Friday, May 15, 2015

My Weekly Commentary: Today's New Paradigm

As an analyst of Bubbles, I’ve grown convinced of some things: First, it’s vital to recognize Bubble distortions early before they become deeply ingrained in markets and economic structures (when policymakers turn even more timid). Second, there is always an underlying source of Credit fueling the Bubble. Third, there are typically major distortions that mask the riskiness of the underlying Credit – government involvement is invariably a major factor along with heavy risk intermediation. Fourth, each Bubble has its own nuances that ensure it can inflate undetected for too long. Fifth, the longer a Bubble inflates the greater the scope of market misperception and structural impairment. And, finally, Bubbles burst when market misperceptions eventually succumb to reality, a development that tends to unfold in the Credit underpinning the boom.

I didn’t think it would come to this. When I began chronicling the “global government finance Bubble” more than six years ago, I saw a backdrop conducive for the biggest Bubble yet: desperate central bankers mindlessly determined to print Trillions, buy Trillions of securities and inflate market values tens of Trillions, while at the same time using zero rates to force savers into risky securities. Yet I never imagined we’d get to mid-2015, with a 5.4% unemployment rate, record stock prices, record M&A, booming corporate debt markets and abundant signs of froth (i.e. Palo Alto, upper-end real estate, Manhattan condos, art, etc.) – and rates would remain stuck at zero. I didn’t expect global bond and currency markets to prove so accommodating.

But here we are - at the precarious stage. I’ve posited that the more deeply systemic a Bubble the less conspicuous its effects. Yet this global Bubble has reached such extremes that obvious signs of excess have sprouted out everywhere – most conspicuously with European debt, M&A, Chinese equities, global sovereign bonds, biotech, etc. And with things turning more overt, there’s now some Wall Street research addressing the topic.

Citi Equities Research (Robert Buckland, Mert Genc, Beata Manthey, Cosimo Recchia, Jonathan Stubbs and Ayush Tambi) published an interesting report late this week, “It’s Bubble Time.” This insightful research is worthy of discussion. I excerpted from the Citi report and then followed with my own thoughts.

From “It’s Bubble Time”: “Bubble Breeders - Previous ageing bull markets have been associated with asset price bubbles. They are often based around a convincing idea (Secular Stagnation?), and fuelled by excess liquidity. They are big enough and last long enough to destroy many contrarian investors.”

From the experience of the past two decades, so-called “bull markets” were not so much “associated with asset prices bubbles” as they were outright manifestations of historic financial Bubbles. “Tech Bubble” market distortions were prevalent in Credit and equities markets by the mid-nineties. Even greater “mortgage finance Bubble” market distortions took root soon after the post-“tech Bubble” reflation was commenced.

A “convincing idea” – or good story – is essential. I’ll add that if sufficient “money” and Credit are thrown at a system a pretty “good story” is bound to pop out. Periods of new technologies clearly provide fertile ground for Bubbles – and are arguably essential to epic Bubbles. As we’ve witnessed now for better than 20 years – and certainly was the case in the two decades prior to the 1929 Crash – a flurry of technological advancement can wield powerful price impacts – along with economic upheaval and instability. Policy confusion is assured.

By their nature, the final phase of an epic Bubble will indeed “destroy many contrarian investors.” There’s a confluence of important dynamics at play. First, during final Bubble phases, officials are by then responding to serious fundamental deterioration with heightened policy desperation. So-called “bears” - positioned based on negative fundamental factors – are squashed by the policy whirlwind. Meanwhile, flows gravitate to the most bullish and aggressive (tending to be those content to overlook weak fundamentals and fragilities).

Such a backdrop foments dangerous Bubble Dynamics. “Money” chases inflating risk markets, while a depleted few retain the resources or willingness to take the other side of this “bull” trade. The upshot is a self-reinforcing market supply/demand imbalance. Over time, as bull market psychology and speculative impulses build, unhinged markets succumb to upside dislocation and “melt-up” dynamics: Too many anxious buyers facing a dearth of sellers.

Benjamin Strong’s “coup de whiskey to the stock market” and the fateful 1927-1929 speculative blow-off illustrate this dynamic. And I point to the summer of 2012 – “do whatever it takes” central banking and the unleashing of global open-ended QE – as the original catalyst for global securities markets upside dislocation.

From Citi: “Bubble Bursters – Rate hikes eventually burst bubbles, but it usually takes a least three to stop the juggernaut. We do not expect the third Fed hike until 3Q16. In the meantime, expensive stocks may keep getting more expensive.”

I would argue that Bubbles are burst by an inevitable reversal of speculative flows and attendant shift in market perceptions. Responding to increasingly conspicuous excess, central bankers will tend to raise rates (too little and too) late in the Bubble cycle. Still, it’s late-cycle “Terminal” excess that dooms Bubbles. Much belated rate increases had little to do with either “tech” or mortgage finance Bubble collapses.

“Tech” collapsed after a reversal of a spectacular market “melt-up” dislocation. Derivatives markets were instrumental – providing speculative leverage - for the upside dislocation and then during the downside collapse. Markets abruptly turned illiquid. “Hot money” rushed for the exits, while too many desperately attempted to buy market insurance and/or place bearish bets. The mortgage finance Bubble burst when “hot money” sought to exit subprime mortgage securitizations and derivatives. Excess associated with over $1 Trillion of subprime CDOs issued in 2006 ensured subprime’s demise. Fed rate policy had little to do with the timing of the collapse.

From Citi: “We suspect that asset price bubbles are formed by four key forces: 1) A new paradigm story supported by convincing fundamentals, 2) Surplus liquidity, 3) A demand/supply imbalance, 4) Business/benchmark risk amongst asset managers… New Paradigms: Every bubble is based on a good story. Tulips are beautiful flowers. 17th Century Far East trading opportunities were vast. Japan’s economic performance post WW2 was spectacular. The internet represented a transformational technology advance. Many of these stories were based on convincing fundamental evidence – they really were new paradigms which would go on to change the world. However, when combined with abundant capital, these great ideas were often accompanied by unsustainable asset price bubbles. What might be the current new paradigm? At a macro level, the most obvious candidate is ‘secular stagnation’ – a world where growth, inflation and interest rates are likely to stay low for the foreseeable future. Fixed income assets are the obvious beneficiaries.”

