Saturday, October 10, 2015

Weekly Commentary: Courage to Print

Dr. Bernanke has referred to understanding the forces behind the Great Depression as the “Holy Grail of Economics.” I believe understanding the ongoing Bubble period offers the best opportunity to discover the “Grail.” When the Washington establishment believed THE Bubble had burst back in 2000/2001, the leading academic espousing inflationism was beckoned to Washington to provide cover for the Fed’s experimental post-tech Bubble reflationary measures. He first served as a member of the Board of Governors of the Federal Reserve System (2002), before being appointed chairman of the President’s Council of Economic Advisors (2005). From the day Ben Bernanke burst onto the scene in 2002, I’ve taken strong exception with his economic doctrine and analysis.

I have yet to read his new memoir. However, I listened attentively this week as he blanketed the airwaves. As I’ve done on occasion for going on 13 years now, I highlight some of Bernanke's thinking (and provide brief comments).

CNBC’s Steve Liesman: “His new book, ‘The Courage to Act – A memoir of a Crisis and Its Aftermath,’ details what he calls ‘the darkest days of the financial crisis when’ he quote ‘stared into the abyss and the behind the scenes struggle to enact innovative policies that he believed saved the economy’… Are you surprised and are you disappointed that after six years of zero percent interest rates – a four and one-half trillion dollar balance sheet – that this economy still struggles with 2% growth?”

Bernanke: “The low growth is coming not from the recession, per se. We’ve come back quite a bit. Unemployment is down to 5%. So we’ve come pretty close to full employment. The slow growth is coming from slow productivity growth. Output per worker has not been growing quickly, and why that’s happening is not totally understood. I don’t think it has much to do with monetary policy. It has to do with the waves of intervention. We saw slowing of productivity growth even before the crisis. So I think that’s part of it. But clearly one of the issues is that we’ve been relying too much on the Fed. The Fed has been the only game in town. It’s been doing most of the policy heavy lifting for the last few years. We need to see more action from other policymakers.”

(Noland: Experimental ultra-loose monetary policies and activist market intervention – along with attendant serial financial Bubbles – over the past twenty years have had a profound impact on the underlying economic structure. These Bubble periods have witnessed profound economic maladjustment that is certainly a major factor behind poor productivity and growth dynamics).

Liesman: “But when you think about six years of zero percent, wouldn’t you have expected that at some point in time that there would have been this pop – that we wouldn’t be doing what we did, for example, in the first quarter 0.6% growth, and concerns almost every quarter that we’re going back into recession.”

Bernanke: “Well, in a slow growth low real return economy – not just in the U.S. but everywhere. And compare the United States with Europe, compare us with Japan and other industrial countries – we’ve been making more progress. I’m not saying things are great. I don’t mean to say that at all. But monetary policy can only do basically two things: It can keep inflation low and stable and it can help the economy come back from recession. And both of those things are happening. More growth has got to come from productivity; it's got to come from capital investment. Those things need some help from other policymakers.”

(Noland: At this point, the entire global economy has been badly impaired by years of flawed monetary management, recurring boom and busts and unprecedented distortions and imbalances. Inflationary monetary policy can inflate asset prices and widen the divergence between inflated markets and deflating economic prospects. Moreover, inflationary monetary policies are especially destabilizing after an extended period where financial returns outperform real economy returns.)

CNBC’s Becky Quick: “Is that a suggestion that this is kind of the new normal. It’s going to be very difficult to fix this.”

Bernanke: “If you look around the world it’s not just the United States. Real interest rates are low everyplace. And we’ve got what I used to call ‘the global savings glut.’ There’s a lot of savings looking for return. There’s not that much in terms of really high return investments available. I think that’s not Fed policy. I think that’s just where the world is right now.”

CNBC’s Joe Kernen: “It could be QE over there too, though.”

Bernanke: “Well, if it were true – if there were lots of high return investments available then you’d be seeing more capital investment than you’re seeing. So I don’t think it can be QE, no.”

(Noland: Having argued against the “global savings glut” thesis throughout the mortgage finance Bubble period, its reemergence is beyond annoying. The paramount issue was never some mythological surplus of “savings,” but instead excessive expansion of Credit, “money” and leveraged speculation.)

Liesman: "So would you weigh in on what Stan Fischer spoke about just last Friday, which is this notion of - should monetary policy be used to create or to worry about financial instability, in the sense that you would raise rates now in order to ward off some of the excesses that Joe was talking about?”

Bernanke: “Well, it should be a last resort because you have to raise rates an awful lot, for example, to have the kinds of effects Joe was concerned about. And we don’t even know very much about what the linkages are. I mean, arguably, if the economy is really weak because you raised rates too soon that could cause financial problems as well. So the right thing to do first is do everything you can on the regulatory, supervisory, macroprudential front. And then, if nothing else works, then you can think about monetary policy. But it's really self-defeating to use the wrong monetary policy…”

(Noland: It’s the same failed asymmetrical policy approach – only much grander – that led to serious market Bubble distortions for more than 20 years now. The Fed slashed rates and added massive liquidity during the 2008/09 financial crisis. And during 2013 and 2014, the Fed added $1.6 TN of additional liquidity in a non-crisis backdrop. The Fed has gone so far as to assure the markets that it will “push back against a tightening of financial conditions” – i.e. a “risk off” market backdrop. On the other side of the equation, the Fed supposedly has macroprudential tools it is to employ to ward off financial excess that risks financial instability. Essentially, the markets fully anticipate the use of “whatever it takes” QE in the event of faltering markets. On the other hand, macroprudential to counter market excess has zero market credibility.)

