdogan. Erdogan’s economic adviser Yigit Bulut called the same day for Basci to convene an emergency meeting to cut borrowing costs further, saying the country couldn’t bear high rates ‘even one more day.’”

January 30 – Bloomberg (Anto Antony): “Bank of Baroda, India’s second-largest bank by assets, plunged the most in seven years, and ICICI Bank Ltd.. the largest private lender, tumbled after their bad-loan provisions surged. Shares of Bank of Baroda closed 11% lower at 193.15 rupees in Mumbai. ICICI shares fell 5.2%... ‘Slowing economic growth weighed down on asset quality,’ Hatim Broachwala, a Mumbai-based banking analyst at Nirmal Bang Institutional Equities Ltd., said… ‘Rising provisions at ICICI Bank and Bank of Baroda are eroding investor confidence’ in the nation’s banks, the analyst said.”

Geopolitical Watch:

January 29 – Bloomberg: “Chinese regulators summoned bank officials for a meeting this month to stress the need to carry out a nationwide directive to cut China’s reliance on foreign technology, said people familiar with the matter. In the Jan. 15 meeting, the China Banking Regulatory Commission suggested lenders not buy new mainframe computers in 2015 and draft plans to replace the ones they now have, said the people, who asked not to be identified because the meeting was private. A senior CBRC official said in November banks rely on foreign brands for 80% of their core servers and systems.”

Japan Watch:

January 29 – Reuters (Leika Kihara and Sumio Ito): “The Bank of Japan has put monetary policy on hold and found backing for its wait-and-see stance from advisors to Prime Minister Shinzo Abe, who worry more easing could send the yen to damagingly low levels, according to officials in the administration and central bank. This newfound caution from some of the same Abe advisors who urged the BOJ to launch its massive stimulus in 2013, means Japan is set to be an outlier at a time when central banks from Canada to the euro zone to Singapore have shocked markets by easing policy in recent days. Concerns about the yen, along with a belief among central bank officials - including Governor Haruhiko Kuroda… suggest the BOJ could hold policy steady until October…‘The environment under which the BOJ is working to hit 2% inflation has changed dramatically. We need to take that into account,’ Economics Minister Akira Amari said…”