Friday, January 23, 2015

My Weekly Commentary: Draghi's Do Whatever it Takes Beats Estimates

As always, the CBB is expression of my own views. It is in no way intended as investment advice. My objective is to chronicle history's greatest Credit Bubble and hopefully add some insight along the way.

Let’s return to where we left off in late-December: “Bubble On, Bubble Off.” The thesis remains that the “global government finance Bubble” was pierced in 2014. However, in a world of unprecedented liquidity excess, deflating Bubbles at the “Periphery” further inflate Bubbles at the “Core.” Last year saw faltering Bubbles in the Emerging Markets (EM) and commodities usher in a new King Dollar reign. While the Fed wound down QE, extraordinary measures by the likes of Draghi and Kuroda safeguard the historic boom in global leveraged speculation. Hot money flooded into U.S. securities markets. These trends run unabated in early-2015.

I’m also not backing away from the view that a prolonged experiment in global monetary inflation is “failing spectacularly”. The stakes are just incredibly high – financial, economic, social, geopolitical… Global policymakers refuse to admit their failings. They will not accept the obvious: printing “money” – creating perceived wealth through electronic debit and Credit entries – will not rectify the world’s ills. Indeed, runaway financial Bubbles lie at the heart of an extraordinary array of worsening global maladies. Disastrously, key central banks have coalesced into the stand that monetary measures have not been aggressive enough.

Especially here in the US, the notion of central bank policy failure is lampooned. My view emanates from “Financial Sphere vs. Real Economy Sphere” analytical framework. Central bank “money” creation further inflates already overinflated financial systems around the globe. This only exacerbates the dangerous divergence between inflating financial Bubbles and disinflationary forces that are overwhelming real economies. If anything, the problems associated with wealth redistribution and inequality – on a national as well as global basis – have become only more conspicuous as some Bubbles burst and others continue to inflate. The geopolitical environment is again noteworthy, albeit Ukraine, Russia, Yemen, the entire Middle East, Paris or Greece.

It is a myth that central banks control a general price level. It's mere folly that monetary policy spurs real and sustainable wealth creation. Doubling down on monetary inflation primarily exacerbates global market and Credit Bubbles. There is increasing risk of a crisis of confidence in the markets, in policymaking and in finance more generally.

This week saw German bund yields close at 36 bps. More incredibly, French sovereign yields ended the week at 54 bps – after averaging about 3.0% in the period 2009-2013. French yields averaged 7.0% during the nineties. Italian yields ended the week at 1.52% - after trading above 7% in 2012 and compared to the nineties average above 8.0%. Spain 10-year yields closed the week at 1.37% - after trading above 7.5% in 2012 (nineties avg. above 8%). Portuguese yields dropped to 2.44% - down from the 2012 high of 15.22%. European equities also celebrated “whatever it takes” Draghi. The French CAC 40 has posted y-t-d gains of 8.6%, with German stocks up 8.6%, Italian equities 7.9%, Portugal 9.6%, Finland 9.7% and Spain 2.9%.

A Friday Bloomberg headline: “Global Bond Markets Jump as ECB Buying Spurs Scarcity Demand.” Globalized “money printing” has inflated bond prices to historic extremes. One could certainly argue that ECB rate, bailout and QE policies have inflated a historic Bubble in European financial asset prices. I found the Q&A segment of Draghi’s press conference (after announcing the ECB’s plan for open-ended $60bn monthly QE) intriguing to say the least.

Question: “What do you answer to those arguing that a possible effect of the QE will be to rise some price bubbles on certain categories of assets?”

Draghi: “…We monitor closely any potential instance of risk to financial stability. So we’re very alert to that risk. So far we don't see bubbles. There may be some local episodes of certain specific markets where prices are going up fast. But to have a bubble… one should also identify the… dramatic increase in leverage or in bank credit. And we don’t see that now. However, as I said, we are alert and if bubbles are of a local nature, they should be addressed by local instruments, namely macroprudential instruments rather than by monetary policy.”

As Draghi’s policy course now mimics that of the Federal Reserve, so do his comments. Actually, his reference to “local episodes” recalls chairman Greenspan’s spurious claim that real estate was a “local market” – hence not prone to nationwide Bubbles. I countered at the time that Bubble Dynamics were prevalent throughout mortgage finance – and that the highly distorted Bubble market was very much a national (international) and policy-induced phenomenon. And Draghi’s assertion that the lack of a “dramatic increase in leverage or in bank credit” is inconsistent with Bubbles – and that “macroprudential” be used to counter localized excess – comes directly from the Fed’s playbook. So, what about central bank Credit? What about global “carry trade,” securities and derivative-based leverage? And why would “macroprudential” be viewed as a credible tool to counter securities market Bubbles when central bank policy is specifically designed to boost securities prices?

Question: “…What would you say to those who are concerned that ECB buying up bonds - electronically printing money - whatever one calls it, is the first chapter in a story that leads inevitably towards hyperinflation? What’s your response to that?”

Draghi: “…I think the best way to answer this is, have we seen lots of inflation since the QE program started? Have we seen that? And now it's quite a few years (since) we started. You know, our experience since we have these press conferences goes back to a little more than three years. In these three years we've lowered interest rates, I don't know how many times, four or five, six times maybe. And each time someone was saying, ‘this is going to be terribly expansionary. There will be inflation.’ Some people voted against lowering interest rates way back at the end of November 2013. We did OMT. We did the LTROs. We did TLTROs. And somehow this runaway inflation hasn't come yet. So what I'm saying is that certainly the jury is still out. But (there) must be a statute of limitations also for the people who say there will be inflation. Yes, when please? Tell me within what?”

