Saturday, December 5, 2015

Weekly Commentary: The Cult of Draghi

Friday’s 370-point surge in the DJIA quickly erased memories of the rough session throughout global financial markets the previous day. It’s worth noting, however, that the euro gave back little of Thursday’s spectacular 3.1% surge, the biggest daily gain versus the dollar since March 2009. Additional Friday losses made for a terrible week in European equities.

With a view that Thursday’s important policy developments and market reactions are best not expunged from our analytical consciousness, it’s worth a brief market recap. Beyond the wild moves in now highly unstable currency markets, European market vulnerability was again on full display. Core euro-area equities indices suffered their biggest selloff since September. Thursday’s session saw the German DAX hit for 3.58%. France’s CAC40 also fell 3.58%, while Spain’s IBEX 35 index dropped 2.41% and Italy’s MIB sank 2.47%. For the week, the German DAX sank 4.8% and French CAC40 dropped 4.4%.

Thursday’s session was also notable for the simultaneous declines in both stock and bond prices, an atypical dynamic especially problematic for so-called leveraged “risk parity” strategies. Ten-year Treasury yields jumped 15 bps (to 2.33%). Bond carnage was worse in the eurozone. German bund yields surged 20 bps (66 bps), with yields up 21 bps in France (99 bps), 25 bps in Italy (1.64%), 24 bps in Spain (1.72%) and 22 bps in Portugal (2.47%).

Despite Friday’s rally, it was a disconcerting week – in global markets, in geopolitics and for a darkening of the “social mood.” It’s worth noting that crude (WTI) traded below $40 on Friday, ending the week down 3.8% to a near 11-year low. Turkish equities were down another 1.8% this week, increasing three-week declines to 9.3%. Further selling pressure in Russian stocks pushed two-week losses to 3.9%. The Russian ruble dropped another 2.4%, ending the week at the lowest level since early-September. Brazilian stocks have dropped 5.8% over two weeks, trading near September lows. Mexican stocks fell 2.8% this week to the lowest level since early-October. Dropping 3.1%, the Colombian peso traded near August lows.

Former Bank of England governor Mervin King (in a Friday panel discussion at the Economic Club of New York): “Just over three years ago in London, you made that magic phrase, ‘We’ll do whatever it takes and, believe me, it will be enough.’ And it had tremendous effects – a great success. Yesterday (Thursday) it didn’t seem to have quite the same effect…

ECB president Mario Draghi: “It was not the same words.”

King: “Why do you think the market reaction was presumably to move the exchange rate in a direction that you wouldn’t have approved of. And are you concerned of that?

Draghi: “Well, as I was saying before, they were not the same words. Let me just tell you how the whole story developed, really. It started in the last governing council [meeting], so about a month-and-a-half ago. We decided to make an assessment whether our monetary policy stance was adequate. And so we basically decided that by December we would decide what to do. Basically, we asked all the economists of the 19 central banks in the euro-area and the economists of the ECB, who actually meet in specific committees, to reflect on this. The assessment was, first, that some things were actually improving, as I just said. On the real side, the recoveries continued, though the levels of growth are still low. But it’s continuing; it’s gradually improving. It’s driven mostly by consumption. And the drivers of this recovery are monetary policy, oil prices and a certain stance of the fiscal policy which is between being neutral and mildly expansionary.

However, on the inflation side, we still see very subdued dynamics. The inflation projections that were delivered in December, yesterday, had a minor downward revision for 2016. But this is one of many downward revisions – one of a series of downward revisions. And these projections actually already contained the improvements in the markets until, say, mid-November. So that was a factor. And right after the cut of these projections, we also had other inflation data that was again slightly weaker than expected. So given this broad description of reality, what the committees did was to propose a package – a package of measures which is the one you’ve seen. This package was basically endorsed by the board and proposed to the governing council. And the governing council approved this package with a very, very large majority. Basically, there isn’t any story like I’ve seen written the last two days. What this package says is what I mentioned during the speech, it was a recalibration of our monetary stance which, incidentally, is the word I used in a speech I gave just before the last governing council [meeting] in Frankfurt. It was not a revolution. It was not a novel monetary policy change. So that is basically the story. And we consider the package that’s been proposed by the committees as exactly the right one.

It was clearly, as the markets have abundantly demonstrated, not a package that was meant to address market expectations. It was a package that was meant to address the reaching of our objectives on inflation. That is to be kept in mind. So the process was pretty robust. The approval process was, as I said before, a large majority of the governing council supported it. It was based on a broad proposal. So, again, some of the commentaries I’ve seen in the past two days dwelled on the presence of some dissenters – and what this could imply as far as the future monetary policies concerned. Like all central banks we have some dissent. I think if there’s one who has shown that unanimity is not a constraint to our monetary policy decisions, it’s me. The bottom line of what I’m saying is [that] QE is there to stay. And if needed, it could be recalibrated. Like, by the way, any of our other instruments – like it happens to all monetary policies everywhere in the world.

In the end, let me say one particular thing about what’s becoming the main policy instrument today – namely our balance sheet. Often people ask, ‘What’s the level – what’s the maximum expansion in your balance sheet?’ Well, the balance sheet of a central bank is a monetary policy instrument. As such, it should be utilized to the extent that is necessary to achieve the objective that our mandate asks us to achieve – namely an inflation rate that’s below but close to 2%. There isn’t any specific limit in using this. In conclusion, I think that we have the power to act. We have the determination to act. We have the commitment to act.