This is insightful analysis. Yet one cannot discuss Bubbles without a central focus on Credit. As such, I would add that “surplus liquidity” is a fundamental characteristic of inflating asset markets. Speculative markets create their own self-reinforcing liquidity. Liquidity is created in the process adding leveraging in search of bull market returns, while borrowing throughout the economy increasingly finds its way into bubbling markets. Moreover, the expectation for ongoing abundant liquidity becomes integral to bull market psychology. The underlying source of Credit and its progressive vulnerability goes unappreciated.

From Citi: “Demand/Supply Imbalance: The next key ingredient of a bubble is a demand/supply imbalance. High demand for a new investment idea usually overwhelms the supply and leads to sharp price increases. Limited supply of land and growing populations often drive house/land price bubbles.”

This critical issue is quite complex. Similar to “surplus liquidity,” “demand/supply imbalance” is inherent to inflating “bull markets”. In the Real Economy Sphere, rising prices tends to self-adjust by dampening demand and boosting supply. In the Financial Sphere, rising securities prices lead instead to heightened demand. Unfettered finance tends to be powerfully self-reinforcing. Importantly, heightened demand for Credit can be accommodated without higher borrowing costs. Rising securities prices spur progressively intense demand.

This already problematic securities market supply/demand dynamic has been radically exacerbated by central bank policies. First, their purchases have removed Trillions of securities from the marketplace. Second, zero rates and collapsing sovereign yields have spurred Trillions into global risk markets. Third, “do whatever it takes” central banking and open-ended QE have emboldened the view that policymakers are determined to backstop global securities markets. This has had a profound impact on risk-taking. Emboldened market participants perceive that policymakers will protect against illiquidity and guard against big downside moves. Moreover, the policy backdrop ensures the availability of cheap market derivative “insurance.”

From Citi: “Business/Career risk: A weary client once defined a bubble to us: ‘something I get fired for not owning’. It is career-threatening for an asset manager to fight a big bubble. For example, the late 1990s TMT bubble almost destroyed the value-based fund management community. Any bond manager hoping that valuations were mean-reverting would have been fired many years ago. Big bubbles are especially dangerous. TMT stocks already represented a large part of equity market benchmarks when they rerated aggressively in the late 1990s. By contrast, Biotech stocks might currently be expensive but their small market cap means they are still not a big benchmark risk. You don’t get fired for not owning Biotech stocks now, but you did get fired for not owning TMT stocks in the late 1990s. Bubbles are obvious in hindsight, but they are very hard to fight in real time. Indeed, proper bubbles are so overwhelming that they force sceptical fund managers to buy into them in order to reduce benchmark risk and avoid significant asset outflows. As these sceptics capitulate, of course they contribute to the bubble and so force other sceptics to capitulate and so on and on until there are no sceptics left to capitulate. It makes sense for an asset management company to manage its business risk but this can end up contributing to the madness. Through this, the modern fund management is almost hard-wired to produce bubbles.”

Again, insightful analysis. I would, however, suggest that it is not so much that “modern fund management is almost hard-wired to produce bubbles” as it is that the entire financial services complex has been transformed by central banks inflating serial Bubbles. Inflation psychology has become deeply, deeply ingrained: everything revolves around purchasing securities that will benefit from ongoing central bank market manipulations and interventions. To survive has meant to climb aboard the great bull. This ensures the entire industry is now on the same side of the “trade” – with functioning “two-way” markets relegated to history. And markets will remain seductively “abundantly liquid” only so long as bullish psychology is sustained.

From Citi: “What Bursts Bubbles?: The new paradigm of this cycle is probably the Secular Stagnation story, with fixed income assets looking the obvious bubble candidates. Nevertheless, our rates strategists think it is too early to call the end of the secular stagnation trades… We also asked our regional equity strategists to identify potential bubbles in their markets… Jonathan Stubbs suggests that Low Risk (low leverage, earnings stability and price beta) stocks look like bubble candidates. European Low Risk stocks (40% are from Consumer Staples and Health Care) are trading at 5x P/BV, well ahead of the 2.5x PBV reached in 2007.”

The issue of Today’s New Paradigm is fascinating. Many see “secular stagnation” as guaranteeing that central bankers won’t bring this party to an end anytime soon – “lower for longer, QE infinity.” True enough, though I don’t see “secular stagnation” as the prevailing market perception underpinning historic securities markets Bubbles.

From my analytical framework, there’s a New Paradigm in Credit and market perceptions that operate at the epicenter of Bubble distortions. The Nineties “New Paradigm” revolved around exciting new technologies; the collapse in communism and rise of global free-market capitalism; and globalization and productivity advancements that would have central banks providing economies and markets more leash to run. For the mortgage finance Bubble, the New Paradigm perception was perpetual “loose money” ensured by the “great moderation” and the fact that policymakers would never allow a crisis in mortgage Credit and housing. Policymakers ensured that “Too Big To Fail” mortgage securities would remain liquid “stores of value” – “money-like.”

Today’s New Paradigm misperception from my perspective: Global central bankers control market liquidity and will not allow another financial crisis. Global securities markets have become too big to fail – with central bankers’ guarantees of liquid and continuous markets elevating global risk markets to the stature of “money-like”. And it is this New Paradigm that has led to monumental financial flows. Trillions have flowed into various types of markets, funds and asset-classes based on the perception of low risk. In particular, the ETF and hedge fund industries have each grown to about $3.0 Trillion.

