Saturday, October 24, 2015

Weekly Commentary: Hobson's Choice

More than two months have passed since the August “flash crash.” Fragilities illuminated during that bout of market turmoil still reverberate. Sure, global markets have rallied back strongly. Bullish news, analysis and sentiment have followed suit, as they do. The poor bears have again been bullied into submission, as the punchy bulls have somehow become further emboldened. The optimists are even more deeply convinced of U.S., Chinese and global resilience (the 2008 crisis “100-year flood” view). Fears of China, EM and global tumult were way overblown, they now contend. As anticipated, global officials remain in full control. All is rosy again, except for the fact that global central bankers behave as if they’re utterly terrified of something.

The way I see it, underlying system fragility has become so acute that central bankers are convinced that they must now forcefully (“shock and awe,” “beat expectations,” etc.) react to any fledgling market “risk off” dynamic. Risk aversion and de-leveraging must not gather momentum. If fragilities are not thwarted early, they could easily unfold into something difficult to control. Such an outcome would risk a break in market confidence that central banks have everything well under control – faith that is now fully embedded in the pricing and structure for tens of Trillions of securities and hundreds of Trillions of associated derivatives – everywhere. With options at this point limited, the so-called “risk management” approach dictates that central banks err on the side of using their limited armaments forcibly and preemptively.

With today’s extraordinary global backdrop in mind, I’m this week noting a few definitions of “Hobson’s Choice”:

“An apparently free choice that actually offers no alternative.” (The American Heritage Dictionary of Idioms)

“A situation in which it seems that you can choose between different things or actions, but there is really only one thing that you can take or do.” (Cambridge Idioms Dictionary)

“No choice at all, take it or leave it.” (Endangered Phrases by Steven D. Price)

There are subtleties in these definitions, just as there are subtleties in financial Bubbles. Importantly, over time Bubbles embody a degree of risk where they stealthily begin to dictate ongoing monetary accommodation. These days, global market Bubbles have reached the point where their message to central bankers is direct and unmistakable: “No choice at all, take it or leave it.” “Keep expanding monetary stimulus or it all comes crashing down – and that’s you Yellen, Draghi, Kuroda, PBOC – all of you…”

As Ben Bernanke’s book tour lingers on, there are comments to add to the debate. From an interview with the Financial Times’ Martin Wolf:

Wolf: “… We have to recognise that neither he nor the Fed expected the meltdown. Does the blame for these mistakes lie in pre-crisis monetary policy, particularly the targeting of inflation, with which he is closely associated? Had interest rates not been kept too low for too long in the early 2000s?”

Bernanke: “The first part of a response is to ask whether monetary policy was, in fact, a major contributor to the housing bubble and all that happened. Serious studies that look at it don’t find that to be the case. People such as Bob Shiller [a Nobel laureate currently serving as a Sterling professor of economics at Yale University], who has a lot of credibility on this topic, says that: it wasn’t monetary policy at all; it came from a mania, a psychological phenomenon, that took off from the tech boom and moved into housing.”

Mortgage Credit almost doubled in six years. Home prices inflated dramatically throughout much of the country, with prices about doubling in key markets (i.e. California). Egregious lending excess was conspicuous. Speculative excesses throughout ABS, MBS, GSE debt securities and mortgage-related derivates (i.e. CDOs) were only slightly less conspicuous.

Why did the Fed fail to impose some monetary restraint (recall that Fed funds remained below 2% for several years of double-digit annual mortgage Credit growth)? Because they had (once again) badly missed their timing. A Bernanke-inspired policy course was determined to see reflationary measures gain robust momentum. The Fed believed that the benefits of prolonging aggressive accommodation greatly outweighed minimal risks (CPI and inflation expectations were contained!). Meanwhile, mortgage finance Bubble excess reached a scale where the Fed would not risk the un-reflationary consequences of piercing the Bubble. Financial and economic vulnerability were too acute for our central bank to take such institutional risk.

Then, one might ask, why exactly had the Fed been so unwilling earlier in the cycle to restrain obviously overheating mortgage and housing marketplaces? This is a critical yet somehow completely neglected issue. Well, it’s because the Federal Reserve had specifically targeted mortgage Credit growth and housing inflation as the reflationary drivers for the post-technology Bubble recovery. Though apparently lost in history, manipulating mortgage Credit and housing markets were the primary (Bernanke’s “helicopter money”) mechanism for the Fed’s war against deflation risk.

