Saturday, April 30, 2016

Weekly Commentary: The Red Line

April 25 – Financial Times (Jennifer Hughes): “Stand easy — or easier, at least. Ten basis points might not be the biggest one-day change for borrowing costs in China’s vast $7tn bond markets, but it was enough on Monday to push the country’s closely watched onshore repo rate back from an eight-month high. That offers a little breathing space for investors to ponder what next for the rising tensions in onshore bond markets. One point to look at is their own leverage as well as their fears for companies… Amid all the furore about the pain of rising rates, one so-far overlooked factor is that investors, as well as companies, appear precariously balanced. The market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt, according to Wind Info. A sharp worsening in market sentiment could force those borrowers into fire sales if their loans are called or cannot be rolled over.”

I recall an early-1998 Financial Times article highlighting the explosive growth in Russian ruble and bond derivatives. Not only had the “insurance” market for risk protection grown phenomenally, Russian banks had become become major operators in what had evolved into a huge speculative Bubble in Russian debt exposures. That was never going to end well.

There was ample evidence suggesting Russia was a house of cards. Yet underpinning this Bubble was the market perception that the West would not allow a Russian collapse. With such faith and the accompanying explosion in speculative trading, leverage and a resulting massive derivatives overhang, any break in confidence would lead to illiquidity, panic and a devastating bust. Just such an outcome unfolded in August/September 1998.

“The market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt” (from FT above). With this undramatic sentence exists the potential for a rather dramatic global financial crisis. And, to be sure, seemingly the entire world has operated under the assumption that Chinese officials (and global policymakers in general) have zero tolerance for crisis – let alone a collapse. So Credit, speculation and leverage have been accommodated – and they combined to run absolute roughshod.

Jennifer Hughes’ FT article (noted above) includes a chart worthy of color printing and thumbtacking to the wall: “China’s Use of Bonds as Loan Collateral Rises Sharply”. The pink line shows “Onshore Market Bonds” having almost doubled since mid-2011 to about 40 TN rmb ($6.17 TN). The Red Line – “Pledge-Style Repos” – has ballooned four-fold since just early 2014 to surpass 40 TN rmb. So basically, in this popular market for inter-bank borrowings, borrowing banks have pledged bond positions larger than the entire market as collateral for their (perceived safe) short-term borrowing needs.

China has an historic Credit problem. It as well suffers from an unfolding “money” fiasco of epic proportions. My analytical framework attempts to differentiate the two, as each comes with its own set of (related) issues. A Credit Bubble is a self-reinforcing but inevitably unsustainable expansion of debt. Money (the contemporary variety) is a financial claim perceived as a safe and liquid “store of nominal value.” Importantly, systemic risk expands exponentially when risky borrowings are financed by an expansion of “money-like” instruments/financial claims. This typically occurs late (“terminal phase”) in the Credit Bubble Cycle.

During the U.S. mortgage finance Bubble period, “Wall Street Alchemy” worked to transform increasingly risky mortgage debt into perceived safe “AAA” securities and instruments. And so long as the rapid expansion of mortgage Credit propelled home prices and economic activity, the Fallacy of Moneyness prevailed. But at some point Bubble risk intermediation processes invariably turn perilous. The disconnect becomes increasingly untenable: enormous risk has accumulated – and continues to swell – backed by a rapid expansion of perceived safe “money.” After months of festering Credit deterioration, it was the breakdown in confidence in the repo market that precipitated the devastating 2008 financial crisis.

How sound is China’s multi-Trillion repo market? In general, lending in short-term, collateralized, inter-bank markets is perceived to be very low risk. Confidence is based on the soundness of the individual institutions in the market; in the quality and liquidity of the debt collateral; and the capacity and determination of official institutions to backstop the marketplace during periods of tumult.

As for China, underpinnings are vulnerable. The banking sector has enjoyed years of explosive growth, which by definition virtually ensures latent fragilities. There are as well major cracks surfacing in China’s corporate bond market, portending serious issues with the collateral backing China’s “pledge-style repos.” And how has corruption and incompetence (not to mention state-directed lending) impacted the quality of banking system assets? At this point, faith that Beijing will backstop system Credit while ensuring uninterrupted economic expansion is fundamental to repo market confidence.

After the incredible $1.0 TN Q1 Chinese Credit expansion, there were indications this week that excess went too far and officials now seek to slow things down (see “China Bubble Watch”). Officials also moved this week to rein in commodities speculation. Efforts were made as well to tighten mortgage Credit, at least in some of the more overheated markets.

I often refer to the “global pool of speculative finance.” Well, after years of rampant Credit excess, China these days has its own unwieldy pool of speculative finance fomenting boom/bust dynamics throughout equities, housing and, more recently, in debt and commodities. And I believe it is a safe assumption that the explosive growth in short-term (“repo”) borrowings has been instrumental in financing myriad asset and speculative Bubbles. Chinese officials, of course, have been keen to avoid bursting Bubbles and all the associated negative economic, social and geopolitical consequences. Regrettably, these efforts have nurtured only greater distortions, risk misperceptions and stupendous Bubble excess.

