This week’s policy move will be debated for years to come. Lost in the debate is how the Fed (along with global central bankers) found itself stuck at zero for seven years (with a $4.5 TN balance sheet) and then saw it necessary to move to raise rates in the most gingerly, market-pleasing approach imaginable.
Traditionally, tightening cycles are necessary to counter mounting excess, including ill-advised lending, speculating and investing. Rate increases back in 1994 exposed what had been a dangerous expansion in speculative leveraging, derivatives and market-based Credit (at home and abroad). With the “bond” market in disarray and Mexico at the precipice, the Greenspan Fed turned its attention to bolstering the markets and non-bank Credit more generally.
Market-based Credit is unstable. This remains the fundamental issue – the harsh reality – that no one dares confront. I would strongly argue that long-term stability in a Capitalistic system requires sound money and Credit (hopelessly archaic, I admit). Over the years, I’ve tried to differentiate traditional finance from unfettered “New Age” finance. The former, bank lending-dominated Credit, was generally contained by various mechanisms (including the gold standard, effective currency regimes, bank capital and reserve requirements, etc.). This is in stark contrast to the current-day securities market-based global financial “system” uniquely operating without restraints on either the quantity or quality of Credit created.
A few data points from the Federal Reserve’s “Z.1” report illuminate why the Credit system had turned fragile back in 1994. After beginning the decade at $6.39 TN, Total Debt Securities (my compilation of Treasuries, Agency Securities, Corporate Bonds and Muni Debt) surged $2.94 TN, or 46%, in four years to end 1993 at $9.33 TN. For comparison, over this period bank (“Private Depository Institutions”) Loans actually declined $169 billion (Total bank Assets rose $137bn to $4.9 TN). Importantly, Total Debt Securities as a percentage of GDP jumped from 113% to 135% in four years, while bank Loans to GDP declined from 57% to 44% (bank Assets 84% to 71%).
Fast-forward to 2014 and securities-based finance completely dwarfed bank loans. Total Debt Securities had inflated to $21.11 TN, or 172% of GDP. At $6.32 TN, bank Loans had increased only marginally to 51% of GDP. It’s worth noting that Equities as a percentage of GDP ended 2004 at 154%, up from 1994’s 86%. Total (Debt & Equities) Securities, at $40 TN, ended 2004 at a then record 326% of GDP. This compares to 1994’s $16.2 TN, or 222%.
The 2008 crisis exposed the incredible leveraged that had accumulated over a protracted period of Fed-induced easy money. It’s my view that Fed policies were used specifically to reflate the securities market Bubble in 1998 and then again in 2001-2002. This then precluded the Fed from adopting real tightening measures throughout the mortgage finance Bubble period that would have risked financial crisis.
Importantly, market-based finance did not equate to freer markets. Indeed it was the exact opposite. Policies at the Greenspan Fed evolved from actively supporting the securities markets and promoting speculation to desperate measures to sustain the Bubble. Dr. Bernanke arrived at the Fed in 2002 with an inflationist ideology to use “helicopter money” to reflate Credit and securities market Bubbles. Ironically, market-based finance became the most powerful tool for central bank manipulation - so powerful that the central planners at the Chinese communist party rushed to adopt securities-based finance.
Post-mortgage finance Bubble reflationary measures inflated the global securities Bubble to historic extremes. Here at home, Total Securities ended 2014 at $74.54 TN, or 430% of GDP. Debt Securities ended the year at $38.3 TN, or 221% of GDP, with Equities at $36.2 TN, or 209% of GDP.
There’s no precedence for such a globalized monetary fiasco, though there are a number of historical episodes that provide valuable insight. John Law’s introduction of paper money in France (1716-1720) and the resulting “Mississippi Bubble” is one of my favorites. The basic flaw in Law’s inflationist theories was his focus on the “medium of exchange” attribute to the exclusion of money’s critical role as a “store of value.” Pertinent as well, when confidence in Law’s financial scheme began to wane, he devalued competitive hard currencies in a desperate attempt to sustain demand for his scheme of paper money and securities. Bernanke, Draghi, Kuroda, Yellen and their central bank colleagues inflate central bank Credit as a “medium of exchange” for securities market inflation and apparently don’t contemplate the “store of value” dilemma that has torpedoed inflationism’s grand illusions throughout history.
The late-twenties period provides invaluable insight: The extreme divergence between the trajectory of commodities and securities prices. Benjamin Strong’s 1927 “coup de whiskey” (Draghi’s 2012 “do whatever it takes”). Policymaker confusion about the nature of inflation. How new technologies, a prolonged investment boom and booming global trade fostered confounding price instabilities. The critical issue of productive vs. non-productive Credit. How the Fed sought to promote capital investment, yet the allure of a speculative securities market Bubble proved too powerful. That there was little understanding of how securities market leverage had fostered acute market, financial and economic fragility. Especially late in the boom, the Fed was in no way in control of either inflation or the flow of finance through the markets and real economy. How everyone was determined to hold their ground, yet the ground gave way beneath them.
“In order to believe you should raise rates for financial stability reasons, you have to believe that there’s a serious problem of over-confidence – of bubble formation. And it seems to me that most of the plausible bubbles are no longer plausible bubbles at this point. Perhaps you could have said there was a bubble element in the high-yield bond market at some point, but you certainly can’t say that today. Perhaps you could have said that about emerging markets at some point. You can’t say it today. Perhaps you could have said it about commodities at some point. You can’t say that today. So the notion of raising rates today as a prophylactic against financial instability seems quite odd. I think we’re much more likely to have problems that come from under-confidence in financial markets than problems that come from over-confidence in financial markets.” Former U.S. Treasury Secretary Larry Summers speaking with Bloomberg’s Tom Keene, December 15, 2015
Unfortunately, Plausible Bubbles Abound. Junk bonds are merely the Periphery of a historic Bubble throughout corporate Credit and debt securities more generally. Troubled EM markets are merely the Periphery of a historic Credit Bubble throughout Latin America, Eastern Europe and Asia, certainly including the runaway mega Chinese Bubble (at the Core). Commodities are merely the Periphery of a historic global speculative Bubble, with financial assets at The Massive Core.
