Saturday, October 31, 2015

Weekly Commentary: Developing or Developed?

October 30 – BloombergView (By Matthew A. Winkler): “Ignore China’s Bears: There's a bull running right past China bears, and it’s leading the world’s second-largest economy in a transition from resource-based manufacturing to domestic-driven services such as health care, insurance and technology. Just when the stock market began its summer-long swoon, investors showed growing confidence in the new economy -- and they abandoned their holdings in the old economy. These preferences follow Premier Li Keqiang's directive earlier in the year at the National People's Congress to ‘strengthen the service sector and strategic emerging industries.’”

Bubbles always feed - and feed off of - good stories. Major Bubbles are replete with great fantasy. Even as China’s Bubble falters, the recent “risk on” global market surge has inspired an optimism reawakening. August rather quickly became a distant memory.

In the big picture, the “global government finance Bubble – the Granddaddy of all Bubbles” is underpinned by faith that enlightened global policymakers (i.e. central bankers and Chinese officials) have developed the skills and policy tools to stabilize markets, economies and financial systems. And, indeed, zero rates, open-ended QE and boundless market backstops create a “great story”. Astute Chinese officials dictating markets, lending, system Credit expansion and economic “transformation” throughout a now enormous Chinese economy is truly incredible narrative. Reminiscent of U.S. market sentiment in Bubble years 1999 and 2007, “What’s not to like?”

Never have a couple of my favorite adages seemed more pertinent: “Bubbles go to unimaginable extremes – then double!” “Things always turn wild at the end.” Well, the “moneyness of Credit” (transforming increasingly risky mortgage Credit into perceived safe and liquid GSE debt, MBS and derivatives) was instrumental for the fateful extension of the mortgage finance Bubble cycle. At the same time, Central banks and central governments clearly have much greater capacity (compared to the agencies and “Wall Street finance”) to propagate monetary inflation (print “money”). Most importantly, this government “money” and the willingness to print unlimited quantities to buttress global securities markets now underpin financial markets on a global basis (“Moneyness of Risk Assets”). And unprecedented securities market wealth underpins the structurally impaired global economy.

China has been a focal point of my “global government finance Bubble” thesis. Unprecedented 2009 stimulus measures were instrumental in post-crisis global reflation. Importantly, China - and developing economies more generally - had attained strong inflationary biases heading into the 2008/09 crisis. Accordingly, the rapid Credit system and economic responses to stimulus measures had the developing world embracing their newfound role of global recovery “locomotive”. I contend that the associated “global reflation trade” was one of history’s great speculative episodes. I have posited that the bursting of this Bubble (commodities and EM currencies) marks a historical inflection point for the global government finance Bubble. I find it remarkable that this analysis remains so extremely detached from conventional thinking.

Conventional analysis revels in seemingly great stories. As an analyst of Bubbles, I methodically contemplate a fundamental question: Is the underlying finance driving the boom sound and sustainable? Over the past 25 years, I’ve pondered this puzzle on too many occasions to count – about market, asset and economic Bubbles - at home and abroad. Arguably, it’s been 25 years of progressively destabilizing global Monetary Disorder. Looking today at the U.S., Europe, Japan and EM – I strongly believe the underlying finance driving the lackluster boom is hopelessly unsound. I as well appreciate that today’s acute monetary instability remains inconspicuous to most analysts.

As a macro analyst, I view China as the global Bubble’s focal point – the weak link yet, at the same time, the key marginal source of Bubble finance. In the short term, China’s ability to stabilize its stock market, incite lending and reestablish their currency peg have been instrumental in the resurgent global “risk on” backdrop. At the same time, I’m confident that the underlying finance driving this historic Bubble is unsound. This will remain a most critical issue.

I have argued that the global government finance Bubble elevated “too big to fail” from large financial institutions to encompass global risk markets more generally. Importantly, so-called “moral hazard” and attendant risk misperceptions evolved into a global phenomenon. And nowhere has this dynamic had more far-reaching consequences than in China. Underpinned by faith that China’s policymakers will backstop system liabilities (i.e. deposits, intra-bank lending, etc.), Chinese banking assets (loans and such) have inflated to double the size of the U.S. banking system. China’s corporate debt market has ballooned to an incredible 160% of GDP (double the U.S.!), again on the view of central government backstops. Then there’s the multi-Trillion (and still growing) “shadow banking” sector, possible only because investors in so-called “wealth management” products and other high-yielding instruments believe the government will safeguard against loss.