Returning to the “China as marginal source of global Credit” theme, one can these days make clearer delineations. Today, Bubble markets and an extraordinarily maladjusted and imbalanced global economy are highly dependent upon ongoing Chinese financial and economic booms. The Chinese Bubble depends upon ongoing speculative excess and asset inflation. And Chinese asset and speculative Bubbles are sustained by cheap “repo” and other short-term “money-like” finance.

With various Bubbles either already faltering or indicating acute fragility, confidence in China’s “repo” finance has turned quite vulnerable. And as goes the Chinese “repo” market so goes China’s asset Bubbles, Credit Bubble and economic Bubble, with ominous portents for global markets and the overall global economy.

Markets were turning keen to this risk earlier in the year. More recently, with Chinese officials having seemingly stabilized their financial and economic systems, global market attention returned to anxious central bankers, zero/negative rates and a couple Trillion additional QE. There was a huge policy-induced short squeeze that bolstered bullishness and sucked in a significant amount of buying power. The leveraged speculating community got turned upside down, with trades going haywire throughout global markets. The return of “risk on” turned into a real pain trade for many. And just when it appeared markets had stabilized and positioning had normalized…

There were indications this week that the “risk on” spell may have been broken. Thursday saw Japan’s Nikkei sink 3.6%, while the yen jumped 2.6%, the “most since 2010.” It was a somewhat histrionic market reaction to the Bank of Japan’s decision not to immediately expand stimulus. For me, it indicated market “risk off” susceptibility. Japanese equities and the yen have been important markets for the leveraged speculating community. Both the Japanese equities rally and the yen pullback were “counter-trend” moves susceptible to hasty market reassessment.

The yen surged 4.7% this week to an 18-month high versus the dollar. Japan’s Topix Bank Index sank 8.6%, increasing 2016 losses to 29.3%. It’s worth noting that financial stocks were under pressure globally again this week. Hong Kong’s Hang Seng Financials were down 2.8% (down 11.3% y-t-d), and European bank stocks fell 2.7% (down 16.7%). The major European equity markets – having been major squeeze and “risk on” beneficiaries over recent weeks – also showed their vulnerability. Germany’s DAX index sank 3.2%, and French stocks were down 3.1%. Rallies dominated by short-squeeze dynamics often have a propensity for abrupt reversals.

Here at home, the Securities Broker/Dealer index was (ominously) slammed 5.5%. Worries, however, were not limited to financials. Having notably benefited from squeeze dynamics, an abrupt reversal saw biotech stocks slammed 5.9%. More prophetic for the general markets – and the economy overall – were further indications this week of a faltering technology Bubble. In a period of general earnings deterioration, it is worth recalling how quickly technology earnings can evaporate (recall 2000 to 2002).

Wall Street darling Apple sank 11% this week on weak earnings. Fear of a rapid slowdown in smart phones also saw the semiconductors (SOX) slide 3.5%. On the back of declines in Apple, Microsoft (down 3.7%) and Netflix (down 6.1%), the Nasdaq100 dropped 3.0%. Tech indices – and the general market - benefited from players crowding further into the big winners (Amazon and Facebook up 6.3%). It’s worth noting that the VIX ended the week at 15.70, up from the week ago 13.95.

Commodities are on fire. The GSCI Commodities index jumped 3.6% this week to a six-month high (up 15.6% y-t-d). Crude gained another $2.27 to $46.01. More interestingly, Gold surged $61 (4.9%) to 14-month highs (HUI up 15.4%!). Silver jumped 5.4% to a 15-month high. Curiously, the dollar index fell 2.2% this week to a one-year low.

From my vantage point, global market vulnerability has reemerged. Sentiment has begun to shift back in the direction of central banks having largely expended their ammunition. This becomes a more pressing issue when market players sense heightened deleveraging risk. Dan Loeb’s (Third Point Capital) comment, “There is no doubt that we are in the first innings of a washout in hedge funds,” provided a timely reminder that the market recovery did little to erase levered player woes. Indeed, market convulsions over recent months have only compounded problems.

It’s during bouts of “risk off” that the true underlying liquidity backdrop is illuminated. Combine short squeezes and the unwind of hedges with QE - and global markets seemingly luxuriate in liquidity abundance. “Risk off” exposes the liquidity illusion. Risk aversion would see longs liquidated and leverage unwound, with a rush to reestablish shorts and risk hedges. And rather quickly de-risking/de-leveraging would overwhelm QE. And if “risk off” is accompanied by Chinese Credit, banking and “repo” problems, well, global crisis dynamics would gather momentum in a hurry.