Liesman: “Except there’s an assumption in there, which you've already proven wrong and you were at the helm when this happened, which is you missed the bubble. You missed it - '07. Eventually, as the book chronicles, you come to see the seriousness of what's happening. What assurances can you give anybody in the public that the Fed will see the next bubble coming?”

Bernanke: “Well, you can't. You can't. But it wasn't - I think that misrepresents what we saw and what we didn't see. We knew house prices were really high. We knew that subprime mortgages were a problem. What we didn't see was the extent to which the financial system was endangered and driven into panic by that problem. Subprime mortgages were a relatively small asset class. But what happened was that they created distrust by investors in all different kinds of securitized assets - and caused a panic that caused money being drawn out of all different kinds of assets. And that panic is what really created the crisis. So it wasn't the fact we didn't know house prices were high. We knew house prices were high. But what was the problem was the weakness in the financial system itself. And there, the first line of defense has got to be more capital, tougher oversight. Those sorts of things to make the system more resilient to whatever shock comes along.”

(Noland: Subprime was definitely not the fundamental issue. Instead, mortgage finance Bubble excesses had seen almost a doubling of mortgage Credit in six years. Bubble distortions had created historic mispricing throughout the Credit market, certainly including Trillions of MBS, ABS, agency securities and corporate debt. A Credit boom had inflated asset prices, perceived wealth, spending, corporate profits and incomes. Over years the Bubble had become deeply systemic. Inevitable risk aversion and a tightening of financial conditions at the Periphery – subprime – unleashed contagion that would ensure a bursting of the Bubble at the Core (home to Trillions of mispriced securities and derivatives). Market panic, deleveraging and an abrupt collapse in Credit growth almost led to system collapse.)

Quick: “We had one market watcher who joined us earlier this morning, Mark Grant. And he suggested that the Fed should sell down or let run off some of its balance sheet - a trillion dollars. Let that run off before they raise interest rates. What do you think about an idea like that?”

Bernanke: “Well, Joe had an earlier comment about how are we going to get out of $4 trillion, that kind of thing. That's actually not a big issue. You know, when the time comes, the Fed is just going to let the balance sheet run off. And that's pretty straightforward. I don't think that's going to create any particular problems. But I think that the concern is that they have less knowledge about how that would work; how that would affect the markets than they do about how short term interest rates would. And so the plan - and the Fed has been very clear about this, is to begin by raising short-term interest rates, which they can absolutely do, even if the balance sheet is still $4 trillion. And then, if the economy is still making forward progress then they can stop reinvesting and the balance sheet will passively run off over time.”

(Noland: Shrinking the Fed’s balance sheet is a big issue. When the Fed articulated it’s so-called “exit strategy” back in 2011, I titled a CBB “No Exit.” The Fed’s balance sheet has more than doubled since 2011. I believe the odds that the Fed again doubles its holdings are significantly greater than those that it will shrink its balance sheet in half.)

Bloomberg’s David Westin: “Monetary policy versus regulatory functions for the Fed, and you talk – page 92 I know it is – you talk about the fact that monetary [policy] wasn’t really the approach that needed to be taken when it came to the bubble in mortgages. And you say in a 2002 speech, ‘financial regulation supervision should be the first line of defense against asset price bubbles and other risks to financial stability.’ Has that been corrected now? There was a regulatory fail, wasn’t there that led to this?”

Bernanke: “Yes, absolutely.” …“So I think the critique of the Fed prior to the crisis – I think a lot of it was focused on monetary policy. People who have looked at it carefully, generally agree that monetary policy was not the main reason for the housing bubble. But one way the Fed was responsible was with other regulators that didn’t do enough to prevent the bad mortgage lending. And there’s a lot of reasons for that. One reasons was that there was this very strong political support for subprime lending because it was creating home ownership so broadly. So I thought that was the main…”

(Noland: I have “looked at it” quite carefully. Monetary policy was indeed the main reason for the mortgage finance Bubble. There is no way mortgage Credit – especially risky loans – would have continued expanding rapidly for years had the marketplace not been convinced that the Fed would aggressively backstop marketplace liquidity and ensure there were no financial crises or severe recessions. The Greenspan/Bernanke puts were instrumental in what became essentially insatiable market appetite for high-yielding MBS, ABS, CDOs and other derivatives.)

Fox’s Maria Bartiromo: “What do you say to those critics now, so many years later who everybody now can judge you, and they judged you from the moment we sort of got to dry land, what do you say to them who say, ‘look, we shouldn’t be bailing out anybody, you guys bailed out everybody, and that’s not the way the Constitution should go, that’s not democracy – that’s not Capitalism?’”

Ben Bernanke: “Well sure. Somebody once said that 'Capitalism without bankruptcy is like Christianity without hell,' basically. You need to have market discipline and all that. But in the middle of the most intense financial crisis in the history of the United States – maybe the history of the world – we had to do whatever we could to keep the system from falling apart. And that’s what we did. And, if anything, the effects of the financial panic on the U.S. economy were even bigger than I thought. And I was very much concerned about that. Now, once the crisis was over, absolutely, everything we could do to make sure it didn’t happen again. To make sure banks are sufficiently well capitalized. That they’re not going to be too big to fail. All those things are really important. But in the middle of a crisis you can’t do that.”