And the dilemma for John Law, for the late-1920s period, during 2007 and again these days: easy money policies meant to support a faltering Periphery work generally to exacerbate excess at the Bubble’s Core. As an analyst of Bubbles, the great challenge is to try to recognize when trouble at the Periphery, rather than supporting continued "Terminal Excess" at the Core, begins to lead to risk aversion, de-leveraging and a tightening of financial conditions at the vulnerable Core.
It was a tricky week. To have such an important policy announcement two days prior to a year-end “quadruple witch” options expiration added complexity. The Fed basically gave the markets exactly what they were expecting, providing reason enough to rally. This rally, right before expiration, was fueled by an unwind of hedges and bearish positions. Yet it wasn’t long before deteriorating fundamentals trumped the Fed’s dovish rate increase. I have not agreed with the conventional thinking that global instability has been mainly about the Fed. So I don’t subscribe to analysis that sees the Fed hike now reducing uncertainty and engendering stability.
The Brazilian real declined 2.7% this week. Brazilian stocks sank 3.0%. Devaluation saw the Argentine peso collapse 36%. Argentina’s Merval equities index sank 10.8% this week. Crowded trades and a proliferation of derivative trading ensure some big bear market rallies. But the bursting of the EM and commodities Bubbles runs unabated. It’s as well worth noting that the yen gained 1.1% against the dollar Friday when the BOJ surprised the market with expanded stimulus measures but disappointed by not boosting QE.
December 18 – Wall Street Journal (Aaron Back): “Bank of Japan Governor Haruhiko Kuroda may have thought he was giving markets an early Christmas present. But investors reacted like they were finding coal in their stockings. The BOJ was widely expected not to make any adjustments to its easing program on Friday. So when headlines hit that it was making moves—extending the maturity of its government bond portfolio and introducing a new stock buying program—reaction was ecstatic. The Nikkei 225 surged by over 2% in minutes. But as traders read through the text of the BOJ statement, elation gave way to befuddlement. Japanese stocks ended the day down 1.9%. The new measures don’t amount to extra easing by any significant degree.”
Until recently, markets remained sanguine in the face of downward pressures on commodities as well as general global consumer and producer price indices. After all, “do whatever it takes” central bankers would be compelled to increase QE to reach their so-called “inflation mandates”. Regarding QE and the global drive to increase inflation, it’s been “If it’s not working just do more of it.” And speculative markets have absolutely loved the QE bonanza. At some point, however, central bankers had to face the reality that QE is highly destabilizing – and not all that effective. First it was the ECB. Now the BOJ. Reality is beginning to set in. “Do whatever it takes” has limits, especially when it comes to QE. Suddenly, the bursting EM and commodities Bubbles appear a lot more problematic.
For the Week:
The S&P500 slipped 0.3% (down 2.6% y-t-d), and the Dow declined 0.8% (down 3.9%). The Utilities rallied 2.9% (down 11.4%). The Banks were little changed (down 3.1%), while the Broker/Dealers declined 0.5% (down 5.8%). The Transports dropped 2.1% (down 19.4%). The S&P 400 Midcaps lost 1.0% (down 5.3%), and the small cap Russell 2000 dipped 0.2% (down 6.9%). The Nasdaq100 slipped 0.5% (up 5.2%), and the Morgan Stanley High Tech index declined 0.8% (up 5.2%). The Semiconductors fell 1.1% (down 4.8%). The Biotechs rallied 3.5% (up 7.4%). Although bullion was down only $8, the HUI gold index was hit 6.2% (down 33.4%).
Three-month Treasury bill rates ended the week at 17 bps. Two-year government yields rose eight bps to 0.95% (up 28bps y-t-d). Five-year T-note yields jumped 12 bps to 1.67% (up 2bps). Ten-year Treasury yields rose seven bps to 2.20% (up 3bps). Long bond yields gained five bps to 2.92% (up 17bps).
Greek 10-year yields dropped 63 bps to 7.77% (down 198bps y-t-d). Ten-year Portuguese yields rose four bps to 2.47% (down 15bps). Italian 10-year yields gained four bps to 1.57% (down 32bps). Spain's 10-year yields jumped 7 bps to 1.69% (up 8bps). German bund yields added a basis point to 0.55% (up 1bp). French yields increased three bps to 0.89% (up 6bps). The French to German 10-year bond spread widened two to 34 bps. U.K. 10-year gilt yields increased two bps to 1.83% (up 8bps).
Japan's Nikkei equities index declined 1.3% (up 8.8% y-t-d). Japanese 10-year "JGB" yields fell five bps to a record low 0.26% (down 6bps y-t-d). The German DAX equities index rallied 2.6% (up 8.2%). Spain's IBEX 35 equities index increased 0.9% (down 5.5%). Italy's FTSE MIB index gained 1.1% (up 11.7%). EM equities were mixed. Brazil's Bovespa index fell 3.0% (down 12%). Mexico's Bolsa rallied 2.2% (down 0.5%). South Korea's Kospi index rallied 1.4% (up 3.1%). India’s Sensex equities index jumped 1.9% (down 7.2%). China’s Shanghai Exchange surged 4.2% (up 10.6%). Turkey's Borsa Istanbul National 100 index rallied 3.1% (down 15.5%). Russia's MICEX equities index was little changed (up 23%).
Junk fund saw outflows jump to $5.1bn (from Lipper), "their largest outflows since August 2014." Overall, outflows from taxable bond funds surged to a record $15.1bn.
Freddie Mac 30-year fixed mortgage rates dipped two bps to 3.93% (up 6bps y-t-d). Fifteen-year rates increased three bps to 3.22% (up 7bps). One-year ARM rates added three bps to 2.67% (up 27bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.03% (down 25bps).