So where do I see Credit vulnerability and the potential for a destabilizing reversal in “hot money” flows? I believe that securities-based speculative leverage has grown to unprecedented dimensions – particularly within the ETF, hedge fund and derivatives complexes. Moreover, currency “carry trade” leverage has exploded, especially after policy-induced devaluations in the yen and euro. And as I’ve been emphasizing lately, an end-of-cycle dynamic has speculative opportunities now quickly transformed into Crowded Trades. Understandably, the bulls see timid central bankers ensuring that this game runs unabated. I suspect heightened market volatility is signaling that de-risking/de-leveraging could emerge at any moment. It was another rough week for the dollar. And what about that move in gold…

For the Week:

The S&P500 added 0.3% (up 3.1% y-t-d), and the Dow increased 0.4% (up 2.5%). The Utilities were little changed (down 7.1%). The Banks were about unchanged (up 1.2%), while the Broker/Dealers declined 0.5% (up 3.8%). The Transports fell 1.9% (down 5.0%). The S&P 400 Midcaps gained 0.8% (up 5.4%), and the small cap Russell 2000 added 0.7% (up 3.3%). The Nasdaq100 rose 0.8% (up 6.1%), and the Morgan Stanley High Tech index increased 0.7% (up 3.5%). The Semiconductors gained 1.1% (up 3.3%). The Biotechs added 1.2% (up 17.4%). With bullion jumping $37, the HUI gold index rallied 3.0% (up 10.5%).

Three-month Treasury bill rates ended the week at a basis point. Two-year government yields declined three bps to 0.54% (down 13bps y-t-d). Five-year T-note yields slipped three bps to 1.46% (down 19bps). Ten-year Treasury yields declined a basis point to 2.14% (down 3bps). Long bond yields gained three bps to 2.93% (up 18bps).

Greek 10-year yields gained six bps to 10.42% (up 68bps y-t-d). Ten-year Portuguese yields added two bps 2.26% (down 36bps). Italian 10-yr yields jumped nine bps to 1.76% (down 13bps). Spain's 10-year yields gained six bps to 1.72% (up 11bps). German bund yields jumped eight bps to a five-month high 0.62% (up 8bps). French yields rose seven bps to 0.90% (up 7bps). The French to German 10-year bond spread narrowed one to 28 bps. U.K. 10-year gilt yields were unchanged at 1.88% (up 13bps).

Japan's Nikkei equities index jumped 1.8% (up 13.1% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.40% (up 8bps y-t-d). The German DAX equities index dropped 2.2% (up 16.7%). Spain's IBEX 35 equities index declined 0.9% (up 10.1%). Italy's FTSE MIB index increased 0.7% (up 23.5%). Emerging equities were mostly higher. Brazil's Bovespa index added 0.2% (up 14.5%). Mexico's Bolsa increased 0.5% (up 5.1%). South Korea's Kospi index rose 1.0% (up 10.0%). India’s Sensex equities index gained 0.8% (down 0.6%). China’s bubbling Shanghai Exchange jumped 2.4% (up 33.2%). Turkey's Borsa Istanbul National 100 index surged 4.2% (up 2.2%). Russia's MICEX equities index declined 0.9% (up 21.1%).

Junk funds saw outflows slow to $89 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained five bps to a nine-week high 3.85% (down 2bps y-t-d). Fifteen-year rates rose five bps to 3.07% (down 8bps). One-year ARM rates were up two bps to 2.48% (up 8bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.01% (down 27bps).

Federal Reserve Credit last week increased $6.3bn to $4.439 TN. Over the past year, Fed Credit inflated $165bn, or 3.9%. Fed Credit inflated $1.628 TN, or 58%, over the past 131 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $3.6bn last week to $3.317 TN. "Custody holdings" were up $23.4bn y-t-d.

M2 (narrow) "money" supply jumped $27.6bn to $11.891 TN. "Narrow money" expanded $612bn, or 5.4%, over the past year. For the week, Currency increased $0.7bn. Total Checkable Deposits surged $58.9bn, while Savings Deposits dropped $32.5bn. Small Time Deposits slipped $1.8bn. Retail Money Funds rose $2.4bn.

Money market fund assets declined $1.4bn to $2.589 TN. Money Funds were down $125bn year-to-date, while being little changed from a year ago.

Total Commercial Paper contracted $24.3bn to $992bn. CP declined $46bn over the past year, or 4.4%.

Currency Watch:

The U.S. dollar index fell 1.7% to 93.23 (up 3.3% y-t-d). For the week on the upside, the euro increased 2.3%, the Norwegian krone 2.3%, the British pound 1.8%, the Swiss franc 1.5%, the Australian dollar 1.3%, the Swedish krona 0.8% and the Japanese yen 0.4%. For the week on the downside, the South African rand declined 1.0%, the Brazilian real 0.7%, the Mexican peso 0.7% and the Canadian dollar 0.5%.

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.5% (up 7.8% y-t-d). Spot Gold jumped 3.1% to $1,225 (up 3.4%). July Silver surged 6.6% to $17.56. (up 12%). June Crude increased 30 cents to $59.69 (up 12%). June Gasoline rose 3.3% (up 40%), and June Natural Gas jumped 4.9% (up 5%). July Copper was little changed (up 4%). July Wheat jumped 6.6% (down 13%). July Corn increased 0.7% (down 8%).

Fixed Income Bubble Watch:

May 13 – Bloomberg (Tracy Alloway): “Peer under the proverbial hood of a big bank or investment company's risk management chassis and one might see a mathematical model that looks something like this. ‘Value at Risk,’ or VaR, models use statistical analysis and historical data to attempt to quantify how much an investor might expect to lose from trading within a certain time frame and within a certain probability. While such VaR models were criticized in the aftermath of the financial crisis for failing to predict heavy losses incurred on subprime mortgage securities and associated assets, they still form the backbone of Wall Street's risk management systems. Traders operate within their limits; woe betide the junior trader who exceeds VaR. But big market moves have been occurring more frequently in recent months, and that's wreaking havoc with VaR models built on certain expectations of the way markets move. These ‘VaR shocks,’ as they're known, can be painful for investors because they often require them to cut positions in order to return to within their VaR limits.”