The Bubble was of the Fed’s making, and our central bank lost control. It became a Hobson’s Choice issue in the eyes of the Fed, and they fully accommodated the Bubble. Historical revisionism seeks to portray Bernanke as the hero that saved the world.

These days, the Fed and global central bankers face a similar yet much more precarious Bubble Dynamic: The Fed specifically targeted higher securities market prices as its prevailing post-mortgage finance Bubble (“helicopter money”) reflationary mechanism. This ensured that the Fed would again be unwilling to impose any monetary restraint before it would then become too risky to remove accommodation (Einstein’s definition of insanity?). In concert, global central bankers now aggressively accommodate financial Bubbles.

Global markets have the Yellen Fed petrified of even a little 25 bps baby-step nudge up from zero rates. Despite booming bond market Bubbles, a huge rise in stock prices, generally loose financial conditions and expanding economic recovery, the Draghi ECB Thursday signaled additional monetary stimulus would be forthcoming (above the current $60bn monthly QE and near-zero rates). Global markets were overjoyed. In the face of much trumpeted financial and economic stabilization, booming corporate debt markets and significant ongoing Credit growth, Chinese officials moved Friday to again cut lending rates and reserve ratios. Markets were more overjoyed.

The halcyon days have returned. Powered by strong earnings from heavyweights Amazon, Microsoft and Google, the Nasdaq 100 (NDX) surged 4.2% this week. The NDX has now rallied 22% off August lows to within about a percent of all-time highs. The S&P500 gained 2.1% this week, closing just a couple percent below record highs. Bloomberg headline: “Junk Bond ETFs Break Monthly Flow Record With a Week to Spare.” And to be clear, that’s an inflow record.

Friday morning from Bloomberg: “$100 Billion Rally Coming in Google, Microsoft, Amazon Shares.” Tech Bubble 2.0 is raging, fueled by the loosest financial conditions imaginable – spurred along by speculative market dynamics and a global industry arms race arguably on a much grander scale than that of the late-nineties. Friday evening from the New York Times: “America’s Heartland Feels a Chill From Collapsing Commodity Prices.” The impact from the faltering global Bubble is spreading. Fed Bubble accommodation ensured incredible wealth has been freely lavished upon Silicon Valley, exacerbating the issue of “the haves and have nots” locally, regionally, nationally and internationally.

It’s certainly worth noting that market strength continues to narrow. The broader market this week badly lagged tech – especially big tech. In a financial management world desperate for relative performance, Fed-induced market rallies compel market participants to jump aboard the big outperformers. It’s exciting – dangerous late-cycle financial market dynamics.

There is as well a powerful real economy dynamic at work. For the most part, the bull vs. bear argument has the economy either rather robust or on the cusp of recession. Most importantly, the U.S. economy is badly imbalanced. Segments and sectors are absolutely booming. Monetary policy is recklessly loose, with cheap liquidity apparently to fuel excess until Bubbles have finally run their course. Meanwhile, vast swaths of the economy suffer from structural stagnation, the aftermath of previous boom/bust episodes. Here, monetary accommodation has little impact. And this stagnation plays a major role in seemingly benign aggregate consumer inflation and economic output data.

Yet when it comes monetary stimulus fueling Bubbles and exacerbating structural imbalances, the U.S. is overshadowed by China. Spurred by a surge in state-directed bank lending, total Credit (“total social financing”) jumped back over $200bn in September. There are also indications that post-stock market Bubble reflationary measures have pushed China’s corporate debt Bubble to only more precarious excess. While many contend that the Chinese economy, markets and currency have stabilized, I see it much more in terms of ongoing unsustainable Credit excess.

Chinese officials missed their timing for reining in Bubble excess by years. It’s now a Hobson’s Choice of throwing everything at the faltering boom. Brief thoughts: The Chinese will need a couple Trillion (in U.S. dollars) of new Credit over the next year, then the year after and so on. Throwing enormous amounts of new Credit at a terribly maladjusted system will ensure epic maladjustment and a Credit Time Bomb. Normally, such dynamics ensure significant currency debasement. I would think in terms of a Credit and Currency Peg Time Bomb.

