Saturday, July 25, 2015

Weekly Commentary: Same Old Same Old

A Friday Bloomberg headline is a good place to begin this week’s CBB: “Emerging Market Currencies Tumble to Record Low in ‘Violent’ Selloff.”

From Ye Xie’s Bloomberg article: “Emerging-market currencies are in free fall. An index of the major developing-nation currencies fell to an all-time low this week, extending its drop over the past year to 19%, according to data compiled by Bloomberg going back to 1999. The Russian ruble, Colombia's peso and the Brazilian real have fallen more than 30% over the past year for some of the worst global selloffs.”

Other notable currency headlines this week: Thai “Baht Posts Worst Weekly Decline Since 2007…” “Indian Rupee Completes Biggest Weekly Decline in Three Months.” “Asia Currencies Decline as Chinese Data Compounds Growth Concern.” “Ringgit Forwards Extend Weekly Losses as Oil Enters Bear Market.” “Taiwan’s Dollar Posts Third Weekly Drop on Signs Growth Slowing.” “Commodity Currencies at Multiyear Lows.”

Importantly, a “violent” currency market this week succumbed to “disorderly”. Disorderly changes things, including the amount of leverage and risk the speculators will tolerate. After a several month (China-inspired) hiatus, the “hot money” exodus has resumed in earnest. Brazil’s real led the week’s loser list, sinking 5.2%.

From the perspective of the burst global Bubble thesis, Brazil has been near the top of my list of concerns. Regrettably, it is becoming a poster child for the consequences of unfettered global “Wildcat Finance”: Destabilizing financial flows, Credit and speculative excess, corruption and malfeasance, deep structural maladjustment, festering social tension and political instability. This week saw Brazil post a wider-than-expected Current Account Deficit ($2.5bn). Inflation is currently running above 9%, its currency is in serious trouble, and the central bank is on the hook for enormous quantities of currency swaps. The major state-directed banks are increasingly vulnerable. And the Brazilian economy is expected to contract about 2% this year. Brazil’s Bovespa equities index sank 6.0% this week to a four-month low. Brazil CDS jumped to the highest level since March.

With recent focus on the Chinese stock market and Greek fiascos, Brazil has been flying under the radar. After a tough 2014, Brazil had been perceived in the marketplace as a beneficiary of Chinese stimulus and the expectation for a recovery in commodity prices. The bursting of the Chinese equities Bubble is now spurring a major reassessment of the bullish view. Commodities are in a freefall, and the marketplace has been abruptly forced to dramatically downgrade prospects for the commodities-dominated economies and currencies – Brazil at the top of the list.

Market faith has held strong that policymakers have everything under control. This perception has had a profound impact on global markets – more specifically, the divergent paths of inflating securities prices and deflating fundamental prospects. The view has been that, with (at its peak) $8.0 Trillion of international reserves, China, Brazil and the like have more than sufficient reserve holdings to stabilize their currencies and weather the storm. Bullishness has proved resilient in the face of faltering economic performance and a $500bn decline in reserve positions from their peak. This may be changing, with potentially major ramifications.

There are now estimates that Chinese financial outflows have surged to a $250bn quarterly pace. If correct, one has to sit back quietly and ponder ramifications.

July 24 – Bloomberg (Y-Sing Liau): “Malaysia’s foreign-exchange reserves fell to the lowest in almost five years, signaling the central bank may have intervened to stem the ringgit’s decline. The holdings dropped 4.7% to $100.5 billion as of July 15 from two weeks earlier…That’s enough to finance 7.9 months of retained imports and is 1.1 times short-term external debt… The currency weakened to a 16-year low of 3.8130 a dollar this month, surpassing the 3.8 level at which it was pegged from 1998 to 2005… A drop in reserves below the psychological $100 billion level may further roil the fragile sentiment, Nizam Idris, Macquarie Bank Ltd.’s head of foreign-exchange and fixed-income strategy…, said…”

“A drop in reserves below the psychological $100 billion level may further roil the fragile sentiment.” Such language recalls the 1997 SE Asian currency collapse. Almost overnight, sentiment shifted away from calm confidence that central banks had an adequate arsenal of reserve holdings. Fear then erupted that rapidly depleting reserves might soon be exhausted – forcing central banks to cut their currencies loose. Suddenly, the window was seen closing fast. A devastating rush for the exits ensued and, so quickly, markets dislocated.

A number of currencies under the most acute pressure this week – Brazil (5.2%), Mexico (2.1%), Russia (2.8%), South Korea (1.8%), Turkey (3.2%) and Colombia (3.2%) – are all on the list of countries that saw outsized increases in foreign currency (largely dollar-) denominated bond issuance since the 2008 crisis. I have highlighted over the past 18 months analysis pointing to, in particular, dollar-denominated EM debt as a global financial “system” weak-link. Not atypically, this flashpoint has been held at bay longer than I had expected. The Fed holding rates at zero, BOJ & ECB QE, and serial Chinese stimulus have been instrumental. While complacency has solidified, underlying structural problems have badly festered.