King: “Your words just now, and also in your speech this morning, which if I remember correctly, towards the end you say, ‘There can be no limit to the extent to which the balance sheet can be used to meet our mandate,’ that is the key thing – meeting the mandate. Was that deliberately designed to try to offset some of the reaction yesterday?

Draghi: “The speech today? No, not really. Well, of course. Let me say this, that’s why I said ‘not really’ and ‘of course’ because it has two parts. It’s actually a well-designed speech because it gives the whole thinking process… The first half is an explanation of why we react with our monetary policy to shocks that seem to have nothing to do with monetary policy – like oil price shocks for example. The second part, which is more closely linked to our recent decision, of course takes into account what we did and has been a fantastic opportunity for clarifying our objectives, our mandate, the process whereby we reached these decisions and give to you, here in New York City, a sense of how the European Central Bank in Frankfurt, a far distant place, actually works.

Mario Draghi has ascended to the status of the world’s most powerful central banker. Amazingly, he leapfrogged even Ben Bernanke back in the Summer of 2012 with his machismo “do whatever it takes.” Along with the BOJ’s Kuroda, the ECB grabbed the QE baton from the Fed and haven’t looked back. Unlike Kuroda and Yellen, he’s a “market guy,” even serving a stint as a Goldman Sachs vice chairman and managing director.

Market participants began falling out of love with Mario Thursday. Until then, he’d been the central banker equivalent of the Wall Street darling growth stock CEO that reliably always beats earning estimates. For the first time, Draghi was a major disappointment. Only two weeks ago he confidently assured the markets he had the quarter (oops, the meeting and QE growth) in the bag.

November 20 – Financial Times (Claire Jones): “Mario Draghi has dropped his clearest hint yet that the European Central Bank is about to inject more monetary stimulus into the eurozone economy, brushing aside staunch opposition from Germany’s powerful Bundesbank. The ECB president said yesterday that ECB policymakers would ‘do what we must to raise inflation as quickly as possible’. The remark echoed a promise Mr Draghi made during the region’s debt crisis in 2012 to do ‘whatever it takes’ to save the single currency.”

Thursday’s wild market reaction to Draghi recalled the many instances over the years when growth stocks were obliterated on an earnings miss. How many times have we heard some variation of, “How could the stock drop 15% when earnings only missed a penny? This is an obvious market overreaction!” Usually, however, those selling down 15% don’t regret exiting. The single penny earnings miss tends to be a harbinger of worse things to come. It often marks an inflection point in the “story” – the beginning of the end of the game. With company management no longer able to “manage” predictable earnings growth, the sophisticated players and momentum speculators want out. While down big on misses, at least there’s usually big trading volume to accommodate sellers.

Draghi has been playing a dangerous game. He shot from the hip in 2012 and then forced his radical policy course down the throats of the ECB governing council. He stoked a historic Bubble in European bonds and equities, then essentially dared the ECB hawks (certainly including the Germans) to crash the party. Over recent years he’s become the Alan Greenspan of global central bankers: The hero and clever maestro. Mario the policy and market genius. In the nineties, the speculator world was content to bet on the Greenspan market backstop. These days, why rely on Kuroda or Yellen when Super Mario’s got your back.

Along the way, he’s attracted quite an adoring crowd – or at least a crowd of Crowded Trades. Euro devaluation has been one of the greatest ever gifts to financial speculation, ensuring the euro short has become one massive Crowded Trade. ECB QE and the resulting historic collapse in euro-zone yields have spurred Crowded Trades throughout European bonds and equities. Draghi’s “whatever it takes” has been an albatross around the necks of the Swiss National Bank, ensuring ultra-loose monetary policy and a Crowded Trade short the Swissy. Similar pressures on the Scandinavian central banks have ensured similar consequences. Only God knows the amount of leverage that has accumulated throughout European fixed income. For that matter, how much liquidity (and leverage) has flowed from Europe into U.S. securities markets? How much to Eastern Europe and EM more generally?

I have serious issues with contemporary central banking. Somehow, it has become accepted policy to openly manipulate and inflate securities markets. It’s the role of central bankers to dictate “market expectations,” just as over the years they’ve seen a crucial role in shaping so-called “inflation expectations.” Crucially, monetary inflation these days feeds “inflationary expectations” throughout securities markets. And as “money” has continued flowing into global market Bubbles, central banks have lost only more influence on inflationary dynamics in real economies.

In the face of Trillions of QE over recent years, commodity prices have collapsed and general consumer price inflation throughout much of the “developed” world has drifted downward. Global central bankers have nonetheless adopted Draghi’s “whatever it takes” to ensure “inflation” reaches their “mandate.”

After the August “flash crash” – global market dislocation – central bankers again convinced the markets that they were willing and able to do “whatever it takes”. And as energy and commodities have come under further pressure (along with consumer price indices), expectations grew that more shock and awe was on the way. It’s a fool’s errand. Draghi, Yellen, Kuroda and others talk “inflation mandate” and markets hear endless “money” to inflate securities markets. And the more global Bubbles have inflated the more emboldened financial players have become of QE Indefinitely.

