Saturday, November 21, 2015

Weekly Commentary: Monetary Fiasco

All great monetary fiascos are forged upon a foundation of misperceptions and flawed premises. There’s always an underlying disturbance in money and Credit masked by supposed new understandings, technologies, capabilities and superior financial apparatus.

During the nineties “New Paradigm” period, exciting new technologies and “globalization” were seen unleashing a productivity and wealth miracle. The Greenspan Fed believed this afforded the economy an accelerated speed limit. With inflation and federal deficits believed conquered, there was little risk associated with low rates and an “asymmetrical” policy approach to support the booming economy and financial markets. The Fed significantly loosened the reins on finance precisely when they needed to be tightened.

The nineties were phenomenal from a financial perspective. Total system Debt about doubled to $25.4 TN. Remarkably, Financial Sector borrowings surged more than 200% to $8.2 TN. Outstanding Agency (GSE) securities ballooned from $1.267 TN to end the decade at $3.916 TN, for growth of 209%. Securities Broker/Dealers (liabilities) jumped 212% to $1.73 TN. “Fed Fund and Repo” expanded 112% to $1.655 TN. Wall Street “Funding Corps” rose 387% to $1.064 TN. Securities Credit surged 414% to $611 billion.

And the most incredible aspect of the nineties boom in “Wall Street Finance”? Pertinent to today’s backdrop, the 1990’s Bubble unfolded over years with barely a notice. Everyone was mesmerized by the Internet, exciting new technologies and the white-hot IPO market. I was fixated on what I was convinced was evolving into epic financial innovation and a historic Credit Bubble. Yet attempts to explain this backdrop to other financial professionals, academics, economists, journalists and even Fed officials went absolutely nowhere. Repeatedly I heard frustrating variations of “Doug, you don’t understand.” “Only banks create Credit.” “The Federal Reserve controls the money supply.” “Fannie and Freddie are only financial intermediaries – they don’t impact system Credit.” “Financial system borrowings don’t matter. Doug, you’re double-counting debt.”

Even back in the nineties, it was largely ideological. Everyone had adopted a doctrine of how finance worked and it was very rare that someone would take a deep dive into developments and the analysis and then challenge orthodoxy. As I’ve noted in the past, it was not until Paul McCulley coined “shadow banking” in 2007 that analysts and policymakers belatedly began to take notice.

Somehow history’s greatest period of financial innovation and Credit excess transpired without drawing the attention of conventional thinkers or even policymakers. Especially by 2006 and 2007, it was the “naysayers” that had been completely discredited. The conventional view held that financial innovation and policy enlightenment had fostered extraordinary financial and economic system stability. Analysis that the GSEs, MBS, ABS, speculative leveraging, securities finance and the derivatives marketplace had nurtured acute systemic fragilities was completely pilloried. The notion back in 2006 and 2007 that the world was at the brink of a major crisis was considered absolute wackoism. Incredibly – and well worth contemplating these days - virtually no one saw the deep structural impairment associated with the protracted Bubble in “Wall Street Finance.”

An even more momentous monetary fiasco has been perpetrated since the 2008 crisis, constructed upon a foundation of even more outlandish misperceptions and flawed premises. It was dumbfounding that virtually everyone disregarded the financial, economic and social ramifications associated with a doubling of mortgage Credit in just over six years. Throughout the boom, the issue of a systemic mispricing of mortgage Credit concerned virtually no one – not the marketplace and certainly not financial regulators. These days, analysis of a deeply systemic mispricing of financial assets on a global basis garners a yawn. Ramifications for an unprecedented inflation in central bank Credit and associated market manipulation go largely unappreciated. Somehow, it is accepted as obvious fact that the expansion of central bank Credit entails overwhelming benefits with minimal risk.

The financial world has come a long way since 2012. ECB president Mario Draghi Friday stated, “We will do what we must to raise inflation as quickly as possible” and use “all the instruments available.” This pronouncement is a historically notable upgrade from 2012’s “whatever it takes,” especially with it coming amid European economic recovery and a securities market boom (i.e. bond yields near record lows).

Meanwhile, sentiment in the U.S. was captured with a simple CNBC headline: “Expect a ‘One-and-Done” Fed Rate Hike.” After delaying a little 25 bps bump in rates for seemingly forever, the Fed now sees it necessary to communicate the most dovish (potential) rate hike in the history of central bankering. And with the People’s Bank of China apparently in the midst of protracted monetary loosening, global markets are back in a holiday mood.

In not too many weeks it will be 2016. The financial crisis hit in 2008. A fundamental CBB maxim over the years is that once commenced monetary inflation becomes virtually impossible to suspend. While the Fed has paused QE, from a global Bubble perspective the BOJ and ECB still combine for about $125 billion monthly QE, with Draghi hankering to upsize. The Fed hasn’t raised rates in about a decade, with Fed funds stuck near zero now for almost seven years. The ECB, BOJ and “developed” central banks around the world are stuck at near zero short-term rates.  Apparently, negative rates are on the way.