For almost six years now, I have argued that the key issue is policy-induced market distortions and attendant financial Bubbles (as opposed to consumer price inflation). The history of monetary inflations is that once commenced they become almost impossible to end. This era’s policy experiment with manipulating securities market inflation makes certain that policy exits will be even more unbearable. Most regrettably, it’s reached a point where a global securities bear market will have devastating consequences – on markets, on economies and geopolitics. So central banks keep pumping and distorting markets – and market operators continue playing the game.

I believe we’ve now reached a precarious phase of instability where confidence in this global monetary experiment is waning. After all, there are years of experience to examine, along with rather conspicuous global financial and economic fragilities. Few have faith that “money” printing will rectify Europe’s - or the world’s - deep structural maladjustments. At the same time, there remains overwhelming confidence that acute fragilities ensure desperate policymakers continue to backstop the markets with liquidity abundance. Things do get crazy at the end of cycles – with lots of “money” slushing around to entice a wildly speculative marketplace. Increasingly, however, it is apparent that central banks have lost control of the massive pool of global speculative finance that they spawned and nurtured.

I believe history will look back to last October’s global, multi-asset class “flash crash” as a warning gone unheeded. Similarly, last week’s shock by the Swiss National Bank’s (SNB) to break the franc’s peg to the euro will also be seen as a harbinger of global market turmoil.

The post-SNB market shock was full of fascinating commentary. “A loss of trust.” One popular pundit called it “the worst central bank policy mistake in 40 years.” Most simply couldn’t fathom Swiss central bankers abruptly changing policy without providing the markets ample warning and time to adjust. This completely shattered the understanding that has developed over the years between market participants and their cherished central bankers.

Well, for much too long central banks have been making promises and assurances they will inevitably be incapable of fulfilling. SNB currency operations required the accumulation of several hundred billion of securities – with major ongoing euro devaluation ensuring huge portfolio losses. The Swiss instituted the extraordinary peg to the euro to stem capital inflows, believing back in 2011 that the crisis of confidence in euroland was of a short-term nature. But with Draghi about to move forward with shock and awe “money” printing, the peg was untenable. This currency link had created such enormous distortions that to ensure marketplace liquidity would surely have required a minimum of hundreds of billions of additional SNB purchases - and massive portfolio losses.

At this point, the sustainability of globalized market-based finance rests upon central bank assurances of “liquid and continuous markets.” It is this promise that underpins highly leveraged securities speculation that now encompasses the globe. It is the guarantee of liquidity and continuous market pricing that provides the foundation of global derivatives markets, especially hedging markets that rely on dynamic trading strategies (adjusting positions dynamically in response to changing market prices).

When the SNB ended the peg on January 15th, the swissy immediately surged 40% against the euro. A huge market dislocated in illiquidity. Those on the wrong side of currency derivative trades had no opportunity to hedge. Those leveraged (short) in swissy “carry trades” were instantly blown out. This wasn’t supposed to happen. This broke a cardinal rule between central banks and the markets.

At the heart of my premise is the analytical view that central bank market assurances sow the seeds of their own destruction. Promise markets stability, liquidity and price continuity and the resulting leverage, hedging and speculative flows will ensure an ugly day of reckoning – market illiquidity and dislocation. This is especially the case in today’s backdrop of a massive and growing pool of speculative finance. First of all, central bank policies are leading to only greater market excess and price distortions. Secondly, all the “money” printing inflates the scope of this “Crowded Trade” of speculative finance now hopelessly destabilizing global markets and economies.

Importantly, currency markets are in disarray. The Swiss franc dislocation provided an overdue reminder of how quickly highly leveraged trades can blow apart. It’s worth noting that this week’s losses in the New Zealand dollar (4.4%) and Australian dollar (3.8%) surpassed the decline in the euro (3.1%). New Zealand and Australian dollars have been popular “carry trades” targets. Eastern European currencies were under further pressure this week. The Singapore dollar, Malaysian ringgit and Turkish lira all declined at least 1% this week. King Dollar also inflicted more pain in commodities markets. WTI crude dropped 7.8% to an almost six-year low. The GSCI Commodities Index sank 3.0% this week (down 9.2% y-t-d) to the lows since early-2009 lows. All is not well in the global economy.

I would be remiss for not mentioning China. I actually believe unfolding Chinese Credit issues likely help to explain the absolutely dismal commodities performance, while perhaps also explaining the unrelenting bid to the dollar and Treasuries. China now faces the same dynamic that has plagued much of the world: liquidity injected to ameliorate Credit stress and spur economic activity instead stokes a speculative Bubble in the stock market. Chinese markets have exacerbated the global divergence between securities market Bubbles and deteriorating fundamental prospects.

For the most part, it was a big week for global equities – especially in Europe and the emerging markets. Market volatility is extraordinary, indicative of festering market structural issues. Short squeezes and the unwind of hedges can at any time spur market rallies. Yet there are further indications of insipient risk aversion and de-leveraging. Draghi’s do “whatever it takes” this week helped emboldened the bullish crowd. And QE does help accommodate the ongoing deleveraging in commodities and currency markets. QE also stokes “developed” sovereign debt market Bubbles. But I don’t see this endless “money” printing as confidence inspiring when it comes to global economic prospects. All this dollar-denominated EM debt remains a major issue. In the face of the ongoing QE onslaught, Credit conditions are tightening – in U.S. high yield, in China, in commodity-related corporates globally and EM generally.