International investors/speculators have been willing to disregard a lot in China. Corruption has been almost systemic. The historic scope of malinvestment is rather conspicuous. China is in the midst of a historic apartment construction and lending Bubble. There’s a strong case to be made that the amount of Chinese high-risk lending is unprecedented in financial history. The massive Chinese banking system is today vulnerable from the consequences of extremely unsound lending to households, corporations and local governments. Chinese lenders are also likely on the hook for hundreds of billions of loans provided to finance China’s global commodities buying binge.

Throughout the now protracted boom, perceptions have held that Chinese officials have things under control. And with a massive trove of international reserves, the Chinese have been perceived to possess ample resources for stimulus as well as banking system recapitalization, as necessary. Erratic Chinese policy moves were widely assailed this summer. And while down $500 billion over recent months, China’s $3.5 TN of reserves have been sufficient to underpin general confidence (once Chinese officials convinced the marketplace that they would stabilize their currency).

Last week’s CBB succumbed to the too colorful language “Credit and Currency Peg Time Bomb.” China’s policy course appears to focus on two facets: to stabilize the yuan versus the dollar and to resuscitate Credit expansion. For better than two decades, similar policy courses were followed by myriad EM policymakers in hopes of sustaining financial and economic booms. Many cases ended in abject failure – often spectacularly. Why? Because when officials resort to such measures to sustain faltering Bubbles it generally works to only exacerbate systemic fragilities. For one, late-stage reflationary measures compound Credit system vulnerability while compounding structural impairment to the real economy. Secondly, central bank and banking system Credit-bolstering measures create liquidity that invariably feeds destabilizing “capital” and “hot money” outflows.

As the globe’s leading superpower and master of the world’s reserve currency, the U.S. has experienced quite contrasting dynamics (to EM). The U.S. financial system has enjoyed the freedom to aggressively expand Credit, with “capital” and “hot money” outflows invariably (and effortlessly) “recycled” right back into U.S. financial assets. With U.S. corporations, households and financial institutions borrowing almost exclusively in dollars, the Fed has enjoyed extraordinary flexibility when it comes to monetary inflation. Post-tech Bubble reflationary policies and dollar devaluation did not risk an EM-style asset/liability currency mismatch. Moreover, post-mortgage finance Bubble QE-amplified liquidity outflows were largely absorbed by China and EM central banks as they accumulated international reserve holdings (flows conveniently recycled back into Treasury and agency securities).

Importantly, faith in the dollar as the unrivaled global reserve currency underpinned confidence in Federal Reserve Credit – while the unfettered inflation of Fed Credit underpinned confidence in the U.S. securities markets and financial system right along with the American economy. It’s worth noting also that the juggernaut German economy has provided considerable flexibility to the ECB and euro currency and Credit management. Unique attributes have also thus far afforded the Bank of Japan phenomenal stimulus and devaluation latitude without inciting a crisis of confidence in the yen or Japanese financial assets. Overall, faith in central bank Credit has inflicted immeasurable damage.

Conventional thinking holds that China’s currency is on the verge of “reserve” status. It is believed that Chinese officials will enjoy similar dynamics and policy flexibility as the U.S., Europe and Japan. The “Credit and Currency Peg Time Bomb” thesis rests upon the view that China is not a leading “developed” economy, but rather one massive “developing”-economy Credit and economic Bubble. I could be wrong on this. But the issue “Developing or Developed?” has profound ramifications for China’s future, as well as for global finance, the international economy and geopolitics more generally.

China presents the façade of a highly advanced, high-tech “developed” economy. But in terms of corruption, reckless lending and state-directed uneconomic investment – China is “developing” at its core. In terms of corporate governance – it’s “developing”. Extreme wealth disparities? Right, “developing.” The government’s obtrusive role in finance and in the real economy, on full display over recent months, is pure “developing.” In short, China simply doesn’t have the history, capitalistic institutional structures nor governance to function as a grounded and well-developed market economy. They were moving in the right direction before fatefully losing control of finance.

I really hope China pulls out of this Bubble period without calamity. But I fear they are locked in a precarious policy course of perpetual Credit excess - a progressively unsound Credit boom destined for a crisis of confidence. They face constant “capital” outflow pressures – from both domestic-based and international sources. Wealthy Chinese will continue to try to get “money” (and their families) out of the country, as international investors and speculators flee an increasingly chaotic backdrop. How enormous is the Chinese speculative “carry trade” playing high-yielding Chinese debt instruments with leverage?