Federal Reserve Credit last week expanded $12.9bn to $4.454 TN. Over the past year, Fed Credit declined $9.4bn. Fed Credit inflated $1.643 TN, or 58%, over the past 162 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week fell $7.7bn to $3.310 TN. "Custody holdings" were down $17.9bn y-o-y.
M2 (narrow) "money" supply was little changed at $12.287 TN. "Narrow money" expanded $690bn, or 6.0%, over the past year. For the week, Currency increased $0.6bn. Total Checkable Deposits dropped $54bn, while Savings Deposits surged $72.5bn. Small Time Deposits slipped $1.5bn. Retail Money Funds declined $2.2bn.
Total money market fund assets fell $20.3bn to $2.734 TN. Money Funds increased $1.0bn year-to-date, and gained $41bn y-o-y (1.5%).
Total Commercial Paper dropped $21.5bn to $1.015 TN. CP increased $7.1bn year-to-date.
Currency Watch:
The U.S. dollar index gained 1.1% this week to 98.70 (up 9.3% y-t-d). For the week on the upside, the South African rand increased 5.0%, the Mexican peso 2.1% and New Zealand dollar 0.1%. For the week on the downside, the Brazilian real declined 2.8%, the euro 2.1%, the Canadian dollar 1.4%, the Swiss franc 1.0%, the Norwegian krone 0.7%, the Swedish krona 0.6%, the Australian dollar 0.2% and Japanese yen 0.2%.
Commodities Watch:
December 14 – Bloomberg (Christine Buurma): “Record warmth sent U.S. natural gas prices tumbling to a 14-year low as December appeared to be a bust for bulls. Gas slumped as the latest forecasts showed temperatures more than 20 degrees Fahrenheit above normal in parts of the eastern U.S. later this month. Cities from Lexington, Kentucky, to Binghamton, New York, broke temperature records dating back to the 19th century over the weekend, AccuWeather Inc. data show. New York City reached a high Sunday of 67 (19 Celsius), a record for the date…”
The Goldman Sachs Commodities Index dropped another 2.1% to another multi-year low (down 26.5% y-t-d). Spot Gold slipped 0.8% to $1,067 (down 10%). March Silver increased 0.2% to $14.09 (down 10%). January WTI Crude declined 82 cents to $34.54 (down 35%). January Gasoline was little changed (down 14%), while January Natural Gas sank 10.6% (down 39%). March Copper was about unchanged (down 25%). March Wheat declined 0.8% (down 18%). March Corn slipped 0.2% (down 6%).
Global Bubble Watch:
December 17 – Financial Times (Dan McCrum): “For examples of the strange spot the financial world is in, let us examine the desks of investment banks which help companies raise money. Look left and it is megadeals, giant mergers and acquisitions, which need tens of billions of dollars sunk as foundations for corporate empires. Look right, however, and the clients are miners and energy companies desperate for capital to pour into holes in the ground, dug when demand for commodities seemed insatiable. It’s boom times or the of end times, depending on which desk takes the phone call.”
December 15 – Bloomberg (Scott Lanman): “Foreigners sold a record net amount of U.S. Treasuries in October as global market turbulence eased and the Federal Reserve signaled it was prepared to raise interest rates in December. Net foreign sales of Treasury bonds and notes were $55.1 billion during October… That compares with net purchases of $17.4 billion in September and the previous record net sales of $55 billion in January… Net selling of U.S. equities by foreign investors was $17.2 billion…”
December 17 – Reuters (Patrick Graham and Jamie McGeever): “If you're trying to identify next year's big risk from global currency markets, look no further than a sharper-than-expected fall in China's yuan. In the many 2016 outlooks published over the past month, most major banks have forecast a 5-7% fall in the value of Beijing's tightly-controlled currency over the next 12 months. But some say that China's concern with the need to bolster flagging exports and competitiveness, or the desire of Chinese savers to get more money out, could easily provoke a faster fall or one of 10% or more. That would in turn encourage more money to leave China and China-related investments, slashing the value of currencies in South Korea, Malaysia or Taiwan and raising broader questions over the durability of Chinese growth… ‘The risk is this depreciation of the yuan becomes less orderly,’ said Vincent Chaigneau, Head of Global Rates and Currency Strategy with Societe Generale…”
December 16 – Bloomberg (Enda Curran): “China is casting Asia adrift. At least, when it comes to exchange rates. That’s the view of analysts pointing out the potential implications of China this month moving away from a managed peg to the dollar. Under the previous regime, as the dollar moved, so moved the yuan. China thereby served as a ‘firewall’ when other Asian currencies were collapsing during the region’s 1997-98 crisis… Almost two decades on, with the emerging markets preparing for fresh volatility in the aftermath of the Federal Reserve kicking off a cycle of interest-rate increases, that firewall is now gone. The danger is that it worsens strains for other Asian currencies, particularly those with current-account deficits that need financing, or with dollar-denominated debt to pay off in an environment of a strengthening U.S. currency.”
U.S. Bubble Watch:
December 14 – Financial Times (Ben McLannahan): “The head of corporate banking at Wells Fargo, the biggest bank in the world by market capitalisation, has warned of ‘stresses’ in its energy portfolio, as the ongoing slump in the price of oil begins to weigh heavily on servicers and producers. Kyle Hranicky, who spent nine years at the helm of the Houston-based Wells Fargo Energy Group before rising to head the corporate banking division in May, said that the bank had been in discussions with clients for several months about preserving cash and cutting borrowing limits. ‘Some have liquidity to survive the cycle but others will be under significant stress and may be forced to sell assets or recapitalise,’ he said. ‘We’ve been in the energy business for over 30 years, so we’re comfortable with cycles. But this one feels deeper and broader and could last longer.’”