There are a number of myths and misperceptions underpinning the great “global government finance Bubble.” For starters, there’s the “so long as inflation (CPI and PPI) remains low and contained, unlimited central bank Credit expansion can be called upon to stabilize markets and economies.”

There is no bigger misperception than the belief that with Fed liabilities largely contained within the U.S. banking system (as a banking system asset) this Credit has minimal impact on the markets and real economy. Many early CBBs attempted to tackle the complex issue of how GSE Credit was distorting the financial system and economy (as well as international financial flows).

Most directly, the expansion of GSE liabilities created purchasing power that spurred a self-reinforcing inflation in mortgage Credit, home prices and sales transactions. Through myriad channels, this Bubble was boosting purchasing power throughout the economy. Less obvious – and certainly unrecognized at the time – mortgage Credit growth was inflating corporate profits and boosting incomes. And through various channels, expanding mortgage Credit was instrumental in expanding the amount of finance flowing into the markets. Importantly, the booming liquidity backdrop incentivized a self-reinforcing Bubble in asset prices, risk-taking and speculative leveraging.

When reading academic papers on “Monetary Finance” (thanks R.C.), it’s clear that the economics community misses key dynamics of central bank monetary inflation. Simplistically, conventional thinking holds that if the federal government issues debt that is then purchased by the central bank, all is good so long as it’s not done in egregious excess. As long as there’s slack (insufficient demand) in the economy, risk remains minimal. This is consistent with the conventional view that’s taken hold in global markets that enlightened central bankers have mastered the science of non-inflationary stimulus of aggregate demand.

It’s interesting that contemporary academic theories and models supportive of Central bank “monetary financing” focus chiefly on traditional concepts of “aggregate nominal demand” and “inflation.” So long as demand is insufficient and inflation low, “monetary financing” is seen as both highly desirable and low-risk. Supposedly there is essentially no limit to the size of the central bank’s holdings of government debt so long as aggregate demand is below potential and inflation is contained. The academics avoid the critical issue of monetary inflation’s highly complex (I would argue unpredictable) impact on security and asset market dynamics, including leveraged speculation and Bubbles.

At the heart of today’s misperceptions is the view that the Federal Reserve is able to purchase Treasury debt without creating inflationary effects so long as Fed Credit is held inertly on the banking system’s balance sheet. Apparently, the federal government can deficit spend and the Fed can monetize this debt with minimal risk because of economic slack and tame inflation. There are today effectively no restraints on the Treasury’s debt load, as there is no reason for the Fed to liquidating its Treasury holdings. As thinking goes, the current backdrop affords central bankers an essentially unlimited capacity to monetize debt, in the process stimulating aggregate demand back to potential. And at some point the Fed (and global central banks) will extinguish their sovereign debt holdings and erase federal government debt obligations altogether

Between 2008 and 2014, the Federal Reserve’s balance sheet swelled $3.604 TN, from $951 billion to $4.555 TN. Over this same period, banking system total assets expanded $3.753 TN (to $16.898 TN). Loans, the banking system’s largest, expanded only $789 billion (to $9.087 TN). The fastest growing asset, Reserves at the Fed, surged from $21 billion to $2.357 TN.

There’s a misperception that banking system holdings of “Reserves at the Fed” signifies that this liquidity has not departed the banking system. In reality, the banking system came to hold Reserves at the Fed as banks created new deposits for customers in exchange for Fed liquidity. Since 2008, Bank Deposits (checkable, small & savings and large time) have expanded $3.982 TN, or 46% (to $12.470 TN to end 2014).

The surge in bank deposits (reflected in M2) is evidence of a historic post-2008 monetary inflation. Why this inflation in purchasing power has not translated into rising CPI is a complex issue (massive global investment/overcapacity, unlimited supply of technologies and digitalized output, a services-based economy, inequitable wealth distribution, “financial engineering”, etc.). Clearly, with the Fed manipulating interest rates and backstopping securities markets through massive QE purchases, “money” has been incentivized to flow into securities and asset markets (over real economy investment). Furthermore, the Fed targeting higher securities market prices has incentivized leveraged speculation and “financial engineering,” both working to draw finance into the “Financial Sphere” as opposed to the “Real Economy Sphere.”