I used “time bomb” terminology because throwing previously inconceivable quantities of new Chinese Credit atop “Terminal Phase” excess ensures exponential growth in systemic risk. Ironically, the huge reserve holdings – perceived to support systemic stability – actually ensure excesses are allowed to run unchecked to catastrophic extremes. I expect “capital” flight will continue to deplete reserve holdings. Markets will fret covert activities employed to support the yuan and bolster reserves. At some point, the markets will contrast the rising mountain of problem and suspect loans (and bonds) to the dwindling stock of reserves - and turn jittery. At some point there will be plenty to worry about in the Chinese banking system and corporate debt markets.

I expect the downside of this historic Credit cycle to come with negative currency ramifications. Reminiscent of the nineties SE Asian Bubbles, Chinese officials are keen to postpone the day of reckoning. Rather than more gradual and less disruptive currency devaluation, determination to cling to reflationary policies coupled with a pegged currency regime ensures a major currency dislocation becomes part of a disruptive general crisis in confidence.

At the end of the day, the massive unabated inflation of government finance – the unprecedented issuance of sovereign debt and central bank Credit - ensures a crisis of confidence in the underlying value of this “money.” Unfettered “money” in the hands of politicians and contemporary central bankers is risky business. Confidence in EM finance has waned, although an ebb and flow has seen sentiment improve over recent weeks. Optimism’s revival has much to do with perceptions of China’s stabilization. Count me skeptical that confidence in China is anything more than skin deep. “Developing or Developed?” How long will they enjoy the flexibility of unfettered Credit and a currency tied to the dollar?

For the Week:

The S&P500 added 0.2% (up 1.0% y-t-d), and the Dow increased 0.1% (down 0.9%). The Utilities rallied 2.9% (down 4.3%). The Banks declined 0.9% (down 2.3%), while the Broker/Dealers gained 1.0% (down 4.6%). The Transports dropped 2.0% (down 11.1%). The S&P 400 Midcaps added 0.3% (down 0.5%), while the small cap Russell 2000 slipped 0.4% (down 3.6%). The Nasdaq100 increased 0.5% (up 9.7%), and the Morgan Stanley High Tech index added 0.2% (up 8.4%). The Semiconductors sank 3.1% (down 3.5%). The Biotechs rallied 2.5% (up 2.3%). With bullion falling $22, the HUI gold index sank 9.7% (down 25.2%).

Three-month Treasury bill rates ended the week at seven bps. Two-year government yields jumped eight bps to 0.72% (up 5bps y-t-d). Five-year T-note yields surged 11 bps to 1.52% (down 13bps). Ten-year Treasury yields rose six bps to 2.14% (down 3bps). Long bond yields added three bps to 2.93% (up 18bps).

Greek 10-year yields jumped 34 bps to 7.59% (down 216bps y-t-d). Ten-year Portuguese yields rose 16 bps to 2.52% (down 10bps). Italian 10-year yields slipped two bps to 1.48% (down 41bps). Spain's 10-year yields increased four bps to 1.67% (up 6bps). German bund yields added a basis point to 0.52% (down 2bps). French yields gained two bps to 0.87% (up 4bps). The French to German 10-year bond spread widened a basis point to 35 bps. U.K. 10-year gilt yields rose six bps to 1.92% (up 17bps).

Japan's Nikkei equities index gained 1.4% (up 9.4% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.30% (down 2bps y-t-d). The German DAX equities index added 0.5% (up 10.7%). Spain's IBEX 35 equities index declined 1.1% (up 0.8%). Italy's FTSE MIB index fell 1.3% (up 18%). EM equities were mostly lower. Brazil's Bovespa index was down a notable 3.6% (down 8.3%). Mexico's Bolsa fell 1.0% (up 3.3%). South Korea's Kospi index slipped 0.5% (up 5.9%). India’s Sensex equities index sank 3.0% (down 3.1%). China’s Shanghai Exchange declined 0.9% (up 4.6%). Turkey's Borsa Istanbul National 100 index slipped 0.9% (down 7.4%). Russia's MICEX equities index declined 0.8% (up 22.5%).

Junk funds this week saw inflows of $2.0bn (from Lipper), the second week of large flows.

Freddie Mac 30-year fixed mortgage rates declined three bps to 3.76% (down 11bps y-t-d). Fifteen-year rates were unchanged at 2.98% (down 17bps). One-year ARM rates fell eight bps to 2.54% (up 14bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 3.84% (down 44bps).

Federal Reserve Credit last week increased $0.9bn to $4.458 TN. Over the past year, Fed Credit inflated $7.4bn, or 0.2%. Fed Credit inflated $1.647 TN, or 59%, over the past 155 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week declined $9.1bn to a six-month low $3.295 TN. "Custody holdings" were little changed y-t-d.