Draghi promises to ‘do what we must to raise inflation as quickly as possible’ – and then delivers no increase in the size of monthly QE purchases. There was no awe – only shock. Tellingly, markets cared little about negative rates or an extension in the QE program. Flashing indications of latent market vulnerability, participants were demanding more “money” and they wanted it now. Draghi’s Friday talk of a “no limit” ECB balance sheet must have Weidmann and responsible members of the ECB at their wits end.

It’s the nature of monetary inflations that there’s always a need for more. Throughout history, it’s been ‘just one more round of ‘printing’’ or ‘just one more year and then we’ll rein things in’. But things spiral out of control – and there’s a lot of currency with a lot more zeros. It can end in hyperinflation, at least when monetary inflation is afflicting the real economy. Today’s strange variety is inflating securities market Bubbles. It will end with Bubbles bursting and confidence collapsing.

Integral to the bursting Bubble thesis is that policymakers are losing control. Granted, such analysis has about zero credibility when markets are in melt-up mode. But perhaps the markets’ response to Draghi is a forewarning.

A headline from Friday’s Wall Street Journal: “Crowded Trades Collapse: U.S. stocks, bonds and the dollar all tumble as popular trading positions are hit by the ECB.” And Friday evening from the WSJ: “Macro Hedge Funds Caught Off Guard by ECB’s Move.”

I’m sticking with the view that unstable markets will continue to pressure de-risking and de-leveraging. With currencies moving 3% in a session and the bond market succumbing as well to wild volatility, it seems obvious that players will have to respond by ratcheting down risk and leverage. It remains a self-destructive backdrop with way too much “money” chasing limited securities market opportunities. Popular trades now come with unfavorable risk versus reward.

I believe global markets are back in high-risk territory, and fragilities wouldn’t be as extreme if global policymakers had allowed an overdue market adjustment to run its course back in August. Markets rallied on notions of QE forever, while the fundamental backdrop continued to deteriorate. The commodities rout has worsened. Brazil has taken a turn for the worse. Meanwhile, fragilities continue to fester in China. Efforts to stabilize a faltering Chinese stock market Bubble have stoked even greater bond market excess. Authorities are cracking down hard on the securities industry with troubling ramifications for faltering financial and economic Bubbles. Here at home, an acutely imbalanced economy beckons for (an inauspicious) “lift off.” The geopolitical backdrop turns more alarming by the week. And now, with only about four weeks left in the year, inflated confidence in global central bankers has sprung a leak.

For the Week:

The S&P500 was little changed (up 1.6% y-t-d), while the Dow increased 0.3% (up 0.1%). The Utilities slipped 0.5% (down 12.4%). The Banks rose 1.1% (up 3.4%), and the Broker/Dealers jumped 1.6% (up 2.5%). The Transports dropped 3.2% (down 13%). The S&P 400 Midcaps fell 1.4% (down 0.2%), and the small cap Russell 2000 dropped 1.6% (down 1.8%). The Nasdaq100 added 0.8% (up 11.3%), and the Morgan Stanley High Tech index rose 0.9% (up 10.6%). The Semiconductors surged 3.1% (up 0.7%). The Biotechs fell 2.1% (up 9.4%). With bullion rallying $29, the HUI gold index surged 13% (down 26%).

Three-month Treasury bill rates ended the week at a multi-year high 21 bps. Two-year government yields added two bps to a five-year high 0.94% (up 27bps y-t-d). Five-year T-note yields gained six bps to 1.71% (up 6bps). Ten-year Treasury yields rose six bps to 2.27% (up 10bps). Long bond yields added a basis point to 3.01% (up 26bps).

Greek 10-year yields jumped 64 bps to 7.94% (down 181bps y-t-d). Ten-year Portuguese yields rose 16 bps to 2.46% (down 16bps). Italian 10-year yields surged 25 bps to 1.65% (down 24bps). Spain's 10-year yields rose 21 bps to 1.73% (up 12bps). German bund yields jumped 22 bps to 0.68% (up 14bps). French yields gained 23 bps to 1.00% (up 17bps). The French to German 10-year bond spread widened one to 32 bps. U.K. 10-year gilt yields increased 10 bps to 1.92% (up 17bps).

Japan's Nikkei equities index dropped 1.9% (up 11.8% y-t-d). Japanese 10-year "JGB" yields rose two bps to 0.33% (up one bp y-t-d). The German DAX equities sank 4.8% (up 9.7%). Spain's IBEX 35 equities index fell 2.3% (down 2.0%). Italy's FTSE MIB index dropped 2.5% (up 15.8%). EM equities were mostly lower. Brazil's Bovespa index declined an additional 1.1% (down 9.3%). Mexico's Bolsa sank 2.8% (down 0.4%). South Korea's Kospi index sank 2.7% (up 3.1%). India’s Sensex equities index fell 1.9% (down 6.8%). China’s Shanghai Exchange recovered 2.6% (up 9%). Turkey's Borsa Istanbul National 100 index fell another 1.8% (down 13.4%). Russia's MICEX equities index dropped 2.3% (up 25.7%).

Junk fund saw inflows of $398 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped two bps to 3.93% (up 6bps y-t-d). Fifteen-year rates declined two bps to 3.16% (up 1bp). One-year ARM rates gained two bps to 2.61% (up 21bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down five bps to 3.89% (down 39bps).

Federal Reserve Credit last week declined $9.0bn to $4.440 TN. Over the past year, Fed Credit dipped $5.9bn. Fed Credit inflated $1.629 TN, or 58%, over the past 160 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week rose $11.3bn to $3.325 TN. "Custody holdings" rose $26bn y-t-d.