For the Week:

The S&P500 gained 1.6% (down 0.3% y-t-d), and the Dow rose 0.9% (down 0.8%). The Utilities added 1.1% (up 4.4%). The Banks recovered 1.9% (down 7.5%), while the Broker/Dealers fell 1.0% (down 7.8%). The Transports surged 2.5% (down 1.7%). The S&P 400 Midcaps jumped 1.7% (up 0.2%), and the small cap Russell 2000 increased 1.0% (down 1.3%). The Nasdaq100 surged 3.3% (up 1.0%), and the Morgan Stanley High Tech index jumped 3.2% (down 0.5%). The Semiconductors advanced 2.5% (down 0.9%). The Biotechs gained another 1.9% (up 7.4%). Although bullion gained $14, the HUI gold index retreated 2.2% (up 19.7%).

One- and three-month Treasury bills rates ended the week at two bps. Two-year government yields were little changed at 0.49% (down 18bps y-t-d). Five-year T-note yields added a basis point to 1.31% (down 35bps). Ten-year Treasury yields declined four bps to 1.80% (down 38bps). Long bond yields dropped eight bps to 2.37% (down 38bps). Benchmark Fannie MBS yields slipped two bps to 2.56% (down 27bps). The spread between benchmark MBS and 10-year Treasury yields widened two to 76 bps. The implied yield on December 2015 eurodollar futures added a basis point to 0.70%. Corporate bond spreads narrowed. An index of investment grade bond risk declined three to 68 bps. An index of junk bond risk sank 21 bps to 357 bps.

Greek 10-year yields dropped 89 bps to 8.29% (down 16bps y-o-y). Ten-year Portuguese yields fell eight bps to a record low 2.44% (down 284bps). Italian 10-yr yields dropped 13 bps to a record low 1.52% (down 239bps). Spain's 10-year yields fell 13 bps to a record low 1.37% (down 234bps). German bund yields dropped nine bps to yet a another record low 0.36% (down 130bps). French yields fell nine bps to a record low 0.54% (down 183bps). The French to German 10-year bond spread was little changed at 18 bps. U.K. 10-year gilt yields declined six bps to 1.48% (down 130bps).

Japan's Nikkei equities index surged 3.8% (up 0.4% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to a record low 0.23% (down 40bps y-o-y). The German DAX equities index surged 4.7% (up 8.6%). Spain's IBEX 35 equities index advanced 5.4% (up 2.9%). Italy's FTSE MIB index was up a notable 6.6% (up 7.9%). Emerging equities were mostly higher. Brazil's Bovespa index slipped 0.5% (down 2.5%). Mexico's Bolsa jumped 3.0% (down 1.2%). South Korea's Kospi index rose 2.5% (up 1.1%). India’s Sensex equities index surged 4.1% to a record high (up 6.5%). China’s volatile Shanghai Exchange slipped 0.7% (up 3.6%). Turkey's Borsa Istanbul National 100 index rose 3.8% (up 5.9%). Russia's MICEX equities index rallied 5.1% (up 19.7%).

Debt issuance has picked up. Investment-grade issuers included Morgan Stanley $5.5bn, Goldman Sachs $3.0bn, Laboratory Corp of America $2.9bn, Bank of America $2.5bn, US Bank Ohio $2.25bn, Southwestern Energy $2.2bn, Adobe Systems $1.0bn, Reliance Industries $1.0bn, Ares Capital $600 million, HealthSouth Corp $500 million, WP Carey $450 million, Progressive Corp $400 million, National Rural Utilities Cooperative $400 million, Jackson National Life $350 million, Partners Healthcare System $300 million and Salmon River Export $243 million.

Convertible debt issuers included SunEdison $400 million and Aegean Marine Petroleum $134 million.

Junk funds saw outflows of $241 million (from Lipper). Junk issuers included Endo Finance $1.2bn, PSPC $1.0bn, Zayo Group $700 million, Aruba Investments $225 million and Speedway Motorsports $200 million.

International debt issuers included Colombia $1.5bn, Dexia $1.5bn, Kommuninvest I Sverige $1.25bn, BPCE $1.3bn, Corporation Andina de Fomento $1.0bn, Dominican Republic $2.5bn, Bank Nederlandse Gemeenten $500 million and Vitality Re $200 million.

Freddie Mac 30-year fixed mortgage rates fell three bps to an 18-month low 3.63% (down 76bps y-o-y). Fifteen-year rates declined five bps to 2.93% (down 51bps). One-year ARM rates were unchanged at 2.37% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 4.28% (down 31bps).

Federal Reserve Credit last week expanded $5.4bn to $4.467 TN. During the past year, Fed Credit inflated $423bn, or 10.4%. Fed Credit inflated $1.657 TN, or 59%, over the past 115 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $15.6bn last week to a seven-month low $3.285 TN. "Custody holdings" were down $60.2bn over the past year, or 1.8%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were down $37bn y-o-y, or 0.3%, to $11.656 TN. Over two years, reserves were $727bn higher for 7% growth.

M2 (narrow) "money" supply surged $67.5bn to a record $11.695 TN. "Narrow money" expanded $694bn, or 6.3%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits rose $12.0bn, and Savings Deposits jumped $54.4bn. Small Time Deposits declined $1.4bn. Retail Money Funds were little changed.

Money market fund assets declined $1.0bn to $2.704 TN. Money Funds were down $3.5bn over the past year, or 0.1%.