(Noland: I argued at the time of the crisis that, of course, policymakers would not allow the system to collapse. But I also warned against actions that carried a serious risk of inflating an especially dangerous Bubble at the heart of “money” and Credit. By no later than 2011, the Fed needed to have taken steps to nudge the financial markets back in the realm of “market discipline and all that.” Rather, it did the exact opposite. Pushing experimental central banking to “open-ended” QE in 2012 was a monumental mistake. Further delaying “normalization” and telegraphing a willingness to “push back against a tightening of financial conditions” in 2013 only compounded the error. Bank capital is not at this point a leading issue – not with tens of Trillions of securities mispriced these days on a global basis.)

Fox’s Greta Van Susteren: “Was this a fun job being chairman of the Federal Reserve?”

Bernanke: “Well, it was an interesting job, that’s for sure. As an economist, I sure learned a lot. But I didn’t really bargain for having history’s greatest financial crisis and deep recession to deal with. No.”

(Noland: “History’s greatest financial crisis” is a stretch – expedient used to rationalize what I believe history will eventually judge as disastrous inflationary policies. Besides, he should have been prepared. Dr. Bernanke, after all, was the Fed governor espousing “helicopter money” and the “government printing press.” The proponent of such radical monetary management should have been on guard for what evolved into relatively conspicuous financial and economic excess. The crisis was predictable.)

Van Susteren “Were there nights in 2008 where you couldn’t even sleep? Were we on the cliff?”

Bernanke: “Absolutely. We are on the cliff and I was in my office on that red sofa trying to stay awake and be on the conference calls. It was a very, very tough time. Particularly in about September and October of 2008.”

The Wall Street Journal’s Jon Hilsenrath: “I want to talk to you a little bit about inflation. You’ve said before, all the way back to your earlier writings on Japan, that a central bank can create inflation if it has the will to do so. Inflation in the United States has been running below the Fed’s 2% target for more than three years now. How do you explain that and has the Fed not done enough to create the inflation that it’s supposed to create?”

Bernanke: “Well, a more accurate statement about creating inflation would be that ‘so long as fiscal policy is at least reasonably cooperative.’ And throughout this past few years, fiscal policy has been either restrictive or at best neutral. So that has been a bit of a drag on that side. The Fed’s doing what it can to get inflation back up to target. But there are a number of things going on: First of all, is the fact that the recovery has been relatively slow and so slack has been absorbed at a reasonably good pace, but probably there’s still a bit of slack left. And secondly, we’ve been hit with what I guess you can call reverse supply shocks. In the seventies we were worried about big increases in oil prices. Now we’re seeing declines in oil prices and a strengthening of the dollar. Those things are depressing near-term inflation. It’s only a longer-term issue if they lead to inflation expectations beginning to move down. And I think there is some uncertainty about that as well. So, between remaining slack and global influences like commodity prices, I think that explains where we are. But getting inflation back up to 2% is a critical thing to accomplish. It’s really at the center of the debate of what the Fed should be doing going forward.”

(Noland: The world would be a much safer place if central bankers accepted the reality that they do not control the nature of inflationary effects. And this would not change if monetary and fiscal polices were orchestrated in tandem by a single central committee.)

Hilsenrath: “You describe in the book how you came to Washington a Republican and left public office an Independent. What changed in the process?”

Bernanke: “I didn’t really change. The political environment changed. I’ve always been moderate in my inclinations. As an economist I was very market oriented, so that put me more on the Republican side. But I was very unhappy with the big increase in partisanship in Washington – the inability to get things done and the increasing influence of the far right and far left in the debates, which was in my view, it’s fine to bring in different points of view, but if it means you can never get anything done – that you're basically going to be focused on shutting down the government –those kinds of things. I thought that was very counterproductive. And so in particular, I was unhappy with both extremes, but on the right – the populist Republican perspective was very anti-Fed and very opposed to what we had done. Obviously, it would be a little inconsistent for me to support the view that went against what we had done…”

(Noland: This is another one of those instances where the monetary administrators somehow remain oblivious to the profound effects of their inflationary monetary mismanagement. As I’ve argued over the years (paraphrasing the late Dr. Kurt Richebacher), the only cure for Bubbles is to not let them inflate. Bubbles, after all, are mechanisms of wealth redistribution and destruction. A burst major Bubble will leave in its wake tremendous social and political tension. These serial booms and busts have inflicted terrible damage upon our great country – economically, socially, politically and geopolitically. Indeed, inflationism is the leading cause of our troublingly divided country – as well as an increasingly fractious world. It was an issue near and dear to the hearts of our nation’s Founding Fathers. And this type of experimental inflationary monetary policy should never have been decided by a small group of unelected officials. One cannot overstate the ramifications and consequences of printing Trillions of dollars and grossly manipulating the financial markets.)

Hilsenrath: “Wasn’t the global savings glut a precursor to the housing bubble?”

Bernanke: “My thinking about this now is that the global savings glut probably kept rates a bit lower than they otherwise would have been. But my thinking about this is a little more complicated now. I think that the sequence of causation was more like this: There was this huge global savings glut – and there was this huge demand for liquid, safe assets. There were not enough Treasuries to go around. And so Wall Street very creatively began to create these supposedly safe assets, which were in fact the AAA tranches of securitized securities that inside included lots of different kinds of credits, including subprime mortgages, for example. And I would argue that the securitized credits were in fact one of the sources of the crisis – I think everyone would agree with that actually. But one of the reasons they were created in the first place in such large amounts, was it was Wall Street responding to the global demand for safe assets. And I think that was one of the mechanisms which the savings glut generated the risky situation that ultimately led to the crisis.”

