Saturday, November 7, 2015

Weekly Commentary: Irreversibly Broken and Dysfunctional

Bloomberg: “The October Jobs Report Gives Fed Officials a Green Light to Raise Rates.”

With global “risk on” back in full swing, the focus of U.S. monetary policy belatedly shifts back to fundamentals. October’s 271,000 was the largest jobs gain since last December. The unemployment rate is down to 5.0%, the low since April 2008. Average hourly earnings were up 2.5% y-o-y in October, the strongest performance since July 2009. The private sector added an eye-opening 268,000 jobs during the month, with Services employment up 241,000. Indicative of an extraordinarily unbalanced economy, no manufacturing jobs were created during October.

Existing home sales are on track for the strongest year since 2007. Automobile sales are booming as well. Monthly auto sales last month posted the strongest October since 2001 (from Dow Jones), with annual sales poised to test the all-time record. Kelley Blue Book is expecting 2015 sales 12% above 2014.

My point is not that the U.S. economy is robust - or even sound. From my perspective, booming home and auto sales reflect the upshot from years of ultra-loose financial conditions and a resulting “Bubble Economy”. Importantly, the Federal Reserve’s extreme monetary accommodation is grossly inappropriate considering U.S. financial and economic backdrops. Keep rates at zero, print a few Trillion, backstop booming financial markets long enough and spur unprecedented inflation in (perceived) Household Net Worth – and Bubble Economy Dynamics will eventually prevail. They have.

The Yellen Fed is now expected to raise rates next month. And, suddenly, there’s some trepidation that “one and done” might not suffice. From a traditional analytical perspective, the Fed has fallen behind the curve in historic fashion. In the past, it would require a series of hikes and a period of time to temper the intense impulses to borrow, lend, spend, invest and speculate. Especially if monetary conditions were held loose for too long, real pain was required to impose some restraint.

Granted, traditional monetary management and system behavior have little to do with the present. Rarely do I encounter the phrase “behind the curve.” The Yellen Fed threw another big monkey wrench into the analysis when it delayed the expected September rate lift-off due to global considerations (China & EM). Markets have been increasingly confused by central bank thinking, with little clarity as to what factors will be driving policy decisions.

At the same time, market participants have remained comforted that global financial fragilities ensure the Fed will hold in the vicinity of zero, with no real “tightening” contemplated. Moreover, the ECB and BOJ will (at the minimum) stick with current QE purchases. The PBOC will surely continue on a course of much lower rates (to zero?) and QE. U.S. fundamentals have mattered little because of the view that the Fed’s attention was directed elsewhere. Friday’s booming non-farm data were too strong to ignore. The U.S. economy appears to have found a head of steam after the summer slowdown.

The S&P500 gained 1%, a strong but unremarkable week. Below the surface remarkable thrives. The Banks (BKX) surged 5.5% and the Securities Broker/Dealers jumped 6.3%. The Biotechs (BTK) rallied 4.4% this week. The small cap Russell 2000 jumped 3.3%. It’s worth noting that the banks, brokers, biotechs and small caps have been popular sectors for short positions. Trading activity in many highly shorted stocks has been wild. Meanwhile, the Utilities sank 4.1% and gold stocks (HUI) were hammered 10.8%.

Below the pleasant exterior exists vicious market internals – and it’s not just stocks and not only in the U.S. Italian yields surged 31 bps this week. Chinese stocks rallied 6.3%. Crude (WTI) sank 4% this week. Gold fell 4.7% and silver sank 5.1%. Currency market violence reemerged this week. The New Zealand dollar sank 3.7% (against the US dollar), while the Brazilian real gained 2.3%. The euro and pound fell 2.4%, and the Swiss franc and Canadian dollar lost about 1.8%. And Thursday from Reuters: “US Swap Spreads Hit Unchartered Negative Levels.” There’s something not right in global markets.

Friday evening from the Financial Times: “Central Banks Confuse With Mixed Messages.” Truth be told, global monetary management is a complete mess. From my perspective, what commenced in the early-nineties with Greenspan nurturing U.S. non-bank Credit expansion has evolved to today’s monetary policy-supported runaway global securities and derivatives markets Bubbles. On the one hand, I believe Fed leadership is concerned about excesses and would prefer to begin a long, drawn-out process of “normalization.” But August provided evidence of persistent acute global fragilities and how quickly booming markets can dislocate.

Greenspan’s rate and yield curve manipulations, along with “asymmetrical” market support, provided a huge advantage to leveraged speculation. Post-2008 crisis bailouts, QE and market manipulations only further incentivized financial speculation. And concerted global open-ended QE in 2012 spurred destabilizing “Terminal Phase” speculative excess. When serious Bubble fragilities reemerged in 2013, Bernanke resorted to assurances that the Fed would push back against any “tightening of financial conditions.” Nowadays, global central bankers have essentially committed to pushing back against “risk off” episodes of de-risking/de-leveraging.