Total Commercial Paper dropped $19.7bn to $1.010 TN. CP contracted $8.6bn over the past year, or 0.8%.

Currency Watch:

The U.S. dollar index jumped 2.7% to a more than 11-year high 94.99 (up 5.2% y-t-d). For the week on the downside, the New Zealand dollar declined 4.4%, the Australian dollar 3.8%, the Canadian dollar 3.5%, the Danish krone 3.3%, the euro 3.1%, the Swedish krona 2.9%, the Norwegian krone 2.7%, the Swiss franc 2.4%, the Singapore dollar 1.3%, the British pound 1.1%, the Mexican peso 0.7%, the South Korean won 0.6% and the Japanese yen 0.2%. For the week on the upside, the Brazilian real increased 1.6%, the South African rand 1.3% and the Taiwanese dollar 0.7%.

Commodities Watch:

The Goldman Sachs Commodities Index sank 3.0% to an almost six-year low (down 9.2% y-t-d). Spot Gold added 1.1% to $1,294 (up 9.2%). March Silver jumped 3.3% to $18.33 (up 17.5%). March Crude sank $3.84 to $45.29 (down 15%). February Gasoline slipped 0.9% (down 9%), and February Natural Gas sank 8.4% (down 1.0%). March Copper fell 4.6% (down 12%). March Wheat slipped 0.5% (up 10%). March Corn was little changed (down 3%).

U.S. Fixed Income Bubble Watch:

January 23 – Bloomberg (Cordell Eddings): “Sales of corporate bonds in the U.S. are off to their slowest start since 2008… Issuers… have sold $92.8 billion in bonds so far this year, down 27% from this point last year and 34% from 2013. The drop comes even as investment-grade bond yields have fallen to 3.05%, below the 3.49% average of the past five years… Issuance is slowing after U.S. companies sold a record $1.65 trillion of debt last year to lock in low interest rates before they were projected to rise.”

January 23 – Bloomberg (Sridhar Natarajan): “The European Central Bank’s resolve to funnel more than a trillion dollars into the region’s capital markets may be a boon for borrowers across the Atlantic. ECB President Mario Draghi unveiled a bond-purchase program to ward off signs of deflation threatening to engulf the euro area similar to the exercise undertaken by the Federal Reserve six years ago. The infusion aimed at boosting asset prices may prompt investors to shift money into U.S. corporate bonds, which offer the most yield relative to company debt in Europe in a decade.”

January 23 – Bloomberg (Lisa Abramowicz): “The promise of yet another trillion-dollar cash infusion from a central bank isn’t enough to bring individual investors back into the market for risky corporate debt. In fact, they keep bailing. Investors pulled $523 million from global high-yield bond mutual and exchange-traded funds in the week ended Jan. 21, according to data compiled by EPFR Global. They withdrew $868 million from funds that buy U.S. speculative-grade loans, bringing their total assets below $100 billion for the first time since September 2013, Wells Fargo… data show.”

Global Bubble Watch:

January 21 – Bloomberg (Elena Logutenkova and Jeffrey Vögeli): “Credit Suisse Group AG and Saxo Bank A/S joined an increasing number of European financial companies warning that the Swiss central bank’s surprise decision to abolish its currency ceiling may dent earnings. Credit Suisse, Switzerland’s second-biggest bank, indicated Monday that currency swings may hurt profit. Denmark’s Saxo Bank said some clients might not be able to settle unsecured amounts, which might cause undisclosed losses. The full force of the decision won’t be known for months and is ‘closer to a nuclear explosion than a 1,000-kilogram conventional bomb,’ Javier Paz, senior analyst in wealth management at Aite Group, said… ‘The aftermath is like a black hole that can suck massive amounts of credit from currency trading as we have known it.’”

January 22 – Bloomberg (Julia Leite and Christine Jenkins): “Latin America is turning into the world leader in corporate-bond defaults. Four companies in the region have skipped dollar-denominated debt payments this month, more than any other area and almost half the total in all of 2014. In a sign bond investors are increasingly concerned about Latin American companies’ ability to repay debt, borrowers led by Mexico’s oil-rig operators have pushed the amount of the region’s bonds trading at distressed prices to $58 billion, about a third of all emerging-market debt trading at such levels.”

January 21 – Bloomberg (Ben Bain): “To appreciate the stunning reversal of fortune wrought by the collapse in oil prices, look no further than Mexico’s rig operators. A year ago, they were poised to be among the biggest winners of the country’s historic move to abandon its seven- decade oil monopoly. Now they’re joining the swelling ranks of distressed borrowers around the world. The change is just another example of how the 53% plunge in crude since June is upending bond investors’ assumptions and stoking unprecedented losses in a country that was supposed to be home to an oil-industry boom. Rig operators… are facing pressure from Petroleos Mexicanos as the government crude producer moves to cut costs. Offshore Drilling -- whose revenue depends on the day rate it charges for ultra-deepwater rigs -- has seen its notes due 2020 lose 28% in value this month alone…”

January 19 – Bloomberg (Andrew Mayeda): “The IMF made the steepest cut to its global-growth outlook in three years, with diminished expectations almost everywhere except the U.S. more than offsetting the boost to expansion from lower oil prices. The world economy will grow 3.5% in 2015, down from the 3.8% pace projected in October… The… lender also cut its estimate for growth next year to 3.7%, compared with 4% in October… ‘The world economy is facing strong and complex cross currents,’ Olivier Blanchard, the IMF’s chief economist, said… ‘On the one hand, major economies are benefiting from the decline in the price of oil. On the other, in many parts of the world, lower long-run prospects adversely affect demand, resulting in a strong undertow.’”