October 18 – Financial Times (Gabriel Wildau): “It seems a long time ago that China was piling up foreign exchange reserves at a record pace as economists fretted about global imbalances from Beijing gobbling up US Treasury bonds. Now investors are wondering how long China’s dwindling forex reserves — down to $3.5tn from a peak of $4tn in June 2014 — can hold out. Capital is flowing out of China at a record pace and the central bank is drawing down reserves to support the renminbi after its recent dramatic fall. A lack of clarity over how China calculates its reserves and how much is readily available to deploy at short notice has intensified these concerns. As growth slows and bad debt rises, investors have viewed China’s massive forex pile… as the ultimate guarantor of financial stability. The prospect that reserves could be quickly exhausted raises doubts about the government’s ability to ward off crisis. It also limits the central bank’s ability to continue foreign exchange intervention, which may have cost as much as $200bn in August alone.”

Thus far, markets have been incredibly tolerant of erratic Chinese policymaking. “We don’t care how you do it, just stabilize your markets and economy.” But at the end of the day, I see a lack of trust weighing on the Chinese currency. China’s Hobson’s Choice: aggressively inflate Credit or not. And this will put the currency at risk – the currency peg at risk. Currency controls, state-directed currency manipulation and derivatives to mask “capital” flight only increase the risk of financial accidents. Commodities and developed sovereign debt markets seem to confirm that China is not out of the woods.

FT’s Wolf: “I ask him whether he is confident that the improvement in the resilience of the banks is adequate. ‘It’s a fool’s game to predict that everything is going to be fine, because either it is fine, in which case nobody remembers your prediction, or something happens, and then …’ They remember your prediction, I interject. Bernanke continues: ‘My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.’”

Miss your plane and you reschedule a later flight. And the issue is certainly not ruling out “any possibility of any kind of financial crisis.” By now we should recognize that failed experimental monetary management was the leading culprit in the so-called “worst financial crisis since the Great Depression.” So what’s at risk today from much more egregious monetary experimentation? With runaway Bubbles at risk or faltering around the globe, central bankers are left with a choice of pushing ever forward with monetary inflation and market manipulation – or coming clean. Clearly they believe they have no choice at all.

For the Week:

The S&P500 gained 2.1% (up 0.8% y-t-d), and the Dow rose 2.5% (down 1.0%). The Utilities slipped 0.5% (down 7.0%). The Banks jumped 3.1% (down 1.5%), and the Broker/Dealers advanced 1.5% (down 5.6%). The Transports rose 2.7% (down 9.2%). The S&P 400 Midcaps added 0.4% (down 0.9%), and the small cap Russell 2000 increased 0.3% (down 3.2%). The Nasdaq100 surged 4.2% (up 9.2%), and the Morgan Stanley High Tech index jumped 3.4% (up 8.1%). The Semiconductors surged 4.8% (down 0.5%). The Biotechs declined 0.7% (down 0.2%). Though bullion declined $13, the HUI gold index gained 1.4% (down 17.1%).

Three-month Treasury bill rates ended the week at a basis point. Two-year government yields increased four bps to 0.64% (down 3bps y-t-d). Five-year T-note yields rose six bps to 1.41% (down 24bps). Ten-year Treasury yields gained five bps to 2.08% (down 9bps). Long bond yields increased two bps to 2.90% (up 15bps).

Greek 10-year yields sank 41 bps to 7.25% (down 250bps y-t-d). Ten-year Portuguese yields declined six bps to 2.36% (down 26bps). Italian 10-year yields dropped 10 bps to a near six-month low 1.50% (down 39bps). Spain's 10-year yields sank 14 bps to 1.63% (up 2bps). German bund yields declined four bps to a six-month low 0.51% (down 3bps). French yields fell seven bps to 0.85% (up 2bps). The French to German 10-year bond spread narrowed three to 34 bps. U.K. 10-year gilt yields rose six bps to 1.86% (up 11bps).

Japan's Nikkei equities index surged 2.9% (up 7.9% y-t-d). Japanese 10-year "JGB" yields declined two bps to a six-month low 0.29% (down 3bps y-t-d). The German DAX equities index surged 6.8% (up 10.1%). Spain's IBEX 35 equities index jumped 2.4% (up 1.9%). Italy's FTSE MIB index added 1.8% (up 19.6%). EM equities were mostly higher. Brazil's Bovespa index was little changed (down %). Mexico's Bolsa gained 1.5% (up 4.3%). South Korea's Kospi index added 0.5% (up 6.5%). India’s Sensex equities index gained 0.9% (down 0.1%). China’s Shanghai Exchange increased 0.6% (up 5.5%). Turkey's Borsa Istanbul National 100 index gained 2.1% (down 6.5%). Russia's MICEX equities index added 0.5% (up 23.5%).