M2 (narrow) "money" supply declined $7.6bn to $12.164 TN. "Narrow money" expanded $645bn, or 5.6%, over the past year. For the week, Currency increased $2.5bn. Total Checkable Deposits fell $15.9bn, while Savings Deposits gained $6.8bn. Small Time Deposits were little changed. Retail Money Funds declined $1.6bn.

Total money market fund assets jumped $18.3bn to $2.717 TN. Money Funds were down $16bn year-to-date, while gaining $88bn y-o-y (3.3%).

Total Commercial Paper fell $6.7bn to $1.056 TN. CP increased $48.8bn year-to-date.

Currency Watch:

October 25 - Reuters: "International Monetary Fund staff are set to give the all-clear for China's yuan to be included in the lender's benchmark currency basket, laying the groundwork for a favorable decision by policymakers, people familiar with the discussions said… The IMF's executive board is scheduled to decide in November on putting the yuan on a par with the dollar, yen, euro and pound sterling and a key factor will be its performance against a checklist of technical criteria, as assessed by IMF staff… ‘Everything is on course technically and there is no obvious political obstacle. The report leans clearly towards including the RMB in the (basket) but leaves the decision for the board,’ one of the officials said… Two other officials said staff would recommend the yuan join the basket, which determines the mix of currencies that countries like Greece receive as part of disbursements from the IMF. ‘There is no real discussion, no obstacles, all seems on course,’ a second official said.”

October 30 – Bloomberg (Fion Li): “Yuan deposits in Hong Kong fell by the most on record in September after China’s surprise devaluation spurred a move out of assets denominated in the currency. Savings fell 84 billion yuan ($13bn) from August to 895 billion yuan… That’s the biggest monthly decline since the city’s lenders started taking deposits in the Chinese currency in 2004. Hong Kong, which has the world’s largest offshore yuan holdings, handled 738.6 billion yuan of trade settled in the currency in September, up from 727.9 billion yuan in the previous month.”

The U.S. dollar index was little changed at 96.91 (up 7.4% y-t-d). For the week on the upside, the Japanese yen, British pound and Canadian dollar each increased 0.7%. The Brazilian real increased 0.5%, the Mexican peso 0.5% and the New Zealand dollar 0.4%. For the week on the downside, the South African rand declined 1.3%, the Norwegian krone 1.2%, the Australian dollar 1.1%, the Swiss franc 1.0%, Swedish krona 0.4% and the euro 0.1%.

Commodities Watch:

The Goldman Sachs Commodities Index rallied 1.8% (down 13.1% y-t-d). Spot Gold fell 1.9% to $1,142 (down 3.6%). December Silver dropped 1.7% to $15.54 (down 0.4%). December WTI Crude jumped $1.66 to $46.39 (down 13%). November Gasoline surged 7.5% (down 5%), and December Natural Gas rallied 1.8% (down 20%). December Copper fell 1.4% (down 18%). December Wheat surged 6.4% (down 12%). December Corn increased 0.7% (down 4%).

Global Bubble Watch:

October 25 – Reuters (Madison Marriage and Chris Newlands): “Global asset managers are facing a double hit to their fees, as sovereign wealth funds withdraw billions to support their oil-dependent economies — and switch to a cheaper in-house investment approach. A collapse in the price of oil since June 2014 is taking its toll on the investment management industry, as oil-producing countries pull money from their wealth funds to make up for a loss of export earnings. Of the world’s 50 sovereign wealth funds, which collectively oversee about $6.5tn, one-third have reported a reduction in their invested assets. Of those affected, half derive their capital from oil, according to data provider Preqin. So far this year, the Saudi Arabian Monetary Agency — the world’s third-largest sovereign fund with $661bn invested — has withdrawn about $70bn from external asset managers. One manager likened the outflow of funds to a stock market crash — calling it ‘our Black Monday’.”

China Bubble Watch:

October 29 – Bloomberg (Justina Lee): “The wealth-management products that banks sell at branches across China are often considered as safe as deposits by customers. There are growing reasons to question that faith. The ability of Chinese lenders’ $2.4 trillion of WMPs to generate the returns they promise is being undermined as monetary easing has pushed corporate bond yields to a five-year low. Loath to lose market share by advertising weaker performance, managers of the funds have been adding leverage, extending maturities and buying higher-yielding notes that are rarely traded, according to consultancy CNBenefit and HSBC Holdings Plc. ‘A large number of WMP funds have entered the bond market and used maturity mismatches and leverage to raise yields,’ said Gao Shanwen, chief economist at Essence Securities Co. in Beijing. ‘If you add the implicit guarantee to that, along with a general lack of transparency and regulation, the bond market really could be the next eye of the storm in financial markets.’ Banks are piling into riskier debt despite warnings of a leverage-fueled bubble from local brokerages, at least five bond defaults this year and the weakest economic growth in a quarter century. This risks a repeat of the trust industry panic that sparked emerging-market turmoil in early 2014 and protests among holders of failed products.”