U.S. Bubble Watch:

January 20 – Bloomberg (Craig Trudell): “A top U.S. executive at Honda Motor Co. said competitors are doing ‘stupid things’ to boost auto sales, including making seven-year-long car loans that harm buyers. Automakers are increasingly selling vehicles with 84-month loans that reduce monthly payments while making it tougher to repay faster than cars lose value, John Mendel, Honda’s U.S. sales chief, said… ‘You’re ringing the bell on a new-car sale, but that customer is saddled -- they’re stretched so thin,’ Mendel said… Extended-term loans are ‘stupid not just for us, but for the industry.’”

January 21 – Bloomberg (Prashant Gopal, Oshrat Carmiel and John Gittelsohn): “Manhattan real estate agent Lisa Gustin listed a four-bedroom Tribeca loft for $7.45 million in October, expecting a quick sale. Instead, she cut the price this month by $550,000. ‘I thought for sure a foreign buyer would come in,’ said Gustin, a broker at Brown Harris Stevens who is still marketing the 3,800-square-foot apartment… ‘So many new condos are coming up right now. They’ve been building them for the past few years and now they’re really hurting the resales.’ A flood of new high-priced condominiums and mansions are coming to market in New York, Miami and Los Angeles just as international buyers, who helped fuel demand in the three cities, are seeing their purchasing power wane with the strengthening dollar. Signs of a pullback may already be showing in Manhattan, where luxury-home sales have slowed amid a surge in construction of towers aimed at U.S. millionaires and foreign investors.”

ECB Watch:

January 19 – Financial Times (Claire Jones and Stefan Wagstyl): “In his tumultuous time as president of the European Central Bank, Mario Draghi has always been able to rely on the unequivocal support of German chancellor Angela Merkel. Not any more. The mutual trust between Europe’s most important central banker and its most powerful political leader will this week be put to the test as the ECB unveils its long-awaited quantitative easing package in the face of serious German reservations about the central bank buying government bonds. Berlin will not publicly oppose the package that Mr Draghi is expected to unveil in Frankfurt on Thursday. But it is pressing for tough conditions which the ECB fears could limit its chances of success. ‘We have made it clear that it is questionable to do QE,’ says one person with a knowledge of government thinking… The stand-off comes at a critical time for Germany, the eurozone and the EU, with the economy stagnant, unemployment high and the union’s reputation as a global economic powerhouse at stake. The euro last week touched an 11-year low against the dollar… Next Sunday, voters go to the polls in debt-laden Greece, the eurozone’s most vulnerable member, in an election which could determine its future in the eurozone.”

January 23 – Bloomberg (Jeff Black and Stefan Riecher): “European Central Bank policy makers Benoit Coeure and Ignazio Visco underlined that their new bond-buying program will be extended if it doesn’t show results. ‘If we haven’t achieved what we want to achieve,’ said Coeure, the ECB’s head of market operations, ‘then we’ll have to do more, or we have to do it for longer.’ Visco, the Italian central-bank governor, said earlier on Friday that ‘we are open-ended’ about asset purchases.”

Global Central Banker Watch:

January 21 – Bloomberg (Simon Kennedy): “Global central banks intensified their battle against slowing inflation as the risk of defeat mounts. The Bank of Canada unexpectedly cut its main interest rate for the first time since 2009 on Wednesday in Ottawa, saying the oil-price shock will drag down inflation. The Bank of Japan expanded and extended a lending program, while two Bank of England policy makers dropped calls for higher interest rates.”

January 21 – Bloomberg (Frances Schwartzkopff and Peter Levring): “Denmark is ready to step up its currency interventions to stamp out any lingering speculation the central bank may be unable to defend its euro peg. ‘We have plenty of kroner,’ Karsten Biltoft, head of communications at the central bank in Copenhagen, said… ‘We have the necessary tools in terms of interest-rate changes and interventions and we have a sufficient supply of Danish kroner.’ The comments follow the central bank’s second rate cut in less than a week, with Governor Lars Rohde lowering the benchmark deposit rate to a record minus 0.35% today… and followed a 15 bps cut on Monday. The easing comes as the European Central Bank unveils an historic bond-purchase program.”

January 21 – Financial Times (James Crabtree in Mumbai and Josh Noble): “Reserve Bank of India governor Raghuram Rajan handed investors a pleasant surprise to kick off 2015, offering up an unexpected interest rate cut last week and sparking further bullish sentiment in a market that had already raced to repeated record highs over the past 12 months. India’s benchmark Sensex jumped 30% last year, the world’s best-performing major index after China, as investors anticipated a range of economic reforms under new prime minister Narendra Modi. A gradual cyclical turnround helped too, following a prolonged downturn that had seen gross domestic product growth fall from nearly 9% in 2011 to just 4.7% in 2014.”

January 21 – Reuters (Humeyra Pamuk and Ece Toksabay): “Turkish President Tayyip Erdogan said… the central bank's 50 bps rate cut had been insufficient and said securing investment and employment was impossible at current interest rates. Erdogan, who has repeatedly called for looser monetary policy, told a news conference that the bank had still ‘not got the message’ on interest rates and that he would share his views with the prime minister and relevant ministers. ‘If we want investment in Turkey, if we are creating jobs, it's not possible with this rate. This rate should go down so that there will be entrepreneurship and competition… (The central bank) will continue to get criticism as long as it continues to take wrong steps. My sensitivity on this issue as the president of this country will continue.’”