December 16 – AFP: “The price of an average apartment in the New York borough of Manhattan has passed the $1 million mark for the first time… The median price -- at the midpoint of all sales prices -- is now $1.1 million, up 11% in a year, said the CityRealty website… Prices in Manhattan have surged by 60% over the past 10 years. The mean price -- the average of all sales prices -- is now $1.9 million, up 5.5% from last year and 72% from 2005. Total real-estate sales in Manhattan this year should reach $24 billion, a 4.2% year-on-year increase, according to CityRealty's projections.”
December 16 – New York Times (Michael Corkery and Mary Williams Walsh): “The governor of Puerto Rico redoubled threats on Wednesday of a major bond default, as an effort to help the struggling commonwealth use bankruptcy to shed debt headed for defeat in Congress. Gov. Alejandro García Padilla warned in a speech at the National Press Club in Washington that Puerto Rico would probably miss debt payments in January or May because its government had run out of cash. ‘There is no money,’ he said. ‘I don’t have a printing machine.’ The governor’s comments came as Congress omitted from a federal spending bill any measures to allow Puerto Rico to restructure its roughly $72 billion of debt in Federal Bankruptcy Court.”
China Bubble Watch:
December 17 – Bloomberg (Malcolm Scott): “China’s economic conditions deteriorated across the board in the fourth quarter, according to a private survey from a New York-based research group that contrasted with recent official indicators that signaled some stabilization in the country’s slowdown. National sales revenue, volumes, output, prices, profits, hiring, borrowing, and capital expenditure were all weaker than the prior three months, according to the fourth-quarter China Beige Book, published by CBB International… The Beige Book’s profit reading is ‘particularly disturbing,’ with the share of firms reporting earnings gains slipping to the lowest level recorded, CBB President Leland Miller wrote… While retail and real estate held up reasonably well, manufacturing and services performed poorly, with revenues, employment, capital expenditure and profits weakening. The survey shows ‘pervasive weakness,’ Miller wrote... ‘The popular rush to find a successful manufacturing-to-services transition will have to be put on hold for a bit. Only the part about struggling manufacturing held true.’”
December 14 – Bloomberg: “China’s government spending surged in November at more than double the pace of gains for revenue, a signal the government has stepped up fiscal stimulus. Fiscal spending jumped 25.9% from a year earlier to 1.61 trillion yuan ($249bn), while revenue rose 11.4% to 1.11 trillion yuan… China’s government usually registers some of its biggest expenditures in the last two months of the year as provincial authorities rush to complete projects and meet spending targets… Receipts from land sales, a major revenue source for local governments, slumped 29.2% in the first 11 months… But in November alone, proceeds from land sales increased 7.4% compared with the same month last year.”
December 13 – Bloomberg: “The fall from grace for China’s biggest brokerage and investment bank, Citic Securities Co., has been fast and steep. The firm -- sometimes referred to as the Goldman Sachs of China -- began the year on its way to eclipsing UBS Group AG in the ranks of the top four securities firms in the world. Now it’s embroiled in a police investigation and a probe by the stock-market regulator. Its chairman is being replaced and its top leadership reorganized. At least nine Citic executives have been investigated for alleged insider trading or haven’t shown up to work and can’t be reached. The origins of its turmoil lie in its role as the highest flier in China’s developing finance field, caught up in the fallout from a stock market crash starting in June that erased $5 trillion in value. Encouraged by multiple pronouncements from policy makers that they wanted Chinese firms to develop the finance tools used in the rest of the world, Citic became a leader. Short selling, stock-index futures, cross-border return swaps -- all were on the table, all permitted with qualified nods by China’s regulators, until the rules changed and suddenly they weren’t.”
December 15 – Bloomberg: “Chinese junk bonds are getting some help from the nation’s central bank, making them more resilient if not immune to the global swoon in the riskiest debt ahead of the Federal Reserve’s interest rate decision. While the average yield on Chinese firms’ speculative-grade notes in dollars has risen 30 bps in the past 30 days to a two-month high of 8.84%, that’s less than the 79 bps jump in similarly rated securities in the U.S. to 8.97%... In China’s onshore market, the yield on five-year securities with local ratings of AA-, considered junk in the nation, has dropped 20 bps in the period to a more than six-year low of 4.67%... The relief for Chinese borrowers comes as the People’s Bank of China seeks to get more money into an economy growing at the weakest pace in a quarter century…”
Brazil Watch:
December 16 – Bloomberg (Filipe Pacheco and Paula Sambo): “Brazil’s credit rating was cut to junk by Fitch Ratings, which became the second major ratings company to strip the country of its investment grade as Latin America’s largest economy heads to its longest recession since the Great Depression amid political turmoil… Brazil’s economy is contracting, lawmakers haven’t shown the will to shore up the budget and efforts to impeach the president are adding to political turmoil and distracting from efforts to fix the situation, Fitch said… Fitch’s move… may shrink the pool of investors that consider buying the country’s securities since many institutions such as pension funds forbid investments in assets rated junk by at least two major ratings companies.”
EM Bubble Watch:
December 17 – Bloomberg (Phil Kuntz): “By fulfilling his campaign pledge to let the Argentinian peso trade freely, President Mauricio Macri did Brazil a nice neighborly favor. The real had been the worst-performing major emerging-market currency for months. Now that distinction belongs to the peso. The peso fell against the U.S. dollar as soon as it started trading Thursday. As of mid-morning… it was down 39% this year, compared with 32% for the real.”
December 14 – Bloomberg (Benjamin Bain): “Wagers that the Federal Reserve will raise interest rates for the first time in almost a decade are souring sentiment toward Mexican stocks. Traders have pulled $840 million from the nation’s largest exchange-traded equities fund this year, the biggest outflow among developing nations… With one of the world’s most-traded currencies, deep corporate ties to the U.S. and policy makers who have pegged the timing of their rate decisions to the Fed’s calendar, Mexico is a popular way for foreign investors to bet on all things emerging markets, said Paul Christopher, … head global market strategist for Wells Fargo Investment Institute. ‘There are a lot of institutional investors who hold Mexico as a proxy,’ Christopher, whose firm oversees $1.7 trillion… This has led ‘to Mexico being the whipping boy.’”