M2 (narrow) "money" supply jumped $19.8bn to a record $12.309 TN. "Narrow money" expanded $736bn, or 6.4%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits rose $21.2bn, while Savings Deposits slipped $2.0bn. Small Time Deposits dipped $1.5bn. Retail Money Funds were little changed.

Total money market fund assets jumped $17.8bn to a multi-year high $2.741 TN. Money Funds increased $8.5bn year-to-date, while gaining $54bn y-o-y (2.0%).

Total Commercial Paper declined $8.5bn to $1.042 TN. CP increased $50bn year-to-date.

Currency Watch:

The U.S. dollar index dropped 1.8% this week to 98.25 (up 8.8% y-t-d). For the week on the upside, the Swiss franc increased 3.3%, the New Zealand dollar 3.3%, the Swedish krona 2.9%, the euro 2.6%, the Brazilian real 2.4%, the Norwegian krone 2.2%, the Australian dollar 2.0% and the South African rand 0.2%. For the week on the downside, the Japanese yen declined 0.3%.

Commodities Watch:

December 4 – Bloomberg (Javier Blas, Grant Smith and Nayla Razzouk): “OPEC abandoned all pretense this week of acting as a cartel. It’s now every member for itself. At a chaotic meeting Friday in Vienna that was expected to last four hours but expanded to nearly seven, the Organization of Petroleum Exporting Countries tossed aside the idea of limiting production to control prices. Instead, it went all in for the one-year-old Saudi Arabia-led policy of pumping, pumping, pumping until rivals -- external, such as Russia and U.S. shale drillers, as well as internal -- are squeezed out of market share. ‘Lots of people said that OPEC was dead; OPEC itself just confirmed it,’ Jamie Webster… oil analyst for IHS Inc., said in Vienna.”

December 4 – Reuters (Ruby Lian and Manolo Serapio Jr): “Cash-strapped Chinese steel mills are dumping iron ore stocks, selling at a loss to shore up cash flow in the latest sign of the sector's worsening crisis, steel mill and trader sources said. The sale of port inventories is deepening a rout in iron ore prices which have already tumbled 25% over the past two months as the sector struggles with overcapacity, falling demand for steel from real estate to shipbuilding, and tight credit. This week, prices for the raw material hit their lowest in a decade… ‘The market declines have been accelerated by steel mills who are selling iron ore at low prices because they are short of cash,’ said an iron ore trader in Beijing.”

The Goldman Sachs Commodities Index fell 1.8% to a new multi-year low (down 20.8% y-t-d). Spot Gold rallied 2.7% to $1,086 (down 8.3%). March Silver recovered 3.6% to $14.55 (down 6.7%). January WTI Crude fell $1.57 to $40.14 (down 25%). January Gasoline sank 7.6% (down 13%), and January Natural Gas declined 1.4% (down 25%). March Copper gained 0.9% (down 27%). March Wheat increased 1.1% (down 18%). March Corn jumped 3.9% (down 4%).

Global Bubble Watch:

December 2 – Financial Times (Joe Rennison and Eric Platt): “Sales of global corporate bonds have eclipsed $2tn for the fourth consecutive year, with a further expected easing of European Central Bank policy seen encouraging companies to take advantage of lower interest rates. Deals from US grocer Whole Foods, Swiss cement group LafargeHolcim and Austrian energy group OMV this week propelled global debt sales to $2.01tn, according to… Dealogic. The figures, which exclude issuance from banks, are approaching the record $2.27tn raised in the whole of last year.”

December 3 – Financial Times: “Central bank tightening in the US and the possibility that the European Central Bank may be close to finishing could derail the M&A boom next year but, there's a fresh reminder that 2015 has been a bumper one. Three of the five record months for deal-making by dollar volume have happened this year, according to... Dealogic. Global M&A volume hit $606.6bn in November, up 7% from the previous record set in October. But with 2,657 tie-ups announced, November was actually the lightest month by number of deals since June 2005… Overall global M&A volume stands at $4.57tn for the year, not far off the record of $4.61tn set in 2007.”

November 30 – Financial Times (Dan McCrum, Eric Platt and Joe Rennison): “Companies have defaulted on $95bn worth of debt so far this year, with 2015 set to finish with the highest number of worldwide defaults since 2009, according to Standard & Poor’s. The figures are the latest sign financial stress is beginning to rise for corporate borrowers, led by US oil and gas companies. The rising tide of defaults comes as investors reassess their exposure to companies that borrowed heavily in recent years against the backdrop of central bank policy suppressing interest rates… The amount of debt owed by US companies relative to the size of their profits has been increasing, according to Alberto Gallo, macro credit strategist for RBS, with the proportion of the most indebted borrowers rising since mid- 2014. ‘This tail of highly levered borrowers is likely to be vulnerable to rising rates,’ he said…”

December 1 – Bloomberg (Narayanan Somasundaram): “Chris Carr, a real estate agent in Sydney’s northwestern suburbs, has had to convince sellers to drop prices on at least six homes in the past two months to complete transactions. Such price cuts sent Sydney dwelling values 1.4% lower in November, the most in five years, as Chinese demand slows, banks raise mortgage rates and buyers balk at record home values. The first open inspection of a home now attracts on average about six groups of prospective buyers, compared with as many as 30 three months earlier, Carr, an agent with Gilmour & Orley, said… ‘Sellers have had to accept up to 10% price reductions,’ said Carr… ‘There is a lack of international buyers, particularly those with a Chinese background now, who were behind the price rise. Local demand is still there, but they are price-conscious.’”