Today’s dilemma – for financial markets and central bankers – is that pushing back against nascent “risk off” unleashes another forceful bout of “risk on.” At this point, it’s either Bubble on or off – destabilizing either way. The global Bubble has grown too distended and the market backdrop too dysfunctional. Central bankers over the past 25 years have created excessive “money,” while incentivizing too much finance into financial speculation. There is now way too much “money” crowded into the securities and derivative markets, and the upshot is an increasingly hostile backdrop for leverage and speculation.

The ECB has been widely criticized for raising rates 25 bps in early-July 2008. In hindsight, the world at the time was on the precipice of a bursting U.S. mortgage finance Bubble. It’s forgotten that eurozone inflation was then running at 4%, fueled by crude that had spiked to $145. The Fed’s aggressive policy response to 2007’s subprime eruption had stoked powerful Bubble excess throughout the markets. And I believe strongly the world would have been better off to have taken the medicine in 2007 rather than have had the Fed further destabilize the situation.

It appeared in August that global financial and economic tumult would hold rate hikes at bay indefinitely. After three months of further central bank accommodation, the turbulent global market recovery has the Fed believing it’s safe to move off zero. Market participants are having a difficult time discerning the backdrop. Have the issues from the summer been resolved and a new bull run commenced? Or are markets in the calm before a more powerful round of “risk off”? Importantly, one scenario has the Fed commencing a “tightening” cycle. The other has no hikes, more QE and perhaps even negative short rates. Extraordinary complexities and uncertainties abound: in the global economy, throughout global markets and with central bank policies.

An interesting debate has unfolded between the tandem Nobel Laureate Michael Spence and former Fed governor Kevin Warsh and Larry Summers. Spence and Warsh last week penned a quite insightful WSJ op-ed, “The Fed Has Hurt Business Investment.” From the article: “We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose ‘shareholder friendly’ share buybacks over investment in a new factory. But public policy shouldn’t bias investments to paper assets over investments in the real economy.”

Former Treasury Secretary Larry Summers was not impressed. He titled his response (on his blog), “This critique of the Fed isn’t backed by logic nor evidence.” “What arguments do Spence and Warsh offer for their heterodox conclusion? They note rightly that monetary policy has been easy and investment has been weak in the current recovery. This is a little like discovering a positive correlation between oncologists and cancer and asserting that this proves oncologists cause cancer. One would expect in a weak recovery that investment would be weak and monetary policy easy. Correlation does not prove causation.”

Spence and Warsh responded with a second WSJ op-ed, “A Little Humility, Please, Mr. Summers.” “First, Mr. Summers mischaracterizes what he calls the ‘Spence-Warsh doctrine.’ He sets out the straw man for his censure, stating Spence and Warsh believe ‘overly easy monetary policy reduces business investment.’ This is an interesting proposition, but it does not happen to be the one we make. Instead, we posit something quite different: ‘QE [quantitative easing] has redirected capital from the real domestic economy to financial assets.’”

This is a crucial debate, and I side strongly with Spence and Warsh. Summers refers to their “heterodox conclusion.” From my analytical perspective, over the years I’ve used the “Financial Sphere” versus the “Real Economy Sphere” framework when discussing divergent policy effects. I have no doubt that various monetary policy tools – rate manipulation, market liquidity backstops and QE – have created major distortions. Importantly, QE has overwhelmingly incentivized the acquisition (investment, leveraged speculation and stock buybacks) of financial assets (stocks, bonds and derivatives). Over the course of Trillions of QE and years of cumulative structural distortions, the consequences have been profound. I fear interminable global financial fragility is the most momentous.

Spence and Warsh focus astutely on QE’s real economy effects. My deepest concern lies within the “Financial Sphere.” As lunatic fringe as it sounds to the emboldened bullish consensus, I believe QE and contemporary central bank doctrine have left global markets Irreversibly Broken and Dysfunctional. The damage is masked only so long as markets remain in “risk on” mode (unless one examines below the surface).

As noted above, there’s something wrong in the markets. Clearly, there are serious struggles unfolding in the hedge fund community. And I believe market instability and policy uncertainty have forced an initial bout of de-risking/de-leveraging. Yet when markets go into (policy-induced) face-ripping, short-squeeze melt-up mode, the pressure to unwind short positions and bearish hedges turns intense. The bulls giggle, not appreciating the ramifications. These chaotic, volatile markets are hard on leveraged speculating community returns. Everyone is forced to over-commit on the long side, ensuring there will be a lot of selling, shorting and hedging when the next “risk off” flares up. Poor performance dictates a heightened state of risk aversion during the next downdraft. Poor performance begets poor performance – and pressure to de-risk and de-leverage.

I recall similar dynamics prior to both the 1998 and 2008 crisis episodes. Friday’s payroll data reinvigorated King Dollar. Energy and commodities prices were under pressure. EM currencies stumbled. And I’m sticking with the view that the global Bubble has been pierced, though central banks have gone to incredible measures to keep pumping. The Fed at this point faces a very serious dilemma.

