Saturday, June 11, 2016

Weekly Commentary: Historic Crazy

Friday was one of those market days that left an uncomfortable feeling in the pit of my stomach. U.S. markets have been resilient thus far, with the S&P500 teasing near record highs. But something is amiss globally. The STOXX Europe 600 Bank Index sank 3.7% Friday (4.8% for the week), to near two-month lows. Deutsche Bank ended the week down 7.7%, trading back close to multi-year lows (down 35% y-t-d). Italian bank stocks were hammered 5.0% Friday (5.9% for the week) to lows goings back to 2013. UniCredit was hit 6.4%. Spanish equities (IBEX) sank 3.5% this week to two-month lows (down 11% y-t-d), while Italian stocks (MIB) dropped 2.1% (down 20% y-t-d). The German DAX was down 2.7%, boosting 2016 losses to 8.5%. French stock lost 2.6% this week (down 7.1%).

German 10-year bund yields are at the brink of turning negative, ending the week at a record low 0.02%. Italian 10-year spreads (to bunds) widened 10 bps this week to a four-month high 136 bps. UK 10-year yields closed Friday at a record low 1.23%. Japanese yields ended the week at a record low negative 0.17%. Treasury yields closed Friday at a three-year low 1.64%.

June 10 - CNBC (Jacob Pramuk): "A new poll showing a majority of British people in favor of leaving the European Union hit foreign exchange and stock markets on Friday. The data in London newspaper The Independent showed that 55% believe Britain should leave the EU, versus 45% who favored staying. The publication said it marked the largest portion of respondents who favored exiting since research firm ORB began polling the issue for it last year."

The British pound dropped 1.39% Friday on polls showing Brexit with a widening lead. Currency markets remain unsettled. The pound dropped 1.8% this week, with the Swedish krona down 2.1%, the Norwegian krone 1.2% and the euro 1.0%. Meanwhile, the Brazilian real surged 3.1%.

Japan’s Topix Bank Index dropped 2.7% to almost one-month lows. Here at home, the Banks (BKX) fell 2.2% and the Broker/Dealers sank 3.6%. Notable financial sector declines included Bank of America/Merrill Lynch 4.1%, Citigroup 3.3% and Goldman Sachs 3.7%.

I can imagine the sense of excitement readers have to dive into the details of the latest Z.1 report. Watching paint dry and grass grow… Even for me, the Fed’s Q1 “flow of funds” data was for the most part uninspiring. At this point, Credit is growing adequately. “Money” is expanding briskly. The vulnerable corporate debt sector came to life during Q1. The banks are “dancing,” with bank Credit now in the strongest expansion since before the crisis. Importantly, securities market values are near all-time highs, with Household Net Worth inflating to record levels. Yet there’s a strong case to be made of latent fragilities – system vulnerability to a reversal in bond, stock and real estate prices.

Non-Financial Debt (NFD) expanded at a 4.8% rate during Q1 (to $45.68 TN), down from Q4’s (distorted) 8.8% but up from Q3’s 2.2%. Total Household debt growth slowed to 2.7% annualized, down from Q4’s 3.7%. Household mortgage debt was unchanged from Q4 at a 1.6% pace, while growth in Consumer Credit was unchanged at 6.1%. Corporate debt growth bounced back strongly during Q1. Corporate Credit growth had been slowing meaningfully, from 2015’s Q1’s 9.1% pace to Q2’s 8.7% to Q3’s 4.8% and then to 2.9% in Q4. The first quarter saw Corporate Credit growth surge to an 8.9% pace. State & Local borrowings accelerated marginally to 2.2%. After the government’s blistering 18.5% fourth quarter borrowing pace, federal debt growth slowed to 4.6% in Q1.

It’s often helpful to view the data in seasonally-adjusted and annualized rate (SAAR) terms. For Q1, Total Borrowings expanded SAAR $2.159 TN (surpassing my $2.0 TN bogey for Credit growth sufficient to sustain the U.S. “Bubble Economy”). For perspective, Total Borrowings expanded $1.990 TN in 2015, $1.836 TN in 2014, $1.566 TN in 2013, $1.910 TN in 2012, $1.297 TN in 2011, $1.569 TN in 2010, $1.226 TN in 2009, $1.908 TN in 2008, and $2.479 TN in 2007.

Breaking down SAAR debt growth for the quarter, Total Household Borrowings increased SAAR $379bn (mortgage $156bn and consumer $214 billion), Total Business SAAR $1.014 TN, State & Local SAAR $66 billion and Federal SAAR $700 billion. It’s worth noting that Business borrowings over the past year have been at the strongest pace since record 2007 debt growth.

Led by ongoing strong Treasury issuance, Total Debt Securities (the Fed’s accumulation) expanded $526 billion during the quarter to a record $40.218 TN. As a percentage of GDP, Debt Securities increased to 221%. Debt Securities began the eighties at 74% of GDP; the nineties at 126%; and the new Millennium at 162%. Total Equities declined marginally during the first quarter to $35.496 TN, or 195% of GDP. Equity Securities began the eighties at 44% of GDP; the nineties at 67%; and ended 1999 at 201%. Total Securities (Debt and Equities) ended Q1 at $76.618 TN, or 420% of GDP. Total Securities began the eighties at 117% of GDP; the nineties at 193%; and the new Millennium at 362%.