October 27 – Wall Street Journal (Chuin-Wei Yap): “In a warren of tiny shops beneath grimy residential towers, a white-haired man selling Snickers bars and fizzy drinks from a kiosk no larger than a cashier’s booth is figuring out a way to move $100,000 out of China. That is twice what Chinese are allowed to send out of the country in a year. Licensed banks won’t do it. But middlemen like Mr. Chen, perched in his mini-mart at the front lines of a vast underground currency-exchange and offshore-remittance network, can and often will. ‘There’s never a certainty that these things can be done,’ said Mr. Chen… ‘But, usually, when things get stricter, the fee will just be a bit higher.’ Facing a turbulent stock market and a weakening economy, many Chinese are trying to move money offshore. That spells business for operations that can end-run capital controls. No official data track the underground transfers, but central-bank officials who attempt to say that underground banks handle about 800 billion yuan ($125bn) annually, and more than usual this year.”

October 27 – Bloomberg: “If anyone doubted the magnitude of the crisis facing the world’s largest steel industry, listening to Zhu Jimin would put them right, fast. Demand is collapsing along with prices, banks are tightening lending and losses are stacking up, the deputy head of the China Iron & Steel Association said… ‘Production cuts are slower than the contraction in demand, therefore oversupply is worsening,’ said Zhu… ‘Although China has cut interest rates many times recently, steel mills said their funding costs have actually gone up.’ China’s mills -- which produce about half of worldwide output -- are battling against oversupply and sinking prices as local consumption shrinks for the first time in a generation amid a property-led slowdown.”

October 26 – Reuters (Pete Sweeney and Jessica Macy Yu): “The Di Mei shopping center in downtown Shanghai is a surprisingly depressing place to shop. The underground mall is located in one of the most shopping-mad cities in China, and yet it is run down and starved of customers. ‘Sometimes I cannot sell even one dress in a day,’ said dress shop owner Ms Xu… Rising vacancy rates and plummeting rents are increasingly common in Chinese malls and department stores, despite official data showing a sharp rebound in retail sales… The answer to that apparent contradiction lies in the rising competition from online shopping and government purchases possibly boosting retail statistics… More importantly, the struggles of Chinese brick-and-mortar retailers amplify a policy conundrum; these malls, built to reap gains from rising consumption, are instead adding to China’s corporate debt problem, currently at 160% of GDP - twice as high as the United States.’ …China is currently the site of more than half the world's shopping mall construction, according to CBRE… even though it appears that many of these malls will not produce good returns for their investors.”

Fixed Income Bubble Watch:

October 30 – Bloomberg (Brian Chappatta): “An index of Puerto Rico bond yields reached a record high this week as investors remain unsure whether they’ll be paid on Dec. 1 and lawmakers in Washington ponder extending a bankruptcy option to the cash-strapped commonwealth. Ten-year Puerto Rico general obligations yield 12.3%, the highest since at least January 2013 and up from 10.1% on Oct. 20… That’s… equivalent to a 21.8% taxable interest rate for the highest earners. Puerto Rico’s bondholders face mounting risks as the commonwealth veers toward default.”

October 29 – Bloomberg (Michelle Kaske and Ezra Fieser): “Puerto Rico Government Development Bank’s disclosure of its available cash is leaving investors wondering if they’ll be paid on Dec. 1. The bank, which oversees the island’s borrowings, had $875 million of net liquidity as of Sept. 30… That’s more than twice the $354 million of principal and interest due in 33 days, with $276 million of the bonds guaranteed by the commonwealth… ‘I don’t trust anything they send out,’ said Daniel Solender, who oversees about $17 billion as head of municipal debt at Lord Abbett & Co…. ‘It’s just hard to tell what’s real or not anymore. It’s almost more political than anything as to what they decide to do with the next payments.’”