It’s almost as if gold, silver and crude prices are now shouting that they win either way. If the China Bubble perseveres along with global QE, inflation has a decent shot of taking root (an ugly scenario for global bond Bubbles). But if the ominous China “repo” Red Line foretells a harsh Chinese and global crisis - crude and the precious metals, in particular, offer rather enticing wealth preservation potential. It’s time again to be especially vigilant.


For the week:

The S&P500 declined 1.3% (up 1.0% y-t-d), and the Dow fell 1.3% (up 2.0%). The Utilities jumped 2.1% (up 11.9%). The Banks dropped 1.5% (down 5.5%), and the Broker/Dealers sank 5.5% (down 9.0%). The Transports were hit 2.7% (up 4.8%). The S&P 400 Midcaps declined 1.0% (up 4.5%), and the small cap Russell 2000 fell 1.4% (down 0.4%). The Nasdaq100 sank 3.0% (down 5.5%), and the Morgan Stanley High Tech index lost 2.0% (down 4.2%). The Semiconductors dropped 3.5% (down 2.7%). The Biotechs sank 5.9% (down 19.1%). With bullion jumping $61, the HUI gold index surged 15.4% (up 110%).

Three-month Treasury bill rates ended the week at 21 bps. Two-year government yields declined four bps to 0.78% (down 27bps y-t-d). Five-year T-note yields dropped seven bps to 1.29% (down 46bps). Ten-year Treasury yields fell six bps to 1.83% (down 42bps). Long bond yields declined four bps to 2.67% (down 35bps).

Greek 10-year yields increased four bps to 8.25% (up 93bps y-t-d). Ten-year Portuguese yields fell 13 bps to 3.13% (up 61bps). Italian 10-year yields added a basis point to 1.48% (down 11bps). Spain's 10-year yields were unchanged at 1.59% (down 18bps). German bund yields gained four bps to 0.27% (down 35bps). French yields rose seven bps to 0.63% (down 36bps). The French to German 10-year bond spread widened three to 36 bps. U.K. 10-year gilt yields slipped a basis point to 1.59% (down 37bps).

Japan's Nikkei volatile equities index sank 5.2% (down 12.4% y-t-d). Japanese 10-year "JGB" yields increased three bps to negative 0.9% (down 35bps y-t-d). The German DAX equities index dropped 3.2% (down 6.6%). Spain's IBEX 35 equities index fell 2.2% (down 5.4%). Italy's FTSE MIB index dipped 0.5% (down 13.2%). EM equities equities were mixed to lower. Brazil's Bovespa index jumped 1.9% (up 24.4%). Mexico's Bolsa added 0.4% (up 6.5%). South Korea's Kospi index declined 1.1% (up 1.7%). India’s Sensex equities index slipped 0.9% (down 2.0%). China’s Shanghai Exchange fell 0.7% (down 17.0%). Turkey's Borsa Istanbul National 100 index slipped 0.6% (up 19%). Russia's MICEX equities index declined 0.7% (up 10.9%).

Junk funds saw inflows slow to $29 million (from Lipper), the ninth straight week of positive flows.

Freddie Mac 30-year fixed mortgage rates jumped seven bps to 3.66% (down 2bps y-o-y). Fifteen-year rates gained four bps to 2.89% (down 5bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up nine bps to 3.76% (down 10bps).

Federal Reserve Credit last week declined $7.0bn to $4.445 TN. Over the past year, Fed Credit increased $0.5bn. Fed Credit inflated $1.634 TN, or 58%, over the past 181 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week fell $3.3bn to $3.239 TN. "Custody holdings" were down $50bn y-o-y, or 1.5%.

M2 (narrow) "money" supply last week expanded $16.1bn to $12.624 TN. "Narrow money" expanded $733bn, or 6.2%, over the past year. For the week, Currency increased $3.0bn. Total Checkable Deposits dropped $35.3bn, while Savings Deposits surged $53.1bn. Small Time Deposits were little changed billion. Retail Money Funds declined $4.2bn.

Total money market fund assets gained $10.3bn to $2.709 TN. Money Funds rose $127bn y-o-y (4.9%).

Total Commercial Paper slipped $1.2bn to $1.110 TN. CP expanded $86bn y-o-y, or 8.4%.

Currency Watch:

April 25 – Reuters (Marc Jones): “Global investors are expected to pull $538 billion out of China's slowing economy in 2016, the Institute of International Finance (IIF) estimated… That number would be down a fifth from the $674 billion pulled out last year, the industry association said, but could accelerate again if fears re-emerge of a ‘disorderly’ drop in the yuan, or the renminbi…”

The U.S. dollar index sank 2.2% this week to 93.02 (down 5.7% y-t-d). For the week on the upside, the Japanese yen increased 4.7%, the Brazilian real 3.7%, the Norwegian krone 2.4%, the euro 2.0%, the Swiss franc 1.9%, the New Zealand dollar 1.8%, the Mexican peso 1.7%, the Swedish krona 1.6%, the British pound 1.5%, the South African rand 1.2% and the Canadian dollar 0.9%. For the week on the downside, the Australian dollar declined 1.4%. The Chinese yuan rose 0.3% versus the dollar.