(Noland: Actually, Wall Street was responding to what was at the time insatiable demand for perceived high-yielding safe – “money-like” assets. I invoked “Moneyness of Credit” throughout the Bubble period. Importantly, however, Dr. Bernanke’s thinking is flawed as to cause and effect. Global liquidity excesses were the consequence of rampant U.S. mortgage Credit growth and speculative leveraging, with attendant trade deficits and financial outflows inundating the world with dollar balances. Much of this dollar liquidity was then recycled back into the U.S. Credit system through the purchase of mortgage-related securities - MBS, ABS, GSE, CDOs and other derivatives. It was a historic episode of self-reinforcing Credit excess and market mispricing that were certainly discernable in real time.)

Hilsenrath: “Should we be worrying about the risk of another bubble given everything you’ve just described?”

Bernanke: “One thing we learned is that you should always be worrying about financial risks. I just want to say, while I was chair the Federal Reserve made some very substantial internal changes to create new capacities – including what is called The Office of Financial Stability. Which means relative to before the crisis, the Fed is now putting huge amounts of staff resources into monitoring the whole financial system…”

Question from Twitter: “Does chairman Bernanke think there are asset bubbles in the global markets now?”

Bernanke: “I don’t see any obvious major mispricings – nothing that looks like the housing bubble before the crisis, for example. But you shouldn’t trust me. What you should do is make your own judgments about individual asset prices. And what the Fed is doing of course is again monitoring very closely all of these different asset categories and trying both to determine if there is some downside risk and, if the downside risk occurs, what would the implications be for the broader system. One of the things I learned from our experience in the crisis was with respect to the housing bubble, the Fed spent a lot of time debating ‘Is it a bubble – isn’t it a bubble? If it is a bubble how big is it?’ That was the wrong way to think about it I think. The right way to have thought about it I think: ‘We don’t know if it’s a bubble. It might be. If it bursts, what’s the worst that can happen?’ And I think that looking at the worst-case-scenario was the right way to do it and the Fed didn’t do enough of that…”

Hilsenrath: “That implies that, the Fed this time around, if it faces some set of questions about whether there’s a bubble will be potentially more proactive either using regulatory tools or monetary policy to address it. Do you think that’s the case?”

Bernanke: “Based on the experience of the crisis, I think if anyone needed convincing that financial crisis or large speculative bubbles are dangerous I think they should be convinced now. So yes, so the Fed has changed its perspective. Formally speaking, the Fed has switched from being a so-called microprudential regulator that’s focused on a narrow set of institutions and markets – to a macroprudential regulator which means that in addition to looking at individual firms and markets is trying to assess the stability of the overall system. And that’s critical and to the extent there are risks that are apparent – either in terms of the structure of the system or in terms of building mispricings or other problems, the Fed needs to be proactive working with other regulators.”

(Noland: The Fed needs to extricate itself from manipulating the financial markets. It needs to end backstopping market liquidity. It must never again print Trillions of new “money” out of thin air. Because so long as the marketplace perceives that the markets are "too big to fail", there will be speculative excess, major securities markets mispricings and Bubble fragilities. No one – average investor or sophisticated financial operator – has a clue as to the degree Fed policies have distorted asset prices. A credible macroprudential regulator would not promote securities market inflation. And when it comes to courage, history has shown it takes tremendous courage to halt monetary inflation.)

I’ll briefly address the markets. What a week. When I commenced writing the previous week’s CBB - a week ago Friday morning - the Dow was 1,000 points lower. The VIX was 24. It closed this week at 17.08, the low since prior to the August “flash crash.” The Transports gained 4.8% this week. The small cap Russell 2000 surged 4.7%. The Morgan Stanley High Tech Index jumped 4.0%. The HUI index rose 16.3%. Stunning U.S. stock gains were outdone overseas. The German DAX surged 5.7%. Spanish stocks rose an incredible 7.4%. EM equities rallied sharply. Russian stocks jumped 7.2%. Brazilian equities rose 5.2%. Hong Kong’s financial stock index jumped 7.1%. The Shanghai Composite gained 4.3%.

The currencies and commodities were as crazy as stocks. The Brazilian real rallied 4.3% and the Indonesian rupiah surged 8.4%. The Russian ruble rallied 7.3%, the Malaysian ringgit 6.5%, the Colombian peso 5.0%, the South Korean won 3.1%, the Turkish lira 2.7% and the South African rand 2.8%. Big moves were not limited to EM. The Australian dollar surged 4.1% and the New Zealand dollar jumped 4.0%. The Norwegian krone gained 3.5%. The Goldman Sachs Commodities Index surged 5.9%. Crude oil jumped 8.7%. Silver rose 3.8% and copper rallied 2.9%. Wild stuff.

It was a brutal week not only for the bears. Hedging strategies came unglued. Long/short strategies suffered in the chaos. Trend-following momentum strategies were crushed by abrupt reversals in equities, Credit, currencies and commodities. In short, there appeared to be a lot of panic buying and considerable mayhem.