This gets to the heart of the most dangerous myth and misperception: that central banks control inflation. I would contend that the Fed some time ago lost control of inflationary dynamics. The move to unfettered global market-based finance was transformative. Runaway financial Bubbles provided virtually unlimited finance for unprecedented growth in manufacturing capacity (i.e. China, Asia, EM, technology, healthcare and all things energy/commodities). At the same time, these Bubbles became magnets for finance, again with major ramifications for inflation dynamics. Moreover, the financial Bubble backdrop ensured major wealth disparities, one more profound factor in today’s highly unusual inflationary backdrop.

For the past two decades, global central bankers have nurtured and accommodated securities market-based finance. The resulting Bubble stimulated growth and perceived wealth creation like never before. Unprecedented post-2008 measures ensured Bubble Dynamics turned increasingly unwieldy. Concerted open-ended QE in 2012 provided the final straw: market Bubbles are out of control. Draghi will not raise consumer price inflation with QE, although he very well could further stoke securities markets inflationary Bubbles. A weaker euro may somewhat raise consumer inflation, yet such “beggar thy neighbor” policies are a zero sum game. Chinese manufactures saw their currency gain another 1% versus the euro this week.

For the Week:

The S&P500 jumped 3.3% (up 1.5% y-t-d), and the Dow rose 3.4% (unchanged). The Utilities sank 3.2% (down 10.6%). The Banks gained 3.0% (up 2.2%), and the Broker/Dealers rose 3.4% (up 0.5%). The Transports surged 3.6% (down 9.2%). The S&P 400 Midcaps gained 2.9% (down 0.4%), and the small cap Russell 2000 increased 2.5% (down 2.5%). The Nasdaq100 surged 4.1% (up 10.6%), and the Morgan Stanley High Tech index jumped 4.4% (up 10.2%). The Semiconductors gained 3.4% (down 3.1%). The Biotechs rose 3.2% (up 8.8%). With bullion down $6, the HUI gold index declined 1.8% (down 34.6%).

Three-month Treasury bill rates ended the week at 10 bps. Two-year government yields jumped seven bps to 0.92% (up 25bps y-t-d). Five-year T-note yields gained three bps to 1.69% (up 4bps). Ten-year Treasury yields slipped a basis point to 2.26% (up 9bps). Long bond yields declined four bps to 3.02% (up 27bps).

Greek 10-year yields fell 15 bps to 6.82% (down 293bps y-t-d). Ten-year Portuguese yields sank 27 bps to 2.47% (down 15bps). Italian 10-year yields declined seven bps to 1.49% (down 40bps). Spain's 10-year yields sank 16 bps to 1.63% (up 2bps). German bund yields fell eight bps to a six-month low 0.48% (down 6bps). French yields declined five bps to 0.82% (down one bp). The French to German 10-year bond spread widened three to 34 bps. U.K. 10-year gilt yields dropped 11 bps to 1.87% (up 12bps).

Japan's Nikkei equities index gained 1.4% (up 13.9% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.31% (down 1bp y-t-d). The German DAX equities surged 3.8% (up 13.4%). Spain's IBEX 35 equities index rose 1.8% (unchanged). Italy's FTSE MIB index increased 1.4% (up 16.5%). EM equities were mostly higher. Brazil's Bovespa index surged 3.5% (down 3.7%). Mexico's Bolsa jumped 2.9% (up 2.1%). South Korea's Kospi index gained 0.8% (up 3.9%). India’s Sensex equities index rose 1.0% (down 5.9%). China’s Shanghai Exchange increased 1.4% (up 12.2%). Turkey's Borsa Istanbul National 100 index fell 1.5% (down 5.9%). Russia's MICEX equities index surged 5.7% to a nine-month high (up 30.8%).

Junk fund flows were negative for the second week, with outflows of $1.4bn (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 3.97% (up 10bps y-t-d). Fifteen-year rates declined two bps to 3.18% (up 3bps). One-year ARM rates declined one basis point to 2.64% (up 24bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 3.97% (down 31bps).

Federal Reserve Credit last week expanded $7.2bn to $4.460 TN. Over the past year, Fed Credit declined $1.9bn. Fed Credit inflated $1.650 TN, or 59%, over the past 158 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week gained $4.6bn to $3.308 TN. "Custody holdings" rose $14.8bn y-t-d.

M2 (narrow) "money" supply declined $13.4bn to $12.280 TN. "Narrow money" expanded $731bn, or 6.3%, over the past year. For the week, Currency was little changed. Total Checkable Deposits rose $8.0bn, while Savings Deposits dropped $19.4bn. Small Time Deposits were about unchanged. Retail Money Funds declined $1.1bn.

Total money market fund assets slipped $2.1bn to $2.712 TN. Money Funds declined $21.1bn year-to-date, while gaining $58bn y-o-y (2.2%).

Total Commercial Paper jumped $17bn to $1.066 TN. CP increased $58bn year-to-date.