Commodities Watch:

April 27 – Reuters (Manolo Serapio Jr.): “Iron ore and steel futures in China fell again on Wednesday as authorities raised trading costs to deter speculative investors believed to be behind last week's big spike in prices and volumes, which had raised fears of a destabilising crash. The Dalian Commodity Exchange increased the transaction fees on steelmaking raw materials iron ore, coking coal and coke for a second time this week. Other commodity exchanges in Shanghai and Zhengzhou have imposed similar curbs to restore calm in markets after a week-long surge unsettled global investors.”

April 26 – Bloomberg (Jasmine Ng): “Goldman Sachs Group Inc. has expressed its concern about the surge in speculative trading in iron ore futures in China, saying that daily volumes are now so large that they sometimes exceed annual imports. The increase in futures trading in the world’s largest importer was among factors that have lifted prices… Iron ore volumes traded on the Dalian Commodity Exchange are up more than 400% from a year ago, they said.”

The Goldman Sachs Commodities Index jumped 3.6% to a near one-year high (up 15.6% y-t-d). Spot Gold surged 4.9% to $1,294 (up 22%). Silver advanced 5.2% to $17.89 (up 30%). WTI Crude gained another $2.27 to $46.01 (up 24%). Gasoline jumped 3.2% (up 25%), while Natural Gas was unchanged (down 9%). Copper was little changed (up 7%). Wheat jumped 3.1% (up 4%). Corn rose 4.3% (up 9%).

Fixed-Income Bubble Watch:

April 28 – Bloomberg (Michelle Kaske): “Even if Puerto Rico manages to strike a last-minute deal to defer bond payments due in three days, the commonwealth’s financial collapse is about to enter an unprecedented phase. Anything short of making the $422 million payment that Puerto Rico says it can’t afford would be considered a technical default. More importantly, it opens the door to larger and more consequential defaults on debt protected by the island’s constitution, and raises the risk of putting efforts to resolve the biggest crisis ever in the $3.7 trillion municipal market into turmoil. Nearly 10 months after Governor Alejandro Garcia Padilla said the commonwealth was unable to repay all its obligations, Puerto Rico has failed to reach an accord on a broad restructuring deal presented to bondholders.”

April 26 – Bloomberg (Anchalee Worrachate and Anooja Debnath): “Bond investors are taking bigger risks than ever before. Yields on $7.8 trillion of government bonds have been driven below zero by worries over global growth, meaning money managers looking for income are pouring into debt with maturities of as long as 100 years. Central banks’ policy is exacerbating matters, as the unprecedented debt purchases to spur their economies have soaked up supply and left would-be buyers with few options. While demand has shown few signs of abating, investors are setting themselves up for damaging losses if average yields rise even a little from their rock-bottom levels. Based on a metric called duration, a half-percentage point increase would result in a loss of about $1.6 trillion in the global bond market…”

April 25 – Reuters (Nichola Groom and Michael Erman): “At an early 2015 investor conference, SunEdison’s then-chief financial officer, Brian Wuebbels, trumpeted the profit potential in the solar developer’s relationship with a venture it had recently spun off. SunEdison had established TerraForm Power Inc as a ‘yieldco,’ a complex financing vehicle to purchase energy projects from SunEdison and other developers. TerraForm lured investors with the promise of reliable dividends based on long-term power contracts. As Wuebbels’ presentation made clear, the yieldcos also created incentives for SunEdison to rapidly acquire more power projects. ‘It's all about growth, creating a pipeline, feeding that pipeline into TerraForm,’ he told investors. The resulting acquisition spree would drive SunEdison deeply into debt - and ultimately into bankruptcy.”

Global Bubble Watch:

April 28 – Bloomberg: “The speculators that traded $261 billion in Chinese commodities in a single day last week are retreating as regulators prepare to step up control of the market. The value of futures traded across China’s three biggest commodity exchanges has shrunk 42% since investors spent 1.7 trillion yuan last Thursday on everything from steel bars to eggs… Markets in the world’s biggest consumer of raw materials have been gripped by a trading frenzy that’s drawn comparisons with the credit-driven stock market rally last year that preceded a $5 trillion rout. Exchanges have responded by raising margins and transaction fees to curb speculation…”

April 28 – Bloomberg (Kana Nishizawa, Yuko Takeo and Anna Kitanaka): “Asia’s two biggest stock markets are jostling for an ignominious prize. Japan’s Topix index and China’s Shanghai Composite Index have tumbled more than 13% in 2016 to rank along Nigerian and Mongolian shares as the world’s worst performers. In the two years through the end of December, the Asian gauges outperformed MSCI’s global measure by at least 20 percentage points. The Bank of Japan stood pat on monetary policy Thursday, sending Tokyo stocks tumbling, while the Shanghai measure fell to a one-month low. The benchmark gauges in two of the world’s largest stock markets, which have a combined value of almost $11 trillion, are declining as investors detect a reduced appetite from policy makers to boost monetary stimulus.”