May 15 - Reuters (Anjuli Davies): “Dealmaking in the United States in 2015 has climbed 48% year-on-year to $565.6 billion, the highest level since 2007, following a string of multi-billion dollar acquisitions this week.”

May 12 – Bloomberg (Anchalee Worrachate): “Some of the biggest beneficiaries of the fixed-income selloff have been futures exchanges as trading in derivatives on German, French and Italian bonds surges. Trading in German bund futures had been in the doldrums, suffering its worst April in at least 10 years before going on to have its best week since 201… Italian bond futures volumes reached a record high. Investors pounced on the derivatives because of a shortage of regular bonds to trade. ‘I’ve certainly observed an increasing differential in terms of liquidity between liquid derivatives and off-the-run cash securities,” said Mark Dowding, a… partner and money manager at BlueBay Asset Management LLP. ‘We’ve made use of liquid derivatives and we’ll continue to do so.’ Trading in 10-year bund futures reached 5.87 million contracts last week, the most since July 2011… The number of outstanding contracts -- known as open-interest -- reached 1.45 million, the highest since 2007. Dealing in Italian futures surged to 779,379 contracts, the most since Bloomberg started gathering the data in 2009.”

U.S. Bubble Watch:

May 13 – Bloomberg (Trista Kelley, Inyoung Hwang and Lorcan Roche Kelly): “They’re cheap, easy to use, and they’re winning over more investors than ever. Now exchange-traded funds -- investment tools that seek to replicate the performance of a portfolio of securities -- are growing at such a clip that their assets are poised to overtake those of hedge funds. It’s no secret hedge funds have had a rough couple of years. Without the returns to make up for high taxes and fees, more investors are turning to the ever-growing range of ETF products on offer. ETFs have lower fees than mutual funds, lower taxes than index funds and are easier to buy or sell quickly than either. And underpinning gains is loose central-bank policy that has been fueling a general movement toward passive investing.”

May 12 – Wall Street Journal (Spencer Jakab): “Investors may need to raise their sights—literally. Their focus around this time each quarter is on the bottom line of companies’ income statements. That is why they call it ‘earnings season,’ after all. But the top line, representing revenue, is the stuff out of which those profits are earned and a more direct function of economic growth. Its implication this quarter and perhaps for all of 2015 is a bit ominous now that 90% of companies in the S&P 500 have released first-quarter results. Revenue is seen dropping by 2.8% year over year in the first quarter, according to figures compiled by FactSet. Any decline is rare.”

May 12 – Bloomberg (Brian Chappatta): “Chicago had its credit rating cut to junk by Moody’s… after the Illinois Supreme Court’s rejection of a state pension-overhaul plan reduced the city’s options for fixing its own underfunded system. The two-level downgrade to Ba1 affects $8.1 billion of general obligations, which were already the lowest-rated among the 90 biggest U.S. cities, excluding Detroit. The outlook is still negative. Moody’s has dropped the city seven levels since July 2013. The reduction to the highest level of junk ‘incorporates expected growth in the city’s highly elevated unfunded pension liabilities,’ Moody’s said… After the May 8 court ruling, ‘we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably.’ The deterioration in the credit standing of the third-most-populous U.S. city underscores how pension promises are squeezing the finances of states and localities nationwide.”

May 12 – Bloomberg (Sarah Mulholland): “Blockbuster real estate deals are back and breaking records as cash from around the globe pours into U.S. office buildings, apartment complexes and other investment properties. Commercial real estate transactions jumped 45% by dollar volume in the first quarter, an increase driven by sales of multiple buildings or entire companies, according to research firm Real Capital Analytics Inc. Since then, General Electric Co. agreed to sell real estate assets to Blackstone Group LP and Wells Fargo & Co. in a deal valued at about $23 billion, the largest property purchase since the financial crisis. As the pot of money set aside for U.S. commercial real estate grows, competition for the best properties is pushing investors to buy in bulk. Based on the pipeline, which includes the GE deal, the second quarter may be one of the biggest on record for property transactions, according to Real Capital. ‘It’s so hard to get things on a single-asset basis,’ said Janice Stanton, an executive managing director at… Cushman & Wakefield Inc. ‘You’re starting to see larger and larger transactions.’ Real estate deals surged to $129 billion during the three months through March, marking the most active start to a year since 2007, according to Real Capital.”

May 15 – Bloomberg (Edward Robinson): “Is peer-to-peer lending out of control? There’s certainly some cause for concern. Consider these facts: P2P loan volume is poised to hit $77 billion this year, a 15-fold increase from just three years ago. LendingClub, the No. 1 player worldwide, is trading at a market value of about $7 billion even though it lost $33 million last year. And in a flashback to the subprime mortgage boom, P2P startups have begun bundling and selling off loans through securitizations. The business of matching lenders with borrowers online… may truly be an innovative way to distribute capital. But is P2P a revolution or just another bubble? Money managers are betting it’s the former as they pile into one of the fastest-growing asset classes in finance…”

May 12 – Wall Street Journal (Eliot Brown and Josh Barbanel): “It’s getting crowded at the top of Manhattan’s apartment market. As condo developers chase billion-dollar paydays through the construction of luxury dwellings, the cranes dotting the city are sparking fears of a supply glut. Builders are plowing ahead with scores of condominiums priced above $20 million in skinny glass towers throughout Manhattan. One building, the 66-story tower at 220 Central Park South, is listing more than 60 apartments above $20 million… By comparison, in 2008, just 29 new condos sold for $20 million or more across all of Manhattan, according to appraisal firm Miller Samuel.”