October 27 – Financial Times (Elaine Moore and Claire Jones): “Italy sold two-year debt at a negative yield for the first time on Tuesday, as concerns over the health of the global economy and expectations of further central bank stimulus reignited a rally in bond markets. The sale gains Italy entry to a select group of countries including Germany, France and Switzerland whose borrowing rates have turned negative as investors prove willing to buy their debt at any price. ‘This is an Alice in Wonderland situation,’ said Andrew Milligan, head of global strategy at Standard Life Investments.”

October 30 – Bloomberg (Sridhar Natarajan): “Feeble global growth, a fidgety Federal Reserve and a tepid earnings outlook have given junk-debt investors a lot of reasons for pause in recent months. But when a bargain shows up, you just can’t hold some of them back. An index of high-yield bonds is on track for its best month in three years, erasing a September meltdown and leaving the gauge poised to eke out a gain for the year, Bank of America Merrill Lynch data show. It would also reverse a run of four straight monthly declines that fueled concern of mounting instability in global capital markets.”

Federal Reserve Watch:

October 28 – Bloomberg (Craig Torres): “Federal Reserve officials pivoted toward a December interest-rate increase, betting that further job gains will lead to higher inflation over time and allow them to close an unprecedented era of near-zero borrowing costs. The Federal Open Market Committee dropped a reference to global risks and referred to its ‘next meeting’ on Dec. 15-16 as it discussed liftoff timing in a statement released Wednesday…, preparing investors for the first rate rise since 2006. ‘The case for a December liftoff continues to build,’ said Ward McCarthy, chief financial economist at Jefferies… ‘Even with the weaker data of late, it is hard to make the case that the economy is still in an emergency’ that requires rates near zero.”

October 27 – Wall Street Journal (Katy Burne): “Surging levels of cash in U.S. money markets threaten to undermine the Federal Reserve’s control over short-term interest rates, some market participants said, citing forces in an obscure corner of the markets that could complicate a move to tighten monetary policy. The Fed’s benchmark federal-funds effective rate, the daily average rate charged on overnight loans between banks, has fallen sharply at the ends of recent months. It has fallen around recent month-ends to just above the 0.05% rate or ‘floor’ the central bank has tried to set as it prepares to raise short-term interest rates for the first time since 2006… The declines underscore the challenges the Fed could face when it eventually raises rates in markets that have experienced dramatic changes since the financial crisis. If the central bank can’t manage interest rates effectively, it would lose control of a key lever that shapes economic and financial activity.”

October 23 – Bloomberg (Daniel Kruger): “Bond investors looking to the Federal Reserve next week for hints about when it will be ready to lift interest rates for the first time since 2006 may be missing a bigger question. With policy makers seemingly making little progress on their path to raising rates, they’re also delaying resolving how they approach the $215 billion of Treasuries poised to mature and roll off the Fed’s balance sheet next year, and almost $800 billion through 2018. That’s creating uncertainty about a less-publicized issue for the central bank: how it plans to reinvest proceeds from holdings of government bonds amassed since the financial crisis, and whether it may do so in a way that addresses rising bond-market volatility.”

Central Bank Watch:

October 28 – Reuters (Balazs Koranyi and Frank Siebelt): “With some rate-setters advocating immediate policy easing last week, European Central Bank President Mario Draghi struck a compromise to keep the doves on side and set up expectations for action in December, central banking sources said. Several influential Governing Council members argued that the ECB's balance sheet was still relatively small, especially compared to the U.S. Federal Reserve while Denmark's deeply negative deposit rate illustrated that there was still room to reduce rates, one source with knowledge of the discussion said. Instead of delivering the wait and see message the market expected, Draghi opted for one that was more dovish and crystal clear, keeping with the ECB's tradition of building a consensus and putting to shame the Fed, which has fumbled with its communication at a critical juncture.”

Leveraged Speculation Watch:

October 26 – Bloomberg (Nabila Ahmed): “Fifteen of the biggest players in the $14 trillion market for credit insurance are also the referees. Firms such as JPMorgan… and Goldman Sachs… wrote the rules, are the dominant buyers and sellers and, ultimately, help decide winners and losers. Has a country such as Argentina paid what it owes? Has a company like Caesars Entertainment Corp. kept up with its bills? When the question comes up, the 15 firms meet on a conference call to decide whether a default has triggered a payout of the bond insurance, called a credit-default swap. Investors use CDS to protect themselves from missed debt payments or profit from them. Once the 15 firms decide that a default has taken place, they effectively determine how much money will change hands. And now, seven years after the financial crisis first brought CDS to widespread attention, pressure is growing inside and outside what’s called the determinations committee to tackle conflicts of interest, according to interviews with three dozen people with direct knowledge of the panel’s functioning who asked that their names not be used.”