January 21 – Bloomberg (Toru Fujioka and Masahiro Hidaka): “The Bank of Japan expanded and extended a lending program set to expire in March to assist Governor Haruhiko Kuroda’s bid to stoke inflation… The central bank increased the main part of the Growth-Supporting Funding Facility to 10 trillion yen ($85 billion) from 7 trillion yen. The bank had given out 5.8 trillion yen in credit as of Dec. 5 under the whole program, which also includes a dollar-lending facility.”

Russia/Ukraine Watch:

January 23 – Wall Street Journal (Greg White): “Ukrainian separatist leader Alexander Zakharchenko said Friday that rebel forces would advance against Kiev’s troops to expand their control to the borders of the Donetsk region, vowing to make no further attempts at peace talks as violence in the region escalated, the Interfax news agency reported. ‘We will attack to the border of Donetsk Region, but if I see threats from other directions, we will liquidate them,’ Mr. Zakharchenko told a group… ‘There will be no more efforts from our side to talk about cease-fires,’ he added. It wasn’t immediately clear just how broad the advance was… But fighting has intensified dramatically in recent weeks. On Thursday, Kiev ceded control over the symbolic Donetsk airport to rebel forces after months of bitter fighting over the ruined facility.”

January 23 – Bloomberg (Daryna Krasnolutska and Rainer Buergin): “Germany warned that time is running out to halt spiralling violence in eastern Ukraine as it called on Russia and the government in Kiev to stand by pledges to end the crisis. Ukraine and Russia must seize ‘what may be the last chance for a peaceful solution’ by fulfilling commitments to secure a cease-fire and withdraw heavy weaponry, German Foreign Minister Frank-Walter Steinmeier said… They must ‘do everything to ensure the spiral of violence and counter-violence is stopped,’ he said. Defense Ministry officials in Ukraine reported more than 100 attacks by pro-Russian rebels in the past 24 hours.”

Brazil Watch:

January 22 – Bloomberg (Mario Sergio Lima and Arnaldo Galvao): “Brazil’s central bank raised interest rates for the third straight meeting, signaling monetary policy tightening will persist as analysts estimate inflation is on track to miss target for the first time in more than a decade. The central bank’s board… boosted the benchmark rate on Wednesday to 12.25% from 11.75%...”

January 23 – Bloomberg (Mario Sergio Lima): “Brazil’s current account gap widened last month more than economists forecast, as weaker commodity prices hurt the country’s terms of trade. The deficit in the current account, the broadest measure of trade in goods and services, widened in December to $10.3 billion from $9.3 billion a month earlier, the central bank said in a report distributed today in Brasilia… The deficit for the full year was $90.9 billion, the biggest ever.”

EM Bubble Watch:

January 21 – Financial Times (Ricardo Hausmann): “Every economic catastrophe brings soul-searching. When Argentina collapsed at the end of 2001, the International Monetary Fund was forced into a critical assessment of its involvement in the country. Similar processes were triggered at the World Bank after unsuccessful development projects in Africa. The coming implosion of the Venezuelan economy should prompt similar introspection — not at the IMF, which has been absent since its ‘expulsion’ by President Hugo Chávez in 2007, but in China. It is hard to exaggerate the magnitude of the Venezuelan collapse. People are queueing for hours to buy food, stores are empty, and the country is in a deep recession. Venezuela has the fastest inflation in the world, while its government debt is the most expensive to insure against default. How did we get here? Venezuela used the period of high oil prices to quadruple its public foreign debt, in order to fuel a domestic spending boom. By 2012, when Venezuelan oil averaged $103, the country was spending as if the price was $194, running up a fiscal deficit of 17.5% of gross domestic product. That is why the economy went into crisis in early 2014… The recent drop has just made a hopeless situation worse. Who gave the country the rope with which to hang itself? Mostly China. China started to lend massively to Venezuela in 2007. Since then it has lent more than $45bn, of which about $20bn is still outstanding.”

Europe Watch:

January 21 – Financial Times (Chris Giles): “The former head of the Bundesbank has cast doubt on the future viability of the euro if countries do not follow Germany in imposing structural reforms to boost their longer-term growth rates. Calling the probable introduction of quantitative easing by the European Central Bank on Thursday as ‘only part of the fix’, Axel Weber, now the chairman of UBS, said that there were legitimate questions hanging over the viability of the single currency. If countries do not reform, he said: ‘I think there will always be questions about the viability of the project and Europe has not done enough to dispel these concerns.’ ...He said he expected a ‘sizeable programme’ of QE, adding: ‘But the real issue is the ECB has continuously bought time for European policy makers to fix the issue.’ Saying the policies of structural reform, particularly in the periphery of the eurozone — Italy, Greece, Spain, Ireland and Portugal — were inadequate, Mr Weber, who was the president of the Bundesbank until 2011, said that because of a lack of recovery in Europe, ‘the problems are back’.”

January 19 – Financial Times (Stefan Wagstyl): “A German media campaign highlighting the alleged dangers of the European Central Bank’s planned government bond-buying programme escalated on Monday, with a leading tabloid newspaper telling readers the euro could be ‘dramatically devalued’ if the plan goes ahead. The salvo by Bild comes as Mario Draghi, ECB president, faces growing criticism of the proposals ahead of the bank’s crucial board meeting… Expectations were reinforced on Monday when French President François Hollande said the ECB will ‘take the decision to buy sovereign debt, which will add significant liquidity to the European economy’.’ While Mr Draghi says QE is needed to stave off the threat of deflation in the eurozone, the German government led by Angela Merkel, the chancellor, believes the programme will not work and could burden taxpayers in Germany and elsewhere with heavy potential losses. The government’s views are widely shared by a sceptical German public.”