Federal Reserve Watch:

May 12 – Wall Street Journal (Michael S. Derby): “After years of telling markets what to expect on the interest-rate front, Federal Reserve officials are telling traders and investors to figure out the outlook on their own. The influential presidents of the New York and San Francisco regional Fed banks seemed eager Tuesday to offer lessons in how market participants should be thinking about central bank policy. Until their March policy meeting, Fed officials had used code such as ‘patient’ and ‘considerable time’ to guide market participants on how long the central bank might wait before lifting short-term interest rates from near zero. By dropping such language, the Fed has made clear it can consider raising rates at any coming meeting, and the decision will depend on how economic data affect the policy makers’ forecasts.”

Global Bubble Watch:

May 10 – Bloomberg (Esteban Duarte): “European policy makers will be focused on Greek aid talks in Brussels on Monday. Investors may need to look further afield to fully explain the sell-off in the continent’s sovereign debt market. China’s foreign-currency reserves had their biggest quarterly drop on record in the first three months of the year and the yuan is trading at the closest to fair value since 2010… That means less demand for assets in dollars and euros from the world’s biggest creditor. The Chinese central bank has amassed $3.73 trillion in currency reserves over the past decade in a bid to hold down the value of the yuan and underpin the competitiveness of its exporters. As the government in Beijing changes gear, cultivating domestic demand to sustain economic growth, it may affect European bond markets just as much as the Greek efforts to win better terms from creditors. ‘It’s quite clear that China’s foreign exchange reserves can’t grow like before,’ said Li Jie, head of the foreign-exchange reserve research center at the Central University of Finance and Economics in Beijing. ‘There will be fewer and fewer funds available from China for European treasury bonds.’”

May 12 – Wall Street Journal (Anjani Trivedi): “As banks scaled back lending during the financial crisis, the bond market bloomed in Asia. Now, as global interest rates begin to rise, the days of easy financing appear to be over. With growth slowing in Asia, bond investors have become more demanding, seeking higher interest rates and better terms for the debt… Since 2008, the bond market in Asia has tripled in size to $1.04 trillion at the end of last year, while loans to large companies have doubled to $407.3 billion, according to Dealogic. Year to date, three times more bonds than loans have been issued in Asia… The booming bond market is a major reason why debt levels in Asia are now higher than they were before the Asian financial crisis of the late 1990s. The bond market has surged because of demand by yield-hungry foreign investors. The International Monetary Fund said assets in emerging-market bond funds have more than doubled to $2.9 trillion since 2008, and foreign investors now hold as much as 40% of the outstanding bonds in some markets.”

May 15 – Bloomberg (Katya Kazakina and James Tarmy): “In a hushed salesroom at Christie’s, five people fought for the chance to own a small square canvas of intersecting black lines with patches of color. The final price on Thursday for Piet Mondrian’s 1929 composition was $50.6 million, an auction record for the modernist painter. It was sold during a two-week auction frenzy in New York to capture the excess cash of the world’s mega-wealthy who are increasingly turning to art as a status symbol and an investment. A record $2.7 billion of art was sold at Christie’s, Sotheby’s and Phillips in day and evening sales that began May 5. The tally surpassed the $2.3 billion at similar sales of Impressionist, modern, postwar and contemporary art in New York in November and represents a 23% increase from $2.2 billion last May. The sales conclude Friday.’ People have a lot of money to spend,’ art dealer David Nahmad said. ‘If there were five more sales, people would be there to buy.’”

May 11 – Bloomberg (Katya Kazakina): “Pablo Picasso’s “Les Femmes d’Alger (Version ‘‘O’’)” sold for $179.4 million, setting a record for any artwork sold at auction. The price for the painting, sold Monday at Christie’s in New York, breaks the record held by Francis Bacon’s $142.4 million triptych since November 2013. The auction house had valued the Picasso at $140 million, the highest presale target of any work.”

Central Bank Watch:

May 14 – Reuters (Howard Schneider): “The European Central Bank will fully complete its programme of money printing to buy chiefly government bonds, its president said on Thursday, adding that he saw little indication of financial imbalances emerging. ‘While we have already seen a substantial effect of our measures on asset prices and economic confidence, what ultimately matters is that we see an equivalent effect on investment, consumption and inflation,’ said Mario Draghi… ‘To that effect, we will implement in full our purchase programme as announced and, in any case, until we see a sustained adjustment in the path of inflation.’”

May 14 – Reuters (Michelle Martin): “The head of Germany's Bundesbank ripped into the European Central Bank on Thursday, saying emergency funding for Greek banks broke the taboo of financing governments and it was not up to central banks to decide who was or wasn't in the euro zone. Jens Weidmann also said it was questionable whether money printing by the ECB to boost the euro zone economy and halt deflation was necessary. Greek banks have been drawing emergency liquidity assistance (ELA) from the country's central bank, a funding lifeline provided in exchange for collateral. They have used some of this emergency funding to buy Greek government debt, indirectly helping to keep the county afloat. The ECB has been raising the cap on the funds weekly, most recently on Tuesday by 1.1. billion euros to 80 billion euros. ‘Given the ban on monetary financing of states, I don't think it's ok that banks which don't have access to the markets are being granted loans which then finance the bonds of their government, which doesn't have access to the markets itself,’ Weidmann told German newspaper Handelsblatt… Asked whether he would be prepared to stop emergency funding to Greek banks and therefore force Athens out of the euro zone, Weidmann said central banks were not responsible for ‘the make-up of the euro zone or granting aid payments’.”

Europe Watch:

May 14 – Bloomberg (Lefteris Papadimas and Renee Maltezou): “Repayment of what Greece owes to the European Central Bank should be pushed into the future, but it is not an option because it fills ECB chief Mario Draghi's ‘soul with fear’, Greece's finance minister said… Yanis Varoufakis said Draghi… cannot risk irritating Germany with such a debt swap because of Berlin's objection to his bond-buying program. Varoufakis first raised the idea of swapping Greek debt for growth-linked or perpetual bonds when his leftist government came to power earlier this year, But Athens has since dropped the proposal after it got a cool reception from euro zone partners.”