Currency Watch:

November 17 – Reuters (Hongmei Zhao and Pete Sweeney): “China has moved to restrict trade at offshore yuan clearing banks, sources told Reuters on Wednesday, stepping up capital controls even as Beijing positions its currency for inclusion in the International Monetary Fund's reserve basket. The move suggests Chinese regulators still harbor concerns about depreciation pressure, which could put China's IMF bid at risk… It marks the latest in a series of steps by the central bank to control the market after a shock devaluation of the yuan in August spurred three months of dramatic capital outflows. Three sources with direct knowledge of the matter said offshore yuan clearing banks and related offshore participant banks had been instructed by the central bank to suspend trading in bond repos and yuan account financing. ‘We received window guidance from the central bank on Friday,’ a trader at an offshore yuan clearing bank said. ‘We have already temporarily suspended trade in account financing and bond repurchases with onshore banks.’”

November 19 – Financial Times (Jamil Anderlini): “Chinese police have arrested hundreds of people suspected of running underground banks that illegally transferred more than Rmb800bn ($125bn) out of China into foreign currencies. News of the busts comes as Beijing has been tightening capital controls to relieve downward pressure on the value of the renminbi and stop money flooding out of the country. The central bank has been intervening heavily in onshore and offshore foreign exchange markets to prop up the value of the Chinese currency since it carried out a small devaluation and changed the mechanism for setting its exchange rate in early August. Police have cracked 170 cases of illegal fund transfers and money laundering involving more than Rmb800bn since April… The paper said illegal flows of money out of the country have not only impacted China’s foreign exchange management system but also seriously disturbed ‘financial and capital markets order’.”

The U.S. dollar index added 0.8% this week to 99.61 (up 10.3% y-t-d). For the week on the upside, the Brazilian real increased 3.7%, the South African rand 3.0%, the Australian dollar 1.2%, the Mexican peso 0.9%, the Norwegian krone 0.4% and the New Zealand dollar 0.4%. For the week on the downside, the euro declined 1.2%, the Swiss franc 1.2%, the Swedish krona 0.6%, the British pound 0.3%, the Japanese yen 0.2% and the Canadian dollar 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index declined 0.5% (down 19.2% y-t-d). Spot Gold slipped 0.5% to $1,078 (down 9%). December Silver dipped 0.4% to $14.17 (down 9%). December WTI Crude recovered 73 cents to $41.46 (down 22%). December Gasoline rallied 3.9% (down 13%), while December Natural Gas sank 9.7% (down 26%). December Copper plunged 4.7% (down 27%). December Wheat fell 1.2% (down 17%). December Corn jumped 3.2% (down 7%).

Global Bubble Watch:

November 19 – Bloomberg (Tracy Alloway): “‘Take this money,’ the markets shout. ‘We don't want it,’ market participants yell in response. Where once unusual market dislocations would lure a host of traders eager to profit from the temporary distortions, a deluge of post-financial crisis changes have converged to dissuade them from doing so. With balance sheets at the big dealer-banks under pressure, and hedge funds unable or reluctant to put on trades, odd dislocations in the markets can now persist indefinitely. Some worry that these newly-stubborn ructions in esoteric corners of the global financial system could exacerbate market moves… ‘As arbitrage goes away, directional moves can become more exaggerated,’ said Peter Tchir, head of macro strategy at Brean Capital LLC. ‘In the short-term, as relationships break down, people have to ‘de-risk’ as old relationships don't hold.’ The lack of arbitrageurs has manifested itself in a number of rare market events in recent weeks the most prominent being swap rates trading below equivalent U.S. Treasuries yields. So-called negative ‘swap spreads’ would historically have drawn traders eager to iron out the kink in the usual state of financial market affairs, but regulatory and cultural change combined with some additional year-end pressures are said to have prevented them from doing so. ‘It speaks about balance sheet limits and a growing fear of losing money short-term,’ said Brian Weinstein, chief investment officer at Blue Elephant Partners… ‘The willingness to carry a losing trade for too long has gotten smaller and smaller.’”

November 15 – Bloomberg (Daniel Kruger, Liz McCormick and Anchalee Worrachate): “Something very strange is happening in the world of fixed income. Across developed markets, the conventional relationship between government debt -- long considered the risk-free benchmark -- and other assets has been turned upside-down. Nowhere is that more evident than in the U.S., where lending to the government should be far safer than speculating on the direction of interest rates with Wall Street banks. But these days, it’s just the opposite as a growing number of Treasuries yield more than interest-rate swaps. The same phenomenon has emerged in the U.K., while the ‘swap spread’ as it’s known among bond-market types, has shrunk to the smallest on record in Australia. Part of it simply has to do with the fact that investors are pushing up yields on Treasuries… as the Federal Reserve prepares to raise borrowing costs for the first time in a decade… ‘These kinds of dislocations can be expected to grow over time,’ said Aaron Kohli, a fixed-income strategist at Bank of Montreal, one of 22 primary dealers that trade directly with the Fed. ‘The market structure and regulatory structure has evolved in a period with very low volatility. Once you take that away, it’s not clear what the secondary implications of that will be.’”