January 19 – Bloomberg (Nikos Chrysoloras and Paul Tugwell): “Syriza widened its lead over Prime Minister Antonis Samaras’s New Democracy in three opinion surveys just days before the general election, prompting one pollster to say the race was all but decided. Syriza, an acronym for Coalition of the Radical Left, led by between 4 percentage points and 6.5 percentage points in separate surveys… That’s up from about 3 points last week. ‘It’s going to be very, very difficult for New Democracy to overturn Syriza’s lead,” Nikos Marantzidis, a professor of political science at the University of Macedonia who presided over the poll broadcast on Skai TV, said… ‘Only a dramatic event of some sort could change things now.’ The University of Macedonia poll showed Syriza’s lead rising to 6.5 points from 4.5 points, the widest margin of the three latest surveys.”

January 20 – Reuters (George Georgiopoulos): “Greece's central bank has moved to protect its banks from any fallout from the coming general election, asking the European Central Bank to approve a stand-by domestic emergency funding line, a Bank of Greece official said… The move comes after two major banks applied to be able to tap an emergency liquidity assistance (ELA) window on Friday as Greeks withdraw cash before the snap election on Jan. 25. ‘We have sent a request to the ECB on ELA approval for all four major banks to have a shield for the banking system,’ the official said… ‘It is up to each bank to decide whether it will use the funding line,’ the official added… Greece's radical left-wing Syriza party is leading in polls. It wants to end austerity and renegotiate debt with its European partners. Under ELA, national central banks can lend to commercial banks but have to get approval from the ECB to do so.”

January 20 – Bloomberg (Peter Levring and Frances Schwartzkopff): “Denmark is trying to silence currency speculators as the government and central bank insist the Nordic country won’t follow Switzerland in severing its euro ties. ‘Circumstances significantly different from Denmark’s’ were behind the Swiss National Bank’s decision, Danish Economy Minister Morten Oestergaard said… ‘Any comparison between Denmark and Switzerland is impossible.’ The comments followed yesterday’s surprise decision by the Danish central bank to cut its deposit rate by 15 bps to minus 0.2%, matching a record low last seen during the darkest hours of Europe’s debt crisis in 2012. Like the Swiss, the Danes lowered rates after interventions in the market proved insufficient.”

Geopolitical Watch:

January 23 – New York Times (Shuaib Almosawa and Rod Nordland): “The American-backed government of Yemen abruptly collapsed Thursday night, leaving the country leaderless as it is convulsed by an increasingly powerful force of pro-Iran rebels and a resurgent Qaeda. The resignation of the president, prime minister and cabinet took American officials by surprise and heightened the risks that Yemen, the Arab world’s poorest country, would become even more of a breeding ground for Al Qaeda in the Arabian Peninsula… The resignation of President Abdu Rabbu Mansour Hadi brought full circle Yemen’s Arab Spring revolution, which ousted former President Ali Abdullah Saleh in 2011 amid massive popular protests. Now Mr. Saleh, who has lately made himself an unlikely ally of the Houthi rebels who toppled the government, is poised to return to the forefront of Yemeni politics… The events in Yemen were not the week’s only death knell for accomplishments of the Arab Spring’s first year, 2011. In Libya, that country’s last remaining intact and functioning institution, its Central Bank with $100 billion in foreign reserves, lost its major Benghazi branch to marauding militiamen.”

January 23 – Financial Times (Sam Jones): “The collapse in the oil price has had ‘disastrous’ consequences for the fight against Isis, Haider al-Abadi, Iraq’s prime minister, has warned world powers. Western leaders meeting Mr Abadi in London on Thursday have promised to increase shipments of ammunition and to consider allowing the Iraqi government to defer millions of dollars of payments for key supplies, in order to alleviate budgetary pressure and ensure the country’s military can continue fighting.”

January 20 – Financial Times (Robin Harding): “Japanese fighter pilots are scrambling their aircraft more often than at the height of the cold war to meet incursions by Russian and Chinese jets… In the nine months to the end of 2014, Japan’s air self-defence force scrambled 744 times, on course to exceed the 12-month record of 944 times set in 1984. The rising number highlights the increased military tension in East Asia and the growing risk of an accident as rival air forces manoeuvre in close proximity.”

China Bubble Watch:

January 23 – Reuters (Pete Sweeney): “The People's Bank of China is desperate to stimulate a slowing economy, but flagging enthusiasm for Chinese assets is blunting its traditional monetary policy tools and forcing the central bank to adopt different tactics. Sustained capital outflows have reduced the effectiveness of the PBOC's open market operations to such an extent that the central bank all but abandoned them in early December, market participants say… Open market operations… are a transparent way of managing the money supply and guiding interest rates. Tinkering with short-term liquidity has proved ineffective, however, in offsetting the deeper capital outflows that China is facing. ‘It's very difficult to drive down lending rates in a very short time, that's the root issue,’ said Zhou Hao, an economist at ANZ in Shanghai... ‘Short-term injections can only calm market fears; not provide long-term liquidity to drive down interest rates.’ Instead, the PBOC has turned to new tools such as short- and medium-term lending facilities (SLFs, MLFs), credit lines it extended directly to banks behind closed doors. These provide liquidity, but their opacity blunts their effectiveness in guiding funding costs for heavily indebted Chinese firms lower.”