For the Week:

The S&P500 gained 1.0% (up 2.0% y-t-d), and the Dow rose 1.4% (up 0.5%). The Utilities sank 4.1% (down 8.3%). The Banks jumped 5.5% (up 3.1%), and the Broker/Dealers surged 6.3% (up 1.4%). The Transports gained 1.4% (down 9.8%). The S&P 400 Midcaps rose 1.3% (up 0.8%), and the small cap Russell 2000 surged 3.3% (down 0.4%). The Nasdaq100 gained 1.3% (up 11.1%), and the Morgan Stanley High Tech index rose 1.9% (up 10.5%). The Semiconductors jumped 2.1% (down 1.5%). The Biotechs surged 4.4% (up 6.8%). With bullion down $53, the HUI gold index sank 10.8% (down 33.3%).

Three-month Treasury bill rates ended the week at 8 bps. Two-year government yields surged 17 bps to a five-and-one-half year high 0.89% (up 22bps y-t-d). Five-year T-note yields jumped 21 bps to 1.73% (up 8bps). Ten-year Treasury yields rose 19 bps to 2.33% (up 16bps). Long bond yields gained 16 bps to 3.09% (up 34bps).

Greek 10-year yields declined nine bps to 7.50% (down 225bps y-t-d). Ten-year Portuguese yields rose 14 bps to 2.66% (up 4bps). Italian 10-year yields surged 31 bps to 1.79% (down 40bps). Spain's 10-year yields jumped 24 bps to 1.91% (up 30bps). German bund yields gained 17 bps to 0.69% (up 15bps). French yields rose 15 bps to 1.02% (up 19bps). The French to German 10-year bond spread narrowed two to 33 bps. U.K. 10-year gilt yields rose 12 bps to 2.04% (up 29bps).

Japan's Nikkei equities index rose 1.0% (up 10.4% y-t-d). Japanese 10-year "JGB" yields increased a basis point to 0.31% (down one basis point y-t-d). The German DAX equities gained 1.3% (up 12.1%). Spain's IBEX 35 equities index increased 0.9% (up 1.7%). Italy's FTSE MIB index added 0.4% (up 18.5%). EM equities were mostly higher. Brazil's Bovespa index jumped 2.3% (down 6.2%). Mexico's Bolsa rose 1.6% (up 4.9%). South Korea's Kospi index increased 0.6% (up 6.6%). India’s Sensex equities index fell 1.5% (down 4.5%). China’s Shanghai Exchange surged 6.1% (up 11%). Turkey's Borsa Istanbul National 100 index surged 3.2% (down 4.4%). Russia's MICEX equities index jumped 6.1% (up 11.0%).

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

Freddie Mac 30-year fixed mortgage rates surged 11 bps to 3.87% (unchanged y-t-d). Fifteen-year rates rose 11 bps to 3.09% (down 6bps). 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 up three bps to 3.87% (down 41bps).

Federal Reserve Credit last week declined $6.6bn to $4.452 TN. Over the past year, Fed Credit increased $6.6bn, or 0.1%. Fed Credit inflated $1.641 TN, or 58%, over the past 156 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week declined another $8.6bn to a seven-month low $3.284 TN. "Custody holdings" were down $9.4bn y-t-d.

M2 (narrow) "money" supply surged $79.2bn to a record $12.248 TN. "Narrow money" expanded $682bn, or 5.9%, over the past year. For the week, Currency increased $3.0bn. Total Checkable Deposits jumped $34bn, and Savings Deposits rose $45.4bn. Small Time Deposits were down $1.4bn. Retail Money Funds slipped $1.7bn.

Total money market fund assets fell $14.8bn to $2.702 TN. Money Funds were down $31bn year-to-date, while gaining $67bn y-o-y (2.5%).

Total Commercial Paper added $1.2bn to $1.057 TN. CP increased $50bn year-to-date.

Currency Watch:

The U.S. dollar index surged 2.3% this week to 99.15 (up 9.8% y-t-d). For the week on the upside, the Brazilian real increased 2.3%. For the week on the downside, the New Zealand dollar declined 3.7%, the South African rand 2.5%, the euro 2.4%, the British pound 2.4%, the Swedish krona 2.2%, Norwegian krone 2.2%, the Japanese yen 2.1%, the Mexican peso 1.9%, the Swiss franc 1.8%, the Canadian dollar 1.7% and the Australian dollar 1.3%.

Commodities Watch:

The Goldman Sachs Commodities Index fell 2.7% (down 15.4% y-t-d). Spot Gold sank 4.7% to $1,089 (down 8.1%). December Silver sank 5.1% to $14.74 (down 6%). December WTI Crude lost $1.87 to $44.52 (down 16%). November Gasoline dropped 2.1% (down 7%), while December Natural Gas increased 1.7% (down 18%). December Copper fell 3.2% (down 21%). December Wheat was little changed (down 11%). December Corn dropped 2.4% (down 6%).