U.S. Bubble Watch:

December 1 – Bloomberg (Victoria Stilwell): “Manufacturing in the U.S. unexpectedly contracted in November at the fastest pace since the last recession as elevated inventories led to cutbacks in orders and production. The Institute for Supply Management’s index dropped to 48.6, the lowest level since June 2009, from 50.1 in October…”

December 2 – Bloomberg (Joe Carroll and Jim Polson): “Billionaire Rich Kinder owned about 11% of Kinder Morgan Inc. valued at more than $10 billion in June when he stepped down as chief executive of the company he co-founded. Now his stake is worth about $5 billion less, and the company that has his name on the door has become the worst-performing pipeline stock in the S&P 500. …Kinder Morgan has lost half its value this year as growth-hungry investors sour on what they see as a slow-moving, debt-laden behemoth that will have difficulty expanding during an industry downturn that’s dragging down most energy companies… For years, pipeline operators such as Kinder Morgan were the darlings of yield-hungry portfolio managers because they had ample access to equity and debt markets to finance the acquisitions and new pipe construction needed to fatten dividends, said Christopher Sighinolfi… analyst for Jefferies LLC. Kinder Morgan’s indicated gross yield is 9.9%.”

November 27 – Wall Street Journal (Laura Kusisto and Alyssa Abkowitz): “Karen Xu, a Shanghai resident looking to invest in U.S. real estate, decided this spring to seek a Miami one-bedroom condominium in the $500,000-to-$750,000 price range. China’s economic slowdown has since changed her mind. ‘I don’t think I’ll be investing in the U.S. right now,’ said Ms. Xu… ‘Maybe I’ll wait another five years, or invest in China.’ Capping a five-year real-estate binge, Chinese nationals surpassed Canadian snowbirds as the top foreign buyers of U.S. homes for the year that ended in March—the most recent annual data—scooping up everything from $500,000 condos in New Jersey to $3 million vacation homes in California to $13 million Manhattan condos. But in recent weeks, some Chinese buyers have started to pull back, scared off by China’s stock-market selloff, slowing economic growth, currency devaluation and tightened restrictions on capital outflows… Chinese individuals are limited to annual overseas investments equal to about $50,000. For years, Chinese have surpassed that limit, in part, by funneling money through relatives and employees. In recent months, the government has made it tougher to transfer money abroad, said real-estate brokers in both countries. ‘It’s like barbarians at the gate,’ said John Chang, a real-estate broker with Re/Max in New York City. Chinese families want to buy, he said, ‘but they just can’t get the money out.’”

December 4 – Bloomberg (Sarah Mulholland): “Commercial real estate investors are receiving ominous signals from the bond market. Yields on U.S. corporate debt are rising -- touching a three-year high last month -- while projected returns on properties from apartment towers to offices to top-tier shopping malls stay stubbornly low. The narrowing divide suggests that, after five years of gains, prices may start to slide as other types of investments become more attractive, according to research firm Green Street Advisors LLC. The hunger for risk that’s pushed up commercial real estate values is fading… Property investors are showing more caution and price appreciation is already slowing, said Andy McCulloch, an analyst at Green Street. ‘People are a little more worried about the overall direction of the economy,’ he said. ‘The frenzied environment has stopped.’”

China Bubble Watch:

December 3 – Bloomberg: “The high-ranking cop who brought down one of China’s top Communist Party officials has been put in charge of a corruption probe of the securities industry in the wake of a summer stock crash, said a person familiar with the matter. The appointment of Fu Zhenghua underscores the importance that President Xi Jinping has given the investigation into possible securities fraud linked to the $5 trillion wipeout in June and July. Fu has had several promotions since Xi came to power in 2012, and oversaw the case against former Politburo Standing Committee member Zhou Yongkang… Zhou was sentenced to life behind bars in June. The 60-year-old former Beijing police chief, who also led a corruption case against one of China’s richest men and busted a huge prostitution ring in 2010, is overseeing a probe under which police have questioned dozens of executives at securities firms amid allegations of insider trading and other malfeasance stemming from the crash, one of the people said. The investigations have intensified in recent weeks, sending fear through China’s finance firms and chilling their investment strategies.”

December 2 – Bloomberg: “China plans to expand the size of its program for addressing high-cost local government debt to about 15 trillion yuan, Finance Minister Lou Jiwei told a closed-door meeting last month… The initiative to swap high-yielding local debt into cheaper municipal bonds is set to run through the end of 2017, Lou said… Officials were previously reported to have approved about 4 trillion yuan for this year. Expanding the effort would help buttress the finances of local governments that are key to implementing infrastructure projects needed to fulfill the leadership’s goals for economic growth. The total cited through 2017 would cover more than half of the 24 trillion yuan of debt local authorities had accumulated as of the end of 2014… When the finance ministry unveiled the debt-swap program in March, it said local governments would be allowed to swap as much as 1 trillion yuan of debt. That quota has since been expanded several times…”