October 28 – Bloomberg (Beth Jinks): “Pershing Square Holdings, the publicly traded security of Bill Ackman’s activist hedge fund, extended losses over the past week amid attacks on Valeant Pharmaceuticals International Inc., bringing its decline this year to 15.9%”

U.S. Bubble Watch:

October 25 – Wall Street Journal (Theo Francis and Kate Linebaugh): “Quarterly profits and revenue at big American companies are poised to decline for the first time since the recession, as some industrial firms warn of a pullback in spending. From railroads to manufacturers to energy producers, businesses say they are facing a protracted slowdown in production, sales and employment that will spill into next year. Some of them say they are already experiencing a downturn. ‘The industrial environment’s in a recession. I don’t care what anybody says,’ Daniel Florness, chief financial officer of Fastenal Co., told investors… Caterpillar Inc. last week reduced its profit forecast, citing weak demand for its heavy equipment, and 3M Co., whose products range from kitchen sponges to adhesives used in automobiles, said it would lay off 1,500 employees, or 1.7% of its total, as sales growth sagged for a wide range of wares. The weakness is overshadowing pockets of growth in sectors such as aerospace and technology.”

October 28 – Bloomberg (Jesse Drucker, Carol Hymowitz and Caleb Melby): “The retirement savings accumulated by just 100 chief executives are equal to the entire retirement accounts of 41% of U.S. families -- or more than 116 million people, a new study finds. In a report scheduled for release today, the Center for Effective Government and Institute for Policy Studies found that the 100 largest chief executive retirement funds are worth an average of about $49.3 million per executive, or a combined $4.9 billion… In recent years, pay and income inequality across different income groups have received increasing attention in the U.S. Significantly less attention has been focused on the growing gulf in retirement savings, a lack of focus that the study’s authors say they are attempting to address.”

October 29 – Wall Street Journal (Candice Jackson): “In a new development of three spec homes in the tony Los Angeles neighborhood of Bel Air, one property will have a 15,000-square-foot guesthouse. Another home has plans that call for a ‘Champagne room,’ a chilled, glass rotunda with walls filled with bubbling liquid. A third home will have a 2,100-square-foot spa with separate steam and massage rooms. The only thing missing: a crowd of buyers who can afford to live in them. The Park Bel Air, the 11-acre development currently under construction, has asking prices that start at $115 million—and go up to $150 million with upgrades and custom furnishings. ‘There are probably only about 3,000 people [in the world] who can afford this,’ says Barry Watts, the Los Angeles-based president of Domvs London, the Park Bel Air’s developer. The buyer ‘needs to be a billionaire.’ In Los Angeles, the latest trophy homes—many of them speculatively built—may top the $100 million mark. Sales at eye-popping prices have been fueled partly by wealthy international buyers who traditionally shopped for second homes in places like New York, London or Monaco, but have lately turned their sights on Los Angeles.”

EM Bubble Watch:

October 28 – Bloomberg (Ye Xie): “Investors be warned. There have been more credit-rating downgrades in developing nations in the first nine months of this year than in the whole of 2014 and the outlook keeps getting gloomier, according to Standard & Poor’s… S&P cut the ratings for 88 bonds sold by developing countries and companies in the third quarter, including Brazil, Zambia and Ecuador, while raising the grades for 22 securities. That brings the total number of downgrades to 224 this year, compared with the 206 cuts in 2014. The ratings cuts will continue to overwhelm emerging markets in the coming months. As of Sept. 30, about 28% of companies in developing nations have a negative outlook or are on the watch list for potential downgrades, compared with 24% in the second quarter…”

October 25 – Reuters (Vrishti Beniwal and Sandrine Rastello): “With funds running short to sustain an infrastructure spending spree that’s underpinning India’s economic growth, Finance Minister Arun Jaitley will step up pressure on state-run companies to pick up the slack. Jaitley plans to meet public-sector companies in November -- two months earlier than usual -- to urge them to pay higher dividends if they don’t invest more… The dividends will go to the government, which is the majority shareholder in companies like Coal India Ltd., the world’s largest producer of the fuel. ‘Public investment is pretty much the only thing that’s propping up growth right now,’ said Jyotinder Kaur, an economist with HDFC Bank Ltd. near New Delhi. It’s crucial for public sector companies and state governments to keep up the momentum, she said.”