November 18 – Financial Times (Paul McClean and Joel Lewin): “Germany sold two-year government debt at a record low yield of minus 0.38% on Wednesday, in a move reflecting expectations of further monetary easing for the eurozone next month… About 10 eurozone countries have two-year debt at negative yields, and investors expect the European Central Bank to cut the rate it pays on overnight deposits, which stands at minus 0.20%, further into negative territory.”

China Bubble Watch:

November 15 – Bloomberg (Alfred Liu): “The loans outstanding of China’s four biggest banks declined for the first time since at least 2009, adding to warning signs for a tepid economy. Total loans by the four lenders, including Industrial & Commercial Bank of China Ltd., amounted to 35.7 trillion yuan ($5.6 trillion) at the end of October, down 65.6 billion yuan from a month earlier… ‘Credit growth is slowing because they are cautious about the economic outlook and asset quality,’ said Chen Shujin, an analyst at DBS Vickers Hong Kong Ltd…. Chinese banks’ troubled loans increased to almost 4 trillion yuan by the end of September… Their profit growth slumped to 2% in the first nine months from 13% a year earlier.”

November 19 – Bloomberg: “Chinese borrowers are taking on record amounts of debt to repay interest on their existing obligations, raising the risk of defaults and adding pressure on policy makers to keep financing costs low. The amount of loans, bonds and shadow finance arranged to cover interest payments will probably rise 5% this year to a record 7.6 trillion yuan ($1.2 trillion), according to… Hua Chuang Securities Co., whose lead fixed-income analyst was top-ranked by China’s New Fortune magazine in 2012 and 2013. Dubbed ‘Ponzi finance’ by Hyman Minsky, the use of borrowed funds to repay interest was seen by the late U.S. economist as an unsustainable form of credit growth that could precipitate financial crises… ‘Some Chinese firms have entered the Ponzi stage because return on investment has come down very fast,’ said Shi Lei, the… head of fixed-income research at Ping An Securities Co., a unit of the nation’s second biggest insurance company. ‘As a result, leverage will be rising and zombie companies increasing.’”

November 19 – Reuters (Engen Tham and Umesh Desai): “Some Chinese banks, hit by a surge of troubled borrowing in a weakening economy, are increasingly failing to recognise loans gone sour on their books to avoid having to stump up capital. Loans to borrowers that have missed a payment are growing three times faster than loans the banks recognise as non performing, according to their regulatory filings. An increasingly large chunk of these overdue loans sit on the banks' books at their full value, even when payments have been missed for more than 90 days… ‘In the past, NPLs outnumbered overdue loans,’ said an official at the China Banking Regulatory Commission (CBRC)… ‘Now overdue loans are surpassing NPLs.’ At 18 listed Chinese banks, overdue loans that had not been written down jumped 57% to 645 billion yuan ($101bn) in the first half of this year from the end of 2014, while NPLs increased 17% to 692 billion yuan, a UBS analysis of Chinese banks' balance sheet data show. For loans overdue for more than three months, the increase was a hefty 166% from the end of 2014 to 149 billion yuan ($23.4bn), a problem that analysts say is more widespread at mid-tier and smaller unlisted Chinese banks.”

November 17 – Bloomberg: “Yet another Chinese coal miner is struggling with debt payments as the slumping economy curbs demand and spurs defaults. State-owned Yunnan Coal Chemical Industry Group Co. and its businesses had 1.31 billion yuan ($205.6 million) of overdue loans as of Oct. 30 due to rising borrowings and a cash shortage… China Chengxin International Credit Rating Co. lowered the parent’s issuer rating to BB from AA on Nov. 13, and put the firm on notice for a possible further cut.”

November 17 – Bloomberg: “The high-drama highway arrest of a prominent hedge fund manager. Seizures of computers and phones at Chinese mutual funds. The investigations of the president of Citic Securities Co. and at least six other employees. Now, add the probe of China’s former gatekeeper of the IPO process himself. The arrests or investigations targeting the finance industry in the aftermath of China’s summer market crash have intensified in recent weeks, creating a climate of fear among China’s finance firms and chilling their investment strategies… The government’s response to the market crash was intervention: state-directed purchases of shares, a ban on initial public offerings and restrictions on previously allowed practices, such as short selling and trading in stock-index futures. Next, high-ranking industry figures came under scrutiny as officials investigated trading strategies, decried ‘malicious short sellers’ and vowed to ‘purify’ the market. Policy makers say ‘now we’re innovating, so you can all come in -- using high-frequency trading, hedging, whatever -- to play in our markets,’ Gao Xiqing, a former vice chairman of the China Securities Regulatory Commission, told a forum in Beijing… ‘A few days later, you say no, the rules we made are not right, there are problems with your trading, and we’re putting you in jail for a while first.’”