Time flies by quickly. It’s difficult to believe three years have now passed since the fateful summer 2012 market tumult. More difficult is it to believe that the S&P500 is up 63% from summer 2012 lows. The Nasdaq Composite has gained 84%. The Shanghai Composite is up a staggering 93% in three years (even after recent selling). Amazingly, the biotechs (BTK) have inflated more than 200%.

There are ominous parallels to the late-twenties. The “Roaring Twenties” were a period of growing global imbalances and market instability, along with mounting deflationary pressures. There was the Fed’s infamous “coup de whiskey” that spurred the fateful 1927 to 1929 speculative run in U.S. markets. Cross-border financial flows turned increasingly destabilizing.

Since 2012, global central banks have been unrelentingly generous with their Whiskey shots. The results have been troublingly late-twenties-like. Over-liquefied markets have gone wild, masquerading as a “bull market.” And as inflationary Bubbles have run roughshod through global securities markets, real economies have continued to stagnate. Imbalances have expanded. Structural maladjustments have significantly worsened. Global “money” and Credit have deteriorated profoundly. Massive global financial flows have turned hopelessly dysfunctional.

It appears that global markets are heading right into another bout of market tumult, with EM again in the crosshairs. There’s just an astounding amount of suspect debt in the world and too deep structural impairment. And, sure, we’ll all be focused on the inevitable policy responses: I’ll assume some Fed official(s) will broach the possibility of restarting QE if “financial conditions tighten.” The BOJ and ECB will consider boosting their QE programs. The Chinese will propose even greater amounts of spending, liquidity and market support. And will the Same Old Same Old matter much beyond sparking one and two-day panic-buying market convulsions?

It sure appeared that bulls were caught flatfooted by this week’s market downdraft. The view has been that the resilient U.S. economy was largely immune to EM and global issues. This week provided evidence of U.S. corporate earnings vulnerability that to this point has remained largely unappreciated. The view has been that U.S. Credit is largely impervious to global issues. Cracks may be surfacing in this fallacy as well.

July 21 – Wall Street Journal (Rob Copeland): “Wall Street is preparing for panic on Main Street. Hedge funds are lining up to profit from potential trouble at some ‘alternative’ mutual funds and bond exchange-traded funds that have boomed in popularity among retirees and other individual investors. Financial advisers have pushed ordinary investors into those funds in search of higher returns, a strategy that has come into favor as Federal Reserve benchmark interest rates remain near zero. But many on Wall Street worry that junk bonds, bank loans and esoteric investments held by some of those funds will be extremely hard to sell if the market turns, leaving prices pummeled in a rush for the exits... Liquid-alternative funds manage a cumulative $446 billion, according to fund tracker Lipper, up from $83 billion at the start of 2009."

“Hedge Funds Gear Up for Another Big Short,” was the WSJ headline for the above noted article. “‘They are going to be toast,’ David Tawil, president of hedge fund Maglan Capital LP, said of the funds holding hard-to-sell assets like emerging-market debt and small-capitalization stocks. ‘It will be one of our first levels of shorting the moment we start to see cracks, because it’s ripe with retail, emotional investors.’”

And a replay from last week’s “Fixed Income Watch:” July 17 – Bloomberg (Tracy Alloway): “…Back in 2005, Citigroup estimated that about $2 billion worth of credit index options were trading per month, or roughly $24bn over the course of the year. Last December, the same Citi analysts figured that about $1.4 trillion of the instruments had exchanged hands in all of 2014, compared with $573 billion worth in 2013.”

And for those willing to ponder a transmission mechanism from agitated global markets to the halcyon U.S. securities marketplace, I’ll offer one: The global energy and commodities collapse leads to major deterioration in U.S. resource company debt, dragging down junk bond performance generally. Outflows from junk, bank loan and Credit funds quicken. Importantly, the increasingly risk averse leveraged speculators begin unwinding long holdings – while others move to get short Credit. And already the market would see a profound change in the liquidity backdrop.

But then there’s the looming problem of all this Credit “insurance” that has been written – the old exuberant “writing flood insurance during the drought”. What free “money” - what genius – that is, until it blows up. Recall subprime CDOs?

If those on the wrong side of today’s Big Trade move to hedge/“re-insure” higher-yielding corporate instruments – that would entail huge additional selling/shorting of corporate bonds and Credit into an already weakened marketplace. And there’s that “vicious cycle” problem inherent to Credit Cycles: As corporate Credit conditions tighten, a lot of Credits that appeared sound throughout the over-liquefied boom period look a lot less so. So more shorting, more outflows, and more shorting and hedging… Buying from myriad fund types and structured products evaporates. Significantly less corporate debt issuance… Less “money” for M&A, buybacks and financial engineering. Lower asset prices. Declining Household Net Worth.