Junk funds this week saw inflows of $3.3bn (from Lipper), "the most in four years," according to Bloomberg.

Freddie Mac 30-year fixed mortgage rates slipped three bps to 3.79% (down 8bps y-t-d). Fifteen-year rates fell five bps to 2.98% (down 17bps). One-year ARM rates jumped eight bps to 2.62% (up 22bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down a basis point to 3.87% (down 41bps).

Federal Reserve Credit last week expanded $6.0bn to $4.457 TN. Over the past year, Fed Credit inflated $20.7bn, or 0.5%. Fed Credit inflated $1.647TN, or 59%, over the past 154 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week declined $13.0bn to a six-month low $3.301 TN. "Custody holdings" were up $8.3bn y-t-d.

M2 (narrow) "money" supply fell $18.7bn to $12.171 TN. "Narrow money" expanded $693bn, or 6.0%, over the past year. For the week, Currency was little changed. Total Checkable Deposits dropped $64.9bn, while Savings Deposits jumped $53.1bn. Small Time Deposits declined $6.2bn. Retail Money Funds slipped $0.8bn.

Money market fund assets were little changed at $2.699 TN. Money Funds were down $34.3bn year-to-date, while gaining $77bn y-o-y (2.9%).

Total Commercial Paper rose $14.5bn to $1.063 TN. CP increased $55.5bn year-to-date.

Currency Watch:

The U.S. dollar index jumped 2.4% to 97.04 (up 7.5% y-t-d). For the week on the upside, the Brazilian real increased 1.2%, the Australian dollar 0.7% and the South Korean won 0.4%. For the week on the downside, the South African rand declined 4.2%, the Norwegian krone 3.4%, the Swedish krona 3.2%, the euro 2.9%, the Swiss franc 2.6%, the Canadian dollar 2.0%, the Japanese yen 1.7%, the Mexican peso 1.0%, the New Zealand dollar 0.8% and the British pound 0.8%.

Commodities Watch:

The Goldman Sachs Commodities Index dropped 3.3% (down 14.6% y-t-d). Spot Gold gave back 1.1% to $1,164 (down 1.7%). December Silver declined 1.4% to $15.81 (up 1.4%). December WTI Crude sank $2.53 to $44.73 (down 16%). November Gasoline lost 1.6% (down 11%), and November Natural Gas sank 6.2% (down 21%). December Copper fell 2.2% (down 17%). December Wheat declined 0.4% (down 17%). December Corn recovered 0.8% (down 4%).

Global Bubble Watch:

October 19 – Bloomberg: “Just because China is burning through its reported foreign-exchange reserves more slowly doesn’t mean it’s losing its commitment to support the yuan. The People’s Bank of China and local lenders increased their holdings in onshore forwards to $67.9 billion in August, positions that would boost China’s currency against the dollar. The amount is five times more than the average in the first seven months, PBOC data show. The positions are part of a three-stage process to support the currency without immediately draining reserves, according to China Merchants Bank Co. and Goldman Sachs Group Inc. Standard central-bank intervention to support a currency generally involves selling dollars and buying the home tender. In this case, China’s large state banks borrowed dollars in the swap market, sold the U.S. currency in the cash spot market and used forward contracts with the central bank to hedge those positions. ‘If you can intervene without actually diminishing your reserves, it’s somehow viewed as better,’ said Steven Englander, global head of Group-of-10 foreign exchange-strategy… at Citigroup Inc. Such central-bank activity ‘may not look quite as dramatic as the sale of reserves, and they may prefer that optically,’ he said. Using derivatives for intervention had the benefit of delaying any decline in the PBOC’s $3.5 trillion trove of foreign-exchange reserves, helping calm investors…”

China Bubble Watch:

October 19 – Bloomberg (Tracy Alloway): “China's markets resemble nothing if not a great rolling ball of money that moves from asset class to asset class, constantly searching for the next source of sizable returns. After shifting away from stocks this summer, when the value of the Shanghai Composite Index almost halved in a dramatic market selloff, the Great Ball of China seems to have found a new home: bonds sold by Chinese corporates. The strength of the switch into corporate credit is underscored in a new report from Zhi Ming Zhang, director of asset allocation research at HSBC, and financial analyst Helen Huang… While the daily turnover of A-shares — shares generally reserved for mainland Chinese investors — has shrunk to a quarter of what it was at the market's peak, a major hallmark of Chinese markets has already been making its way into corporate credit: namely, leverage. ‘Since the equity market slide started in July 2015 and liquidity switched from equity to credit products, there has been a growing leveraged investment in corporate bonds listed on the exchange market,’ the two analysts note.”