November 18 – Wall Street Journal (Grace Zhu and Esther Fung): “Separate gauges of China’s property market and its vital-but-murky shadow-banking system both showed more weakness, as the country’s economic growth engine continues to sputter. Assets under management at China’s trust companies posted their first quarterly decline in five years, due to the cooling economy and a summer stock-market rout… Trust companies, which take money from investors and lend out to other firms, are an important part of China’s informal—or shadow -- banking system, which is a key source of funding for companies underserved by the state-run banking system. Total assets under trust management stood at 15.62 trillion yuan ($2.45 trillion) at the end of September, down 1.58% from the second quarter… Trust assets still were up 20.6% on a year-over-year basis. Net profit for the whole trust sector was also down 30% from a quarter earlier to 15.69 billion yuan in the July-September period…”

November 17 – Bloomberg: “China’s home-price recovery slowed in October, as a supply glut in less-prosperous cities challenges the authorities’ efforts to revive the residential market with interest-rate cuts and easing of mortgage restrictions. New-home prices increased in 27 cities, 12 fewer than in September… Prices dropped in 33 cities, compared with 21 in September, and were unchanged in 10. The number of unsold new homes nationwide increased 14% to 437 million square meters (4.7 billion square feet) as of Oct. 31… Chinese President Xi Jinping has vowed to ‘ease property inventory’ after the government cut interest rates last month for the sixth time in a year.”

November 17 – Bloomberg: “Crude steel production in China will collapse by 23 million metric tons next year, according to the nation’s leading industry group. That’s equivalent to more than a quarter of annual output from the U.S. Supply from the top producer may drop 2.9% to about 783 million tons from 806 million tons in 2015, according to the China Iron & Steel Association. The slump would be driven by a deepening downturn in local demand and as mills encounter stiffer opposition to exports, Deputy Secretary General Li Xinchuang said… ‘You can’t find any bright spots,’ Li said in Shanghai, citing weakness across Asia’s largest economy. ‘Property developments used to enjoy annual growth of 20% and now at best it is 5%. Infrastructure investments haven’t taken off due to lack of funds despite of all the planned numbers of projects. Manufacturing investments have also dropped like a stone.’”

Fixed Income Bubble Watch:

November 17 – Bloomberg (Sridhar Natarajan and Christine Idzelis): “Investors who piled into anything and everything in the junk-debt market in recent years have begun to run in the other direction at the first sign of trouble. The turnabout has caught Wall Street’s biggest banks off guard and is increasingly leaving them on the hook for funding takeovers that investors want little part of. On Tuesday, Bank of America Corp. and Morgan Stanley were forced to shelve the debt package backing the year’s largest leveraged buyout -- $5.5 billion meant to fund Carlyle Group LP’s purchase of Veritas, Symantec Corp.’s data-storage business… ‘It’s very much a whipsaw market,’ said Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors LLC. ‘Outside of a recessionary period, this has been pretty brutal.’ Fixed-income investors are fast pulling down the shutters on the riskiest deals as they brace for the Federal Reserve to raise the benchmark rate for the first time in almost a decade and the outlook for global growth darkens. That has left banks grappling with more than $15 billion of deals that money managers have rejected or demanded huge discounts to buy in recent weeks. Skittish investors could also cause those banks to think twice about putting together deals with high leverage in the future… The average price of leveraged loans in the secondary market has plunged below 90 cents on the dollar to a four-year low.”

November 16 – Reuters (Edward McAllister): “An autumn credit crunch was expected to hit many independent U.S. oil producers, starving the industry of billions of dollars and further denting company budgets and drilling plans. But banks that adjust their loans to energy companies every six months based on the oil price and volumes of reserves were more lenient than many expected this time, leaving producers with more cash for drilling and allowing them to supply more oil to a market already flush with excess crude. The biannual process, known in the industry as redetermination, shaved only 4% off bank loans to oil and gas companies… It offers cash-starved energy firms a lifeline right when oil prices are back near six-year lows around $40 per barrel because of global oversupply… In total, the producers retained access to $30.7 billion in credit this fall, $1.4 billion less than in the spring. ‘Is anyone looking to ring the death knell for the energy industry?’ asked Thomas Rinaldi, institutional investor service director at global energy consultancy Wood Mackenzie. ‘I don’t think so.’”

November 19 – Bloomberg (Tracy Alloway): “A financial market record was quietly reached this week. Allocations to corporate bonds by big buy-side investors moved to 35.5%, up from 35.3% last week, according to the latest Stone McCarthey survey of senior money managers. It is an all-time high for a data series that began back in 1999, when the figure was as low as 19.1%.”