December 16 – Bloomberg (Andrew Willis and Matthew Bristow): “Colombia is nursing paper losses of more than $100 billion after its oil boom fell short of expectations, wiping out 90 percent of the value of what was once Latin America’s biggest company. From being the world’s fifth-most valuable oil producer at its zenith in 2012, worth more than BP Plc, state-controlled Ecopetrol SA now ranks 38th. Its market capitalization has fallen to $14.5 billion, down from its peak of $136.7 billion.”
December 14 – Bloomberg (Zainab Fattah): “Dubai developers halted delivery of about a quarter of the properties set for completion this year, bolstering apartment rents but failing to stop a 16% price decline, according to CBRE Group Inc. About 6,000 nearly-completed homes sit empty in newer developments such as Dubailand, Jumeirah Village Circle and Dubai Sports City as some developers withhold keys from buyers, according to CBRE… Single-family home rents declined 4% compared with a 14% drop in values…”
Fixed Income Bubble Watch:
December 14 – Reuters (Marc Jones and John O’Donnell): “U.S. investors withdrew $15.4 billion from taxable bond funds over the week ended Dec. 16, Lipper said…, as some funds posted record-setting withdrawals in a week marked by fears over the stability of the bond market. ‘We saw some very large redemptions, in fact, we set some records,’ said Tom Roseen, head of research services for Lipper. The outflows across mutual funds and ETFs invested in bonds came on a dramatic week that whipsawed funds and markets.”
December 13 – Wall Street Journal (Matt Wirz, Mike Cherney and Corrie Driebusch): “Traders and regulators have fretted for more than a year that mayhem might ensue if U.S. mutual funds sought to sell rarely traded bond investments. After junk-bond prices posted their largest drop since 2011 on Friday, investors say they are bracing for another difficult week, likely featuring hectic trading and large splits between buy and sell orders. Gaps as wide as 10% between the price bondholders are willing to accept and buyers are willing to pay…”
December 15 – Wall Street Journal (Sarah Krouse, Kirsten Grind and Mike Cherney): “Investors retreated from the U.S. junk-bond market for the third straight trading day and stocks of large asset managers were hit by heavy selling, a sign that the deepest turmoil in financial markets since summer is intensifying. Some investors reported difficulties selling lower-rated bonds quickly or at listed prices, though others said the market appeared to stabilize somewhat after the record plunge in prices on Friday. While the market for the highest-quality bonds remains intact, there are signs across Wall Street that investors are losing confidence in lower-quality bonds and the firms that most actively deal in them. Waddell & Reed Financial Inc., which manages the $6.2 billion Ivy High Income Fund that has suffered the largest outflows this year of any junk-bond fund, tumbled 7.5%. AllianceBernstein Holding LP, which runs the $5.8 billion AB High Income Advisor fund, dropped 7%.”
December 14 – Bloomberg (Cordell Eddings and Christine Idzelis): “You had to see this one coming. Warnings of a high-yield bust were plentiful: The shale driller that missed its first payment. The clothing manufacturer and the software maker among the many companies that issued debt, payable in more debt, earmarked to reward managers who’d already loaded them up with debt. They had willing buyers, all of them. Investors have poured $240 billion into junk-bond funds since 2008, tripling the total commitment, in a desperate hunt for decent returns while the Federal Reserve pumped $3.5 trillion into the financial system and kept interest rates near zero for seven years. Junk-bond traders helped fund America’s shale boom and gave the cheapest money ever, even to companies deemed by Moody’s… to be ‘very high credit risk, poor standing.’ Now they’re finding out what happens when the fling is over and everyone wants their money back at once.”
December 15 – Financial Times (Pan Kwan Yuk): “It may be known as junk, but there is a reason bankers like to market speculative bonds as high-yield. The yield on the lowest rated slices of US corporate debt — those rated triple C or lower by one of the major credit agencies — shot above 18% as investors scrambled out of one of the riskiest parts of the bond market, according to Bank of America Merrill Lynch data. Investors have fled junk bond mutual funds and exchange traded funds at a brisk pace… BlackRock iShares HYG and State Street’s JNK, the two largest high-yield bond ETFs, have recorded outflows of $749m and $897m since the month began, according to FactSet.”
Leveraged Speculation Watch:
December 18 – Bloomberg (Nishant Kumar): “Hedge fund closures surged in the three months to the end of September as money managers reeled from declines in commodity and equity markets, while high-yield credit spreads widened. The number of funds liquidated climbed to 257, up from 200 in the previous three months, according to… Hedge Fund Research…, and taking total closures in the first nine months to 674, compared with 661 during the same period last year… Liquidations rose ‘as investor risk tolerance fell sharply, and energy commodities and equities posted sharp declines, resulting in net capital outflows, wider performance dispersion and meaningful differentiation between hedge funds,’ Kenneth Heinz, president of HFR, said…”
December 17 – Bloomberg (David Yong and Klaus Wille): “Global hedge funds betting on distressed debt are suffering their worst year since 2008 as corporate defaults in emerging markets such as Asia spiked higher and the fifth year of a commodity slump fueled losses. Things might only get worse. Funds using distressed-debt strategies lost 4.5% this year through November, set for the first annual decline since the global financial crisis, according to Eurekahedge Pte. Some investors are predicting more losses after a market rout forced Third Avenue Management LLC to liquidate a mutual fund.”
December 14 – Bloomberg (Christine Harper): “Lucidus Capital Partners, a high-yield credit fund founded in 2009 by former employees of Bruce Kovner’s Caxton Associates, has liquidated its entire portfolio and plans to return the $900 million it has under management to investors next month… ‘The fund has exited all investments,’ Chief Executive Officer Christon Burrows and Chief Investment Officer Geoffrey Sherry said… ‘We would like to thank our investors and counterparties for their support over the years.’”