Over recent years, painful short squeezes often provided lift-off for another bull market leg higher. To be sure, once squeezes gain a head of steam, predicting when they’ve run their course tends to be tricky business. But I’m sticking to the view that the global Bubble has burst and contagion has set its sight on the Core. Despite this week’s powerful squeeze, I don’t believe markets have overcome deleveraging/de-risking pressures. I expect wild volatility to continue to weigh on leveraged currency “carry trades.” I would be surprised if the hedge fund community doesn’t suffer year-end outflows. And I certainly don’t think we’ve heard the last of China’s financial and economic woes. Yet in these unstable markets, anything can happen.

For the Week:

The S&P500 jumped 3.3% (down 2.1% y-t-d), and the Dow gained 3.7% (down 4.1%). The Utilities increased 1.1% (down 8.7%). The Banks recovered 2.1% (down 4.6%), and the Broker/Dealers rallied 2.1% (down 9.0%). The Transports surged 4.8% (down 9.7%). The S&P 400 Midcaps jumped 4.1% (down 0.7%), and the small cap Russell 2000 surged 4.7% (down 3.3%). The Nasdaq100 gained 2.4% (up 3.2%), and the Morgan Stanley High Tech index jumped 4.0% (up 4.1%). The Semiconductors rose 3.5% (down 8.4%). The Biotechs dropped 2.6% (up 0.3%). With bullion gaining $17, the HUI gold index surged 16.3% (down 18.7%).

Three-month Treasury bill rates ended the week at zero. Two-year government yields rose six bps to 0.64% (down 3bps y-t-d). Five-year T-note yields jumped 11 bps to 1.40% (down 25bps). Ten-year Treasury yields rose 10 bps to 2.09% (down 8bps). Long bond yields gained 10 bps to 2.92% (up 17bps).

Greek 10-year yields sank 34 bps to 7.57% (down 218bps y-t-d). Ten-year Portuguese yields gained 11 bps to 2.39% (down 23bps). Italian 10-yr yields increased six bps to 1.69% (down 20bps). Spain's 10-year yields rose five bps to 1.82% (up 21bps). German bund yields jumped 10 bps to 0.61% (up 7bps). French yields rose 10 bps to 0.99% (up 16bps). The French to German 10-year bond spread was unchanged at 38 bps. U.K. 10-year gilt yields jumped 16 bps to 1.86% (up 11bps).

Japan's Nikkei equities index surged 4.0% (up 5.7% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.31% (down one bp y-t-d). The German DAX equities index jumped 5.7% (up 3.0%). Spain's IBEX 35 equities index surged 7.4% (up 0.3%). Italy's FTSE MIB index jumped 4.0% (up 17.1%). EM equities were much higher. Brazil's Bovespa index rallied 5.2% (down 1.3%). Mexico's Bolsa surged 3.8% (up 2.9%). South Korea's Kospi index jumped 2.5% (up 5.4%). India’s Sensex equities index rose 3.3% (down 1.5%). China’s Shanghai Exchange surged 4.3% (down 1.6%). Turkey's Borsa Istanbul National 100 index surged 6.5% (down 7.6%). Russia's MICEX equities index jumped 7.2% (up 23.8%).

Junk funds this week saw inflows of $735 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates dropped nine bps to a 23-week low 3.76% (down 11bps y-t-d). Fifteen-year rates fell eight bps to 2.99% (down 16bps). One-year ARM rates rose two bps to 2.55% (up 15bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 3.90% (down 38bps).

Federal Reserve Credit last week declined $1.3bn to $4.447 TN. Over the past year, Fed Credit inflated $35bn, or 0.8%. Fed Credit inflated $1.636 TN, or 58%, over the past 152 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $5.2bn last week to a 10-week low $3.329 TN. "Custody holdings" were up $35.4bn y-t-d.

M2 (narrow) "money" supply dropped $46.6bn to $12.182 TN. "Narrow money" expanded $720bn, or 6.3%, over the past year. For the week, Currency increased $2.0bn. Total Checkable Deposits fell $11.4bn, and Savings Deposits dropped $34.4bn. Small Time Deposits slipped $1.1bn. Retail Money Funds declined $1.8bn.

Money market fund assets jumped $19.5bn to $2.688 TN. Money Funds were down $44.6bn year-to-date, while gaining $57bn y-o-y (2.2%).

Total Commercial Paper surged $86.5bn to $1.044 TN. CP increased $37bn year-to-date.

Currency Watch:

The U.S. dollar index dropped 1.1% to 94.89 (up 5.1% y-t-d). For the week on the upside, the Brazilian real increased 4.3%, the Australian dollar 4.1%, the New Zealand dollar 4.0%, the Norwegian krone 3.5%, the South African rand 2.8%, the Mexican peso 2.0%, the Swedish krona 1.9%, the Canadian dollar 1.6%, the euro 1.3%, the Swiss franc 1.0% and the British pound 0.9%. For the week on the downside, the Japanese yen declined 0.3%.

Commodities Watch:

The Goldman Sachs Commodities Index surged 5.9% (down 9.2% y-t-d). Spot Gold increased 1.6% to $1,157 (down 2.4%). December Silver jumped 3.8% to $15.82 (up 1.4%). October Crude surged $3.97 to $49.63 (down 6.8%). October Gasoline jumped 5.1% (down 4%), and October Natural Gas increased 1.2% (down 13.5%). December Copper jumped 2.9% (down 14.6%). December Wheat slipped 0.8% (down 14%). December Corn was down 1.7% (down 4%).