April 27 – Bloomberg (Michelle Kaske): “The world’s biggest financial market has shrunk by 20% during the past year and a half. Currency trading via CME Group Inc., ICAP Plc and Thomson Reuters Corp. -- three of the largest trading platforms -- fell to $538 billion per day last month, from more than $669 billion in September 2014… The figures show the extent of the slump in a market that this month saw some banks report less client activity…”

April 25 – Bloomberg (Jasmine Ng): “The recent spike in speculative trading in commodities in China has stunned global markets, according to Morgan Stanley, which cited a jump in local activity for steel, iron ore and cotton as well as eggs and garlic. ‘Now China’s speculators engage commodities,’ analysts including Tom Price and Joel Crane said… ‘China’s latest speculative spike has stunned global markets.’”

April 24 – Reuters (Kirsti Knolle): “Europe and Japan's central bank policies of negative interest rates are a ‘horror’ and will run counter to the desired effect, Jeffrey Gundlach… who runs DoubleLine Capital, said… Gundlach… said negative rates would not help fight deflation but withdraw liquidity from the market because people would rather hoard cash than invest or deposit it in a bank account. Negative interest rates ‘are the stupidest idea I have ever experienced,’ the newspaper Finanz und Wirtschaft quoted Gundlach as saying… ‘The next major event (for financial markets) will be the moment when central banks in Japan and in Europe give up and cancel the experiment.’”

April 27 – Reuters (Se Young Lee): “Global shipments of smartphones shrank 3% in the first quarter from a year earlier in the market's first year-on-year contraction on record, researcher Strategy Analytics said…, reflecting growing strains on the industry.”

U.S. Bubble Watch:

April 28 – Wall Street Journal (Theo Francis and Kate Linebaugh): “U.S. corporate profits, weighed down by the energy slump and slowing global growth, are set to decline for the third straight quarter in the longest slide in earnings since the financial crisis. Weakness was felt across the board, with executives from Apple Inc. to railroad Norfolk Southern Corp. and snack giant Mondelez… saying the current quarter remains tough. …Based on the 55% of companies in the S&P 500 index that had already reported results Thursday morning, Thomson Reuters expects overall earnings to decline by 6.1% in the first quarter compared with a year earlier… Seven of 10 broad economic sectors in the S&P 500 including consumer staples and technology companies are expected to report flat to falling profits, while six are likely to report flat or declining revenues…”

April 27 – Wall Street Journal (Annamaria Andriotis): “The slump in crude prices is starting to show up as missed payments by consumers in the oil patch. In states from Oklahoma and Texas to North Dakota and Wyoming, rising unemployment in the energy sector is pushing up loan delinquencies and raising the risk of new losses for banks. Wells Fargo… this month reported an increase in borrowers falling behind on payments in areas including Houston and parts of Alaska. J.P. Morgan… said auto-loan delinquency rates picked up in some energy-related markets.”

April 29 – Bloomberg (Joe Carroll and David Wethe): “Chevron Corp. lost money during the first quarter for the first time in almost a quarter century amid an oil-market collapse that’s sparked currency crises, corporate bankruptcies, credit downgrades and hundreds of thousands of layoffs across the industry.”

April 26 – CNBC (Alex Rosenberg): “Used car prices look set to suffer their first meaningful decline since 2008. And the likely culprit is the strong number of new vehicle sales. According to ‘NADA Used Car Guide,’ used car prices will fall 5 to 6% this year.”

April 27 – Bloomberg (Oshrat Carmiel): “A cool-down in Manhattan’s apartment-rental market is hitting the bottom line of Equity Residential as the landlord is forced to offer concessions to tenants who suddenly have a lot of competition to choose from. ‘New York City just turned very quickly and more deeply than we expected,’ Chief Operating Officer David Santee said… With the city accounting for about 20% of the firm’s revenue, ‘if you can’t achieve 3 or 4% rate growth there, then it’s going to impact your full-year growth.’”

China Bubble Watch:

April 25 – Barron’s (Shuli Ren): “The People’s Bank of China is worried that easy money will exacerbate China’s bad debt problem and encourage speculative behavior. Over the weekend, the PBoC’s Vice Governor Chen Yulu said that financial institutions are facing increasing credit risks. China’s total debt rose to a record 237% of its GDP in the first quarter as money supply jumped 13% year-on-year, well above China’s nominal GDP growth rate. Well-respected Chinese financial magazine Caixin reported this afternoon that the PBoC is now asking its banks to pare back lending this month. The central bank is asking banks to lower the amount of new loans to just 70% of what was planned at the beginning of the month. Strategists and analysts are now saying that ample liquidity is driving Chinese investors to conduct speculative trading in commodity futures.”

