Saturday, July 4, 2015

Weekly Commentary: The Triad

So how big of a deal is the Triad of Turmoil unfolding in Greece, China and Puerto Rico? Thus far, general contagion has been minimal. Bullish sentiment remains resilient. In Europe, investors have been encouraged by relative market stability throughout “peripheral” bond markets (Spain, Italy, Portugal, etc.). Emerging markets have so far been largely immune to the dramatic 29% three-week Chinese stock market pummeling. In the U.S., investors have yawned at the prospect of a Puerto Rico debt restructuring. Big yawn (except for the stocks of the Credit insurers!)

I am reminded of how the VIX (equity volatility) index sank heading right into the 2008 financial crisis. After the spring of 2007 subprime bust, it took a full 15 months for market turmoil to erupt into a systemic crisis. By September 2008, a series of policy moves (including rate cuts and the Bear Stearns bailout) had engendered deeply ingrained market complacency. In the face of evolving Credit system fragility, market perceptions solidified that government policymakers had the situation well under control. This complacency was integral to crisis vulnerability.

The conventional view holds that the Lehman collapse was the pivotal crisis catalyst. Policymakers failed to appreciate the consequences of allowing a major financial institution to fail. Having learned this agonizing lesson, policymakers will ensure that such mistakes – and such crises – are not repeated. Market participants these days do not question global policymakers resolve to eradicate crises. QE infinity.

I have always contended that an ugly collapse of the mortgage finance Bubble was inevitable. Trillions of mispriced debt circulated in the markets. This epic mispricing (i.e. widening divergence between inflating securities prices and deteriorating fundamental prospects) would begin surfacing with the unavoidable slowdown in system Credit growth (and attendant decline in house prices/spending). Policy responses intended to “stabilize” the financial system and economy only prolonged “Terminal Phase” excesses, ensuring greater financial and economic dislocation.

From my analytical perspective, Greece, China and Puerto Rico offer important evidence of the ongoing spectacular failure of the global financial “system”/infrastructure – additional support for the view of the abject failure of inflationism (inflationary policies). From the perspective of Credit excess; market excesses, mispricing and distortions; and economic maladjustment, today’s global government finance Bubble puts the mortgage finance Bubble to shame.

In general, policies to inflate out of debt problems only exacerbate Bubble excesses. Measures that postpone necessary financial and economic adjustment – “kicking the can” – prove only to exacerbate fragilities. Importantly, there is no inflating out of deep structural maladjustment globally, maladjustment currently coming home to roost in Greece, China and Puerto Rico. The Triad offer a warning of the stormy seas ahead.

It is now going on seven years of recurring bouts of “post-crisis” market scares, anxious policy responses and inflating securities prices. There’s no mystery surrounding today’s deep complacency. Yet is it crucial to appreciate that the current round of market unrest occurs in the face of zero rates, subsequent to Trillions of QE/“money” printing and generally large government deficit spending. More than $10 TN of global central bank Credit (“money”) has been created out of thin air. Larger quantities of non-productive government debt have been issued. This monetary inflation has spurred securities and asset price inflation that has stimulated spending and economic activity.

When a desperate Mario Draghi resorted to “whatever it takes” central banking back during the 2012 European financial crisis, I wrote that the latest effort to kick the can was “a pretty good wallop.” I still believe it would have been better to cut Greece loose, restructure the euro currency and commence the healing process. European and global policymakers instead pushed forward with unprecedented inflationary measures.

Well, three years of the loosest monetary policy imaginable – including ECB and concerted global QE – certainly did not resolve Greece’s dire predicament. Indeed, even the IMF admits – after repeated bailouts over the past five years – the situation has only worsened. In their Thursday report, the IMF stated that Greece needs another $70 of new aid.

“Black hole” Greece remains the poster child for dysfunctional global finance. The country is hopelessly insolvent. As with any bankrupt entity, salvaging economic value requires debt restructuring/forgiveness. Extend and pretend has run its fateful course. Yet because of European financial integration and monetary union – not to mention the age-old blunder of throwing so much “good money” after bad – there is no turning back from a failed policy course. A tragic predicament has fallen upon the Greeks, a humiliated people fuming at their loss of dignity and sovereignty. Of course they will push back against European integration and Capitalism. This could turn really ugly.