May 12 – Bloomberg (Esteban Duarte, John Follain and Birgit Jennen): “Euro-area governments are considering putting together an aid package for Greece to cushion the country’s economy if it was forced out of the euro, according to two people familiar with the discussions. The Greek government doesn’t expect to need that help. Prime Minister Alexis Tsipras says he’s not considering leaving the currency bloc and is focused on getting the aid he needs to avoid a default. Even so, European officials are considering mechanisms to ring fence Greece both politically and economically in the event of a euro breakup, in order to shield the rest of the currency bloc from the fallout, one of the people said.”

May 11 – Wall Street Journal (Gabriele Steinhauser): “The International Monetary Fund is working with national authorities in southeastern Europe on contingency plans for a Greek default, a senior fund official said—a rare public admission that regulators are preparing for the potential failure to agree on continued aid for Athens. Greek banks are big players in some of its neighbors’ financial systems. In Bulgaria, subsidiaries of National Bank of Greece SA, Alpha Bank SA, Piraeus Bank SA and Eurobank Ergasias SA own around 22% of banking assets, roughly the same as Greek banks own in Macedonia. Greek banks are also active in Romania, Albania and Serbia. ‘We are in a dialogue with all of these countries,’ said Jörg Decressin, deputy director of the IMF’s Europe department. ‘We are talking with them about the contingency plans they have, what measures they can take.’”

China Bubble Watch:

May 12 – Dow Jones: “Chinese financial institutions issued 707.9 billion yuan ($114bn) worth of new yuan loans in April, down from 1.18 trillion yuan in March and below economists' expectations… Newly extended loans in April were below the 950 billion yuan forecast by a poll of 11 economists by The Wall Street Journal. Total social financing, a broader measure of credit in the economy, came to 1.05 trillion yuan in April, down from 1.18 trillion yuan in March.”

May 15 – Financial Times (Jamil Anderlini): “China has ordered its banks to prop up insolvent provincial government projects, in the latest effort to support rapidly cooling growth and put off dealing with the mountain of debt that has built up in the past six years. Authorities told financial institutions to keep lending to local government projects even if the borrowers are unable to make principal or interest payments on existing loans. The directive, issued jointly by the finance ministry, banking regulator and central bank, highlights the challenges facing China as it struggles to deal with the massive volume of debt left in the wake of its post-crisis stimulus, amid a sharply slowing economy… It explicitly banned financial institutions from cutting off or delaying funding to any local government project started before the end of last year and said any projects that are unable to repay existing loans should have their debt renegotiated and extended.”

May 15 - “Chinese Premier Li Keqiang on Friday said there was improvement in the economy but that more ‘forceful measures’ are needed to boost growth. In a speech urging the bureaucracy to effectively implement central government policy, Li warned that investment activity is moderating and that the trade sector is under ‘big pressure’ owing to weak global conditions. ‘We must take more forceful measures to consolidate the improvement trend and withstand downwards pressure,’ he said…”

May 14 – Reuters (Kevin Yao): “China's fiscal spending jumped 33.2% in April from a year earlier… quickening sharply from the 4.4% rise seen in March, reflecting the government efforts to support a slowing economy. The government has set a wider budget deficit for 2015 to step up spending and spur economic growth, and policy insiders have told Reuters that in addition to further monetary easing, the government may resort to fiscal stimulus. Government spending totaled 1.25 trillion yuan ($201.57bn) in April, the ministry said. ‘Finance departments have earnestly implemented the pro-active fiscal policy despite slower economic growth and the pressure on fiscal revenues,’ the ministry said. For the first four months, spending rose 26.4% from a year earlier, it said.”

May 15 – Dow Jones (Grace Zhu): “China on Friday called on banks not to cut off lending to struggling local government-financing vehicles, saying that authorities could use available funds to ensure that infrastructure projects get completed. China's central bank, the banking regulator and the finance ministry said in a joint notice that the funds could be used for projects approved before Sept. 21, 2014, which are already under construction. The notice… asked lenders not to cut off or reduce credit to approved projects. It also urged banks to provide more financial support to the agriculture sector as well as to affordable- housing and urban-rail projects launched by local government-financing vehicles.”

May 11 – Bloomberg (Enda Curran): “China faces a currency conundrum. Exports are slumping and competitiveness is waning after its currency's more than 10% rise in real trade-weighted terms in the past year. Here's why: The first problem is capital flow. Money is leaving China as investors cool on the nation's growth prospects and as they look for better returns elsewhere. Louis Kuijs, Royal Bank of Scotland’s chief China economist, reckons that China lost $300 billion in financial outflows in the six months through March. A weaker yuan would give more reason to head for the exit. Then there's the issue of China wanting reserve status for its currency. It is lobbying the International Monetary Fund to include the yuan in its so-called Special Drawing Rights basket. To convince the IMF to back their push, China cannot let the currency weaken. At least not much. All that means exporters are set for more pain.”

May 13 – Bloomberg (Jill Mao): “China’s wealth machine shows no signs of stopping. Four new billionaires emerged on Tuesday after the biggest three-day gain in Chinese stocks since January pushed their stocks by the exchange-imposed limit to new highs, while two others exceeded the $1 billion mark on Wednesday… China has minted more than 50 billionaires so far this year as markets surged. The benchmark Shanghai Composite Index posted a 7% gain over three days… The Shenzhen index, which tracks shares on the smaller of the nation’s two stock exchanges, advanced for a fourth day on Wednesday to a record as the central bank cut interest rates for the third time in six months over the weekend.”

May 14 – Bloomberg (Lorcan Roche Kelly): “The phenomenal rally in Chinese stocks has run out of steam in the past couple of weeks. The bounce stocks received from Sunday's interest rate cut has not lasted long enough for the Shanghai Composite Index to reclaim the highs achieved in April. One company that we have previously looked to as a possible canary in the coal mine for Chinese stocks is Beijing Baofeng Technology which had been rising exactly 10% —the maximum allowed by the exchange— every single day since it launched in March. Last week, that run ended when the stock closed up a mere 5.89%. Well, overnight in Shanghai, the unthinkable happened —Baofeng closed down at the end of the session, losing 4.41%.”