Global Bubble Watch:

November 3 – CNBC (Jeff Cox): “Renowned hedge fund manager Stanley Druckenmiller believes the Federal Reserve has created a type of bubble that won’t end well. A frequent Fed critic, the head of Duquesne Capital said the central bank has created a bubble of short-term investing through its near zero interest rates and quantitative easing. On the heels of the financial crisis, the Fed cut its target rate to near zero and conducted three rounds of money printing during which it expanded its balance sheet to $4.5 trillion. Druckenmiller said the first round of QE was necessary to stem the financial crisis… But he thinks the Fed took its cheap-money policies too far. ‘All you do when you're doing this is you're pulling demand forward to today,’ Druckenmiller said… at the annual DealBook conference. ‘This is not some permanent boost you get. You're borrowing from the future. I think there's been such a misallocation of resources that this has gone on so long and unnecessarily (and) the chickens will come home to roost.’ He also blasted the culture the Fed's policies have nurtured in which companies are devoting trillions to share buybacks even after market prices have surged more than 200% since March 2009.”

November 2 – Bloomberg (Simone Foxman and Katherine Burton): “Paul Singer, the billionaire founder of $27 billion hedge fund firm Elliott Management, said stock and bond markets are structurally ‘unsound’ as evidenced in recent market volatility. In a wide-ranging letter that warned of the effects from low interest rates, unrest in the Middle East, and leverage in the financial system, Singer, 71, said steep declines and rapid recoveries in financial markets, such as the Aug. 24 stock market slump, and recent flash crashes in bond markets, probably foreshadow the future. ‘All of the innovations and complexity in the modern world of finance combine in different ingredients at different times with different catalysts to create fragility, not stability,’ he wrote… ‘We wonder if the overall impact of financial innovation, including derivatives, structured products, high frequency trading and communication advances, is net negative, albeit with a possibly long delay before the drawbacks become visible.’”

November 1 – Bloomberg (Daniel Kruger and Lucy Meakin): “Ask any bond trader in Tokyo, London or New York what their view on the global economy is, and you’re likely to get a similar, decidedly downbeat answer. That’s not just because fixed-income types are a dour bunch at the best of times. A quick scan across government debt markets suggests that investors are pricing in the likelihood that growth and inflation around the world will remain tepid for years to come. In Europe, bonds yielding less than zero have ballooned to $1.9 trillion, with the average yield on securities in an index of euro-area sovereign notes due within five years turning negative for the first time. Worldwide, the bond market’s outlook for inflation is now close to levels last seen during the global recession. And even in the U.S., the bright spot in the global economy, 10-year Treasury yields are pinned near 2% -- well below what most on Wall Street expected by now.”

November 2 – Bloomberg: “The ranks of China’s wealthy continue to surge. As their economy shows signs of weakness at home, they’re sending money overseas at unprecedented levels to seek safer investments — often in violation of currency controls meant to keep money inside China. This flood of cash is being felt around the world, driving up real estate prices in Sydney, New York, Hong Kong and Vancouver. The Chinese spent almost $30 billion on U.S. homes in the year ending last March, making them the biggest foreign buyers of real estate. Their average purchase price: about $832,000. Same trend in Sydney, where Chinese investors snap up a quarter of new homes and are forecast to double their spending by the end of the decade. In Vancouver, the Chinese have helped real estate prices double in the past 10 years. In Hong Kong, housing prices are up 60% since 2010. In total, UBS Group estimated that $324 billion moved out last year. While this year’s numbers aren’t yet in, during the three weeks in August after China devalued its currency, Goldman Sachs calculated that another $200 billion may have left. So how do these volumes of cash get out when Chinese are limited by rules that allow them to convert only $50,000 per person a year?”

November 4 – Bloomberg (Angus Whitley): “Chinese demand for Australian property, which has helped propel the price of an average Sydney house to about A$1 million ($720,000), is waning as an economic slowdown at home dents confidence, according to Credit Suisse… Falling auction clearance rates in Sydney and Melbourne, two of the most popular destinations for purchasers from China in Australia, suggest there are fewer cashed-up foreign buyers, Credit Suisse analysts Damien Boey and Hasan Tevfik said… Home values in places such as Sydney, Vancouver and parts of the U.S. have been surging as Chinese buyers seeking a safe haven for their cash circumvent controls at home to pile into properties abroad. In Sydney, home values jumped 44% in the three years to September, spurred by record-low interest rates and a stream of buyers from China who were estimated to be snapping up almost a quarter of the city’s new homes.”

November 1 – Reuters (Simon Johnson and Johan Sennero): “House buyers in Sweden have never had it so good, at least by some measures. But cheap credit and spiraling prices may be creating a bubble - one that could send the country's economy reeling when it bursts. Sweden now has one of the fastest growth rates of any developed economy. Inflation is near zero and official interest rates are below zero. Home buyers can take advantage of interest-only loans and a variety of tax breaks. On the other hand, consumer debt is about 175% of disposable income, one of the highest rates in Europe. Housing prices keep rising - apartments in Stockholm cost around $6,350 per square meter, on a par with London's $6,750. Most Swedes would take a century to repay mortgages at current rates.”

China Bubble Watch:

November 1 – Reuters (Xiaoyi Shao and Nicholas Heath): “Activity in China's manufacturing sector unexpectedly contracted in October for a third straight month…, fuelling fears the economy may still be losing momentum in the fourth quarter despite a raft of stimulus measures. Adding to those concerns, China's services sector, which has been one of the few bright spots in the economy, also showed signs of cooling last month, expanding at its slowest pace in nearly seven years. As the first major indicators of business conditions in China released each month, the PMIs reinforced the view that the economy remains in the midst of a gradual slowdown which will require Beijing to roll out more support in coming months.”