October 20 – Bloomberg: “Chinese bankers say a debt-driven bond market rally is starting to show the same signs of overheating that preceded a collapse in equities. Repurchase transactions allowing investors to use existing note holdings as collateral to borrow money for one day doubled in the past year to a record 2.1 trillion yuan ($331bn) on Tuesday. The cost of such funding in the interbank market has risen to 1.87% from a five-year low of 1% in May and has swung violently before, reaching 11.74% in June 2013… Credit spreads near the narrowest in six years are being questioned after a state-owned steel trader missed a bond payment. ‘There are signs of an overheating market, and certainly the rally can’t last for long,’ said Wei Taiyuan, an investment manager at China Merchants Bank… ‘Leverage in the bond market is much higher than at any time in history. If equities continue to perform well, or initial public offerings resume, the liquidity-fueled rally may come to an end.’”

October 17 – Financial Times (Ben Bland): “Waning demand at home and abroad is forcing Chinese manufacturers to cut prices and reduce minimum order sizes, further contributing to deflationary pressures that are compounding the nation’s economic woes. Factory executives and international buyers at the Canton Fair, China’s biggest trade exhibition, said that footfall was down on previous years and that more discounting and better terms were necessary to secure deals. ‘These are really difficult times, with demand particularly weak in key markets such as Europe,’ said Wendy Weng, sales manager for Amethyst, which makes quirkily designed, wireless speakers at its factory in Guangdong province. ‘This speaker used to cost $45 but we have cut the price to $40 and will have to live with the lower profit.’”

October 19 – Reuters (David Stanway): “China generated 454.8 billion kilowatt-hours (kWh) of power in September, down 3.1% from the same month last year…, with industrial demand still under pressure as the economy slows. Power generation growth has been falling this year as a result of declining consumption levels in downstream industries like steel, which are struggling with crippling rates of overcapacity and weak prices.”

October 22 – Bloomberg: “China’s home prices rose in September in more than half of the 70 major cities monitored by the government for the first time in 17 months, as home-purchase restrictions were loosened and interest rates cut. New-home prices rose in 39 cities, compared with 35 in August… Prices dropped in 21 cities, fewer than the 25 in August, and were unchanged in 10. The recovery in prices last month extended to a larger number of smaller cities, underpinned by five rate cuts since November and easing of property curbs as the government is dealing with the slowest economic expansion since 2009.”

Fixed Income Bubble Watch:

October 23 – CNBC (Jeff Cox): “U.S. companies not only are issuing more debt than ever. They're also extending it to durations never seen before. The end result could be a good deal for the issuers but not as great for investors. Average corporate debt maturity surged to 21.3 years in September… That's by far the longest duration since SIFMA began keeping such records in 1996… Investment-grade bond issuance has totaled $978.5 billion in the first nine months of 2015, a record for the first three quarters and 13% higher than the pace for the same period in 2014, which ended up with a record $1.13 trillion in issuance. High-yield, or junk, issuance, also has been strong at $224.3 billion, though it is nearly 9% off last year's total for the same period…”

October 22 – Bloomberg (Brian Chappatta and Michelle Kaske): “Puerto Rico’s benchmark general-obligation bonds fell to the lowest price since August after the Obama administration proposed giving the commonwealth unprecedented authority to restructure its entire debt burden through bankruptcy protection. General-obligation debt is viewed as possessing the highest likelihood of repayment since municipalities pledge to use all legally available resources to compensate bondholders. Adding to investor concern were comments from Puerto Rico Congressman Pedro Pierluisi during a Senate hearing on Thursday that some of the commonwealth’s bonds may have been issued unconstitutionally and shouldn’t be repaid if that’s the case… Prices touched 70.343 cents on the dollar, the lowest since Aug. 25. That equals a tax-free yield of almost 12%.”

October 22 – Bloomberg (Anooja Debnath): “German two-year notes advanced, pushing the yield to a record-low, after ECB President Mario Draghi said policy makers will reexamine the degree of stimulus they are providing in December. The yield on Germany’s two-year note fell three basis points, or 0.03 percentage point, to minus 0.29%..., after earlier dropping to minus 0.295%...”