May 11 – Financial Times (Gabriel Wildau): “China's technology stock mania scaled new heights on Monday when shares in a Shanghai-listed real estate company rose by the maximum 10% daily limit after it changed its name to P2P Financial Information Service Co. The company, formerly known as Shanghai Duolun Industry, acknowledged in filings that it had not started developing a peer-to-peer lending business. But the company estimated that an Internet domain it recently registered,, was worth $100m. The website currently features a few photos and a Chinese caption stating ‘This domain is worth $100m.’ While Duolun is perhaps the most extreme example of the irrational exuberance for tech stocks now sweeping China’s market, it is not unique. The tech-heavy ChiNext board in Shenzhen rose 5.6% on Monday to an all-time high. A total of 33 ChiNext-listed stocks hit their upper limit and the index has now risen 109% in 2015. The Shenzhen Composite index… is now up 67% in 2015 compared with 34% for the Shanghai Composite.”

May 12 – Wall Street Journal (Lingling Wei): “China is launching a broad stimulus to help local governments restructure trillions of dollars in debts while prodding banks to lend more, as fresh data add to signs of a worsening slowdown in the world's second-largest economy. In a directive marked ‘extra urgent,’ China'sFinance Ministry, central bank and top banking regulator laid out a package of measures to jump-start one of the government's most-important economic-rescue initiatives: a debt-for-bond swap program aimed at giving provinces and cities some breathing room in repaying debts. Central to the directive… is a plan by the People's Bank of China that will let commercial banks use local-government bailout bonds they purchase as collateral for low-cost loans from the central bank. The goal is to provide Chinese banks with more funds to make new loans.”

May 12 – Reuters (Xiaowen Bi, Hongmei Zhao and Zheng Li): “China is set to let banks and local governments use municipal bonds as collateral for borrowing, sources told Reuters…, which could pump prime a fledgling market Beijing hopes will help local authorities manage their unwieldy debts. China created its municipal bond market in September last year in the hope that by forcing local governments to raise funds only through bond sales, financial markets can impose budget discipline on the governments and curtail their borrowing, which has climbed in recent years to at least $3 trillion. To combat so far weak demand for the muni bonds, regulators will for the first time let banks use them as collateral when they borrow from the central bank, three sources with direct knowledge of the matter said.”

May 11 – Bloomberg: “China’s vehicle exports tumbled 22% last month, hurt by a rising currency and political instability in key markets… Exports of passenger and commercial vehicles fell to 61,600 units in April, according to… the China Association of Automobile Manufacturers. For the first four months, overseas shipments dropped 15%, jeopardizing this year’s export goal of 860,000 units…”

May 15 – Bloomberg (David Yong): “Renhe Commercial Holdings Co. faces the glare of the offshore bond market on Monday when the Chinese developer shows its ability to repay debt. The pressure on Renhe comes after Standard & Poor’s called its recent discounted buyback of dollar notes a ‘distressed exchange’ that equaled a default. The mall builder is scheduled to repay $79 million of securities maturing on May 18 to investors who snubbed the December offer. Tensions are simmering in China’s U.S. currency debt market after two companies defaulted on coupons in the last month amid signs of more financial stress in the world’s second-biggest economy.”

EM Bubble Watch:

May 12 – Bloomberg (Onur Ant and Ali Berat Meric): “Turkey’s current-account deficit widened in March to its highest level this year as exports declined faster than imports, exposing the currency to the risk of a selloff. The shortfall in the current account… grew to $4.96 billion from $3.39 billion a year earlier… Although the gap had been shrinking since December as the trade deficit narrowed, it reversed direction in March as exports posted their biggest drop since 2009.”

Brazil Watch:

May 14 – Bloomberg (Francisco Marcelino): “Banco do Brasil SA, Latin America’s largest bank by assets, dropped the most in almost a month after it set aside more money to cover soured loans. Shares of the company slid 4.3 %... Provisions soared 43% to 5.99 billion reais ($2bn) in the first quarter from a year earlier… The increase was related to higher credit risks, and wasn’t prompted by clients who stopped paying, Chief Financial Officer Jose Mauricio Coelho told reporters…”

Geopolitical Watch:

May 11 – Los Angeles Times (Carol J. Williams): “Neither Russia nor China has one inch of coastline on the Mediterranean Sea, making it an unlikely and provocative venue for their first joint naval war games. The 10 days of maneuvers that got underway Monday will include live-fire exercises in the strategic sea connecting Europe, Africa and the Middle East. The point is lost on no one: A powerful new alliance of eastern giants is flexing its muscles in the very backyard of Western Europe — much as China has done on its own in the Pacific. The war games follow Chinese President Xi Jinping’s visit to Moscow, where he headlined Victory Day celebrations and spent three days making billion-dollar deals with Russian President Vladimir Putin. Russia’s World War II allies mostly stayed away.”

May 13 – Wall Street Journal (Eva Dou and James Hookway): “Beijing strongly condemned on Wednesday a proposed U.S. military plan to send aircraft and Navy ships near disputed South China Sea islands to contest Chinese territorial claims over the area. ‘Do you think we would support that move? We are severely concerned about relevant remarks made by the American side. We believe the American side needs to make clarification on that,’ said Foreign Ministry spokeswoman Hua Chunying. The unusually strong comments came after U.S. officials said Defense Secretary Ash Carter had asked his staff to look at options to counter China’s increasingly assertive claims over disputed islets in the South China Sea. Those options, officials said, include flying Navy surveillance aircraft over islands and sending U.S. Navy ships within 12 nautical miles of reefs that have been built up in recent months around the Spratly Islands. ‘We always uphold the freedom of navigation in the South China Sea,’ Ms. Hua said. ‘But the freedom of navigation definitely does not mean the military vessel or aircraft of a foreign country can willfully enter the territorial waters or airspace of another country. The Chinese side firmly upholds national sovereignty and security.’”