Global Bubble Watch:

October 6 – Wall Street Journal (Min Zeng and Lingling Wei): “Central banks around the world are selling U.S. government bonds at the fastest pace on record, the most dramatic shift in the $12.8 trillion Treasury market since the financial crisis. Sales by China, Russia, Brazil and Taiwan are the latest sign of an emerging-markets slowdown that is threatening to spill over into the U.S. economy. Previously, all four were large purchasers of U.S. debt… Foreign official net sales of U.S. Treasury debt maturing in at least a year hit $123 billion in the 12 months ended in July, according to Torsten Slok, chief international economist at Deutsche Bank Securities, the biggest decline since data started in 1978. A year earlier, foreign central banks purchased $27 billion of U.S. notes and bonds.”

October 7 – Bloomberg (Stephen Morris): “Global financial firms’ estimated $100 billion or more exposure to Glencore Plc may draw more scrutiny as regulatory stress tests approach after the commodity giant’s stock plunge this year, according to Bank of America Corp. Bank shareholders and regulators may be concerned that Glencore’s debt and trade finance deals, of which a ‘significant majority’ are unsecured, will reveal higher-than-expected risk and require more capital once the lenders are put through U.S. and U.K. stress tests, BofA analysts said… Adding an estimated $50 billion of committed lines to the company’s own reported gross debt, the analysts say financial firms’ exposure may be three times larger than Glencore’s reported adjusted net debt of less than $30 billion. ‘The banking industry may have significantly more exposure to Glencore than is generally appreciated in the market,’ analysts including Alastair Ryan and Michael Helsby said in a note titled ‘The $100 Billion Gorilla In the Room.’”

October 7 – CNBC (Kate Kelly): “A new report estimates that Bank of America, Citigroup, JPMorgan Chase, and Morgan Stanley have lent $350 million apiece to the troubled commodity giant Glencore PLC — meaning they will be on the hook for potential losses if things deteriorate at the trading and mining company. In a note issued late Wednesday afternoon, analysts at CreditSights used accountings of bank loans prepared by the data firm Dealogic to estimate who had lent what to Glencore as part of its $15.3 billion revolving credit facility. The analysts deduced that ‘North American banks accounted for 20%’ of the revolver, according to the note, with four major U.S. banks taking the lead and four Canadian banks in similar positions.”

October 2 – Reuters (Svea Herbst-Bayliss): “U.S. hedge funds are bracing for their worst year since the 2008 financial crisis after a dramatic sell-off in healthcare and biotechnology stocks triggered double-digit losses for some prominent players last month. September's sucker punch in the biotech sector, on top of a grim August when global markets tumbled due to fears about slowing growth in China, have pushed many hedge fund managers deep into the red. ‘These are some of the worst numbers we have seen since the crisis,’ said Sam Abbas, whose Symmetric IO tracks hedge fund managers' returns… While the biotech sector held up relatively well during the initial market sell-off in August, it cratered in September. ‘It was the last remaining bastion of alpha and a sector where many hedge funds were hiding. Now it has succumbed,’ said Peter Rup, chief executive and chief investment officer at Artemis Wealth Advisors Llc, which invests in hedge funds.”

October 7 – UK Telegraph (Mehreen Khan): “Governments and central banks risk tipping the world into a fresh financial crisis, the International Monetary Fund has warned, as it called time on a corporate debt binge in the developing world. Emerging market companies have ‘over-borrowed’ by $3 trillion in the last decade, reflecting a quadrupling of private sector debt between 2004 and 2014, found the IMF's Global Financial Stability Report. This dangerous over-leveraging now threatens to unleash a wave of defaults that will imperil an already weak global economy, said stark findings from the IMF's twice yearly report.”

China Bubble Watch:

October 6 – Bloomberg (Enda Curran): “As China’s leadership steps on the economic-stimulus gas pedal, there’s one image in the rear-view mirror that looms large. Then-Premier Wen Jiabao’s cabinet unveiled a $586 billion program to boost growth in the depths of the 2008 global credit turmoil, a move that opened the floodgates for a record debt surge that current Premier Li Keqiang and President Xi Jinping have had to cope with. Unlike that binge, Li and Xi are opting for targeted measures, more of which were unveiled last week… ‘The more cautious approach towards stimulus reflects concerns among Chinese policymakers about the massive expansion in credit that occurred in China during 2009-2010, which has created significant new imbalances and problem loans in the Chinese financial system,’ said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight in Singapore.”

October 7 – Bloomberg (Lianting Tu): “As a rout in Chinese stocks this year erased $5 trillion of value, investors fled for safety in the nation’s red-hot corporate bond market. They may have just moved from one bubble to another. So says Commerzbank AG, which puts the chance of a crash by year-end at 20%, up from almost zero in June… The boom contrasts with caution elsewhere. A selloff in global corporate notes has pushed yields to a 21-month high, and credit-derivatives traders are demanding near the most in two years to insure against losses on Chinese government securities. While an imminent collapse isn’t yet the base-case scenario for most forecasters, China’s 42.1 trillion yuan ($6.6 trillion) bond market is flashing the same danger signs that triggered a tumble in stocks four months ago: stretched valuations, a surge in investor leverage and shrinking corporate profits… ‘The Chinese government is caught between a rock and hard place,’ said Zhou Hao, a senior economist in Singapore at Commerzbank… ‘If it doesn’t intervene, the bond market will actually become a bubble. And if it does, the market could crash the way the equity market did due to fast de-leveraging.’”