Eminent German economist and a founding father of the ECB Otmar Issing (quoted by Bloomberg’s Jeff Black): “The illusion was, and is, that, having joined the euro, it is irreversible. Mutual trust is certainly not there any more and it will be very difficult to restore it… If the Greeks can get away with the violation of all promises, commitments, then I think it will have a contagion effect on other countries. Then we’ll be entering into a monetary union very different from what was intended. It will be the end of the zone of fiscal solidity.”

“Yes” or “No” Sunday, there will be no near-term resolution to the “Greek” crisis. On both sides, trust has been irreversibly broken. Starved of finance, the economy is on a death spiral. I don’t see how the Greeks and Germans continue to share a common currency. And, at the end of the day, I don’t see how the Italians and Germans share the euro either.

Despite Draghi’s aggressive backstop, periphery spreads widened meaningfully this week. Portuguese spreads to bunds surged 33 bps, Italian bonds to bunds 23 bps and Spanish yields to bunds 23 bps. Major Spain and Italy equity indexes were clobbered for more than 5.0%. European corporate bonds were bolstered by the ECB’s inclusion of corporate bonds on its list of securities eligible for QE purchases.

On the other side of the globe, Chinese policymakers are as well succumbing to desperate measures, as they attempt to control evolving financial and economic crises. The Chinese Bubble has been epic. Its collapse will be spectacular and frightening. Chinese stocks sank almost 30% in just three weeks. In the past, global markets would have been unnerved. Not these days, in this phase of terminally deep-rooted complacency.

Ominously, a series of Chinese policy measures has failed to stabilize stock prices. Confidence has been badly shaken, as one of history’s great manias falters. Yet for global markets, the perception that Chinese policymakers have things under control persists. After all, China has $3.7 Trillion (after declining another $113bn in Q1) of international reserves to use at official discretion. The central government as well has control over a massive state-sponsored financial apparatus, ensuring Credit expansion on demand.

Chinese officials have made a series of fateful errors. “Terminal Phase” Credit Bubble excess has been stoked to unprecedented extremes. While the central government certainly maintains the capacity to print, spend, cajole lending, intervene in markets, manipulate and stimulate – it has nonetheless lost control of the Bubble. There are Trillions – and counting – of bad loans. Malinvestment has been unprecedented – and counting.

Considerable study notwithstanding, the Chinese repeated key mistakes from the Japanese Bubble period. And whether they appreciate it or not, they are also replaying dynamics similar to those of the U.S. in the late-1920s. They have resorted to loose finance as a remedy to stabilize a system under the spell of Bubble Dynamics. Policy measures have been used to sustain rapid Credit expansion. They hoped their stimulus measures would drive productive investment, system reflation and reform. Predictably, as was the case preceding the 1929 Crash, liquidity flowed in stunning overabundance to an increasingly out-of-control speculative Bubble throughout the securities markets.

Closer to home, loose finance is also coming home to roost in Puerto Rico. This little island has accumulated enormous amounts of debt. This can has also been kicked down the road about as far as possible, yet another victim of dysfunctional financial markets.

I have posited that the global government finance Bubble has been pierced. In Greece, Chinese stocks and Puerto Rico I find confirmation. It’s worth noting that crude (WTI) was hammered almost 7% this week. Iron ore prices declined seven straight sessions. Brazilian stocks were hit for almost 3%. Commodity currencies were taken out to the woodshed.

The global leveraged speculating community had placed decent bets in Greece, China and Puerto Rico, seeing opportunities at the fringes in a world of zero rates, aggressive QE and determined central bank market backstops. So between the leverage in Greek and Puerto Rican bonds, and the unwind in margin debt in China, there’s now a catalyst for some self-reinforcing globalized de-risking/de-leveraging.

Typically, I would expect waning liquidity and mounting contagion effects to immediately begin their journey from the “periphery” to the “core.” There is, however, nothing normal about this cycle. Never before have global central bankers worked in concert to sustain financial Bubbles. I expect air to continue to come out of the global Bubble. I expect de-risking/de-leveraging and contagion to gain momentum, though near-term market prospects are clear as mud.

I find the degree of bullishness in the U.S. almost difficult to fathom. Silicon Valley is back in full-fledged mania mode. Manhattan is not far behind. Throughout the country, there are pockets of boom and plenty of stagnation. Economic imbalances are conspicuous - upshots of now decades of flawed policies and dysfunctional finance.