Buoyed by near-record securities market values, the bloated Household Balance Sheet remains a primary Bubble Economy variable. Household Assets increased another $855bn during Q1 to a record $102.6 TN. And with Liabilities up only $18 billion during the quarter, Household Net Worth (HNW) jumped $837 billion to a record $88.1 TN. HNW ended 2007 at $66.7 TN, and then fell below $49.0 TN in early 2009. HNW-to-GDP ended the first quarter at 483%, compared to 446% and 461% to end Bubble Years 1999 and 2007. Household holdings of Financial Assets increased $300 billion to a record $71.1 TN (390% of GDP). Inflating home prices saw Real Estate holdings jump almost $500 billion during the quarter to a record $25.8 TN. Household Net Worth has now inflated 81% from Q1 2009 lows.

It’s worth pondering the divergence between deflating stock prices and inflating bank assets. Q1 growth in “Private Depository Institutions” was off the charts. Net Acquisition of Financial Assets surged SAAR $1.766 TN, up from Q4’s $312 billion, Q3’s $179 billion, Q2’s $156 billion and Q1 2015’s $1.427 TN. Loan Assets jumped SAAR $903 billion, with commercial business loans surging to SAAR $446 billion. For comparison, Loans increased $676 billion in 2015, $579 billion in 2014, $261 billion in 2013, $272 billion in 2012 and $143 billion in 2011. Loans expanded a record $696 billion in 2007. Bank Assets have expanded $4.015 TN, or 29%, since the end of 2010 to $17.712 TN.

On the bank (“Private Depository Institutions”) Liability side, Deposits are expanding rapidly. Total Deposits expanded nominal $252 billion during the quarter, or 7.8% annualized. Deposits have inflated $3.589 TN, or 37%, in just over five years to $13.215 TN.

During the quarter, bank lending picked up the slack as other sectors slowed markedly. The GSE’s contracted SAAR $88 billion, reversing some of Q4’s strong expansion (SAAR $298bn). Agency MBS growth slowed to SAAR $125 billion, down from Q4’s SAAR $195 billion. The Asset-Backed Securities (ABS) market contracted SAAR $228 billion during the quarter, after contracting SAAR $86 billion during Q4. Finance Companies contracted SAAR $65 billion during Q1, after expanding SAAR $18bn in Q4.

Security Broker/Dealer balance sheets remain in a curious flux. After contracting a notable SAAR $839 billion during Q4, Net Acquisition of Financial Assets expanded SAAR $191 billion during the quarter. Holdings of Treasury Securities increased SAAR $105 billion during Q1, and Miscellaneous Assets surged SAAR $443 billion. Corporate & Foreign Bonds declined SAAR $102 billion, Corporate Equities contracted SAAR $124 billion and Security Repurchase Agreements declined SAAR $72 billion. On the Liability side, Loans increased SAAR $157 billion.

Funding Corps (“subsidiaries, custodial accounts for reinvested collateral of securities lending operations…) posted the strongest growth in many quarters. Net Acquisition of Financial Assets surged SAAR $478 billion, up from Q4’s $182 billion. On the Liability side, Securities Loans Net jumped SAAR $315 billion, following Q4’s SAAR $163 billion contraction, Q3’s SAAR $178 billion advance, Q2’s SAAR $209 billion contraction and Q1’s SAAR $139 billion increase. The data point to ongoing instability in securities lending and speculative finance more generally.

It’s my view that significant amounts of speculative finance continue to gravitate from the faltering global “periphery” to the perceived stable “core” U.S. securities and asset markets. Z.1 data have not necessarily supported this analysis in recent quarters. After two consecutive quarters of net liquidation, Rest of World (ROW) “Net Acquisition of Financial Assets” increased $667 billion during Q1. Holdings of U.S. Corporate Bonds increased SAAR $178 billion, after Q4’s SAAR $364 billion gain. ROW now holds $3.075 TN of U.S. corporate bonds, $6.285 TN of Treasuries, $5.564 TN of U.S. equities, $2.064 TN of short-term deposits/money funds/repos, and $3.659 TN of direct investment. After beginning the new Millennium at $5.621 TN, ROW holdings of U.S. assets have inflated to a staggering $23.104 TN.