November 1 – Bloomberg (Lianting Tu and David Yong): “China faces another test in its credit markets this week after a coal firm signaled it may default on its dollar debt. Hidili Industry International Development Ltd. is not in a position to repay $190.6 million of principal and interest due Nov. 4. on its 8.625% notes, it said… The mining company… has defaulted on some of its 6 billion yuan ($947 million) of loans, it said… Defaults at China’s companies, the world’s biggest corporate borrowers, have spread this year amid the weakest economic growth in a quarter century that’s hurt commodities and manufacturing.”

November 4 – Bloomberg (Ting Shi): “China’s new development blueprint was officially handed down Tuesday by the Communist Party’s Central Committee. But the details leave little doubt as to President Xi Jinping’s hand in crafting the document. From promoting the ‘Chinese dream’ to pledging to ‘purify’ the Internet, the sweeping policy document enshrines slogans, catchphrases and priorities the Chinese president has tested out since taking power in November 2012. Their inclusion in the party’s five-year plan -- a Soviet-style holdover of the centrally planned economy -- ensures Xi’s assertive, nationalist vision will shape China’s development through the end of the decade, if not many years beyond… ‘It bears Xi Jinping’s fingerprints, as does everything else in the Chinese government now. He is the top man, not first among equals, just first. One-man rule is back in China,’ said Stein Ringen, a professor of sociology and social policy at the University of Oxford. ‘This is Xi saying, ‘I am in charge and I will continue to be in charge.’’”

November 1 – New York Times (Michael Forsythe): “He has been called China’s Carl Icahn. But the billionaire owner of one of the country’s most successful investment firms is now the latest suspect in a broadening crackdown on corruption in the financial industry. The fund manager, Xu Xiang, nicknamed Big Xu, was apprehended in dramatic Hollywood fashion, more worthy of a spy movie than of a financier’s arrest. As the police closed in, the highway patrol sealed off the 22-mile Hangzhou Bay Bridge for more than 30 minutes and eventually apprehended Mr. Xu near the exit late Sunday morning… The government offered scant details on the arrest. ‘Xu Xiang and others are suspected of insider trading and other offenses and are in criminal detention,’ said a brief statement on the Xinhua News Agency, the government’s official media outlet.”

November 5 – Bloomberg: “Passenger-vehicle sales in China increased at the fastest pace in seven months after the government cut a tax on car purchases to boost sagging demand in the world’s largest auto market. Retail deliveries of cars, SUVs and multipurpose vehicles rose 11.3% to 1.85 million units last month... Retail sales through October gained 6.4% to 16.2 million units. Effective through the end of next year, the tax cut lowered the levy on vehicles with engines 1.6 liters or smaller by half to 5%.”

Fixed Income Bubble Watch:

October 31 – Bloomberg (Ezra Fieser): “The Puerto Rican government could run out of cash as soon as Nov. 15, forcing it to order a partial shutdown or reduce working hours for public employees, the island’s budget director told a local newspaper. Luis Cruz Batista, executive director of the Office of Management and Budget, said the government is monitoring cash flow and has $150 million in reserves to fund essential services, including schools, police and health care, even if other agencies are reduced or temporarily shuttered. While the government has repeatedly said it may face a cash flow shortage, Cruz’s comments were the first time the administration of Governor Alejandro Garcia Padilla put a date on a possible partial shutdown.”

November 5 – Financial Times (Martin Z. Braun): “The second act of Puerto Rico’s long-building debt drama is about to begin, and waiting in the wings is a veteran cast. It includes an embattled politician, his foe, the former executive of a failed bank, and those with roles in the Wall Street bailout, Argentina’s default and America’s biggest municipal bankruptcies. Locked out of the capital markets as it edges toward a record-setting default, the Caribbean island of 3.5 million people may run out of cash as soon as this month… While Puerto Rico has already defaulted on securities backed by legislative appropriations, it may mark the first time the government has failed to make good on obligations guaranteed by its full faith and credit -- a pivotal moment that could haunt it for years. With a debt load of $73 billion, more than any state but California or New York, and an economy that’s contracted in all but one year since 2006, Garcia Padilla says the island can’t afford to pay back what it owes… The debt restructuring the governor wants to push through would be by far the largest ever in $3.7 trillion municipal market.”

November 4 – Financial Times (Eric Platt): “Credit risks are rising to the fore as private equity groups seek to put a near-record $540bn cash pile to work, pushing leverage back to levels not seen since the boom of 2007. A warning from Standard & Poor’s this week follows a sluggish few years for the leveraged buyout market, which has forced sponsors to lever up deals, leaving less cushion if the tide turns. Analysts at the rating agency say that despite the lack of megadeals since Energy Future Holdings, once known as TXU, was taken private at the market peak, excessive leverage has increased credit risk. ‘It has become increasingly challenging for sponsors to make efficient use of this dry powder,’ said Allyn Arden, analysts at S&P. ‘Private equity funds are more likely to drive up demand for assets as they compete with corporate issuers for acquisitions, potentially resulting in even higher purchase price multiples and weaker credit metrics on new deals.’ The debt burden of the largest 20 companies taken private since the start of 2014 has climbed to an average 7.6 times earnings before interest, tax, depreciation and amortisation, above the 6.2 average for the largest deals in 2010-11 and about a point below the 8.7 times average recorded for the biggest transactions in the 2005-07 boom.”