Importantly, even after six years of recovery I still do not see the backdrop for a sustainable U.S. Credit up cycle. In fact, Credit growth slowed sharply during Q1 (to 2.8% annualized from 4.9%). The Credit slowdown is consistent with weakening corporate profits. Stock buybacks and financial engineering have lost much of their previous punch. For now, with financial conditions so loose, M&A booms, as asset prices generally maintain an inflationary bias. Things look somewhere between ok and good only so long as asset markets remain inflated.

I believe enormous amounts of leverage continue to accumulate throughout the securities markets. Actually, I view borrowings to finance M&A, stock buybacks, and leveraged speculation in bonds and stocks as the prevailing (unrecognized) source of Credit fuel inflating this Bubble. This type of Credit is inherently susceptible to reversals in asset prices. I suspect as well enormous amounts of finance continue to flow into U.S. asset markets from faltering Bubbles (and currencies) around the globe (China, Europe, Latin America and the Middle East). This flow of finance is similarly unstable.

As such, I discern a much greater degree of market vulnerability than the complacent consensus. Greece and China could easily become catalysts for the most serious bout of market risk-off since the financial crisis. There will come a point when markets come face-to-face with the reality that policymakers do not have things under control.

For the Week:

The S&P500 dropped 1.2% (up 0.9% y-t-d), and the Dow fell 1.2% (down 0.5%). The Utilities gained 1.1% (down 7.5%). The Banks lost 1.8% (up 4.2%), and the Broker/Dealers gave back 1.5% (up 7.6%). The Transports fell 1.5% (down 11.1%). The S&P 400 Midcaps dropped 1.8% (up 3.7%), and the small cap Russell 2000 sank 2.5% (up 3.6%). The Nasdaq100 declined 1.1% (up 4.7%), and the Morgan Stanley High Tech index dropped 1.8% (unchanged). The Semiconductors were hit 1.8% (down 0.2%). The Biotechs lost 1.7% (up 20.5%). With bullion down $7, the HUI gold index fell 2.2% (down 9.2%).

Three-month Treasury bill rates ended the week at zero. Two-year government yields dropped nine bps to 0.63% (down 4bps y-t-d). Five-year T-note yields sank 13 bps to 1.63% (down 2bps). Ten-year Treasury yields fell nine bps to 2.38% (up 21bps). Long bond yields declined five bps to 3.19% (up 44bps).

Greek 10-year yields surged 317 bps to 14.01% (up 427bps y-t-d). Ten-year Portuguese yields jumped 19 bps to a 2015 high 2.91% (up 29bps). Italian 10-yr yields gained nine bps to 2.24% (up 35bps). Spain's 10-year yields rose 19 bps to 2.20% (up 59bps). German bund yields dropped 14 bps to 0.79% (up 25bps). French yields declined six bps to 1.24% (up 41bps). The French to German 10-year bond spread widened eight to a one-year high 45 bps. U.K. 10-year gilt yields sank 19 bps to 2.00% (up 25bps).

Japan's Nikkei equities index declined 0.8% (up 17.7% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.47% (up 15bps y-t-d). The German DAX equities index was hit for 3.8% (up 12.8%). Spain's IBEX 35 equities index sank 5.2% (up 4.9%). Italy's FTSE MIB index fell 5.4% (up 18.4%). Emerging equities were mostly lower. Brazil's Bovespa index was smacked for 2.8% (up 5.0%). Mexico's Bolsa declined 1.1% (up 4.4%). South Korea's Kospi index added 0.7% (up 9.9%). India’s Sensex equities index gained 1.0% (up 2.2%). China’s Shanghai Exchange sank 12.1% (up 14.0%). Turkey's Borsa Istanbul National 100 index dropped 2.8% (down 5.3%). Russia's MICEX equities index slipped 0.8% (up 16.8%).

A reversal of junk funds flows this week saw inflows of $800 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose six bps to 4.08% (up 21bps y-t-d). Fifteen-year rates gained three bps to 3.24% (up 9bps). One-year ARM rates added two bps to 2.52% (up 12bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.24% (down 4bps).

Federal Reserve Credit last week dropped $19.3bn to $4.441 TN. Over the past year, Fed Credit inflated $110bn, or 2.5%. Fed Credit inflated $1.630 TN, or 58%, over the past 138 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $10.8bn last week to $3.379 TN. "Custody holdings" were up $86bn y-t-d.