April 27 – Bloomberg: “China’s bond traders are getting a painful lesson on the dangers of leverage. After years of racking up profits by borrowing cheaply and plowing the proceeds into higher-yielding debt, investors are now rushing to unwind those wagers amid the deepest selloff in 13 months. The bets are getting squeezed from both sides as bond prices sink and borrowing costs rise to one-year highs in the 8 trillion yuan ($1.2 trillion) market for repurchase agreements, used by traders to amplify their buying power… ‘It looks like everybody is cutting their leverage, passively or pro-actively, as pessimistic sentiment continues to brew,’ said Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management… ‘Carry trades have become riskier.’”

April 24 – Financial Times (Gabriel Wildau and Don Weinland): “China’s total debt rose to a record 237% of gross domestic product in the first quarter, far above emerging-market counterparts, raising the risk of a financial crisis or a prolonged slowdown in growth, economists warn. Beijing has turned to massive lending to boost economic growth, bringing total net debt to Rmb163 trillion ($25 trillion) at the end of March… Such levels of debt are much higher as a proportion of national income than in other developing economies, although they are comparable to levels in the U.S. and the eurozone. While the absolute size of China’s debt load is a concern, more worrying is the speed at which it has accumulated — Chinese debt was only 148% of GDP at the end of 2007.”

April 27 – Reuters (Spencer Anderson): “Chinese officials are rushing to introduce a new form of bail-in debt as early as this year as the country's biggest banks face a capital shortage that could run close to $1 trillion. Bankers say China's four largest lenders are under pressure to begin boosting their total loss-absorbing capacity (TLAC) in months, rather than years, as faster credit growth and rising bad loans have added to the amount of capital they need to comply with international standards for systemically important banks... ‘I think what has happened is that they have looked at how much capital needs to be raised, and realised that they need to start moving,’ said a Hong Kong-based debt capital markets banker specialising in financial institutions.” …Global banking regulators estimated the TLAC shortfall of China's four global systemically-important banks at $387 billion last November… A few weeks later, Moody's came out with its own estimate of $584 billion, far larger than a $115 billion funding gap for US banks and a $201 billion requirement for European banks… Bankers now say that earlier forecasts had not sufficiently accounted for the expected growth of Chinese banks' balance sheets over the next decade. Factor that in, they say, and the TLAC bill could be as high as $1 trillion.”

April 28 – Wall Street Journal (Anjani Trivedi): “It couldn’t be clearer that Chinese banks have a trove of bad loans on their books. The more pressing question: How long before it begins to wear down their healthy-looking capital bases? China’s largest banks this week reported another quarter of essentially flat profit growth a larger stock of fast-souring loans and most notably, a rapidly diminishing ratio of provisions to absorb potential losses on these loans. For now, the banks have found a precarious balance of provisioning just enough for bad loans in a way that keeps profit growth flat. The problem is nonperforming loans are rising fast, and the amount being set aside to provision for them isn’t quite cutting it.”

April 29 – Reuters (Engen Tham and Matthew Miller): “Three of China's Big Five lenders said they cut their loan-loss allowance ratio to around 150%, an indication the banking regulator may be lowering the amount of cash some banks need to set aside for future losses. For China's big commercial banks, the move allows lenders to report stable earnings, even as the volume of bad loans rise and revenue from traditional lending declines, analysts say. ‘It's a compromise," said Patricia Cheng, Head of China Financial Research for CLSA… ‘Even though banks are sitting on less buffer, they are hoping that with monetary easing, defaults can be managed.’”

April 28 – Reuters (Xiaowen Bi): “China's securities regulator ordered the country's major commodity futures exchanges this week to control speculative trading activity, sources told Reuters, after a surge in prices sparked fears of a boom-and-bust cycle. In response, commodity futures exchanges in Dalian, Shanghai and Zhengzhou ordered major institutional investors that lack a commodities background to rein in their trading… Investors, including hedge funds and retail investors, have placed big bets on Chinese commodities futures this year, driving up contracts including in iron ore, rebar, cotton and even eggs.”

April 25 – Bloomberg: “China’s banking regulator in Shanghai is halting business between commercial banks and six real estate agencies for a month, the latest in a string of measures to contain risks in the housing market… The regulator will also suspend the personal mortgage business for two months of seven local branches of banks including Industrial & Commercial Bank of China, Bank of China Ltd. and HSBC Holdings Plc for violations of lending rules.”

April 26 – Bloomberg: “A Chinese government-backed steelmaker faces the highest default risk among the nation’s listed companies with bonds due in the next year, according to the Bloomberg Default Risk model, amid mounting signs of stress at state firms… Three Chinese state-owned enterprises have reneged on bond obligations this year, compared with only one in the same period of 2015. Dongbei Special Steel Group Co. defaulted on bonds three times in the past month… ‘The market no longer believes SOE giants with high debt ratios and big losses are too big to fail,’ said Shi Lei, the head of fixed-income research at Ping An Securities… ‘The recent defaults have completely changed Chinese investors’ views on credit risks.’”