October 8 – Bloomberg (Justina Lee): “China’s credit guarantees, lauded by Premier Li Keqiang for helping fund smaller firms, are backfiring as a slowing economy risks causing a chain of defaults. Failures of guaranteed loans surged 86% last year to about 400 billion yuan ($63bn), according to UBS Group AG. At the nation’s Big Five lenders, such borrowings made up 18% of the total and 29% of non-performing financing… Standard & Poor’s said specialist guarantee firms are suffering, while the industry’s second-largest company halted operations amid accusations that it took on too much financial risk. Credit guarantees, which began as a way to help smaller firms obtain funding by merging the risks of various borrowers, have now expanded to cover debt such as bonds issued by cash-strapped local-government financing vehicles and online peer-to-peer loans. The business works on the assumption that borrowers are unlikely to default at the same time, a premise that collapsed in the U.S. during the global financial crisis when slumping home prices sparked a chain reaction of defaults… China’s guarantee firms backed 2.6 trillion yuan of loans as of end-2014, an 18% increase from the previous year, Moody’s… data show. They also provided surety for 56.3 billion of new bonds, 79% more than in 2013, China Chengxin International Credit Rating Co. said.”

October 3 – Reuters (Kevin Yao): “China is studying plans to curb currency speculation even as it seeks to quicken the process of making the yuan trade freely, a deputy central bank governor said. Beijing will further open up its capital markets and develop its foreign exchange market as it aims to ‘accelerate the renminbi convertibility on the capital account,’ Yi Gang wrote in an article published in China Finance magazine, a central bank publication. The yuan is also known as renminbi. While the yuan is already convertible under China's current account, the broadest measure of trade in goods and services, the capital account, which covers portfolio investment and borrowing, is still subject to restrictions due to worries about abrupt capital flight and hot money inflows.”

October 6 – Financial Times (Gabriel Wildau): “China’s stock index futures market, once the world’s most vibrant, has been decimated in recent weeks by new regulations designed to discourage bearish speculators blamed for a stock market rout. Share trading resumes in China on Thursday after a string of public holidays since the end of September and comes as futures trading volume averaged only 127,000 contracts per day last month. Just a few months ago, futures contracts based on the CSI 300 index, which tracks the largest companies traded in Shanghai and Shenzhen, were the most heavily traded in the world. Daily volume in July averaged 1.7m contracts, higher than the 1.5m for S&P 500 futures traded in Chicago. Trading volume spiked when China’s stock market began its dramatic tumble in late June, as investors rushed to hedge their long positions or bet on further declines. Then regulators stepped in with a crackdown, sinking volumes. The campaign started with a police investigation into so-called ‘malicious short selling’ in the futures market but later expanded into new rules that raise the cost of futures trading.”

Fixed Income Bubble Watch:

October 4 – Bloomberg (Andrea Wong and Anchalee Worrachate): “More and more, bond traders are drawing the same conclusion: central bankers globally are coming up short in their attempts to combat the world’s economic woes. Even after hundreds of interest-rate cuts and trillions of dollars in quantitative easing, the bond market’s outlook for inflation worldwide is approaching lows last seen during the financial crisis. In the U.S., Europe, U.K., and Japan, those expectations are now weaker than they were before their respective central banks began their last rounds of bond buying. That’s leading investors to write off the Federal Reserve’s chances of raising interest rates this year and increase their bets that it will tighten less than policy makers forecast in the years to come. Speculation has also increased that the European Central Bank and Bank of Japan will need to step up their quantitative easing in the face of deflationary pressures, despite statements to the contrary from their own officials. ‘There’s a lack of faith in monetary policy -- you’ve thrown the kitchen sink at it, you’ve cut rates to zero, you’re printing money -- and still inflation is lower,’ said Lee Ferridge, the head of macro strategy for North America at State Street Corp. ‘It leads to a risk-off environment.’”

October 8 – Reuters (Sam Forgione): “Investors in U.S.-based funds pulled $36.2 billion out of taxable bond funds in the third quarter, marking the biggest outflows from the funds since the fourth quarter of 2008, preliminary Lipper data showed… Funds that hold investment-grade corporate bonds posted $30.6 billion in outflows over the quarter to mark their biggest quarterly outflows since Lipper records began in 1992…”

October 4 – Bloomberg (Manuel Baigorri Ruth David): “Worried about China’s economic slowdown, oil at its lowest price in six years or Volkswagen AG’s diesel scandal? Dealmakers aren’t. Yet. More than $1 trillion of mergers and acquisitions were announced in the third quarter, over 20% higher than the same period last year… And that’s without including what could be the biggest acquisition of the year -- Anheuser-Busch InBev NV’s intention to make a takeover proposal for rival brewer SABMiller Plc… Forget a quiet summer; M&A markets just had their busiest September on record. Companies are still hungry for deals, and willing to pay large premiums for major M&A opportunities…”

Central Bank Watch:

October 6 – CNBC (Matthew J. Belvedere): “Federal Reserve policymakers should not wait until inflation rises to their 2% target to increase interest rates, former Dallas Fed President Richard Fisher said… ‘Just because it's not at 2% doesn't mean you don't start the process because this is a huge tanker going through the sea and you start slowing down way out before you dock,’ Fisher told CNBC's ‘Squawk Box’… Former Fed Chairman Ben Bernanke argued strenuously on the program Monday that the central bank's 2% target is sacrosanct. ‘Easy money is justified by the need to get inflation up to the target,’ he said on CNBC, making his case for why the Fed should not rush to increase rates.”