M2 (narrow) "money" supply surged $40.9bn to a record $12.005 TN. "Narrow money" expanded $629bn, or 5.5%, over the past year. For the week, Currency increased $1.2bn. Total Checkable Deposits jumped $29.2bn, and Savings Deposits gained $10.5bn. Small Time Deposits slipped $1.8bn. Retail Money Funds added $1.9bn.

Money market fund assets rose $13bn to $2.614 TN. Money Funds were down $118bn year-to-date, while gaining $44bn y-o-y.

Total Commercial Paper dropped $28.3bn to $952bn. CP declined $102bn over the past year, or 9.6%.

Currency Watch:

The U.S. dollar index increased 0.6% to 95.95 (up 6.3% y-t-d). For the week on the upside, the yen increased 0.9%. For the week on the downside, the New Zealand dollar declined 2.4%, the Canadian dollar 2.1%, the Norwegian krone 1.9%, the Swedish krona 1.8%, the Australian dollar 1.7%, the British pound 1.1%, the Mexican peso 1.1%, the South African rand 0.9%, the Swiss franc 0.8%, South African rand 0.9% and the Brazilian real 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.4% (up 3.8% y-t-d). Spot Gold lost 0.6% to $1,169 (down 1.4%). September Silver declined 0.7% to $15.66 (up 1%). August Crude sank $4.11 to $55.52 (up 4%). August Gasoline fell 2.3% (up 36%), while August Natural Gas traded little changed (down 4%). September Copper declined 0.7% (down 7%). September Wheat jumped 4.0% (unchanged). September Corn surged 9.2% (up 8%).

Greece Crisis Watch:

July 3 – Financial Times (Kerin Hope): “Greek banks are preparing contingency plans for a possible 'bail-in' of depositors amid fears the country is heading for financial collapse, bankers and businesspeople with knowledge of the measures said… The plans, which call for a ‘haircut’ of at least 30% on deposits above €8,000, sketch out an increasingly likely scenario for at least one bank, the sources said. A Greek bail-in could resemble the rescue plan agreed by Cyprus in 2013, when customers’ funds were seized to shore up the banks, with a haircut imposed on uninsured deposits over €100,000. It would be implemented as part of a recapitalisation of Greek banks that would be agreed with the country’s creditors — the European Commission, International Monetary Fund and European Central Bank.”

July 2 – Financial Times (Shawn Donnan and Claire Jones): “Greece needs more than €60bn in new financial help over the next three years and faces decades under a daunting mountain of debt that will make it vulnerable to future crises, the International Monetary Fund has warned. In a new analysis that lays out Greece’s economic dilemma in stark terms, the IMF on Thursday called for Europe to grant the country ‘comprehensive’ debt relief, arguing for the doubling of the maturities on its debts from 20 to 40 years. The fund’s assessment is likely to provide succour to the Syriza-led government which is campaigning for a No vote in a referendum on Sunday. But the IMF also blamed it for the country’s deteriorating situation.”

July 2 – Reuters (Renee Maltezou and David Chance): “The International Monetary Fund delivered a stark warning on Thursday of the huge financial hole facing Greece as angry and uncertain voters prepare for a referendum that could decide their country's future in Europe. Days after Greece defaulted on part of its IMF debt, the Fund, part of the lenders' ‘troika’ behind successive international bailouts, said Greece needed an extra 50 billion euros over the next three years, including 36 billion from its European partners, to stay afloat. It also needed significant debt relief… Prime Minister Alexis Tsipras' rejection of what he terms the "blackmail" of EU and IMF creditors demanding spending cuts and tax hikes has so angered Greece's partners that there is no hope of reconciliation before Sunday.”

China Bubble Watch:

July 2 – Financial Times (Gabriel Wildau): “Chinese shares fell again on Thursday despite moves by regulators to buoy the market, reinforcing growing concerns about the volatility of Chinese stocks. China Securities Regulatory Commission moved late on Wednesday to relax collateral rules on margin loans. But that failed to staunch market losses on Thursday, with the Shanghai Composite Index closing down 3.5% and the Shenzhen stock exchange finishing the day down 5.6%... China has now entered a bear market, with its two main indices recording a more than 20% drop over the last three weeks. The move to loosen rules on margin finance — using borrowed money to trade shares — represents something of a climbdown by the regulator, which had previously tried to curb leveraged bets. Margin lending has been a major driver of the rally that propelled China’s main stock index to a seven-year high on June 12.”