April 25 – Bloomberg (Anchalee Worrachate and Anooja Debnath): “While the headline numbers from China have pointed to an overall stabilization in the economy this year, and possibly even a pick up in the past couple of months, fresh provincial data shows a splintering growth path that complicates the policy outlook. Of the 29 of 31 provinces and municipalities to have published gross domestic product reports for the first quarter, 25 reported a slowdown from 2015’s full-year pace and 14 are undershooting their expansion targets. And the worst news may not even be out yet: Two rust belt provinces in the northeast -- Liaoning and Heilongjiang -- haven’t released their figures yet.”

ECB Watch:

April 27 – Bloomberg (Alessandro Speciale): “Mario Draghi hit back at German criticism of the European Central Bank’s policies, saying the attacks may undermine efforts to restore the inflation needed for higher interest rates. ‘People in Germany can rest assured that their ECB president is doing everything to restore inflation to the right level,’ he said… ‘Our policy is working, but we must be patient; investor confidence has not yet been fully restored.’ Simmering German discontent toward the ECB’s policies of low rates and bond purchases erupted this month when Finance Minister Wolfgang Schaeuble said Draghi was partly responsible for the rise of populist parties and was hurting retirement plans.”

April 29 – Bloomberg (Fergal O'Brien and Maria Tadeo): “Mario Draghi’s policy challenge was highlighted once again on Friday, with the fastest economic growth in a year overshadowed by a renewed drop in consumer prices. The euro-area inflation rate fell to minus 0.2% in April…”

Europe Watch:

April 27 – Reuters (Andreas Kroener and Matthias Inverardi): “The European Central Bank's ultra-low interest rates could worsen problems for already weak banks in Europe, German Chancellor Angela Merkel said…, calling for a tightening of monetary policy. The ECB unveiled a large stimulus package in March that included cutting its deposit rate deeper into negative territory and increasing asset buys, despite the objections of Germany, the largest economy in the euro zone. The ECB stimulus prompted a fresh wave of criticism from German politicians who fear the ultra-easy monetary policy is eroding both the savings of thrifty citizens and also bank margins, putting the banking system at risk. ‘The risks remain high. There are still too many weak banks in Europe and the low interest rates ... will tend to make this problem worse over the coming years,’ Merkel said…

April 28 – Bloomberg (Patrick Donahue): “Germany’s surging anti-immigration party isn’t just railing against asylum seekers. It’s also gunning for the European Central Bank, an alleged ‘master plan’ to eliminate cash and negative deposit rates that it says amount to financial ‘repression.’ To Alternative for Germany, a proposal by the German Finance Ministry to limit cash transactions to 5,000 euros ($5,670) and ECB considerations to phase out the 500-euro note are more than measures aimed at curtailing criminal activity. They’re a first step in banning paper money and robbing helpless account holders of their privacy, according to Joerg Meuthen, the party’s co-chairman. ‘This is a master plan on the road to eliminating cash in order to take complete control over financial transactions,’ Meuthen, a professor of economics at the University of Public Administration in Kehl, said… ‘Everything people spend will be completely under surveillance by the state.’”

April 27 – Bloomberg (Ian Wishart and Eleni Chrepa): “European Union President Donald Tusk rejected Greece’s request for a leaders’ meeting, saying euro-area finance ministers should convene in the next few days to resolve disagreements on the nation’s bailout program. ‘We have to avoid a situation of renewed uncertainty for Greece,’ Tusk… told reporters... I am convinced that there is still more work to be done by the ministers of finance.’ Prime Minister Alexis Tsipras sought the meeting to confirm that terms of the stalled bailout review conformed with the nation’s rescue program set out in July 2015…”

Japan Watch:

April 27 – Barron’s (William Pesek): “Moments before Tokyo trading opened yesterday, the Zero Hedge blog fired out a tweet that said it all: ‘Only 20 minutes until Japan pretends it has a market.’ It would be funnier if it weren’t so spot on in ways that raise troubling questions for the No. 3 economy. Since April 2013, the Bank of Japan has steadily morphed into a giant hedge fund. First, it cornered the bond market, buying up more than twice the debt the government issues each year. Now, it’s dominating stocks with gargantuan purchases of exchange-traded funds, according to estimates from Goldman Sachs and others. By some measures, the BOJ is a top-10 holder of almost all Nikkei 225 companies - a kind of stealth nationalization of Japan Inc.”

April 24 – Bloomberg (Yuji Nakamura, Anna Kitanaka and Nao Sano): “They may not realize it yet, but Japan Inc.’s executives are increasingly working for a shareholder unlike any other: the nation’s money-printing central bank. While the Bank of Japan’s name is nowhere to be found in regulatory filings on major stock investors, the monetary authority’s exchange-traded fund purchases have made it a top 10 shareholder in about 90% of the Nikkei 225 Stock Average… It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion.”