It’s worth noting a Friday afternoon Bloomberg headline: “Junk-Debt Market Rocked as Cautious Creditors Stymie New Deals.” And if a little worry about Chinese and Brazilian – to name the most obvious – financial institutions begins to creep into the equation, the backdrop rather quickly turns complex and uncertain.

For the Week:

The S&P500 fell 2.2% (up 1.0% y-t-d), and the Dow dropped 2.9% (down 1.4%). The Utilities declined 2.2% (down 7.2%). The Banks slipped 1.0% (up 5.6%), and the Broker/Dealers dropped 3.3% (up 6.2%). The Transports fell 2.7% (down 11.7%). The S&P 400 Midcaps declined 2.1% (up 1.7%), and the small cap Russell 2000 dropped 3.2% (up 1.8%). The Nasdaq100 fell 2.2% (up 7.6%), and the Morgan Stanley High Tech index slipped 0.5% (up 4.0%). The Semiconductors were hit 3.7% (down 6.5%). The high-flying Biotechs reversed course and were slammed for 4.7% (up 22.8%). With bullion sinking another $33, the HUI gold index dropped 10.6% (down 30%).

Three-month Treasury bill rates ended the week at three bps. Two-year government yields added a basis point to 0.68% (up one basis point y-t-d). Five-year T-note yields fell six bps to 1.61% (down 4bps). Ten-year Treasury yields dropped nine bps to 2.26% (up 9bps). Long bond yields fell 12 bps to 2.96% (up 21bps).

Greek 10-year yields jumped 33 bps to 11.11% (up 137bps y-t-d). Ten-year Portuguese yields fell 12 bps to 2.49% (down 13bps). Italian 10-yr yields declined five bps to 1.86% (down 3bps). Spain's 10-year yields slipped three bps to 1.89% (up 28bps). German bund yields dropped 10 bps to 0.69% (up 15bps). French yields dropped 11 bps to 0.96% (up 13bps). The French to German 10-year bond spread narrowed a basis point to 27 bps. U.K. 10-year gilt yields fell 15 bps to 1.93% (up 18bps).

Japan's Nikkei equities declined 0.5% (up 17.7% y-t-d). Japanese 10-year "JGB" yields dipped two bps to 0.40% (up 8bps y-t-d). The German DAX equities index dropped 2.8% (up 15.7%). Spain's IBEX 35 equities index fell 1.5% (up 10%). Italy's FTSE MIB index declined 1.1% (up 23.6%). Emerging equities markets were under pressure. Brazil's Bovespa index sank 6.0% (down 1.5%). Mexico's Bolsa fell 2.4% (up 2.6%). South Korea's Kospi index lost 1.5% (up 6.8%). India’s Sensex equities index declined 1.2% (up 2.2%). China’s Shanghai Exchange dropped 1.8% (up 25.9%). Turkey's Borsa Istanbul National 100 index was hit 4.9% (down 8.2%). Russia's MICEX equities index dropped 3.3% (up 14.2%).

Junk funds this week saw inflows of $82 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell five bps to 4.04% (up 17bps y-t-d). Fifteen-year rates declined four bps to 3.21% (up 6bps). One-year ARM rates rose four bps to 2.54% (up 14bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down five bps to 4.12% (down 16bps).

Federal Reserve Credit last week jumped $12.0bn to $4.461 TN. Over the past year, Fed Credit inflated $97.4bn, or 2.2%. Fed Credit inflated $1.650 TN, or 59%, over the past 141 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $4.3bn last week to $3.340 TN. "Custody holdings" were up $47bn y-t-d.

M2 (narrow) "money" supply gained $5.9bn to a record $12.043 TN. "Narrow money" expanded $635bn, or 5.6%, over the past year. For the week, Currency increased $4.5bn. Total Checkable Deposits dropped $26.0bn, while Savings Deposits jumped $26.8bn. Small Time Deposits slipped $2.1bn. Retail Money Funds rose $2.7bn.

Money market fund assets jumped $16.2bn to $2.649 TN. Money Funds were down $84bn year-to-date, while gaining $86bn y-o-y (3.3%).

Total Commercial Paper surged $19.2bn to a seven-month high $1.048 TN. CP increased $22BN over the past year.

Currency Watch:

July 21 – Wall Street Journal (Anjani Trivedi): “China’s yuan is on track to post one of its longest streaks of stable trading in a decade, just as its financial markets reel and growth sputters, reflecting how disconnected the currency remains from the country’s hefty challenges. Ten years ago Tuesday, the People’s Bank of China unpegged the yuan from the U.S. dollar. Yet the currency remains tightly controlled, with the central bank regularly buying and selling it in the domestic foreign-exchange market to maintain a desired level. That firm grip has steadied the yuan despite a ream of unsettling news out of China, ranging from a selloff that had knocked trillions in value from Chinese equities to second-quarter growth of 7%... Since May, the Chinese currency has barely moved against the U.S. dollar, declining 0.01%.”