October 20 – Financial Times (Eric Platt): “After years of investor enthusiasm, US high-yield debt is once again living up to its name. Yields on lower quality rated securities have soared since January as investors ask a pivotal question: are they being paid enough for the risk of owning junk-rated bonds? Junk bond yields… rose above 8% in October for the first time since 2012 as investors retreated from funds focused on speculative debt… The junk market in the past has often signalled big turning points in risk appetite among investors, and lowly rated companies are finding difficulty securing financing as investors demand greater compensation in the form of higher yields… Sales of new bonds issued by junk-rated groups in 2015 are down 9% from a year earlier, while leveraged loan origination has fallen by more than a third, according to UBS. That comes as investors have pulled $14.3bn from mutual funds and exchange traded funds for the sector since the middle of April, according to Lipper. The withdrawals have pushed yields on the weakest companies, those rated triple C and lower, to 14%, according to Bank of America Merrill Lynch.”

October 22 – Bloomberg (Eric Balchunas): “When the cat’s away, the mice will play. Money has flowed back into exchange-traded funds that invest in junk-rated corporate debt at the fastest rate ever, after the Federal Reserve's recent decision not to raise interest rates and despite persistent concerns over liquidity in the market. After taking in another half a billion dollars yesterday alone, junk bond ETFs have now taken in more than $4 billion so far in October. This puts them over the top in terms of the biggest monthly cash haul of all time–and there’s still a full week to go.”

October 18 – Wall Street Journal (Juliet Chung and Sarah Krouse): “U.S. banks are going to new lengths to ward off a surprising threat to their financial health: big cash deposits. State Street Corp., the Boston bank that manages assets for institutional investors, for the first time has begun charging some customers for large dollar deposits, people familiar with the matter said. J.P. Morgan… has cut unwanted deposits by more than $150 billion this year, in part by charging fees. The developments underscore a deepening conflict over cash. Many businesses have large sums on hand and opportunities to profitably invest it appear scarce. But banks don’t want certain kinds of cash either, judging it costly to keep, and some are imposing fees after jawboning customers to move it.”

Federal Reserve Watch:

October 23 – Financial Times (Henny Sender): “The US Federal Reserve is losing credibility with the biggest beneficiaries of its own stimulus policy — financial players with access to cheap credit. Part of a brokerage report assessing the threats to financial markets noted last week that more quantitative easing could be needed in the US, even after three previous rounds of the policy. ‘We see another round of QE as one of the biggest risks to equities, suggesting $4.5tn was not enough to prop up the economy,’ analysts at Bank of America Merrill Lynch wrote… ‘What if there is a QE 4 and the market sells off?’ asks one Singapore-based hedge fund manager. ‘There is no ammunition left. The Fed is out of bullets.’ Wall Street, in other words, seems to be belatedly joining the cynics’ camp regarding the effectiveness of the Fed’s policies.”

October 19 – Financial Times (Gavyn Davies): “This week has seen speculation about a mutiny from two members of the Federal Reserve’s board of governors against the leadership of Janet Yellen and Stanley Fischer, both of whom continue to say that they ‘expect’ US rates to rise before the end of the year. Although ‘mutiny’ is a strong term to describe differences of opinion in the contemplative corridors of the Fed, there is little doubt that the institution is now seriously split on the direction of monetary policy… Ms Yellen faces an unenviable task in finding a compromise path that both sides of the Federal Open Market Committee can support. This week’s ‘rebellion’ within the board was led by Lael Brainard, a rookie governor who was previously an undersecretary at the US Treasury… During the euro crisis, her frequent trips across the Atlantic won her respect, and marked her out as a clear thinking Keynesian who wanted emergency action from the European Central Bank long before Mario Draghi came to that view.”

Central Bank Watch:

October 22 – Financial Times (Claire Jones): “The European Central Bank signalled it would expand its €1.1tn quantitative easing programme in December and cut its deposit rate should the slowdown in emerging markets threaten the eurozone’s economic recovery. The euro fell 1.67% against the dollar to $1.116 after Mario Draghi, the ECB’s president, said policymakers’ measures would need to be ‘re-examined’ at its December 3 vote. He said the central bank stood ready to adjust the ‘size, composition and duration’ of its QE programme. At the moment, it is buying €60bn of mostly government bonds a month and has said it will continue to do so at least until September 2016. Investors in Europe viewed Mr Draghi’s refusal to rule out an interest-rate cut and his allusion to further QE as a signal to buy, sending prices for European assets sharply higher on Thursday.”