June 30 – Reuters (Nathaniel Taplin and Umesh Desai): “Despite reassurances by regulators that margin debt in China's stock markets remains manageable, total leverage could be as much as $645 billion - magnifying risks not just for retail investors, but also the thinly stretched corporate sector. Margin debt… has officially roughly doubled since the beginning of 2015. That rapid run-up in leveraged trading was brought into sharp focus last week as China's benchmark CSI 300 index tumbled 14%, raising fears of forced selling that could trigger broader financial instability. But the official numbers only tell part of the story. While margin debt with brokerages stood at 2.2 trillion yuan ($354bn) in late June…, analysts say that money borrowed to speculate on stocks from largely unsanctioned ‘shadow lenders’ such as trusts could have reached nearly twice that amount, taking total debt to up to 20% of free float. ‘No matter how much you want to borrow, we can give it to you,’ said a so-called grey market lender based in Shenzhen. ‘If you want to borrow 100 million yuan for example, we need seven days because we need to issue a (wealth management) product for you. If you want to borrow a few million, we can give you the money right away.’”

July 1 – Financial Times (Gabriel Wildau): “At a stock trading hall for retail investors near People’s Square in Shanghai on Wednesday, the mood is glum. Shenyin Wanguo, like other Chinese brokerages, maintains its hall for investors to hang around, make a few trades and share tips. Among the mostly elderly investors there, zest for market speculation goes hand-in-hand with the socialist conviction that the government can and should protect them from risk. ‘Even I, an old party member who started playing the market in the 1990s — I don't believe the regulators any more,’ says Ms Xu, 76-year-old retiree. China’s main stock index lost 5% on Wednesday, shrugging off an interest-rate cut by the central bank over the weekend. The market has now tumbled 22% since hitting a seven-year high on June 12. Ms Xu blames the securities regulator for approving too many initial public offerings, siphoning demand away from existing shares… She also lost money punting on internet stocks amid pledges by top leaders to promote the technology sector. ChiNext, the Shenzhen-based start-up index, had more than tripled in the year to early June but has since plummeted 30%. ‘The country is promoting ‘internet plus’ so I bought some internet-themed stocks,’ she says. ‘Their results looked good. But then came a few days of limit-down. Now I’m stuck,’ she says… Reflecting the surge of retail investors into the market, trading accounts holding at least some stock hit 68m by the end of May, up 27% from a year earlier…”

June 30 – Bloomberg (Fox Hu and Kyoungwha Kim): “China’s financial industry joined the nation’s securities regulator in moving to shore up the nation’s $7.7 trillion stock market, spurring the biggest rally in more than six years. Money managers should avoid panic selling because a ‘structural rally is brewing,’ the Asset Management Association of China said in a letter to its members… Guotai Junan Securities Co., the country’s second-largest brokerage, said it would ease restrictions on margin trading. Investors should have ‘confidence’ and ignore ‘irresponsible rumors,’ China Securities Regulatory Commission spokesman Zhang Xiaojun said…, while the Ministry of Finance said it may allow the nation’s pension fund to invest in equities.”

June 30 – Bloomberg: “Zhang Minmin is one of tens of thousands playing in one of the riskier corners of China’s stock market, borrowing money at high interest rates through unregulated online lenders to amplify his bets on potential equity gains. ‘Sometimes when the market is good, I would make profits enough to buy an Audi in just a week or two. However, when the market is down, it’s also possible to lose half an Audi very quickly,’ said Zhang, a 32-year-old who works in the financial industry in Hangzhou… As more Chinese jumped into the market in the hope of instant wealth, peer-to-peer websites offering loans for stock investing have mushroomed. They are among a multitude of sources of leverage outside of traditional margin financing that threaten to complicate any efforts to prevent an unruly reversal of China’s stock market boom, which is already faltering.”

Fixed Income Bubble Watch:

June 30 – New York Times (Mary Williams Walsh): “When Puerto Rico’s governor told lawmakers and citizens on Monday that the commonwealth could not pay its $72 billion in debt, many wondered how a small, seemingly low-key American island in the Caribbean could have amassed a debt big enough to crush it. The answer lies in a confluence of factors, including American investors’ desire to avoid taxes; the mutual fund industry’s practice of competing on the basis of yield; complacency about the practice of long-term borrowing to plug holes in budgets; and laws that supposedly give bond buyers ironclad guarantees. That brew of incentives has produced truly staggering numbers. On a per-capita basis, Puerto Rico has more than 15 times the median bond debt of the 50 states, according to Moody’s… The governor, Alejandro García Padilla, said on Monday that at the rate the debt situation is developing, every man, woman and child on the island would owe creditors $40,000 by 2025… ‘We cannot allow the heavy weight of the debt to bring us to our knees,’ the governor said in a live televised address, proposing a debt restructuring. For years, investors were lining up to lend Puerto Rico money, so it was easier to borrow than to fix any number of financial or structural shortcomings.”