The U.S. dollar index slipped 0.8% to 97.20 (up 7.7% y-t-d). For the week on the upside, the euro increased 0.8%, the New Zealand dollar 0.8%, the Swedish krona 0.8% and the Japanese yen 0.2% For the week on the downside, the Brazilian real declined 5.2%, the South African rand 2.5%, the Mexican peso 2.1%, the Australian dollar 1.2%, Canadian dollar 0.6%, British pound 0.6%, Norwegian krone 0.4% and the Swiss franc 0.1%.

Commodities Watch:

The Goldman Sachs Commodities Index sank 4.5% (down 7.5% y-t-d). Spot Gold lost 2.9% to $1,099 (down 7.2%). September Silver dropped 2.3% to $14.49 (7%). September Crude sank $2.75 to $48.14 (down 10%). August Gasoline was slammed 5.3% (up 24%), and August Natural Gas lost 3.1% (down 4%). September Copper fell 4.5% (down 16%). September Wheat sank 7.6% (down 13%). September Corn dropped 4.2% (up 1%).

Greece Crisis Watch:

July 20 – Bloomberg (Lorcan Roche Kelly and Nikos Chrysoloras): “Today the Greek central bank released its monthly balance sheet for June 2015. The balance sheet is dated to June 30—the day after capital controls were introduced in Greece. The seven-month jog on Greek lenders was about to turn into a full blown bank run during that last weekend of June, after Prime Minister Alexis Tsipras broke talks with creditors and called a referendum… Savers formed long queues in front of ATMs as doubts over the country's place in the euro area spurred them to withdraw their cash from banks. The new data from the central bank shows that the total value of banknotes in circulation in Greece reached an all time high of €50.5 billion ($54.5bn). That's an increase of more than €5 billion in the month of June alone.”

July 21 – Reuters (Jan Lopatka): “Bozena Vargova, a retired physiotherapist from Slovakia, cannot understand why her country should bail out Greeks who often earn twice as much as Slovaks and run up debts. ‘I don't feel like we should give anything to Greece,’ said Vargova, who lives on a pension of 370 euros a month, while the average Greek pension is 833 euros. In the bitter wrangling over whether the euro zone should bail out Greece, some people sympathetic to Athens framed the debate as a stand-off between Europe's rich and poor: wealthy Germany humiliating poverty-stricken Greece. But in the case of Slovakia - and other ex-Communist countries now in the euro zone - the dividing line is not about wealth levels but about attitudes to indebtedness and sacrifice.”

China Bubble Watch:

July 24 – CNBC (Isabel Reynolds): “The preliminary China Caixin purchasing managers index (PMI) surprised markets by dropping to a 15-month low in July, with analysts pinning the hit on the recent stock market crash and weak export demand. The index, released Friday, fell to 48.2, coming in well below the 49.7 forecast from a Reuters poll and the 50-mark separating growth from contraction. ‘The PMI came as a big surprise for the market, which was expecting an increase,’ Dariusz Kowalczyk, senior economist at Credit Agricole private bank, said. ‘I believe the reading reflects the negative impact of the stock market crash, the weaker outlook for consumption and the worsening of availability of funding for investment,’ he said, noting that initial public offerings (IPOs) were suspended in the wake of stock market turmoil.”

July 23 – Bloomberg: “China should slow the pace of opening up its capital markets after the recent equities rout, according to a researcher with the State Council. The nation’s domestic financial rules appear to have gone ‘backwards’ after the government took unprecedented measures to halt the stocks slide, Qing Wu, a researcher at the State Council’s development research center, said… China’s goal of opening up the capital account and making the currency fully convertible is still a challenge and needs to be reassessed, he said. The market rout wiped out almost $4 trillion and prompted the government to introduce a spate of support measures including suspending initial public offerings and allowing more than 1,400 companies to halt trading.”

July 23 – Reuters (Pete Sweeney): “China has enlisted $800 billion worth of public and private money to prop up its wobbly stock markets, a Reuters analysis shows, but the impact of the unprecedented government-orchestrated rescue has so far been modest. Public statements, media reports and market data reveal that Beijing unleashed 5 trillion yuan (515 billion pounds) in funds - equivalent to nearly 10% of China's GDP in 2014 and greater than the 4 trillion yuan it committed in response to the global financial crisis - to calm a savage share sell-off… ‘I'm quite negative towards the rescue,’ said Yang Weixiao, analyst at Founder Securities in Beijing. ‘The problem is, all these measures only change the supply-demand relationship, without changing the fundamentals. So there's no real support, and the calm could be only temporary. If the governments exits the bailout, prices could accelerate their journey back to fundamentals.’”