November 2 – Bloomberg (Christine Idzelis and Sridhar Natarajan): “Speculative-grade companies have finally found their window to return to the debt market. Just as long as they’re not too junky. After a tumultuous span that left the market largely shut during October, bankers have brought more high-yield debt the past three trading days than at any time during the previous month. T-Mobile US Inc. doubled a note and loan sale to $4 billion… and Goodyear Tire & Rubber Co. raised $1 billion on the same day… Avago Technologies Ltd. will start marketing a $7.5 billion loan this week… What those companies have in common are BB tier ratings that place them in the upper ranks of speculative-grade debt. In a reversal from previous rallies those higher-rated securities are leading the latest revival just as investors have cash to invest. ‘There’s no doubt that’s why the higher-quality issuers are still able to get deals done,’ said Anthony Valeri… strategist at LPL Financial. ‘There’s still strong demand for yield.’…Investors poured more than $5.3 billion to U.S. funds that purchase below investment-grade securities in the past two weeks… That’s reduced net redemptions for the year to $2.3 billion.”

Leveraged Speculation Watch:

November 3 – Reuters (Svea Herbst-Bayliss): “Billionaire investor William Ackman's Pershing Square Holdings portfolio has lost 19% this year after his bet on Valeant Pharmaceuticals International soured, turning one of last year's biggest winners into one of this year's most prominent losers. Pershing Square Holdings lost 7.3% in October, the firm, which invests roughly $16 billion for state pension funds, endowments and wealthy investors said on a Web site.”

Federal Reserve Watch:

November 5 – Reuters (Jonathan Spicer, Ann Saphir and Howard Schneider): “When the U.S. Federal Reserve tweaked its policy statement last week and put a December rate rise squarely back in play, it took a calculated gamble that reaching for an old and controversial policy tool would get financial markets' attention. That gamble was to specifically reference the next policy meeting as a date of a possible lift-off, and it had the desired effect: investors quickly rolled back bets that rates would stay near zero until next year. But interviews with current and former Fed officials, and with those close to policymakers, show the decision to use what is called calendar guidance in central bank parlance and what some described as a ‘hammer’ did not come easy. Some officials felt that even mentioning a date in the context of a potential policy change would be taken not as a contingent expectation but as a promise that would be painful to break. The last time the Fed flagged its next meeting for possible action was in 1999, as JPMorgan economist Michael Feroli pointed out. It resorted to calendar-based commitments of ultra-easy policy during the global financial crisis and recession, but ended that practice three years ago.”

Central Bank Watch:

November 6 – Bloomberg (Jeff Black and Boris Cerni): “Two European Central Bank Governing Council members said they see no need as yet to ease monetary policy further in December, despite continued signals from the ECB’s leadership that such a decision remains an option. ‘Knowing what I know as of today, including those inflation outcomes’ for the euro zone in October, ‘which I think were more positive than I would have expected, I would see even less reason to make changes now,’ Estonia’s Ardo Hansson told Bloomberg… His Slovenian counterpart, Bostjan Jazbec, said in Brdo, Slovenia, that he doesn’t ‘see the need for further additional unconventional measures by the ECB at the moment.’”

Leveraged Speculation Watch:

November 1 – Bloomberg (Lianting Tu and David Yong): “At last, currency traders are finding some traction. The carry-trade strategy, in which investors borrow in currencies with low interest rates and use the proceeds to buy an asset with higher rates, surged in October after posting losses for most of the year, according to a UBS Group AG index… ‘The high yielders present value because they’ve been beaten up so badly,’ Philip Simotas, ROW’s chief operating officer, said… ‘Those yields just become too juicy to pass up.’ The… company, which manages $435 million, is buying the currencies of Turkey, South Africa and Indonesia, funded by lower-yielding counterparts such as the euro and yen. Carry trades returned 4.7% in October, the most since January 2012…”

U.S. Bubble Watch:

November 4 – Bloomberg (Elizabeth Campbell and Brian Chappatta): “This U.S. earnings season is on track to be the worst since 2009 as profits from oil & gas and commodity-related companies plummet. So far, about three-quarters of the S&P 500 have reported results, with profits down 3.1% on a share-weighted basis… This would be the biggest quarterly drop in earnings since the third quarter 2009, and the second straight quarter of profit declines. Earnings growth turned negative for the first time in six years in the second quarter this year. The damage is the biggest in commodity-related industries, with the energy sector showing a 54% drop in quarterly earnings per share so far in the quarter, with profits in the materials sector falling 15%. The picture is brighter for the telecom services and consumer discretionary sectors, with EPS growth of 23% and 19% respectively so far this quarter.”