Leveraged Speculation Watch:

October 5 – Financial Times (Miles Johnson, Michael Mackenzie and Dan McCrum): “Hedge funds have suffered their biggest monthly monetary loss since the 2008 financial crisis in the wake of market turbulence that battered the portfolios of some of the industry’s best known investors. The sector as a whole lost $78bn due to its performance in August, the worst monthly absolute fall in assets since October 2008… according to research by Citi… Total hedge fund industry assets at the end of August stood at $3.05tn, according to Citi, down 0.2% year on year. Total hedge fund assets have doubled since 2008, according to HFR… While final numbers are not yet in for September many in the industry expect an acceleration in losses across stocks and bonds. Anthony Lawler, a portfolio manager at GAM, said the broad based nature of the recent sell-off was particularly painful for hedge funds that had bet hard on sectors or companies they believed were undervalued. ‘Well researched equities held by stock pickers can perform badly, not because they are a bad pick, but because they are held by a concentrated group of people who can be forced to reduce or sell when the market turns south,’ he said.”

U.S. Bubble Watch:

October 7 – Bloomberg (Alex Barinka and Caroline Chen): “The biotechnology sector’s two-and-a-half-year deluge of public market debuts, with dozens of companies raising billions of dollars in funding, has ground to a halt. After CytomX Therapeutics Inc. priced its initial public offering late Wednesday, not a single biomedical, drug or therapeutics company is expected to follow suit in the next 30 days. That would make this the slowest monthlong period for IPOs for those industries since February 2013… The lull follows two of the highest-flying years in at least the past decade and a half: in 2013, a record $7.1 billion was raised from 50 biopharmaceutical IPOs that began trading, while the following year’s record 81 offerings brought in a total of about $6 billion…”

EM Bubble Watch:

October 3 – Financial Times (Avantika Chilkoti): “Concern over external debt in corporate Indonesia is mounting as companies seek to roll over more than $42bn of foreign currency loans within the next 12 months, following a period of steep rupiah depreciation. External debt is a red flag to investors. It added fuel to the Asian financial crisis of 1997-98, as ravaged currencies magnified foreign currency borrowings across swathes of the region… And while external debt is more modest, it has been rising in recent years. In Indonesia the private sector’s bill has doubled since 2010 to $169.2bn this July… A quarter of these are short-term borrowings maturing in under a year and 96% are in foreign currency. The rupiah has dropped over 18% since the beginning of the year against the US dollar.”

October 5 – Bloomberg (Stefania Bianchi and Dinesh Nair): “Abu Dhabi is reviewing its largest state-owned companies as the slump in crude oil pressures the emirate’s finances, four people with knowledge of the matter said. Abu Dhabi National Energy Co. and International Petroleum Investment Co. are in talks with banks on options including strategic partnerships, share sales and asset disposals, the people said…”

Brazil Watch:

October 5 – Reuters (Guillermo Parra-Bernal and Jeb Blount): “State-led Petróleo Brasileiro SA , struggling with the biggest debt load among global oil firms, on Monday cut $11 billion from capital spending plans for this year and next as Brazil's currency and oil prices slump. Petrobras, as the company is commonly known, plans to cut 2015 investment by 11% to $25 billion from the previous $28 billion… Investment for 2016 will be cut 30% to $19 billion from $27 billion.”

October 5 – Bloomberg (David Biller): “Brazil’s consumer prices in September rose more than economists forecast, as traders wager the central bank won’t be able to avoid raising borrowing costs again to tame above-target inflation. Monthly inflation as measured by the benchmark IPCA index accelerated to 0.54% from 0.22% in August… Inflation in the 12 months through September slowed to 9.49% from 9.53% a month earlier.”

Japan Watch:

October 6 – Financial Times (Robin Harding): “The Bank of Japan has kept monetary policy on hold with an upbeat statement acknowledging risks from a slowdown in emerging markets but otherwise made little concession to recent bad data. By highlighting strength in the domestic economy, the statement signals some genuine BoJ optimism, reducing the chances of the central bank expanding its monetary stimulus at the end of this month. The statement suggests the BoJ thinks Japan’s recovery is basically on track, with a slowdown in Asian export markets posing a modest but containable risk.”

Geopolitical Watch:

October 7 – Bloomberg (Robin Emmott): “Russia's military build-up in Syria includes a ‘considerable and growing’ naval presence, long-range rockets and a battalion of ground troops backed by Moscow's most modern tanks, the U.S. ambassador to NATO said… Speaking on the eve of a NATO defense ministers meeting to be dominated by Russia's intervention in Syria's civil war, U.S. Ambassador to NATO Douglas Lute said Moscow had managed a ‘quite impressive’ military deployment over the past week to its Syria naval base in Tartous and its army base in Latakia. ‘There is a considerable and growing Russia naval presence in the eastern Mediterranean, more than 10 ships now, which is a bit out of the ordinary,’ he told a news briefing.”

October 9 – Financial Times (Demetri Sevastopulo): “The US is poised to sail warships close to China’s artificial islands in the South China Sea as a signal to Beijing that Washington does not recognise Chinese territorial claims over the area. A senior US official told the Financial Times that the ships would sail inside the 12-nautical mile zones that China claims as territory around some of the islands it has constructed in the Spratly chain. The official… said the manoeuvres were expected to start in the next two weeks. The move, which is likely to raise tensions between the powers, comes amid disagreement over several issues, including US allegations that China is engaging in commercial cyber espionage.”