Europe Watch:
December 14 – Reuters (Marc Jones and John O’Donnell): “European Union countries' reluctance to integrate in the face of an influx of refugees and with the possible departure of Britain from the bloc could ultimately hurt creditworthiness, Standard & Poor's said… ‘Indications are mounting that the long process of integration may have come to a halt,’ the credit rating agency said in a report, outlining the risk of a 'disjointed' European Union. ‘In fact, signals are that it might be going into reverse," it said, citing the narrowly averted departure of Greece from the euro currency area, a refugee crisis and a weakened Franco-German partnership. The European Union, which spans 28 states from Britain to Malta, has been credited with dismantling borders, making it easier for workers and money to move between countries.”
December 17 – Bloomberg (Esteban Duarte): “The corruption allegations that resurfaced this week to spice up Spain’s election campaign could yet derail Prime Minister Mariano Rajoy’s bid for a second term. In a prime-time television debate Monday, opposition leader Pedro Sanchez told Rajoy he isn’t fit to lead the country as he attacked the prime minister again and again over links to his former party treasurer, Luis Barcenas, who is the focus of a graft investigation. Barcenas’s lawyer said in an interview the same day that his client plans to submit evidence showing the prime minister received cash payments from -- and had full knowledge of -- a secret party slush fund used to receive political contributions.”
Geopolitical Watch:
December 17 – Bloomberg (Natasha Doff and Kateryna Choursina): “Ukraine said it won’t repay $3 billion in bonds due to Russia, moving a step closer to a court battle amid a new wave of economic tension between the two ex-Soviet neighbors… Russia said on Friday it will wait until a 10-day grace period on the bond expires on Dec. 30 before starting legal action. Ukraine, its finances reeling from a two-year-old conflict with Russian-backed separatists in the east of the country, had pushed Russia to join a $18 billion restructuring with commercial creditors this year. But Russia argued the debt was sovereign, despite its unusual Eurobond form, and proposed its own repayment terms.”
December 15 – Reuters (Tim Kelly): “The U.S. Pacific Fleet Commander has warned of a possible arms race in the disputed South China Sea which could engulf the region, as nations become increasingly tempted to use military force to settle territorial spats instead of international law. Commander Admiral Scott Swift urged nations, like China, to seek arbitration to settle maritime disputes. ‘My concern is that after many decades of peace and prosperity, we may be seeing the leading edge of a return of ‘might makes it right’ to the region,’ Swift said… ‘Claimants and non-claimants alike are transferring larger shares of national wealth to develop more capable naval forces beyond what is needed merely for self defense,’ Swift said.”
U.S. Bubble Watch:
December 14 – Financial Times (Ben McLannahan): “The head of corporate banking at Wells Fargo, the biggest bank in the world by market capitalisation, has warned of ‘stresses’ in its energy portfolio, as the ongoing slump in the price of oil begins to weigh heavily on servicers and producers. Kyle Hranicky, who spent nine years at the helm of the Houston-based Wells Fargo Energy Group before rising to head the corporate banking division in May, said that the bank had been in discussions with clients for several months about preserving cash and cutting borrowing limits. ‘Some have liquidity to survive the cycle but others will be under significant stress and may be forced to sell assets or recapitalise,’ he said. ‘We’ve been in the energy business for over 30 years, so we’re comfortable with cycles. But this one feels deeper and broader and could last longer.’”
December 16 – AFP: “The price of an average apartment in the New York borough of Manhattan has passed the $1 million mark for the first time… The median price -- at the midpoint of all sales prices -- is now $1.1 million, up 11% in a year, said the CityRealty website… Prices in Manhattan have surged by 60% over the past 10 years. The mean price -- the average of all sales prices -- is now $1.9 million, up 5.5% from last year and 72% from 2005. Total real-estate sales in Manhattan this year should reach $24 billion, a 4.2% year-on-year increase, according to CityRealty's projections.”
December 16 – New York Times (Michael Corkery and Mary Williams Walsh): “The governor of Puerto Rico redoubled threats on Wednesday of a major bond default, as an effort to help the struggling commonwealth use bankruptcy to shed debt headed for defeat in Congress. Gov. Alejandro García Padilla warned in a speech at the National Press Club in Washington that Puerto Rico would probably miss debt payments in January or May because its government had run out of cash. ‘There is no money,’ he said. ‘I don’t have a printing machine.’ The governor’s comments came as Congress omitted from a federal spending bill any measures to allow Puerto Rico to restructure its roughly $72 billion of debt in Federal Bankruptcy Court.”
China Bubble Watch:
December 17 – Bloomberg (Malcolm Scott): “China’s economic conditions deteriorated across the board in the fourth quarter, according to a private survey from a New York-based research group that contrasted with recent official indicators that signaled some stabilization in the country’s slowdown. National sales revenue, volumes, output, prices, profits, hiring, borrowing, and capital expenditure were all weaker than the prior three months, according to the fourth-quarter China Beige Book, published by CBB International… The Beige Book’s profit reading is ‘particularly disturbing,’ with the share of firms reporting earnings gains slipping to the lowest level recorded, CBB President Leland Miller wrote… While retail and real estate held up reasonably well, manufacturing and services performed poorly, with revenues, employment, capital expenditure and profits weakening. The survey shows ‘pervasive weakness,’ Miller wrote... ‘The popular rush to find a successful manufacturing-to-services transition will have to be put on hold for a bit. Only the part about struggling manufacturing held true.’”
December 14 – Bloomberg: “China’s government spending surged in November at more than double the pace of gains for revenue, a signal the government has stepped up fiscal stimulus. Fiscal spending jumped 25.9% from a year earlier to 1.61 trillion yuan ($249bn), while revenue rose 11.4% to 1.11 trillion yuan… China’s government usually registers some of its biggest expenditures in the last two months of the year as provincial authorities rush to complete projects and meet spending targets… Receipts from land sales, a major revenue source for local governments, slumped 29.2% in the first 11 months… But in November alone, proceeds from land sales increased 7.4% compared with the same month last year.”