November 2 – UK Guardian (Simon Bowers): “The US has overtaken Singapore, Luxembourg and the Cayman Islands as an attractive haven for super-rich individuals and businesses looking to shelter assets behind a veil of secrecy, according to a study by the Tax Justice Network (TJN). The US is ranked third, behind Switzerland and Hong Kong, in the financial secrecy index… The performance of the US will come as a surprise to Barack Obama’s administration, which has been widely credited with doing more than any other government to compel offshore banks to hand over information on hidden assets. In recent years the US has also won unprecedented disclosure battles with Swiss banks notorious for protecting client information behind Switzerland’s secrecy laws. ‘Though the US has been a pioneer in defending itself from foreign secrecy jurisdictions it provides little information in return to other countries, making it a formidable, harmful and irresponsible secrecy jurisdiction,’ the TJN report said. The scale of hidden offshore wealth around the world is difficult to assess. The economist Gabriel Zucman has put it at $7.6tn, while the TJN’s James Henry, a former chief economist at consultancy McKinsey, estimated three years ago it could be more than $21tn.”

November 3 – Bloomberg (Mark Clothier and David Welch): “Automakers reported the best two-month stretch of U.S. sales in 15 years… The burgeoning demand for autos is adding to evidence the U.S. economy is strengthening as the Federal Reserve prepares to raise interest rates as soon as next month. Sales are surging as job growth, available credit and affordable fuel encourage shoppers to replace aging models, especially with sport utility vehicles.”

November 2 – Bloomberg (Matt Scully and Tracy Alloway): “Skopos Financial, a deep-subprime auto finance company based in Irving, Texas, is packaging $154 million of loans made to borrowers with weak credit -- and some without a credit score -- into bonds rated investment grade. More than three-quarters of the loans backing the deal are to borrowers with credit scores under 600 and another 14% have no credit score at all… That would place the bulk of the obligations well below what’s typically considered good credit. The offering is the latest prepared by privately backed auto lenders that offload their risk into securities bought by institutional investors. Skopos, which is backed by Lee Equity Partners LLC, the… private equity firm started by Thomas H. Lee, has only been in business since 2012.”

November 4 – Bloomberg (Elizabeth Campbell and Brian Chappatta): “When Illinois returns to the municipal market after its unprecedented 18-month borrowing drought, it may find its budget impasse will cost taxpayers millions of dollars in the coming decades. On a $1 billion offering of 25-year tax-exempt bonds, it would cost about $175 million more now than if an equal amount was issued with spreads at 2014 levels, based on data compiled by Bloomberg that assumes the yield equals the interest rate paid. Now in its fifth month without a spending plan, signs are mounting that debt sales for cash-strapped Illinois are only going to get more expensive.”

EM Bubble Watch:

November 4 – Bloomberg (Luke Kawa): “Just like Christmas music, the year-ahead previews from Wall Street seem to come a little earlier each year. UBS's global strategy team recently released its 2016 Outlook… The strategists are cautiously optimistic on the outlook for global equities and do not expect carnage in fixed income. If there's one asset class UBS is unreservedly bearish about, it's emerging markets. The developing world is ‘entering a new and dangerous phase,’ according to strategist Yianos Kontopoulos. ‘[U]p until recently, weak EM growth was largely seen as part of an adjustment narrative, where currency depreciation and soft domestic demand allowed EM economies to transition away from unsustainable external balances, [but] this narrative is now changing in one fundamental way,’ he wrote. ‘After several years of weak growth, EM macro balance sheets are eroding fast.’”

November 2 – Bloomberg (Vivian Nereim): “A measure of growth in Saudi Arabia’s non-oil private industries dropped to the lowest level in six years in October as the slump in oil prices slowed the biggest Arab economy’s momentum. The Emirates NBD Purchasing Managers’ Index fell to 55.7 from 56.5 in September… The same measure for the United Arab Emirates fell to 54 from 56 in September, the lowest since April 2013…”

November 2 – Reuters (Orhan Coskun and ERcan Gurses): “Turkey's new cabinet will bear the firm stamp of President Tayyip Erdogan with a slew of loyal advisors set for ministerial posts, senior officials said…, suggesting his grip will tighten as the AK Party returns to govern alone. The AKP's dramatic electoral comeback on Sunday, clawing back a majority lost only five months earlier, was a personal victory for Erdogan, whose ambition for stronger presidential powers rests on the party he founded controlling parliament. Opponents fear the result… will exacerbate his authoritarian instincts. There are already signs that a crackdown on dissent is intensifying. Authorities detained dozens of people, including senior police officers and bureaucrats… on suspicion of links to Fethullah Gulen, a U.S.-based Muslim cleric Erdogan accuses of plotting to overthrow him with bogus corruption accusations. The offices of a left-leaning news magazine were raided over a cover suggesting the election result could trigger conflict.”

November 4 – Bloomberg (Alex Nussbaum): “The global crash of commodity prices and a looming increase in U.S. interest rates threaten to put a damper on the rapid rise of clean energy in the developing world, Goldman Sachs Group Inc.’s chief strategy officer told investors… Nations dependent on metals and mining for income rode China’s demand for commodities in recent years to build up their economies and envision big investments in wind and solar power. Now, with growth slowing in China and elsewhere, the same countries face declining revenue that may make environmental measures a tougher sell, Goldman’s Stephen Scherr said… ‘Where they were inclined for a host of different reasons to be more aggressive regulators of coal, they are probably less inclined to do that, in part because it has negative consequences’ for the local economy, Scherr said. ‘Those countries are hell-bent on maintaining that middle-class and not losing it.’”