Leveraged Speculation Watch:

October 20 – New York Times (Alexandra Stevenson): “For years, the hedge fund industry attracted billions of dollars as investors searched for higher returns. But over several rocky months, managers reversed their gains for the year, investors headed for the exit and some firms shut down. Over all, the total amount of money that hedge fund managers have available to invest in stocks, bonds, commodities and currencies shrank by $95 billion in the third quarter of the year, according to data from HFR… It is the biggest outflow since the third quarter of 2008 in the depths of the financial crisis. Investors have been left with steep losses after months of global market volatility set off by a series of unexpected moves by central banks around the world, political turmoil in Greece, a debt default in Puerto Rico and a market rout in China. The turbulence has been unkind to every type of strategy deployed by hedge fund managers, from investing in distressed companies to buying equities.”

October 22 – Bloomberg (Charles Stein): “A long list of prominent investors, including hedge fund star Bill Ackman and the managers of the Sequoia Fund, made billions of dollars in paper gains as Valeant Pharmaceuticals International Inc. soared over the past five years. Now they’re watching those profits melt away. Valeant plummeted as much 40% on Wednesday after a short seller published a report accusing the company of an Enron-like strategy of recording fake sales by using phony customers. The stock pared losses, closing down 19%... Valeant has declined 55% from an intraday peak of $263.81 on Aug. 6… The slump from that high point translates into a paper loss of as much as $4.9 billion for Ruane, Cunniff & Goldfarb, which runs the $8.1 billion Sequoia Fund and was the biggest investor in the stock as of June 30. Ackman’s Pershing Square Capital Management lost about $2.8 billion.”

October 19 – Wall Street Journal (Rob Copeland): “The trade that was supposed to carry the year is ruining it instead. Hedge-fund and private-equity managers over the past year began piling into debt issued by troubled energy companies, hoping to profit off a reversal of oil’s slide. They raised billions of dollars for the effort, in many cases telling backers it was a once-in-a-generation chance to pounce. But crude has continued to fall, slamming the companies and many large investors who thought they had bought in near the bottom… ‘A lot of hot money chased into what we believe are insolvent companies at best,’ said Paul Twitchell, partner at hedge-fund firm Whitebox Advisors LLC… ‘Bonds getting really cheap doesn’t mean they are a good buy.”

U.S. Bubble Watch:

October 19 – Bloomberg (Elizabeth Campbell and Brian Chappatta): “Illinois was lowered to three steps above junk by Fitch… amid a political stalemate that has left the state without a budget for nearly four months, worsening a financial crisis that has already triggered credit downgrades to cities and local agencies. The one-step downgrade to BBB+ from A- affects $26.8 billion of general-obligation bonds… Illinois is already the worst-rated state with an A3 by Moody’s…, four steps above junk, and an equivalent A- by Standard & Poor’s. The nation’s fifth-most-populous state is grappling with more than $6 billion of unpaid bills because the Democrat-controlled legislature and Republican Governor Bruce Rauner can’t agree on a spending plan for the year that started July 1.”

October 19 – Wall Street Journal (Rolfe Winkler, Douglas MacMillan, Telis Demos and Monica Langley): “Dropbox Inc. had no trouble boosting its valuation to $10 billion from $4 billion early last year, turning the online storage provider’s chief executive into one of Silicon Valley’s newest paper billionaires. But the euphoria has begun to fade. Investment bankers caution that the San Francisco company might be unable to go public at $10 billion, much less deliver a big pop to recent investors and employees who hoped to strike it rich… Still, the company is a portent of wider trouble for startups that found it easy to attract money at sky’s-the-limit valuations in the continuing technology boom. The market for initial public offerings has turned chilly and inhospitable, largely because technology companies have sought valuations above what public investors are willing to pay. So far this year, only 14% of IPOs in the U.S. were done by tech companies, the smallest percentage since at least the mid-1990s, according to Dealogic.”