Leveraged Speculation Watch:

November 18 – Bloomberg (Sabrina Willmer): “BlackRock Inc., the world’s largest asset manager, is winding down a global macro hedge fund after losses and investor redemptions eroded assets. BlackRock Global Ascent lost 9.4% this year…, on track for its worst year since inception in 2003. The fund, which had $4.6 billion in assets just two years ago, has shrunk to less than $1 billion… BlackRock, known better for its exchange-traded funds and mutual funds, is joining money managers including Fortress Investment Group LLC and Bain Capital that shuttered macro funds this year. Many investors have struggled to navigate market turns that included an unexpected surge in the Swiss franc in January, a rally in European government bonds in April, a surprise devaluation of the Chinese yuan in August, falling oil and gold prices and a third-quarter selloff in stocks that were popular with hedge funds.”

November 16 – Bloomberg (Saijel Kishan, Katherine Burton and Simone Foxman): “Some of the world’s top hedge fund managers scaled back their U.S. stock investments last quarter as markets tumbled. The value of Stan Druckenmiller’s disclosed U.S.-listed equity holdings dropped 41% to $868 million, according to a filing… The listed holdings at Louis Bacon’s Moore Capital Management fell 39% to $1.65 billion, while at David Tepper’s Appaloosa Management, they dropped 30% to $2.82 billion… ‘I could see myself getting bearish, and I can’t see myself getting bullish,’ Druckenmiller, a longtime hedge fund manager who worked for George Soros for more than a decade, said…”

Central Bank Watch:

November 19 – Financial Times (Claire Jones): “Eurozone policymakers mooted ramping up their monetary stimulus as early as October… The ECB is expected to unleash an enhanced version of its €1.1trn quantitative easing package and consider cutting one of its benchmark interest rates deeper into negative territory in its early December vote. The accounts for the rate-setting governing council’s late October meeting in Malta, published yesterday, show weak regional and global growth, as well as the resistance of the US Federal Reserve to raising rates which almost forced the ECB to act sooner. ‘It was argued that in such an environment, the risk of deflation remained relevant,’ the accounts read. ‘Against this background, the view was put forward that a case could be made for considering reinforcing the ECB’s accommodative monetary policy stance already at the current meeting and, in any case, to act sooner rather than later.’”

November 18 – Financial Times (Claire Jones): “Mario Draghi has dropped another hint that the European Central Bank is readying more measures to boost the eurozone’s recovery, saying there were signs a major measure of inflation would take longer to return to policymakers’ target. The ECB president, who has already said the central bank will re-examine the case for more monetary easing in early December, told the European Parliament… that ‘signs of a sustained turnaround in core inflation have somewhat weakened.’ …Mr Draghi’s nod to the consumer price measure suggests the ECB chief is likely to unleash a more aggressive quantitative easing package and consider cutting interest rates next month. ‘The option of doing nothing would go against price stability,’ Mr Draghi said in a dovish set of remarks. ‘That is what will outline the strategy for the coming months.”

November 18 – Financial Times (Claire Jones): “The European Central Bank is willing to break an earlier promise and delve deeper into the world of negative interest rates. The uncertainties of this topsy turvy universe are numerous, but economists believe there is plenty of room for the eurozone’s central bankers to cut rates further. A move deeper into negative territory, which would raise the cost imposed on lenders who leave their accounts at the eurozone’s monetary guardian in the black, could come as soon as December 3.”

U.S. Bubble Watch:

November 18 – New York Times (Alexander Burns and Giovanni Russonello): “Half of New York City residents say they are struggling economically, making ends meet just barely, if at all, and most feel sharp uncertainty about the future of the city’s next generation, a new poll shows. The poll, conducted by The New York Times and Siena College, shows great disparities in quality of life among the city’s five boroughs. The stresses weighing on New Yorkers vary widely, from the Bronx, where residents feel acute concern about access to jobs and educational opportunity, to Staten Island, where one in five report recently experiencing vandalism or theft. But an atmosphere of economic anxiety pervades all areas of the city: 51% of New Yorkers said they were either just getting by or finding it difficult to do so.”

November 19 – Bloomberg (Sridhar Natarajan): “Federal regulators have started to intensify their scrutiny of risky company loans extended by Wall Street’s biggest banks, just weeks after completing an annual audit of corporate lending… JPMorgan Chase & Co., Deutsche Bank AG and Credit Suisse Group AG are having their lending practices examined again, said the people, asking not to be identified… Banking regulators have been trying for more than two years to curb excessive risk-taking by Wall Street’s biggest lenders as they seek to limit bank exposure to loans made to heavily indebted companies. Their campaign is back in the spotlight as investors shy away from highly levered buyout loans.”