December 13 – Bloomberg: “The fall from grace for China’s biggest brokerage and investment bank, Citic Securities Co., has been fast and steep. The firm -- sometimes referred to as the Goldman Sachs of China -- began the year on its way to eclipsing UBS Group AG in the ranks of the top four securities firms in the world. Now it’s embroiled in a police investigation and a probe by the stock-market regulator. Its chairman is being replaced and its top leadership reorganized. At least nine Citic executives have been investigated for alleged insider trading or haven’t shown up to work and can’t be reached. The origins of its turmoil lie in its role as the highest flier in China’s developing finance field, caught up in the fallout from a stock market crash starting in June that erased $5 trillion in value. Encouraged by multiple pronouncements from policy makers that they wanted Chinese firms to develop the finance tools used in the rest of the world, Citic became a leader. Short selling, stock-index futures, cross-border return swaps -- all were on the table, all permitted with qualified nods by China’s regulators, until the rules changed and suddenly they weren’t.”
December 15 – Bloomberg: “Chinese junk bonds are getting some help from the nation’s central bank, making them more resilient if not immune to the global swoon in the riskiest debt ahead of the Federal Reserve’s interest rate decision. While the average yield on Chinese firms’ speculative-grade notes in dollars has risen 30 bps in the past 30 days to a two-month high of 8.84%, that’s less than the 79 bps jump in similarly rated securities in the U.S. to 8.97%... In China’s onshore market, the yield on five-year securities with local ratings of AA-, considered junk in the nation, has dropped 20 bps in the period to a more than six-year low of 4.67%... The relief for Chinese borrowers comes as the People’s Bank of China seeks to get more money into an economy growing at the weakest pace in a quarter century…”
Brazil Watch:
December 16 – Bloomberg (Filipe Pacheco and Paula Sambo): “Brazil’s credit rating was cut to junk by Fitch Ratings, which became the second major ratings company to strip the country of its investment grade as Latin America’s largest economy heads to its longest recession since the Great Depression amid political turmoil… Brazil’s economy is contracting, lawmakers haven’t shown the will to shore up the budget and efforts to impeach the president are adding to political turmoil and distracting from efforts to fix the situation, Fitch said… Fitch’s move… may shrink the pool of investors that consider buying the country’s securities since many institutions such as pension funds forbid investments in assets rated junk by at least two major ratings companies.”
EM Bubble Watch:
December 17 – Bloomberg (Phil Kuntz): “By fulfilling his campaign pledge to let the Argentinian peso trade freely, President Mauricio Macri did Brazil a nice neighborly favor. The real had been the worst-performing major emerging-market currency for months. Now that distinction belongs to the peso. The peso fell against the U.S. dollar as soon as it started trading Thursday. As of mid-morning… it was down 39% this year, compared with 32% for the real.”
December 14 – Bloomberg (Benjamin Bain): “Wagers that the Federal Reserve will raise interest rates for the first time in almost a decade are souring sentiment toward Mexican stocks. Traders have pulled $840 million from the nation’s largest exchange-traded equities fund this year, the biggest outflow among developing nations… With one of the world’s most-traded currencies, deep corporate ties to the U.S. and policy makers who have pegged the timing of their rate decisions to the Fed’s calendar, Mexico is a popular way for foreign investors to bet on all things emerging markets, said Paul Christopher, … head global market strategist for Wells Fargo Investment Institute. ‘There are a lot of institutional investors who hold Mexico as a proxy,’ Christopher, whose firm oversees $1.7 trillion… This has led ‘to Mexico being the whipping boy.’”
December 16 – Bloomberg (Andrew Willis and Matthew Bristow): “Colombia is nursing paper losses of more than $100 billion after its oil boom fell short of expectations, wiping out 90 percent of the value of what was once Latin America’s biggest company. From being the world’s fifth-most valuable oil producer at its zenith in 2012, worth more than BP Plc, state-controlled Ecopetrol SA now ranks 38th. Its market capitalization has fallen to $14.5 billion, down from its peak of $136.7 billion.”
December 14 – Bloomberg (Zainab Fattah): “Dubai developers halted delivery of about a quarter of the properties set for completion this year, bolstering apartment rents but failing to stop a 16% price decline, according to CBRE Group Inc. About 6,000 nearly-completed homes sit empty in newer developments such as Dubailand, Jumeirah Village Circle and Dubai Sports City as some developers withhold keys from buyers, according to CBRE… Single-family home rents declined 4% compared with a 14% drop in values…”
Fixed Income Bubble Watch:
December 14 – Reuters (Marc Jones and John O’Donnell): “U.S. investors withdrew $15.4 billion from taxable bond funds over the week ended Dec. 16, Lipper said…, as some funds posted record-setting withdrawals in a week marked by fears over the stability of the bond market. ‘We saw some very large redemptions, in fact, we set some records,’ said Tom Roseen, head of research services for Lipper. The outflows across mutual funds and ETFs invested in bonds came on a dramatic week that whipsawed funds and markets.”
December 13 – Wall Street Journal (Matt Wirz, Mike Cherney and Corrie Driebusch): “Traders and regulators have fretted for more than a year that mayhem might ensue if U.S. mutual funds sought to sell rarely traded bond investments. After junk-bond prices posted their largest drop since 2011 on Friday, investors say they are bracing for another difficult week, likely featuring hectic trading and large splits between buy and sell orders. Gaps as wide as 10% between the price bondholders are willing to accept and buyers are willing to pay…”
December 15 – Wall Street Journal (Sarah Krouse, Kirsten Grind and Mike Cherney): “Investors retreated from the U.S. junk-bond market for the third straight trading day and stocks of large asset managers were hit by heavy selling, a sign that the deepest turmoil in financial markets since summer is intensifying. Some investors reported difficulties selling lower-rated bonds quickly or at listed prices, though others said the market appeared to stabilize somewhat after the record plunge in prices on Friday. While the market for the highest-quality bonds remains intact, there are signs across Wall Street that investors are losing confidence in lower-quality bonds and the firms that most actively deal in them. Waddell & Reed Financial Inc., which manages the $6.2 billion Ivy High Income Fund that has suffered the largest outflows this year of any junk-bond fund, tumbled 7.5%. AllianceBernstein Holding LP, which runs the $5.8 billion AB High Income Advisor fund, dropped 7%.”