July 19 – Bloomberg: “The second major bailout program from China’s leadership this year underscored its preference for relying on the banking system to shore up markets, a strategy that risks the need for further intervention over time. As details emerged last week on a stock-support plan valued at as much as $483 billion, investors became better acquainted with an agency called China Securities Finance Corp. that previously had a limited role in economic policy. The unit is now being deployed, with financing from state-owned banks, to buy up the nation’s depreciated equities. The maneuver -- with a magnitude that’s drawing comparisons with the U.S. government’s emergency funding during the 2008 financial crisis -- is the latest in a series of policy measures that avert short-term pain even as they potentially store up risks for the longer term. It follows a decision in May to reopen back-door lending to heavily indebted local government financing vehicles, through an order to banks to keep funding projects even if borrowers couldn’t meet payments. ‘This scale of intervention reinforces the moral hazard that is already rampant in the credit side of the Chinese financial industry,’ said Victor Shih, a professor at the University of California at San Diego… ‘With the moral hazard spreading to the equity side, there will be no end to the expansion of the central bank’s balance sheet, which is necessary to keep both credit and equity afloat.’”

July 21 – Reuters (Shu Zhang and Nicholas Heath): “China's central bank and finance ministry will inject billions of dollars into the country's policy banks, Caixin reported on Tuesday… The People's Bank of China will inject $45 billion into the Export-Import Bank of China (EXIM) and the finance ministry will inject 100 billion yuan ($16bn) into the Agricultural Development Bank of China (ADBC), Caxin, a respected domestic financial magazine, reported… Beijing is stepping up reforms at its policy lenders to drive economic growth and boost Chinese companies' global competitiveness. Reuters reported last week that China Development Bank Corp (CDB), the country's biggest policy lender, will receive a capital injection of $48 billion from the central bank. After this round of capital injection totalling $109 billion, the central bank will replace the finance ministry as the biggest shareholder in CDB and EXIM, Caixin said.”

July 20 – Financial Times (Gabriel Wildau): “In the wake of the Chinese stock market’s dramatic fall early this month, police and securities regulators announced they had launched an investigation into ‘malicious short selling’ in the equity futures market. The announcement was part of measures intended to stabilise the market after it fell 30% from its peak in mid-June, but it also raised the question: What makes short selling ‘malicious’? The lurid terminology, coupled with a lack of detail on what behaviour is being targeted, has led critics to suspect that the investigation is an extralegal attempt to intimidate would-be sellers. But lawyers say that bearish bets can be illegal if they are based on inside information or made with the intent to influence prices.”

July 22 – Wall Street Journal (Rob Copeland and Mia Lamar): “The world’s biggest hedge fund has turned on the world’s fastest-growing economy. Bridgewater Associates LP, one of Wall Street’s more outspoken bulls on China, told investors this week that the country’s recent stock-market rout will likely have broad, far-reaching repercussions. The fund’s executives once had been vocal advocates of China’s potential. But that was before panic in the country’s stock markets shaved a third of the value off Shanghai’s main index, battering hordes of mom-and-pop investors and hedge funds alike, before partially rebounding. ‘Our views about China have changed,’ Bridgewater’s billionaire founder, Raymond Dalio, wrote… in a note sent to clients… ‘There are now no safe places to invest.’”

Fixed Income Bubble Watch:

July 23 – Financial Times (Joe Rennison and Nicole Bullock): “Companies have sold more ‘jumbo’ bond deals since January than over the previous five years combined, amid a surge in merger and acquisition activity and a race to lock in low funding costs before US interest rates rise. The surge in $10bn-plus bond sales this year comes against the backdrop of strong investor demand for large slices of high quality debt from blue-chip companies and low borrowing costs… The 12 $10bn-plus deals seen so far this year, totalling $157bn, have topped the entire total from March 2009 to the end of 2014, according to… Dealogic. The rise of jumbo offerings has helped fuel a bumper year for corporate debt offerings, with sales of investment-grade paper climbing to its highest ever year-to-date total — $1.1tn has been sold worldwide, compared with just over $1tn last year. ‘Before 2013 a $5bn bond financing would have been seen as a ‘jumbo’ deal for US dollar capital markets,’ said Jonny Fine, head of investment grade syndicate in the Americas at Goldman Sachs. ‘Today with the proliferation of $10bn plus and $15bn plus bond deals, that bar has moved considerably higher.’”

July 22 – Bloomberg (Brian Chappatta and Michelle Kaske): “Investors may receive as little as 35 cents on the dollar under a restructuring of Puerto Rico debt if the commonwealth defaults, Moody’s… said. Debt sold by the island’s Government Development Bank, Highways and Transportation Authority, Infrastructure Finance Authority and Municipal Finance Authority is among the $26 billion with the lowest recovery rates, Moody’s estimated… The debt is ranked Ca, the second-lowest rating from the… company. ‘We believe that the probability of default is approaching 100%, and that losses given default are substantial,’ Moody’s analysts wrote. ‘Bondholder recoveries will be lowest on securities lacking explicit contractual or other legal protections.’”