June 30 – New York Times (Michael Corkery and Alexandra Stevenson): “Hedge funds like Appaloosa Management, Paulson & Company and Blue Mountain Capital gathered in a conference room at the Barclays offices in Midtown Manhattan last September to talk about what was then the hottest trade: Puerto Rico. An hour into the conversation, however, it became clear that if things started going bad, not everyone in the room was going to get along. Some had wagered on real estate, while others had bought up the debts of the central government and its troubled electric utility. Those divisions intensify an increasingly contentious battle the hedge funds are beginning to wage to salvage an investment that, less than a year ago, looked like a sure thing. This week’s announcement by Gov. Alejandro García Padilla of Puerto Rico that the commonwealth may seek to delay debt payments has thrown the hedge funds’ investment strategies into turmoil. Even debts that appeared to be secure now seem in jeopardy, sending hedge funds and other investors scrambling to re-examine their legal rights and potential remedies should the government push for a restructuring.”

July 3 – New York Times (Lizette Alvarez): “It’s the lunch hour at Baker’s Bakery, a fixture in Río Piedras, one of Puerto Rico’s oldest neighborhoods, but the bustle at the counter is long gone. The front door opens and shuts only a few times an hour as customers, holding tighter than ever to their money, judiciously pick up some sugar-sprinkled pastries and a café con leche. On the first day of the new sales tax, which jumped to 11.5% from 7%, the government’s latest rummage for more revenue, Puerto Rico’s malaise was unmistakable. ‘People don’t even answer you when you tell them, ‘Buenos dias,’’ said Ibrahim Baker… ‘Everyone is depressed.’ After nearly a decade of recession, Puerto Rico’s government says it cannot pay its $73 billion debt much longer. Gov. Alejandro García Padilla warns that more austerity is on the way, a necessity for an island now working feverishly to rescue itself. With so many bracing for another slide toward the bottom, the sense of despair grows more palpable by the day.”

July 2 – Bloomberg (Michelle Kaske): “As Puerto Rico confronts a worsening fiscal crisis, its troubled electric company made a critical bond payment, buying time to negotiate with creditors. The $415 million installment Wednesday from the Puerto Rico Electric Power Authority provided a small break from the financial storm that’s provoked worry in Washington and on Wall Street, where mutual funds and hedge funds for years snapped up the commonwealth’s debt… While investors pushed up the price of its bonds Wednesday, officials are still working to renegotiate $9 billion of debt to free up cash needed to turn the utility around.”

July 1 – Wall Street Journal (Maria Armental): “Moody’s… on Wednesday cut Puerto Rico’s ratings one notch further into junk territory, citing the commonwealth’s declaration that it cannot pay its debt. Gov. Alejandro García Padilla said… Monday that Puerto Rico’s debts were ‘unpayable’ and called for concessions from creditors. The cut to Caa2—the seventh downgrade in five years, underscoring Puerto Rico’s long-running financial woes—applies to about $55.5 billion in bonds, including debt from the Puerto Rico Aqueduct & Sewer Authority. Puerto Rico has about $72 billion in debt outstanding, nearly 70% of its economic output and is struggling with high unemployment and a declining population.”

U.S. Bubble Watch:

July 2 – Bloomberg (Jennifer Kaplan and Joseph Ciolli): “For five years, U.S. companies have dodged the ignominy of falling profits, often by beating analysts’ estimates by just enough to push earnings higher than they were the previous year. Repeating the trick will be their biggest challenge to date. Six days before the start of earnings season, Wall Street forecasters predict profits will fall 6.5% in the second quarter, the most bearish estimate of the bull market… U.S. earnings have been under pressure for nine months as falling oil prices cut results at energy providers and the dollar’s ascent curbed demand for American exports. While one quarter of declining profits isn’t the end of the recovery, it’s more ammunition for bears who say equity valuations are too high.”