Brazil Watch:

October 28 – Reuters (Anthony Boadle): “Opposition activists handcuffed themselves to a pillar in Brazil's Congress on Wednesday seeking the impeachment of President Dilma Rousseff for mismanaging a once-booming economy and undermining confidence in the country. The small protest inside the foyer of the lower chamber highlighted the growing pressure on Brazilian politicians to begin impeachment proceedings against a president struggling to survive economic recession and a huge corruption scandal. ‘Impeachment can't wait. Brazil cannot put up with more unemployment, recession, inflation, currency devaluation and lack of international confidence. We have to remove this president,’ said the group's leader, Carla Zambelli. Opinion polls have shown that two in every three Brazilians want to see Rousseff impeached…”

Japan Watch:

October 30 – Bloomberg (Toru Fujioka and Masahiro Hidaka): “The Bank of Japan declined to step up its monetary stimulus Friday even as it postponed its time-frame for reaching a 2% inflation target for the second time this year. BOJ Governor Haruhiko Kuroda and his fellow board members said in a report detailing updated economic projections that the slide in oil prices was to blame for reduced consumer-price forecasts for the coming two years… Kuroda defended the decision to keep policy unchanged, saying that the central bank isn’t losing credibility and that its actions so far -- implementing an unprecedentedly large monetary stimulus program -- are having the intended effects.”

October 28 – Bloomberg (Yuji Nakamura Nao Sano): “Japan’s central bank already owns more than half of the nation’s market for exchange-traded stock funds, and that might just be the start… With 3 trillion yen ($25bn) a year in existing firepower, the BOJ has accumulated an ETF stash that accounted for 52% of the entire market at the end of September, figures from Tokyo’s stock exchange show.”

Europe Watch:

October 25 – Reuters (Madeline Chambers): “Support for German Chancellor Angela Merkel's conservatives has dropped to its lowest level in more than three years, a poll showed on Sunday, as her allies in the state of Bavaria stepped up criticism of her handling of the refugee crisis. Horst Seehofer, head of the conservative Christian Social Union (CSU) in Bavaria, the entry point for most migrants coming to Germany, said that the existence of the conservative bloc was at stake if she did not ‘correct’ her asylum policy.”

October 26 – Reuters (Paul Taylor): “Poland's lurch to the nationalist right in the first election to be influenced by Europe's refugee crisis is sending shudders of anxiety through the European Union leadership in Brussels, where officials expect a prickly relationship. EU officials have not forgotten the first time Jaroslaw Kaczynski's conservative Law and Justice (PiS) party ran the biggest member state in central Europe in 2005-2007. Warsaw held up ratification of the EU's Lisbon Treaty, fought for more voting power in the bloc, and obstructed the launch of partnership talks with Russia. ‘Things are going to get much more difficult,’ said a senior EU official involved in trying to forge compromises among the 28 EU governments.”

Geopolitical Watch:

October 27 – Washington Post (Simon Denyer): “China denounced what it called a ‘dangerous and provocative’ act Tuesday after an American warship sailed within 12 nautical miles of a Chinese-built artificial island at the center of a regional dispute over maritime territory and sea routes. The incident reflects rising tensions between the United States and China over Beijing’s aggressive program of land reclamation and construction on rocks and reefs in the Spratly archipelago in the South China Sea, whose shores include Vietnam, Taiwan and the Philippines. The U.S. naval action was intended to uphold the principle of freedom of navigation in international waters, American officials said, and underscores that Washington does not accept China’s claim to territorial waters around the man-made islands.”

October 28 – New York Times (Jane Perlez): “Much more is at stake in the American decision to challenge China by sending a destroyer near islands it built in the South China Sea than a handful of rocks, even if they sit on major shipping lines and deposits of natural resources. China, analysts say, is seeking to establish a sphere of influence in these waters — and edge out the United States. What that means — whether it represents a crisis, or a natural and inevitable shift given China’s economic strength — depends on whom you ask. But there is little doubt that China is thinking big about how these islands could limit America’s military options, about how control over these waters could give it leverage over key trade routes and about how making the United States look hapless could strengthen its diplomatic clout in the region.”

October 25 – New York Times (David E. Sanger and Eric Schmitt): “Russian submarines and spy ships are aggressively operating near the vital undersea cables that carry almost all global Internet communications, raising concerns among some American military and intelligence officials that the Russians might be planning to attack those lines in times of tension or conflict. The issue goes beyond old worries during the Cold War that the Russians would tap into the cables — a task American intelligence agencies also mastered decades ago. The alarm today is deeper: The ultimate Russian hack on the United States could involve severing the fiber-optic cables at some of their hardest-to-access locations to halt the instant communications on which the West’s governments, economies and citizens have grown dependent.”