May 14 – Reuters (David Brunnstrom): “U.S. Secretary of State John Kerry will leave China ‘in absolutely no doubt’ about Washington's commitment to ensuring freedom of navigation and flight in the South China Sea when he visits Beijing this weekend, a senior State Department official said… Setting the scene for what could be contentious encounters with Chinese leaders, including President Xi Jinping, the official said Kerry would warn that China's land-reclamation work in contested waters could have negative consequences for regional stability - and for relations with the United States. On Tuesday, a U.S. official said the Pentagon was considering sending military aircraft and ships to assert freedom of navigation around rapidly growing Chinese-made artificial islands in the disputed South China Sea. China's Foreign Ministry responded by saying that Beijing was ‘extremely concerned’ and demanded clarification. U.S. Assistant Secretary of Defense David Shear told a Senate hearing the United States had right of passage in areas claimed by China. ‘We are actively assessing the military implications of land reclamation and are committed to taking effective and appropriate action…’”

May 14 - Xinhua: “Chinese Ambassador to the United States Cui Tiankai reiterated Wednesday that Washington has no right whatsoever to intervene in the legitimate activities conducted by China in the South China Sea, while urging related parties to resolve the disputes through diplomatic talks. …Cui slammed what he called double standards adopted by the United States when it comes to the land reclamation activities in the region. While pointing an accusing finger at China, Washington has chosen to keep silent on earlier such activities conducted by some other countries which illegally occupied Chinese islands and reefs, he said. Cui rebuked the claim made by some U.S. lawmakers at a Senate hearing Wednesday that China is raising tensions in the South China Sea, citing that it was the active intervention by the United States in the maritime disputes that has actually created tensions in the area. The veteran Chinese diplomat also criticized the U.S. plan to send military planes and ships to assert ‘freedom of navigation’ around China-owned islands and reefs in the South China Sea. ‘The Cold-War mentality, which is prone to the use of force to resolve disputes, is already outdated.’”

May 15 – Reuters (Greg Torode): “When the U.S. navy sent a littoral combat ship on its first patrol of the disputed Spratly islands in the South China Sea during the past week, it was watching the skies as well. The USS Fort Worth, one of the most modern ships in the U.S. navy, dispatched a reconnaissance drone and a Seahawk helicopter to patrol the airspace… While the navy didn't mention China's rapid land reclamation in the Spratlys, the ship's actions were a demonstration of U.S. capabilities in the event Beijing declares an Air Defence Identification Zone (ADIZ) in the area - a move experts and some U.S. military officials see as increasingly likely.”

May 12 – Reuters (Megha Rajagopalan): “China rebuked the Philippines on Tuesday for taking journalists to a disputed island in the South China Sea, dismissing its occupation as ‘futile and illegal’ in the latest war of words between the two sides. China claims 90% of the South China Sea, which is believed to be rich in oil and gas. Its claims overlap with those of Brunei, Malaysia, the Philippines, Vietnam and Taiwan. The Philippines took foreign and local journalists this week to Thitu Island, the biggest island occupied by Manila in the region. China's Foreign Ministry said the Philippines was endangering international law. ‘China has made clear on many occasions that it opposes the Philippines' futile and illegal occupation,’ said ministry spokeswoman Hua Chunying. ‘The reality of the situation has again proven the Philippines to be a rule-violator and a troublemaker.’”

Russia and Ukraine Watch:

May 13 – Financial Times (Alex Barker): “Russia is irresponsibly stepping up its nuclear rhetoric in a bid to rattle the west, Nato’s military chief has said, underlining the alliance’s concern about Russian threats to deploy nuclear weapons in Crimea. Warning that nuclear nations had to be careful in both actions and words, Gen Philip Breedlove said Moscow was deliberately using threatening language in a bid to ‘give pause to Nato’s decision-making’. ‘This discussion of nukes and the possibility of moving nukes into certain areas or employing nukes if something had not gone correctly in Crimea and all these other things, which have been put out there — this is not responsible language from a nuclear nation,’ he said… Nato diplomats have been struck by Russia’s aggressive discussion of the use of nuclear weapons, noting a pattern of threats that were rarely seen even at the height of the Cold War. It is prompting a potential rethink of the military alliance’s planning on deterrence and nuclear doctrine, in part to ensure no miscalculations are made in a crisis.”

May 15 – Reuters (Natalia Zinets): “Foreign creditors must agree to the ‘legitimate’ deal offered by Ukraine in talks on restructuring around $23 billion (15 billion pounds) worth of its debt, Prime Minister Arseny Yatseniuk said… Negotiations turned sour this week after a group of Ukraine's largest bondholders repeated objections to any writedown on the principal owed, while the Finance Ministry accused creditors of being unwilling to negotiate in good faith. Speaking to parliament… Yatseniuk said that bondholders should appreciate the parlous state of Ukraine's finances. ‘The country is at war. We have lost 20% of our economy. We approached creditors with a clear position on the procedure and terms of restructuring,’ he said.”

May 13 – Bloomberg (Roman Olearchyk and Elaine Moore): “Ukraine’s $23bn debt restructuring negotiations appeared to reach boiling point late on Tuesday after the government issued a sharply worded statement that questioned the transparency, responsiveness and good faith of a creditors’ committee. With positions hardening weeks before a planned June deadline to avoid default, the finance ministry of war-torn and recession-battered Ukraine in the statement said it was ‘concerned about the approach taken by the creditors’ committee representing the country’s external debt holders and their lack of willingness to engage in negotiations.’”

Japan Watch:

May 14 – Dow Jones (Takashi Nakamichi): “Bank of Japan Gov. Haruhiko Kuroda tried Friday to refute skepticism over the impact of his monetary easing program, saying it was as powerful as 10 interest rate cuts and was working well to reinvigorate the economy. Speaking at a seminar in Tokyo, Mr. Kuroda brushed aside Japan's near-zero inflation as a temporary phenomenon and laid out a long list of achievements he ascribed to the central bank's aggressive easing program…”