Leveraged Speculation Watch:

April 27 – CNBC (Jay Yarow): “Hedge funds are getting killed, says hedge fund manager Dan Loeb. Loeb's Third Point Capital put out its quarterly letter to investors on Tuesday, calling the first three months of 2016 "one of the most catastrophic periods of hedge fund performance that we can remember since the inception of this fund.’ Third Point was down 2.3 percent during the first quarter, which compares with a 1.3% gain for the S&P 500 over the same period. (As bad as that may be, though, it could have been worse — Bill Ackman's Pershing Square was down more than 25% in the quarter.)… ‘There is no doubt that we are in the first innings of a washout in hedge funds and certain strategies… We believe we are well-positioned to seize the opportunities borne out of this chaos and are pleased to have preserved capital through a period of vicious swings in treacherous markets.’”

April 27 – New York Times (Alexandra Stevenson and Matthew Goldstein): “The billionaire investor William A. Ackman has become the unofficial leader of a thundering herd that has lost billions of dollars betting on Valeant Pharmaceuticals over the past year... Mr. Ackman’s firm has lost billions of dollars on Valeant. Shares of the Canadian drug maker have plummeted 85% since he first pitched the company as one of his best investment ideas at a hedge fund charity event last year. Not coincidentally, big names like Paulson & Company, Viking Global Investors and Brahman Capital have also lost billions, collectively, by betting on Valeant — underscoring a growing phenomenon of hedge fund groupthink. It is a reflection of big-dollar investors chasing too few ideas and getting tripped up when things turn poorly for a company they have set big markers on.”

April 26 – Bloomberg (Sabrina Willmer and Nishant Kumar): “Investors in Brevan Howard Asset Management have asked to pull about $1.4 billion from the firm’s main hedge fund, according to two people with knowledge of the matter, as investors flee the industry at the fastest pace since the financial crisis.”

EM Bubble Watch:

April 26 – Bloomberg (Sabrina Willmer and Nishant Kumar): “The Malaysian government’s reputation took another hit on Tuesday after state-owned 1Malaysia Development Bhd. defaulted on a $1.75 billion bond. The ringgit fell and 1MDB’s dollar debt slumped… The missed payment triggered cross defaults on 7.4 billion ringgit ($1.9bn) of 1MDB debt, including borrowings that are guaranteed by the Malaysian government… The default is the latest episode in financial scandals that have rocked 1MDB…”

Brazil Watch:

April 29 – Barron’s (Johanna Bennett): “As if things weren’t bad enough in Brazil, unemployment has now hit double digits, and could keep rising through the rest of 2016. The country’s unemployment rate rose to 10.9% in the first quarter of 2016, up from 9% at the end of 2015 and 6.5% at end-2014, statistics agency IBGE said. And according to economists surveyed in a recent Reuters poll, the number of unemployed could keep rising and is unlikely to drop before 2018.”

Geopolitical Watch:

April 29 – Bloomberg: “Russia offered support for China’s opposition to U.S. actions in two of Asia’s biggest security flash points amid mounting tensions on the Korean Peninsula and in the South China Sea. Foreign ministers from China and Russia expressed ‘grave concern’ about the possible U.S. deployment of the Thaad anti-missile system in South Korea to defend against the growing North Korean nuclear threat. Russia also backed China’s stance that non-claimants like the U.S. shouldn’t ‘interfere’ in territorial disputes in the South China Sea.”

April 26 – CNBC (Matthew J. Belvedere): “Apple may find itself eventually shut out of China, a leading expert on global political risk to corporations said… ‘It's very possible,’ Ian Bremmer, founder and president of the Eurasia Group, told CNBC's ‘Squawk Box’… ‘I'd be very surprised in five years' time if we see Apple having the kind of access to the Chinese consumer that they presently enjoy,’ he said. Bremmer said he could foresee a scenario with Apple having ‘the kind of issues Facebook presently has in China.’ Facebook is banned there.’”

April 28 – Reuters (Jason Lee): “China's parliament passed a controversial law governing foreign non-government organizations, Xinhua state news agency said…, giving wide powers to the domestic security authority and prompting criticism from Amnesty International. The law is part of a raft of legislation, including China's counterterrorism law and a draft cyber security law, put forward amid a renewed crackdown on dissent by President Xi Jinping's administration. The law, which is set to come into effect on Jan. 1, 2017, grants broad powers to police to question NGO workers, monitor their finances, regulate their work and shut down offices.”

April 24 – Reuters (Matthew Miller): “China must be on guard against foreign infiltration through religion and stop ‘extremists’ spreading their ideology, President Xi Jinping told a top-level meeting on managing religion… China must also manage the Internet to promote the Communist Party's religious theories and policies, the official Xinhua news agency cited Xi as saying. ‘We must resolutely resist overseas infiltration through religious means and guard against ideological infringement by extremists…’ Communist party members must adhere to Marxist principles and remain ‘staunchly atheist’, Xi said…”