July 21 – Bloomberg (Asjylyn Loder, Bradley Olson and Dawn Kopecki): “Halcon Resources Corp. almost ran into trouble with its banks in June 2013. And again in March 2014. And in February 2015. Each time, the shale driller came close to violating debt limits set by its lenders, endangering a credit line that provided as much as $1.05 billion in much-needed cash. Each time, Halcon’s banks… loosened their restrictions, allowing Halcon to keep borrowing. That kind of patience may be coming to an end. Bank regulators have issued warnings on the risks involved in lending to U.S. drillers, threatening a cash crunch in an industry that’s more dependent than ever on other people’s money. Wall Street has been one of the biggest allies of the shale revolution, bankrolling thousands of wells from Texas to North Dakota. The question is how that will change with oil prices down by half since last year to $50.36 a barrel… Banks so far have been willing to keep the money flowing because drillers that come close to maxing out their credit lines have paid them off by tapping public markets. U.S. producers have raised about $44 billion through bonds and share sales in the first half of this year, the most since 2007…”

U.S. Bubble Watch:

July 21 – Reuters (Dan Freed): “U.S. banks are setting aside more money to cover bad loans to energy companies after oil prices plunged over the last year, raising the possibility that deteriorating loans could start to weigh on their earnings, some analysts said. Loan credit quality for U.S. banks has been improving since the financial crisis. In the first quarter, 2.49% of loans on banks' books were delinquent, the lowest level since the fourth quarter of 2007…The rate peaked at 7.4% in the first quarter of 2010. Weakness among energy company loans could be a sign that overall credit quality among U.S. banks has little room to improve, analysts said. Executives from both JPMorgan… and Wells Fargo… told investors last week, when posting earnings, that they were increasingly concerned about loans to oil and gas companies.”

July 23 – Reuters (Lucia Mutikani): “U.S. home resales rose in June to their highest level in nearly 8-1/2 years, a sign of pent-up demand that should buoy the housing market recovery and likely keep the Federal Reserve on track to raise interest rates later this year. The National Association of Realtors said… existing home sales increased 3.2% to an annual rate of 5.49 million units, the highest level since February 2007. ‘The economy really has the wind at its back now,’ said Chris Rupkey, chief financial economist at MUFG Union Bank… Home resales this year are on track to record their biggest gain in eight years, the NAR said.”

Global Bubble Watch:

July 18 – Reuters (Umesh Desai): “Beijing may have averted a crisis in its stock markets with heavy-handed intervention, but the world's biggest corporate debt pile - $16.1 trillion and rising - is a much greater threat to its slowing economy and will not be so easily managed. Corporate China's debts, at 160% of GDP, are twice that of the United States, having sharply deteriorated in the past five years, a Thomson Reuters study of over 1,400 companies shows. And the debt mountain is set to climb 77% to $28.8 trillion over the next five years, credit rating agency Standard & Poor's estimates. Beijing's policy interventions affecting corporate credit have so far been mostly designed to address a different goal - supporting economic growth, which is set to fall to a 25-year low this year… Though it wants more of that credit going to smaller companies and innovative areas of the economy, such measures are blunt instruments. ‘When the credit taps are opened, risks rise that the money is going to 'problematic' companies or entities,’ said Louis Kuijs, RBS chief economist for Greater China.”

July 20 – Financial Times (Joe Rennison): “The level of assets in exchange traded funds has surpassed those held by hedge funds for the first time, highlighting how their explosive growth has upended the global fund management industry since the financial crisis. ETFs… accounted for $2.971tn globally at the end of the second quarter, according to… ETFGI, up $45bn since the end of March. Hedge funds also grew, but by just $30bn to $2.969tn, according to Hedge Fund Research… Fixed income ETFs make up around 15% of all global ETFs, compared to 77.6% for equities and around 4% for commodities. The ETF industry recently passed its 25th anniversary but fixed income ETFs have only been around for 15 years.”