November 28 – Reuters: “A year after China's financial regulators squared up to the systemic perils of ‘shadow banking’, the threat is shifting to a booming corporate bond market, and risky borrowers' debt is finding its way into products aimed at retail investors. An opaque network of trust companies and non-bank lenders had grown their annual market to a hefty 2.9 trillion yuan (£299 billion) in loans before regulators stepped in, spooked by rising defaults on wealth-management products (WMPs) backed by such high-interest shadow lending. Now the high-risk borrowers who took those loans, such as unlisted real-estate firms struggling with a stagnant property market and financing companies backing shoddy local government investment, are finding a new avenue of funding after regulators began allowing unlisted companies to issue bonds on public exchanges. New corporate bond issuance leaped to 914 billion yuan in the third quarter, accounting for 29% of all new credit, up from 381 billion yuan and just 8% in the first. And the profile of new borrowers looks strikingly like the patrons of the shadow banking set. Of the 57 firms posting bond listing announcements in Shanghai in October, 23 were local-government-owned project or infrastructure investment firms. Beijing engineered the freeing up of the bond markets as a transparent alternative funding route, and the credit crunch that followed its clampdown on shadow banking guaranteed a high take-up. But wealth managers are now turning these bonds into leveraged high-yielding products and selling them to investors desperate for returns after a real-estate slump and summer stock-market crash.”

November 30 – Wall Street Journal (Anjani Trivedi): “A Chinese fishing company’s failure to repay its lenders this month could prove to be a drop in an ocean of emerging-market corporate-debt defaults, as economic conditions worsen for companies that have spent years piling up their borrowing. Defaults are already mounting as companies struggle to generate enough cash to meet their interest costs and repayments. The dollar’s strength is exacerbating the problems for companies that borrowed in the U.S. currency. Corporate defaults in emerging countries have hit their highest level since 2009 this year, and are already up 40% over last year, according to Standard & Poor’s. For the first time in years, emerging-market companies are defaulting more often than their U.S. peers. The default rate on emerging-market corporate high-yield debt over the past 12 months has reached 3.8%, compared with 2.5% in the U.S., according to Barclays… Tension between companies and their lenders is growing, too… Many companies in difficulty are, like China Fishery, Asia-based. While emerging-market corporate debt globally has risen fivefold over the past decade, totaling $23.7 trillion in early 2015, according to the Institute of International Finance, much of the increase has come from emerging Asia… The taps are now drying up. Waning lender appetite and the growing inability to raise capital despite low interest rates has left bond issuance in emerging markets down almost 30% from a year ago… Against that backdrop, companies and countries in emerging markets are due to repay almost $600 billion of debt maturing next year…”

November 29 – Bloomberg: “China’s securities regulator is investigating Citic Securities Co., Haitong Securities Co. and Guosen Securities Co. over alleged breaches of rules on margin and short-selling contracts. The China Securities Regulatory Commission probes involve contracts the three brokerages signed with clients on margin finances and short-selling, according to exchange filings by the companies Sunday.”

December 4 – Bloomberg: “Five months after a debt-fueled rally in Chinese stocks turned into a $5 trillion rout, the bond market is testing authorities’ ability to contain leverage without sparking a crash. Outstanding repurchase agreements in the nation’s interbank market, used by debt investors to amplify their buying power, surged to 8.01 trillion yuan ($1.25 trillion) in November, the highest level since at least 2012… In a sign that policy makers are becoming concerned about the jump in leverage, China’s clearing house for exchange-listed debt expanded the conditions under which it can restrict financing last week… ‘After the stock rout, leverage on bond investments has risen considerably,” said Ji Weijie, a credit analyst at China Securities… ‘The new rules will reduce the attractiveness of using leverage in the exchange bond market. They are likely the beginning of a series more detailed measures.’”

November 30 – Bloomberg: “China’s manufacturing conditions slipped to the weakest level in more than three years as sluggishness in the nation’s old growth drivers add to risks facing the government’s growth target. The official purchasing managers index fell to 49.6 in November… the lowest level since August 2012… The non-manufacturing PMI rose to 53.6 from 53.1 a month earlier.”

December 4 – South China Morning Post (Sandy Li): “Hong Kong home sales sank last month to a record low as an imminent interest rate in the US this month scared away prospective buyers. According to Land Registry data, November saw 2,826 registered residential transactions, down 14.4% from October and 41.7% less than in November last year… ‘Total home sales including those in primary and the secondary market dropped to the lowest level since we have started to gauge property transactions in 1996,’ said Wong Leung-sing, an associate director of research at Centaline Property Agency. He said prospective buyers in general held back their purchases in view of softening home prices and a potential rate hike also dented interest… ‘Sales volume in the secondary market fell for the fourth straight month to a 20-year low,’ Wong said. Hong Kong home prices fell 4.5% after peaking in September…”

Brazil Watch:

December 1 – Financial Times (Joe Leahy): “Brazil’s gross domestic product fell by a record 4.5% year-on-year in the third quarter, confirming fears that Latin America’s largest country is on track for its worst recession since the Great Depression. Lower commodity prices, fiscal contraction and the fading of a consumer credit boom have battered what was once one of the world’s fastest-growing economies. Brazil has also taken a hit from the sweeping ‘Car Wash’ investigation into corruption at Petrobras, the state-owned oil company, which has paralysed congress and the corporate sector. The scandal has also begun to spread to the financial services industry, with the arrest last week of billionaire banker André Esteves, chief executive of investment bank BTG Pactual… The slowdown is generating a perfect storm of negative economic data. Unemployment rose to 7.9% in September, up from 4.7% in October last year, inflation is running at more than 10% for the first time since 2002 and Brazil’s government budget deficit is now at 9.5% of gross domestic product.”