January 22 – Financial Times (Josh Noble): “International bond investors are giving Chinese property companies the cold shoulder, forcing them to look elsewhere for funding as concerns mount over corporate governance and cash flow in the sector. Mainland developers have become a core part of the Asian junk bond market, raising $19.5bn in 2013 and $21.4bn last year, according to Dealogic. A quarter of that borrowing came in January in both years. Chinese real estate companies raised $5.3bn in dollar bond markets during the first three weeks of 2013 and $4.9bn over the same period in 2014. This year, not a single deal has been completed. Bankers say a number of property companies — including some of the best known — have postponed debt-raising plans or are looking elsewhere for financing as investors turn increasingly cautious.”

January 23 – Bloomberg: “The surge in borrowing costs for Chinese junk bond issuers is spreading to investment-grade companies amid the nation’s corruption campaign and following missed payments by Kaisa Group Holdings Ltd. The average spread at issuance on dollar-denominated notes from China sold since Jan. 1 with investment-grade ratings has leapt to 259 bps from 207 in the second half of last year… Concerns are mounting that even China’s best-rated companies may get caught up in government probes as President Xi Jinping targets both ‘tigers and flies’ in his anti-graft drive. In the highest profile cases, at least seven officials have been removed at China National Petroleum Corp. including the former chairman Zhou Yongkang, a previous member of the party’s Politburo Standing Committee in charge of domestic security. ‘The China premium used to be close to nothing when compared to the developed names globally,’ Raymond Chia, head of credit research in Asia ex-Japan for Schroder Investment Management Ltd., which controls about $450 billion, said… ‘But now, with the corruption clampdown which makes the government the locksmith, as well as the commodity price impact, investors are having a more careful look at Chinese names.’”

January 19 – Bloomberg: “As Europe grapples with terrorism and Switzerland scrapped a currency peg, the troubles of a Chinese developer that’s never reached $3 billion in market value became something investors from New York to London couldn’t ignore. A missed $23 million interest payment by Kaisa Group Holdings Ltd. earlier this month puts it at risk of being the first Chinese real estate company to default on its dollar-denominated bonds. That may signal deeper risks for China’s already fragile and corruption-prone property market… Chinese companies comprised 62% of all U.S. dollar bond sales in the Asia-Pacific region ex Japan last year, issuing $244.4 billion of the $392.5 billion total… Borrowing costs for many developers in the world’s second-largest economy have surged since Kaisa’s travails began. Yields on Chinese dollar-denominated speculative grade debt climbed to 12.38% on Jan. 16, a Bank of America Merrill Lynch index shows, the highest since June 2012. The junk debt has lost 5.7% in 2015, the worst start to a year on record.”

January 20 – Bloomberg: “Kaisa Group Holdings Ltd. can’t repay a 2.5 billion yuan ($402 million) trust due tomorrow and the product will be transferred to a third party so investors can get their money back, two people familiar with the matter said. Ping An Trust Co. established the two-tranche trust product on behalf of Kaisa in April last year, the people said… The money on the largest portion comes due Jan. 21 and an as yet undisclosed third party will take it over so investors can be repaid their principal plus interest, the people said… ‘The bailout won’t help the development of a sound credit risk pricing mechanism,’ said Liu Dongliang, a senior analyst at China Merchants Bank… ‘But in the short term, it helps maintain stability in the financial market, especially when onshore credit risks are rising.’”

January 23 – Bloomberg: “Lei Jie, the chairman of China’s Founder Securities Co. and its joint venture with Credit Suisse Group AG, can’t be contacted by Founder as the government questions executives at the company’s parent. Lei asked for a week’s sick leave Jan. 12 and the firm hasn’t been able to reach him since Jan. 19… Founder Securities, China’s sixth-largest listed brokerage, and parent Peking University Founder Group are embroiled in disputes with billionaire Miles Kwok’s Beijing Zenith Holdings Co., the brokerage’s second-largest shareholder.”

January 23 – Bloomberg: “Chinese banks’ bad-loan ratio jumped the most in at least a decade in the fourth quarter as a property-market slump and an economic slowdown constrained borrowers’ repayment ability. Nonperforming loans accounted for 1.29% of commercial banks’ total advances as of Dec. 31, up from 1.16% three months earlier… The bad-loan ratio for all banking institutions, including policy banks, stood at 1.64% at the end of last year, according to the CBRC.”

January 21 – Bloomberg (Michael S. Arnold): “China will build a 7,000-kilometer (4,350-mile) high-speed rail link from Beijing to Moscow, at a cost of 1.5 trillion yuan ($242 billion), Beijing’s city government said… The rail line seeks to facilitate travel across Europe and Asia… The journey from Beijing to Moscow would take ‘two days’ on a route passing through Kazakhstan, the post said.”

Japan Watch:

January 23 – Bloomberg (Toru Fujioka and Francine Lacqua): “Bank of Japan Governor Haruhiko Kuroda signaled the central bank may need to look at fresh options if more stimulus is needed to propel inflation to levels unseen since stagnation set in two decades ago. ‘If, really, our possible path to 2% inflation is significantly affected, then of course we can make adjustment to our monetary policy,’ Kuroda said… in Davos, Switzerland, on Friday. Asked whether the BOJ will have to get more creative, he said ‘yes, I think so.’”