July 22 – Reuters (Lauren Tara LaCapra): “John McCormick has been on a mission for the past five years: to bring hedge funds to the masses. That may seem like a tough sell. Traditional hedge funds, those lightly regulated investment pools open exclusively to large institutions and rich individuals, have been duds lately, trailing the U.S. stock market’s performance every year since 2009 by an average of 10 percentage points, according to Hedge Fund Research Inc data. But already, McCormick, a senior managing director at Blackstone Group LP, has been wildly successful. He has done so as a tireless evangelist for what are called liquid alternative investments, or ‘liquid alts.’ Like hedge funds, they invest in everything from simple stocks and bonds to all sorts of complex derivatives and other ‘alternative’ assets. The main difference is that liquid alts are packaged as mutual funds and marketed to retail investors who can’t invest in traditional hedge funds… Though critics complain about high fees, opaque strategies and other factors that they say make liquid alts inappropriate for small investors, these products have become one of the fastest-growing types of mutual fund. Liquid alt assets under management in the U.S. and Europe have surged to about $440 billion, according to Preqin, a research firm specializing in alternative investments. In 2008, analysts estimate, the figure was less than $100 billion… The reason for their popularity, McCormick said, lies in the 2008 financial crisis and the damage it inflicted on many small investors’ portfolios. ‘You have baby boomers nearing retirement who experienced a scary event in 2008,’ he said. ‘People who thought they had diversification and didn’t really have it.’ The long lists of assets liquid alt funds hold are designed to provide that diversification, he said.”

Europe Watch:

July 24 – Bloomberg (Andrew Mayeda): “Now that Greece is eligible again for loans from the IMF, getting any more money from the fund may hinge on a test of wills between Christine Lagarde and Angela Merkel. The bailout of as much as 86 billion euros ($95bn) proposed by European leaders this month assumes financing from the International Monetary Fund and is conditional on Greece seeking a new loan program from the IMF once the current one expires in March. The… IMF, which requires borrowers to have sustainable debt, has made clear it won’t ask its 187 other member nations to approve a deal until euro-area states significantly ease terms on existing loans. That means that either Lagarde, the IMF managing director, or German Chancellor Merkel may need to cede ground if Greece is to receive bailout money from the IMF.”

EM Bubble Watch:

July 24 – Bloomberg (Olga Tanas and Anton Doroshev): “The $5.3 trillion foreign-exchange market is losing confidence in the ability of Latin America’s leaders to turn the region’s flagging economy around. Brazil’s real is the world’s worst-performing major currency this year, plunging 19%. Mexico’s peso is at a record low. Venezuela’s black-market bolivar has depreciated so much that a monthly minimum wage now fetches just over $11. The worst may be yet to come. Already reeling from a rout in commodities that has slowed growth to little more than a standstill, the region is now being rocked by corruption scandals in the two biggest economies: Brazil and Mexico. Strategists at Morgan Stanley said in a July 15 report they couldn’t find one Latin American currency to recommend.”

July 21 – Financial Times (Gabriel Wildau): “The new Brics development bank formally launched in Shanghai on Tuesday, with representatives from Brazil, Russia, India, China and South Africa envisioning a nimbler, more responsive alternative to institutions such as the World Bank. The inauguration of the lender, officially called the New Development Bank, comes less than a month after the launch of the China-led Asia Infrastructure Development Bank, which similarly aims to create a parallel global investment institution in which developing countries have greater influence. Although it has only five founding members compared”

Brazil Watch:

July 21 – Bloomberg (Sabrina Valle): “Brazil's national development bank lost out on an estimated $2 billion by setting interest rates too low on loans to junk-rated countries and builders facing corruption allegations, said the federal prosecutor leading an investigation into the lender. The prosecutor, who is assigned to Brazil’s budget watchdog, said the losses are tied to $12 billion of loans from a workers fund that the state bank known as BNDES shouldn’t have made because the rates trailed inflation. More than two-thirds of that cash funded projects from Angola to Venezuela by builder Odebrecht SA, whose chief executive officer was indicted this week… ‘We’re questioning the real social benefits of these loans,’ federal prosecutor Marinus Marsico… ‘If BNDES’s goal is to promote national development, why is the bank allocating scarce funds to a couple of private companies overseas?’ The inquiry marks another offshoot in ever-widening corruption scandals that have paralyzed builders and fractured the political alliance President Dilma Rousseff needs to stabilize the economy and avert a credit-rating downgrade.”

Geopolitical Watch:

July 20 – Bloomberg (David Tweed): “China renewed its protests over U.S. spy planes entering what it claims as territory after the commander of the U.S. Pacific Fleet joined a surveillance flight over the disputed South China Sea. ‘For a long time, U.S. military ships and aircraft have carried out frequent, widespread, and up-close surveillance of China, seriously harming bilateral mutual trust and China’s security interests, which could easily cause an accident at sea or in the air,’ the Ministry of Defense said… Admiral Scott Swift joined a seven-hour surveillance mission on a P-8A Poseidon plane on July 18 to witness the aircraft’s full range of capabilities… China claims more than 80% of the South China Sea, where it has been engaged in an accelerated program of reclamation around artificial islands it’s created in the Spratly chain. Five other countries claim features in the waters, home to some of the world’s busiest shipping lanes. ‘We want to reassure those in the region, who ask to be reassured about the U.S. presence, of the fact that it will be sustained here,’ Swift told reporters…”