December 14 – Bloomberg (Cordell Eddings and Christine Idzelis): “You had to see this one coming. Warnings of a high-yield bust were plentiful: The shale driller that missed its first payment. The clothing manufacturer and the software maker among the many companies that issued debt, payable in more debt, earmarked to reward managers who’d already loaded them up with debt. They had willing buyers, all of them. Investors have poured $240 billion into junk-bond funds since 2008, tripling the total commitment, in a desperate hunt for decent returns while the Federal Reserve pumped $3.5 trillion into the financial system and kept interest rates near zero for seven years. Junk-bond traders helped fund America’s shale boom and gave the cheapest money ever, even to companies deemed by Moody’s… to be ‘very high credit risk, poor standing.’ Now they’re finding out what happens when the fling is over and everyone wants their money back at once.”
December 15 – Financial Times (Pan Kwan Yuk): “It may be known as junk, but there is a reason bankers like to market speculative bonds as high-yield. The yield on the lowest rated slices of US corporate debt — those rated triple C or lower by one of the major credit agencies — shot above 18% as investors scrambled out of one of the riskiest parts of the bond market, according to Bank of America Merrill Lynch data. Investors have fled junk bond mutual funds and exchange traded funds at a brisk pace… BlackRock iShares HYG and State Street’s JNK, the two largest high-yield bond ETFs, have recorded outflows of $749m and $897m since the month began, according to FactSet.”
Leveraged Speculation Watch:
December 18 – Bloomberg (Nishant Kumar): “Hedge fund closures surged in the three months to the end of September as money managers reeled from declines in commodity and equity markets, while high-yield credit spreads widened. The number of funds liquidated climbed to 257, up from 200 in the previous three months, according to… Hedge Fund Research…, and taking total closures in the first nine months to 674, compared with 661 during the same period last year… Liquidations rose ‘as investor risk tolerance fell sharply, and energy commodities and equities posted sharp declines, resulting in net capital outflows, wider performance dispersion and meaningful differentiation between hedge funds,’ Kenneth Heinz, president of HFR, said…”
December 17 – Bloomberg (David Yong and Klaus Wille): “Global hedge funds betting on distressed debt are suffering their worst year since 2008 as corporate defaults in emerging markets such as Asia spiked higher and the fifth year of a commodity slump fueled losses. Things might only get worse. Funds using distressed-debt strategies lost 4.5% this year through November, set for the first annual decline since the global financial crisis, according to Eurekahedge Pte. Some investors are predicting more losses after a market rout forced Third Avenue Management LLC to liquidate a mutual fund.”
December 14 – Bloomberg (Christine Harper): “Lucidus Capital Partners, a high-yield credit fund founded in 2009 by former employees of Bruce Kovner’s Caxton Associates, has liquidated its entire portfolio and plans to return the $900 million it has under management to investors next month… ‘The fund has exited all investments,’ Chief Executive Officer Christon Burrows and Chief Investment Officer Geoffrey Sherry said… ‘We would like to thank our investors and counterparties for their support over the years.’”
Europe Watch:
December 14 – Reuters (Marc Jones and John O’Donnell): “European Union countries' reluctance to integrate in the face of an influx of refugees and with the possible departure of Britain from the bloc could ultimately hurt creditworthiness, Standard & Poor's said… ‘Indications are mounting that the long process of integration may have come to a halt,’ the credit rating agency said in a report, outlining the risk of a 'disjointed' European Union. ‘In fact, signals are that it might be going into reverse," it said, citing the narrowly averted departure of Greece from the euro currency area, a refugee crisis and a weakened Franco-German partnership. The European Union, which spans 28 states from Britain to Malta, has been credited with dismantling borders, making it easier for workers and money to move between countries.”
December 17 – Bloomberg (Esteban Duarte): “The corruption allegations that resurfaced this week to spice up Spain’s election campaign could yet derail Prime Minister Mariano Rajoy’s bid for a second term. In a prime-time television debate Monday, opposition leader Pedro Sanchez told Rajoy he isn’t fit to lead the country as he attacked the prime minister again and again over links to his former party treasurer, Luis Barcenas, who is the focus of a graft investigation. Barcenas’s lawyer said in an interview the same day that his client plans to submit evidence showing the prime minister received cash payments from -- and had full knowledge of -- a secret party slush fund used to receive political contributions.”
Geopolitical Watch:
December 17 – Bloomberg (Natasha Doff and Kateryna Choursina): “Ukraine said it won’t repay $3 billion in bonds due to Russia, moving a step closer to a court battle amid a new wave of economic tension between the two ex-Soviet neighbors… Russia said on Friday it will wait until a 10-day grace period on the bond expires on Dec. 30 before starting legal action. Ukraine, its finances reeling from a two-year-old conflict with Russian-backed separatists in the east of the country, had pushed Russia to join a $18 billion restructuring with commercial creditors this year. But Russia argued the debt was sovereign, despite its unusual Eurobond form, and proposed its own repayment terms.”
December 15 – Reuters (Tim Kelly): “The U.S. Pacific Fleet Commander has warned of a possible arms race in the disputed South China Sea which could engulf the region, as nations become increasingly tempted to use military force to settle territorial spats instead of international law. Commander Admiral Scott Swift urged nations, like China, to seek arbitration to settle maritime disputes. ‘My concern is that after many decades of peace and prosperity, we may be seeing the leading edge of a return of ‘might makes it right’ to the region,’ Swift said… ‘Claimants and non-claimants alike are transferring larger shares of national wealth to develop more capable naval forces beyond what is needed merely for self defense,’ Swift said.”