Brazil Watch:

November 6 – Financial Times (Joe Leahy): “Every week that passes in recession-hit Brazil seems to bring a new, bigger estimate for the size of the hole in the government’s finances. The latest came on Wednesday from Hugo Leal, a lawmaker from congress’s fiscal commission who is overseeing a bill covering the government’s 2015 budget. He said he would amend the bill to allow for a 2015 primary fiscal deficit — the budget balance before interest rates — of R$119.9bn (US$32bn), more than double that of the government’s most recent official estimate. The blowout, which mainly accounted for government off-budget liabilities with state banks, highlights the central problem facing Latin America’s biggest economy… As government debt grows so does the burden of servicing it, eating up the budget in a country that has among the highest interest rates in the world, with the central bank’s benchmark lending rate running at 14.25%. ‘It is going to be like [playing] Pac-Man,’ said Angel Gurría, the secretary-general of the Organisation for Economic Cooperation and Development… ‘You run like crazy simply to stay where you are.’”

Japan Watch:

November 1 – Bloomberg (Toru Fujioka, Keiko Ujikane and Tomoko Sato): “After twice this year putting off his inflation target yet declining to step up monetary stimulus, Bank of Japan Governor Haruhiko Kuroda has discouraged some analysts from thinking he’ll ever boost policy again… With policy unchanged even as the central bank cut forecasts for growth and prices, some observers are now struggling to determine what it would take for the governor to pull the trigger for more asset purchases. ‘The possibility of further easing is highly unpredictable,’ said Kyohei Morita, the chief Japan economist for Barclays Plc. ‘The BOJ has become something I don’t really understand,’ said Morita, who’s been analyzing the Japanese economy for more than two decades.”

Europe Watch:

November 5 – Financial Times (Tobias Buck, Anne-Sylvaine Chassany and Jim Brundsen): “Spain will miss its budget deficit target by an even wider margin than previously thought, the European Commission warned on Thursday, dealing a political blow to Madrid… Brussels also raised the alarm over France’s fiscal position, saying Paris is on course to miss its deficit targets this year, next year and in 2017… French finance minister Michel Sapin has insisted Paris would largely meet the eurozone’s deficit limit of 3% of GDP in 2017… Mr Sapin on… reiterated the government’s commitment to meet the target, pointing to €15.4bn worth of planned savings on public spending in 2017. Brussels said it expected Spain’s deficit to stand at 4.7% of GDP this year and 3.6% in 2016.”

Geopolitical Watch:

November 2 – Reuters (Andrea Shalal and Idrees Ali): “The U.S. Navy plans to conduct patrols within 12 nautical miles of artificial islands in the South China Sea about twice a quarter to remind China and other countries about U.S. rights under international law, a U.S. defense official said…‘We’re going to come down to about twice a quarter or a little more than that,’ said the official… ‘That's the right amount to make it regular but not a constant poke in the eye. It meets the intent to regularly exercise our rights under international law and remind the Chinese and others about our view,’ the official said.”

November 6 – Financial Times (Geoff Dyer): “Teddy Roosevelt, who more than a century ago was the first to define the Pacific as a core US interest, once urged his countrymen to ‘speak softly and carry a big stick’. On Thursday, America’s understated defence secretary Ashton Carter used a visit to the US aircraft carrier named in the former president’s honour to deliver a highly symbolic warning to China. Speaking from the deck of the USS Theodore Roosevelt — nicknamed ‘The Big Stick’ — in the South China Sea, Mr Carter said there was ‘a lot of concern about China in the region’. ‘Many countries in the region are coming to the United States and asking us to do more with them so that we can keep the peace out here,’ Mr Carter said, as he warned of ‘extravagant claims and the militarisation, principally by China’ in the South China Sea. As he spoke, the USS Theodore Roosevelt was 150-200 nautical miles south of the Spratly Islands, the contested areas of the South China Sea where China is building a number of artificial islands.”

November 1 – Financial Times (Demetri Sevastopulo): “The US is debating whether to position more ships and naval assets in Europe as Russian warships and submarines operate at levels not seen in two decades, according to the new head of the US Navy. Admiral John Richardson, chief of naval operations, told the Financial Times that the navy was reassessing its global posture in the face of the Russian activity, which stretches from the Black Sea and Mediterranean to the Pacific. ‘Their submarine force and their navy are as active as they have been in a long time, 20 years or so,’ Adm Richardson said… ‘How are we going to posture our forces to make sure that we maintain the appropriate balance and are suitably engaged?’ Adm Richardson said the navy was evaluating whether to boost its presence in Europe and the Pacific. ‘That’s the conversation we’re having right now.’ While some of the stepped up activity stems from Russia’s involvement in Syria, its navy has been increasingly active from the eastern US coast to the Pacific.”