October 20 – Bloomberg (Miles Weiss and Katya Kazakina): “Being part of the 1% just took on new meaning. That’s about the rate at which billionaire Steve Wynn is borrowing against his extensive art collection as wealth management firms push to win business from the world’s ultra-rich. The casino mogul pledged 59 works of art as collateral for a loan from Bank of America Corp., one of several steps he recently took to raise cash… The 73-year-old founder of Wynn Resorts Ltd. said the arrangements permit him to borrow at less than 1% ‘This is a great time to be poised with ample cash,” Wynn said…”

EM Bubble Watch:

October 21 – Wall Street Journal (Nicolas Parasie): “Middle Eastern oil exporters face a combined $1 trillion budget shortfall in the next five years if crude prices stay at present lows and economic reforms aren't introduced more rapidly, an International Monetary Fund official said. Countries such as Saudi Arabia and Kuwait are coping with the impact of falling oil prices by drawing down some of the vast reserves they built up in recent years thanks to high oil prices. They’ve also started borrowing more, though spending on large infrastructure projects and social handouts hasn’t significantly come down yet.”

October 18 – Bloomberg (Matthew Martin): “Saudi Arabia is delaying payments to government contractors as the slump in oil prices pushes the country into a deficit for the first time since 2009, according to three people with knowledge of the matter. Companies working on infrastructure projects have been waiting six months or more for payments as the government seeks to preserve cash… Saudi Arabia is responding to the decline in crude, which accounts for about 80% of revenue, by tapping foreign reserves, cutting spending, delaying projects and selling bonds. Net foreign assets fell by about $82 billion at the end of August after reaching an all-time high last year.”

October 20 – Bloomberg (Ahmed Feteha): “Saudi Arabia may run out of financial assets needed to support spending within five years if the government maintains current policies, the International Monetary Fund said, underscoring the need of measures to shore up public finances amid the drop in oil prices. The same is true of Bahrain and Oman in the six-member Gulf Cooperation Council, the IMF said… Kuwait, Qatar and the United Arab Emirates have relatively more financial assets that could support them for more than 20 years… Saudi authorities are already planning spending cuts as the world’s biggest oil exporter seeks to cut its budget deficit.”

October 19 – Bloomberg (Paul Wallace): “When Zambia first sold bonds in international markets in 2012, the country got so much demand it could have issued 16 times the $750 million it raised. Fast forward three years to an offering in July and the southern African nation only got twice as many bids for the $1.25 billion on sale. The drop in appetite illustrates the problems besetting much of Africa, where falling prices for commodities from oil to copper are sapping growth and revenues at a time when governments want to boost investment in everything from energy infrastructure to schools and hospitals. Ghana this month became only the fourth country in the past decade to issue a Eurobond at yields above 10%, while Zambia earlier joined six other nations that had sold debt at rates higher than 9% since 2010.”

Brazil Watch:

October 21 – Bloomberg (Vivianne Rodrigues and John Fraher): “A group of high-profile Brazilian lawyers filed with the lower house today an impeachment request against President Dilma Rousseff. The petition, will be examined by the president of the lower house -- which may take days -- and if accepted, may set in motion a process that could take as long as several months to be concluded… What Are the Charges? Rousseff’s opponents accuse her of everything from doctoring fiscal accounts to allowing state-run oil company Petrobras to incur losses from corruption. The president denies wrongdoing. The impeachment filing made by a group of high-profile lawyers, led by Helio Bicudo, Miguel Reale Jr and Janaina Paschoal, specifically says the president has continued to doctor government accounts this year, in addition to breaking the country’s fiscal law in 2014.”

Geopolitical Watch:

October 22 – Reuters (Andrew Osborn): “Russian President Vladimir Putin's approval rating has hit a record high of almost 90%, primarily as a result of his decision to launch air strikes against Islamist militants in Syria, Russia's state pollster said… VTsIOM, the pollster, said Putin's rating had reached 89.9% in October, up from a previous high of 89.1% in June. In January 2012, it put his rating at 58.8%. ‘Such a high level of approval for the work of the Russian president is linked, in the first instance, to events in Syria, to Russian air strikes on terrorist positions there,’ VTsIOM said…”

October 22 – Bloomberg: “China’s military chiefs are seeking to unify the country’s cyber warfare capabilities as they build a modern fighting force that relies less on ground troops. The plan is part of a broader shift toward a unified military command similar to that of the U.S. to meet President Xi Jinping’s goal of transforming the People’s Liberation Army into a force that can ‘fight and win modern wars.’ …A move to a centralized command reporting to the Central Military Commission would better organize China’s cyber warfare capabilities, which are scattered across a variety of units and ministries. It would further elevate the role of cyber within a PLA that has long prioritized the army over the navy and air force, two branches that require a high level of computerization skills.”