December 1 – Bloomberg (David Biller): “Latin America’s largest economy shrank more than analysts forecast, as rising unemployment and higher inflation sapped domestic demand, pulling the nation deeper into what Goldman Sachs now calls ‘an outright depression.’ Gross domestic product in Brazil contracted 1.7% in the three months ended in September, after a revised 2.1% drop the previous quarter… ‘What started as a recession driven by the adjustment needs of an economy that accumulated large macro imbalances is now mutating into an outright economic depression given the deep contraction of domestic demand,’ Alberto Ramos, chief Latin America economist at Goldman Sachs… wrote…”

December 1 – Bloomberg (Noah Buhayar and Julia Leite): “Banco BTG Pactual SA had its credit grade cut to junk by Moody’s… on concern that the investment bank will struggle to keep enough cash on hand and maintain its franchise following the arrest last week of its founder Andre Esteves. The ratings firm lowered its baseline credit assessment for the business, Grupo BTG Pactual SA’s main operating subsidiary, two levels to Ba2 from Baa3… It made the same change for the firm’s long-term global local- and foreign-currency deposit ratings, placing the bank two levels below investment grade. The ratings remain on review for further downgrades.”

November 27 – Reuters (Guillermo Parra-Bernal and Tatiana Bautzer): “The reliance of Brazil's Grupo BTG Pactual SA on market funding may pose an immediate challenge for new boss Persio Arida, who sought to calm clients… The São Paulo-based investment bank tapped Arida, a former president of Brazil's central bank, as acting chief executive officer following the arrest of founder and controlling shareholder André Esteves in a sweeping corruption probe earlier this week… Against that hostile market backdrop, BTG Pactual has to refinance 15.3 billion reais ($4bn), or about 55% of its banking arm's funding, within 90 days. With long-term borrowing and equity covering only 23% of BTG Pactual's funding needs, Arida must convince investors to park their money in the bank for a longer period, even if that means paying more for it.”

December 3 – Reuters (Paul Kilby): “Investors were keeping a cautious eye on Brazil again Wednesday after the local press reported that impeachment proceedings had been opened against embattled President Dilma Rousseff. While the news broke late in the day, the sovereign's 2025s inched about a 1/4 point lower to hit around 85.50-85.75, while five-year CDS was being quoted at around 453bp. ‘The news has still got to sink in,’ one broker told IFR. The move is likely to complicate the Brazilian credit story at a time when the arrest and resignation of BTG Pactual CEO Andre Esteves last week has sent its bond prices reeling.”

EM Bubble Watch:

November 30 – Bloomberg (Arif Sharif): “Saudi Arabian banks are feeling the squeeze from falling oil prices. The rate at which banks in the biggest Arab economy lend overnight to each other jumped the most in seven years in November, the fifth straight month of increases, following a slump in deposits the previous month that forced lenders to seek more funds from each other. ‘The drop in deposits in October, in absolute amount, is probably the biggest since the 1990s,’ Murad Ansari, a bank analyst at EFG-Hermes Holding SAE, said… ‘There are payment delays from the government to contractors, which is one of the reasons for the decline in private sector deposits, and public sector deposits are shrinking as the government is running a deficit.’”

December 2 – Bloomberg (Benjamin Bain): “As far as bond traders are concerned, Empresas ICA SAB’s missed interest payment this week is just a prelude to what’s likely to be the biggest default in Mexico in at least two decades. On Monday, the builder said it will use a 30-day grace period to make a $31 million interest payment on $700 million of its notes. The announcement triggered a tumble in the $1.35 billion of overseas bonds issued by Mexico’s largest construction company, leaving the securities down 73% this year…The builder reported its biggest net loss in 14 years in October in the wake of government cutbacks to infrastructure projects that account for almost 90% of its pipeline. If the company halts payments on all its notes, it would eclipse glassmaker Vitro SAB as the biggest corporate bond defaulter in Mexico since Moody’s… began tracking the data in 1995.”

Fixed Income Bubble Watch:

December 4 – Financial Times (Eric Platt): “More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings. The figures, which will be lifted by downgrades on Wednesday evening that stripped four of the largest US banks of coveted A level ratings, have unnerved credit investors already skittish from a pop in volatility and sharp swings in bond prices. Analysts with Standard & Poor’s, Moody’s and Fitch expect default rates to increase over the next 12 months, an inopportune time for Federal Reserve policymakers, who are expected to begin to tighten monetary policy in the coming weeks. S&P has cut its ratings on US bonds worth $1.04tn in the first 11 months of the year, a 72% jump from the entirety of 2014. In contrast, upgrades have fallen to less than half a billion dollars, more than a third below last year’s total. The ...rating agency has more than 300 US companies on review for downgrade, twice the number of groups its analysts have identified for potential upgrade. ‘The credit cycle is long in the tooth by any standardised measure,’ Bonnie Baha, head of global developed credit at DoubleLine Capital…’The Fed’s quantitative easing programme helped to defer a default cycle and with the Fed poised to increase rates, that may be about to change.’”