November 19 – Wall Street Journal (Josh Zumbrun): “Subprime auto lending is shifting into higher gear, raising some concerns in Washington where top financial regulators have sounded alarms about this category of loans. Over the six months through September, more than $110 billion of auto loans have been originated to borrowers with credit scores below 660, the bottom cutoff for having a credit score generally considered ‘good’… Of that sum, about $70 billion went to borrowers with credit scores below 620, scored that are considered ‘bad.’ … Overall household borrowing has climbed to $12.1 trillion, the highest level in more than 5 years, with rising balances for mortgages, auto loans, student loans and credit cards in the third quarter, according to the report.”

Brazil Watch:

November 18 – Bloomberg (Jonathan Levin and Peter Millard): “The debt clock is ticking down at Brazil’s troubled oil giant, Petrobras. Next up: $24 billion of repayments over 24 months. That’s a towering hurdle for a company that hasn’t generated free cash flow for eight years and whose borrowing rates are soaring. Annual debt servicing costs have doubled to 20.3 billion reais ($5.4bn) in the past three years. The delicate task of managing the massive $128 billion mound of debt… – 84% of it in foreign currencies -- falls to the two banking veterans parachuted atop the company earlier this year, CEO Aldemir Bendine, 51, and Chief Financial Officer Ivan Monteiro, 55. The pair came from the state-controlled Banco de Brasil SA to contain the damage from the biggest corruption scandal in the country’s history… Petrobras dollar bonds due in 2024 yield 10.07%, or 3.80 percentage points more than when they were issued in March 2014 in one of its last major international financing efforts. Citing adverse conditions in capital markets, the company canceled a 3 billion reais bond issue last month after a downgrade to junk status.”

November 19 – Bloomberg (David Biller and Matthew Malinowski): “Brazil’s inflation exceeded 10% for the first time in 12 years, complicating President Dilma Rousseff’s efforts to revive an economy that is also battling higher-than-forecast unemployment. Consumer prices rose 0.85% from Oct. 15 to Nov. 12, pushing the 12-month inflation rate to 10.28%... As consumer prices in Latin America’s biggest economy continue to accelerate, Brazil’s central bank has delayed its plan of slowing inflation to its 4.5% target to 2017 from 2016. The bank has signaled it will keep rates on hold for a third consecutive meeting next week as it is caught between higher living costs and the deepest recession in 25 years.”

Japan Watch:

November 15 – Bloomberg (Keiko Ujikane): “Japan’s economy contracted in the third quarter as business investment fell, confirming what many economists had predicted: The nation fell into its second recession since Prime Minister Shinzo Abe took office in December 2012. Gross domestic product declined an annualized 0.8% in the three months ended Sept. 30, following a revised 0.7% drop in the second quarter…Weakness in business investment and shrinking inventories drove the contraction as slow growth in China and a weak global outlook prompted Japanese companies to hold back on spending and production.”

Geopolitical Watch:

November 18 – Wall Street Journal (Ben Otto): “President Barack Obama and President Xi Jinping laid out competing visions for trade in Asia Wednesday, showing how the U.S. and China are vying for commercial as well as military influence in one of the most important corners of the global economy. Mr. Obama, visiting the Philippines along with other world leaders for the annual Asia-Pacific Economic Cooperation summit, set out the American-led Trans-Pacific Partnership as a model for expanding trade ties around the Pacific. The U.S. intends it to be a sweeping, new-era pact—among countries that account for more than a quarter of global trade—raising global standards in such areas as intellectual property rights, labor practices and the overhaul of state-owned enterprises… Security analysts have described the TPP as an economic component of Washington’s broader swing toward Asia, which also includes deepening military relationships with countries such as Vietnam and the Philippines while contesting China’s claims to sovereignty over busy shipping routes through the South China Sea.”

November 15 – Reuters (Leika Kihara): “Japan has expressed concern to China about the pace of capital outflows from the country and has suggested Beijing moves very slowly in reforming its currency system to avoid repeating Japan's past mistakes. After a summer of market turmoil, China now appears to be at a critical juncture as capital outflows reach hundreds of billions of dollars and Beijing draws down heavily on its, albeit large, currency reserves… The stocks slump of more than 40% in a matter of a few months and the shock devaluation of the yuan acted as a reminder of how quickly Beijing could lose control of its markets… ‘The pace of capital outflows is alarming,’ said a senior official with knowledge of Japan's currency diplomacy. ‘If China's financial system is destabilised, the effect on Japan and the rest of Asia would be enormous.’ Publicly, Japanese officials have urged China to proceed with reform and expressed confidence that Beijing has the tools and expertise to manage. But privately, they have adopted a different tone…”