July 2 – Bloomberg (Asjylyn Loder and Bradley Olson): “The insurance protecting shale drillers against plummeting prices has become so crucial that for one company, SandRidge Energy Inc., payments from the hedges accounted for a stunning 64% of first-quarter revenue. Now the safety net is going away. The insurance that producers bought before the collapse in oil -- much of which guaranteed minimum prices of $90 a barrel or more -- is expiring. As they do, investors are left to wonder how these companies will make up the $3.7 billion the hedges earned them in the first quarter after crude sunk below $60 from a peak of $107 in mid-2014… The hedges staved off an acute shortage of cash for shale companies and helped keep lenders from cutting credit lines, many of which are up for renewal in October. With drillers burdened by interest payments on $235 billion of debt, $89 billion of it high-yield, a U.S. regulator has warned banks to beware of the ‘emerging risk’ of lending to energy companies.”

June 30 – New York Times (Michelle Higgins): “After flirting with records for more than a year, the average sales price of a Manhattan apartment hit a new high in the second quarter… A strong local economy, combined with high demand and not enough listings, pushed the average sales price up 11%, to $1.87 million, compared with the same period in 2014, surpassing the previous peak of $1.77 million reached in the first quarter of last year, according to Jonathan J. Miller, the president of the appraisal firm Miller Samuel… ‘It’s like everyone revved up their engines again,’ said Pamela Liebman, the chief executive of the Corcoran Group… ‘We saw continuous demand across all price points, buoyed by some exciting new developments that have come on the market and a continued influx of buyers from China.’ ‘In all my years of doing this,’ she added, ‘I have never seen such a hunger for New York City real estate.’”

Central Bank Watch:

July 2 – Bloomberg (Amanda Billner and Saleha Mohsin): “Sweden’s central bank lowered its main interest rate deeper into negative levels and expanded its bond purchases to the end of the year as the turmoil in Greece raises the specter of further krona gains. The repo rate was cut to minus 0.35% from minus 0.25%... The bank expanded its bond purchasing program by 45 billion kronor ($5.3bn) to the end of year, adding to the 80 billion kronor to 90 billion kronor already announced.”

Global Bubble Watch:

June 30 – New York Times (Peter Eavis): “There are some problems that not even $10 trillion can solve. That gargantuan sum of money is what central banks around the world have spent in recent years as they have tried to stimulate their economies and fight financial crises. The tidal wave of cheap money has played a huge role in generating growth in many countries, cutting unemployment and preventing panic. But it has not been able to do away with days like Monday, when fear again coursed through global financial markets. The main causes of the steep declines in stock and bond markets were announcements out of Greece and Puerto Rico. And in China, the precipitous declines in its stock market were also a sobering reminder that stubborn problems lurked in the global economy.”

June 30 – Reuters: “Mergers and acquisitions (M&A) worldwide in the second quarter of 2015 almost matched the record set in the second quarter of 2007, according to preliminary Thomson Reuters data, as big companies turned to deals to boost their market share. Low interest rates and stronger confidence among chief executives have led to a steady rise in M&A activity in the last two years to close to pre-2008 financial crisis levels. The second quarter of 2015, however, stands out for the number of mega deals that were clinched or attempted… Such large deals drove M&A volumes globally in the second quarter of 2015 up by 34.6% year-on-year to $1.33 trillion as of June 26, shy of the record $1.41 trillion seen in the second quarter of 2007.”

Europe Watch:

July 2 – Reuters (Laura Benitez and Abhinav Ramnarayan): “The European Central Bank took the market by surprise on Thursday when it added three Italian corporates to the list of names eligible for purchase under its quantitative easing programme…. While the central bank was rumoured to be considering adding corporates to its QE list in October last year, it only included governments, supranationals, agencies and covered bonds - all considered to carry little risk. ‘I suspect it's driven by the ECB's struggle to find the liquidity on pure sovereign names over the summer, remembering they front-loaded purchases in June anticipating net redemptions in July and August,’ one corporate syndicate banker said. ‘They're also sending a message that they have firepower if needed to help markets in the face of the Greece saga.’”