July 22 – Washington Post (Anna Fifield): “There is little room for subtlety at the Museum of Chinese People’s Resistance Against the Japanese Invasion. Ahead of the 70th anniversary of the ‘Chinese People’s Anti-Japanese War and the World Anti-Fascist War Victory Commemoration Day,’ as the end of World War II is known here, the museum has an array of wartime Japanese artifacts — including flags, medals and guns — in a special display case under a glass floor. ‘We want to keep Japan under our feet,’ said Li Yake, a 22-year-old college student… Beijing and Tokyo have been edging toward improved relations… But at the same time, China’s propaganda machine has been ratcheting up the anti-Japanese rhetoric, prompting suggestions that it’s trying to stoke fears of new Japanese militarism to focus attention on a foreign threat rather than Xi’s own ruthless efforts to centralize power. ‘Anti-Japanese nationalism is so high and so combustible,’ said Xie Yanmei, a Beijing-based analyst for the International Crisis Group… Then, it was part of an effort to legitimize the leadership and stoke national unity after the Tiananmen Square incident. ‘It's hard to put that genie back in the bottle.’”

July 20 – Reuters (Tim Kelly): “Japan called on China… to halt construction of oil-and-gas exploration platforms in the East China Sea close to waters claimed by both nations, concerned that Chinese drills could tap reservoirs that extend into Japanese territory. Japan's Defense Ministry added the demand to its annual defense review after hawkish members of the ruling party complained that its original draft was too soft on China, a ministry official said. China resumed exploration in the East China Sea two years ago, the report said. In 2012, Japan's government had angered Beijing and purchased a disputed island chain there… ‘We have confirmed that China has started construction of new ocean (exploration) platforms and we repeat our opposition to unilateral development by China and call for a halt,’ the ministry said.”

July 24 – Reuters (Ben Blanchard): “China said on Friday it had every right to drill in the East China Sea close to waters disputed with Japan, adding that it did not recognize a ‘unilateral’ Japanese median line setting out a boundary between the two in the waters. Japan this week called on China to halt construction of oil-and-gas exploration platforms in the East China Sea close to waters claimed by both nations, concerned that Chinese drills could tap reservoirs that extend into Japanese territory. Patrol ships and aircraft from both countries have been shadowing each other in the area over the past couple of years, raising fears of a confrontation and clash.”

July 20 – Reuters (Bozorgmehr Sharafedin Nouri): “The United States said… it was disturbed by anti-U.S. hostility voiced by Iran's top leader after a nuclear deal, as both countries' top diplomats sought to calm opposition to the accord from hardliners at home. U.S. Secretary of State John Kerry said a speech by Iranian Supreme Leader Ali Khamenei on Saturday vowing to defy American policies in the region despite a deal with world powers over Tehran's nuclear program was ‘very troubling’. ‘I don't know how to interpret it at this point in time, except to take it at face value, that that's his policy,’ he said…”

Russia and Ukraine Watch:

July 24 – Bloomberg (Olga Tanas and Anton Doroshev): “A crisis has spread to almost every third Russian company town, where one employer dominates the local economy, and only a fraction of them will get government aid, officials said on Wednesday. ‘We have 319 monocities, and 94 of them are classified as in crisis,’ Economy Minister Alexey Ulyukayev said… ‘According to our estimates, the funds allocated in the budget for four years will be enough for 20-30 monocities.’ Russia is on course for its widest budget deficit in five years after last year’s slump in oil prices and sanctions over Ukraine pushed the economy into recession.”

Japan Watch:

July 23 – Bloomberg (Masaaki Iwamoto): “Japan’s debt is unsustainable and could climb to almost three times the size of its economy by 2030 unless the government does more to cut its budget, the International Monetary Fund said. The government should consider rules to curb spending, limits on extra budgets and independent assessments of its projections… Reliance on optimistic economic assumptions risks harming confidence in its plan to put the budget into surplus, excluding interest payments, by 2020, according to a report… ‘Doubts about long-term fiscal sustainability could lead to a jump in the sovereign risk premium, forcing abrupt further fiscal adjustment with adverse feedback to the financial system and the real economy,’ the IMF said. ‘Japan’s extremely high financing needs point to vulnerabilities to changes in market perceptions.’ The Bank of Japan should stand ready to increase monetary stimulus further and provide stronger guidance to markets, the IMF said…”

July 23 – Bloomberg (Isabel Reynolds): “Spending hours defending his security policies on television, scrapping a $2 billion Olympic stadium plan and playing up concerns about China, Japanese Prime Minister Shinzo Abe is battling to claw back a slide in support. His approval rating plunged below 40% in polls taken after he pushed bills through parliament last week to expand the role of Japan’s military. While he’s at no immediate risk of being ousted, he must avoid dropping into the danger zone around the 20% mark at which successive premiers have been toppled at the ballot box or by their party.”