December 2 – Bloomberg (Lisa Abramowicz): “Sinkholes are popping up in the credit market. Specific junk bonds are simply plummeting in value on little trading. For example, nothing all that obvious triggered a plunge in Syniverse Holdings, whose bonds fell to 39 cents on the dollar Monday, from 84.25 cents less than a month earlier. Debt of Intelsat, United States Steel, SandRidge Energy and Ultra Petroleum all lost about 30% last month. Yet looking broadly, there isn’t a financial crisis in developed markets. U.S. stocks are still eking out gains. Companies are still issuing bonds. So why the precipitous drops without warning? The explanation is that asset managers are being forced to exit their riskiest positions, either because of withdrawals or to placate increasingly nervous investors, and they’re finding no buyers on the other side. When these fund managers finally get an offer to shed their unwanted holdings, they’re just taking it, even if it means taking a huge loss.”

Leveraged Speculation Watch:

December 1 – Bloomberg (Katherine Burton Saijel Kishan): “When BlueCrest Capital Management told investors Tuesday it would no longer oversee money for outsiders, one thing founder Michael Platt didn’t mention was that clients had already pulled billions of dollars this year. Platt, who cited client demands and pressure on fees as a reason for his decision, isn’t alone in feeling the heat from investors. Firms including Och-Ziff Capital Management Group LLC and Mason Capital Management have seen cash flee this year, and others such as Fortress Investment Group LLC’s macro funds business shut down after redemptions and losses. Hedge fund investors are losing patience even with marquee firms as many of them struggle this year, especially those that offer macro strategies or stock funds heavily weighted to rising shares. Some managers have lost money for two years running, while others… are suffering declines that rival their worst year. After the weakest third-quarter inflows in six years, the industry could see outflows in the fourth quarter, said investors and bankers who watch the ebb and flow of hedge fund assets.”

Central Bank Watch:

December 4 – CNBC: “European Central Bank Governing Council member Jens Weidmann argued that the latest round of monetary easing from the bank was not needed - after the package disappointed many in the markets. Weidmann, who is the president of Germany's Bundesbank, said… that latest economic data confirmed his views that the sharp decline in energy prices supported the single currency region's economic recovery and that the close to zero inflation is in great part due to the low oil price.”

Japan Watch:

November 30 – Reuters (Leika Kihara): “Bank of Japan's governor has dismissed calls from critics to go slow on hitting the central bank's 2% inflation target and stressed the need to take ‘whatever steps necessary’ to achieve its ambitious consumer price goal. Various policymakers in Japan, including BOJ board members, have recently warned that pushing up prices too quickly could hurt consumption and have called for the central to give itself more time to achieve its inflation target. However, BOJ Governor Haruhiko Kuroda… reinforced the need to reinflate prices as a central bank priority. ‘If the BOJ were to move slowly toward achieving the price target, wage adjustments would also be slow,’ Kuroda told business leaders… ‘In order to overcome deflation -- in other words, break the deadlock -- somebody has to show an unwavering resolve and change the situation. When price developments are at stake, the BOJ must be the first to move.’ …But he warned that the slowdown in emerging markets, if prolonged, could hurt business sentiment and discourage companies from boosting capital expenditure. ‘We'll ease policy or take whatever steps necessary without hesitation if an early achievement of our price target becomes difficult,’ he told a news conference…”

Geopolitical Watch:

December 3 – Washington Post (Andrew Roth): “Russian President Vladimir Putin threatened the Turkish leadership Thursday over the downing of a Russian warplane even as he called for a unified coalition with the West to fight terrorism in the Middle East. ‘Only Allah knows why they did it,’ Putin said about the downing in an hour-long address to Russian lawmakers and other public figures, Russia’s own state of the union address. ‘And I guess Allah decided to punish the ruling clique in Turkey by stripping it of its sanity… ‘We are not planning to and will not engage in saber-rattling,’ Putin said. ‘But if someone thinks that he can commit a foul war crime, the murder of our people, and just get away with some tomatoes or limits in construction and other spheres, then he is deeply mistaken.’ …He also took aim at the United States and the West for the wars in Iraq, Libya and Syria, saying they destabilized regions ‘that looked quite good until recently but are now areas of anarchy… We know who . . . decided to change regimes in those countries and impose their own rules…They destroyed those states and then they washed their hands of it, opening the road to radicals, extremists and terrorists.’”

December 2 – New York Times (Steven Erlanger): “For the first time in six years, NATO… invited a new member to join the military alliance, prompting a heated response from Russia and further underscoring escalating tensions between the Cold War adversaries. The invitation, to tiny Montenegro, came nine years after the Balkan nation began the process of accession. But the timing of the offer came at a particularly delicate moment… In Moscow, the offer to Montenegro… prompted fury and threats. Dmitri S. Peskov, the Kremlin spokesman, said that a NATO expansion would be met with unspecified retaliatory measures from Russia. ‘The continuing expansion of NATO and NATO’s military infrastructure to the East, of course, cannot but lead to response actions from the East, namely the Russian side,’ Mr. Peskov said.”

December 2 – Reuters (Matt Siegel): “A major cyber-attack against Australia's Bureau of Meteorology that may have compromised potentially sensitive national security information is being blamed on China, the Australian Broadcasting Corporation (ABC) reported… The Bureau of Meteorology owns one of Australia's largest supercomputers and the attack, which the ABC said occurred in recent days, may have allowed those responsible access to the Department of Defence through a linked network. The ABC, citing several unidentified sources with knowledge of the ‘massive’ breach, placed the blame on China, which has in the past been accused of hacking sensitive Australian government computer systems.”