June 30 – Bloomberg (David Goodman and Anchalee Worrachate): “The European Central Bank’s first full quarter of quantitative easing hasn’t stopped the region’s government bonds from heading for their worst performance on record. The rout started in April after the ECB’s purchases helped send yields on more than $2 trillion of euro-area sovereign debt below zero… ECB President Mario Draghi added fuel to that fire this month when he said markets must get used to periods of higher volatility. The latest turmoil in Greece further undermined bonds from Europe’s periphery, even as it revived some demand for the relative safety of German debt. Euro-area sovereign securities handed investors a 5.7% loss this quarter through June 29… That was led by a 16% decline in Greek securities, with German bonds dropping 4.7% and Spain’s 6.4%.”

June 30 – Bloomberg (Katie Linsell and Sally Bakewell): “Measures of risk in Europe's credit markets surged after Greek debt talks broke down, rising the most since Lehman Brothers Holdings Inc. failed in 2008. A benchmark of credit-default swaps rose by as much as 20% to the highest in more than a year, according to data compiled by Bloomberg. Greek bank bonds dropped to their lowest levels on record and contracts insuring the Mediterranean nation’s sovereign debt indicated a 91% probability of default.”

July 1 – Bloomberg (Jeff Black): “Trust between euro-area countries has deteriorated so badly that the idea that the single currency can’t be undone is now dead, former European Central Bank Executive Board member Otmar Issing said. ‘Mutual trust is certainly not there any more, and it will be very difficult to restore,’ Issing, 79, said… ‘The idea -- you might now say the illusion -- was and is that having joined the euro, it is irreversible.’ Seventeen years after Issing began as the chief economist of the brand-new ECB in Frankfurt, the currency zone is wracked by turmoil surrounding Greece and its possible exit from the bloc. Still, while today’s policy makers insist the region can cope from the fallout of a country leaving, Issing said such an event may even strengthen the resolve of remaining members. ‘I would be quite confident that if governments and people in other European countries see the mess, the chaos, which will accompany Greece for some time to come, they will undertake the utmost efforts to avoid repetition of such a situation,’ he said. ‘All the others have to really commit themselves.’”

EM Bubble Watch:

June 30 – Bloomberg (David Biller): “As the world nervously watches the Greek debt talks break down, there's another corner of the planet that's struggling. Growth in most of Latin America and the Caribbean is coming to a screeching halt, dragged down by Argentina, Brazil and Venezuela. Economists expect the region (excluding Mexico) to expand an almost nonexistent 0.1% this year, a forecast that would mean faring worse than the U.S. for a second straight year. It's a reversal of fortunes…”

Brazil Watch:

July 2 – Financial Times (Joe Leahy and Aline Rocha): “Brazilian prosecutors on Thursday said that Petrobras’ official estimates for losses it had suffered from corruption were too low, suggesting that the state-owned oil company may have to adjust its 2014 financial statements. Petrobras in April told investors during the release of its 2014 financial statements that it estimated losses directly related to a vast corruption scandal at the company at R$6.2bn. But one of the prosecutors working on the case, Carlos Fernando dos Santos Lima, said ‘We have no doubt that the losses are significantly larger than the R$6bn that was announced.’”

Geopolitical Watch:

July 2 – New York Times (Paul Mozur): “When a draft of China’s new national security law was made public in May, critics argued that it was too broad and left much open to interpretation. In the final form of the law… Beijing got more specific, but in a way that is sending ripples through the global technology industry. New language in the rules calls for a ‘national security review’ of the technology industry — including network and other products and services — and foreign investment. The law also calls for technology that supports key sectors to be ‘secure and controllable,’ a catchphrase that multinationals and industry groups say could be used to force companies to build so-called back doors — which allow third-party access to systems — provide encryption keys or even hand over source code. As with many Chinese laws, the language is vague enough to make it unclear how the law will be enforced, but it suggests a new front in the wider clash between China and the United States over online security and technology policy.”

Russia and Ukraine Watch:

July 1 – Bloomberg (Natasha Doff): “Ukraine’s Eurobonds dropped for a fourth day as Bank of America Merrill Lynch warned the nation is underestimating the repercussions of default and investors awaited the outcome of Tuesday’s debt talks in Washington. The country’s $2.6 billion of bonds maturing in July 2017 fell 0.97 cent to 47.53 cents on the dollar…, extending this week’s drop to 1.95 cents. The government might be shut out of international debt markets if it continues to take a hard line with creditors that leads to a debt moratorium, Bank of America Merrill Lynch economist Vadim Khramov wrote… Ukraine has threatened to stop paying its international creditors if they don’t accept a proposal that includes a writedown to the face value of about $19 billion of bonds.”