June 10 – Financial Times (Mehreen Khan): “A small change in central bank interest rates risks triggering an abrupt reversal in global markets, in echoes of the last financial crisis, the head of the German Bundesbank has warned. In his latest warning on the unwanted side effects of persistently low interest rates, Jens Weidmann said investors and asset managers could become ‘increasingly nervous’ in a world stuck with near negative rates as it raised the possibility ‘of a sudden hike in risk premiums’. He said monetary policymakers’ attempts to issue forward guidance hinting that rates will stay lower for longer, and lengthy aggressive bond-buying, had ignored consequences for financial stability…”

Credit Bubbles survive only so long as ample new Credit is forthcoming. Asset Bubbles persevere only so long as new “money” flows readily into the asset class and prices continue to inflate. I have argued that the current Bubble is deeply systemic, impacting virtually all asset classes. Undoubtedly, however, the most spectacular Bubble excesses continue to unfold throughout global bonds and fixed-income. I can appreciate Bill Gross discussing a $10 TN “supernova” that’s going to explode catastrophically “one day”. I can also respect legendary speculator George Soros’ decision to return to active trading with a host of bearish views and bets he expects to pay off one day soon. Gross and Soros are examining the same world as we are and must be in similar utter disbelief at what has transpired. Things turn notoriously Crazy near the end. We have witnessed Historic Crazy.

For the Week:

The S&P500 slipped 0.1% (up 2.6% y-t-d), while the Dow added 0.3% (up 2.5%). The Utilities jumped 1.1% (up 15.7%). The Banks fell 2.2% (down 6.7%), and the Broker/Dealers sank 3.6% (down 10.7%). The Transports gained 0.4% (up 3.4%). The S&P 400 Midcaps were little changed (up 7.2%), and the small cap Russell 2000 was unchanged (up 2.5%). The Nasdaq100 fell 1.1% (down 2.9%), and the Morgan Stanley High Tech index declined 0.8% (down 0.6%). The Semiconductors lost 0.9% (up 5.4%). The Biotechs sank 3.9% (down 17.8%). With bullion surging $30, the HUI gold index jumped 1.9% (up 107.7%).

Three-month Treasury bill rates ended the week at 24 bps. Two-year government yields declined four bps to 0.73% (down 32bps y-t-d). Five-year T-note yields fell six bps to 1.17% (down 58bps). Ten-year Treasury yields dropped six bps to 1.64% (down 61bps). Long bond yields fell six bps to 2.45% (down 57bps).

Greek 10-year yields jumped 21 bps to 7.34% (up 2 bps y-t-d). Ten-year Portuguese yields declined seven bps to 3.07% (up 55bps). Italian 10-year yields rose five bps to 1.38% (down 21bps). Spain's 10-year yields fell four bps to 1.42% (down 35bps). German bund yields declined five bps to 0.02% (down 60bps). French yields slipped two bps to 0.39% (down 60bps). The French to German 10-year bond spread widened three to 37 bps. U.K. 10-year gilt yields dropped six bps to 1.23% (down 73bps).

Japan's Nikkei equities index slipped 0.2% (down 12.8% y-t-d). Japanese 10-year "JGB" yields dropped six bps to a record low negative 0.17% (down 43bps y-t-d). The German DAX equities index sank 2.7% (down 8.5%). Spain's IBEX 35 equities index fell 3.5% (down 11%). Italy's FTSE MIB index declined 2.1% (down 20.1%). EM equities were mixed to lower. Brazil's Bovespa index dropped 2.4% (up 14%). Mexico's Bolsa fell 1.5% (up 5.1%). South Korea's Kospi index jumped 1.6% (up 2.9%). India’s Sensex equities index declined 0.8% (up 2.0%). China’s Shanghai Exchange slipped 0.4% (down 17.3%). Turkey's Borsa Istanbul National 100 index was down 1.6% (up 7.2%). Russia's MICEX equities index added 0.9% (up 8.1%).

Junk funds saw inflows of $748 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell six bps to 3.60% (down 44bps y-o-y). Fifteen-year rates declined five bps to 2.87% (down 38bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down five bps to 3.71% (down 35bps).

Federal Reserve Credit last week added $1.1bn to $4.423 TN. Over the past year, Fed Credit dipped $5.6bn. Fed Credit inflated $1.612 TN, or 57%, over the past 187 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week expanded $11.6bn to $3.241 TN. "Custody holdings" were down $115bn y-o-y, or 3.4%.

M2 (narrow) "money" supply last week fell $11.0bn to $12.744 TN. "Narrow money" expanded $799bn, or 6.7%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits dropped $40.3bn, while Savings Deposits jumped $32.5bn. Small Time Deposits were little changed. Retail Money Funds dipped $4.0bn.

Total money market fund assets declined $8.0bn to $2.725 TN. Money Funds rose $115bn y-o-y (4.4%).

Total Commercial Paper dropped $14.1bn to a four-month low $1.052 TN. CP expanded $87bn y-o-y, or 9.0%.

Currency Watch:

June 6 – Wall Street Journal (Gregor Stuart Hunter): “A single U.S. jobs report was all it took to ruin summer for Asian central bankers. Policy makers in the region’s major economies have spent much of the year hoping their currencies would weaken against the dollar, which would help stoke exports. In recent weeks those hopes seemed on track, as expectations grew that the Federal Reserve would soon raise interest rates. China’s yuan and Japan’s yen both slid against the dollar in May, the yuan by the most since August and the yen by the most in a year and a half. But the hopes came crashing down Friday, when figures showing weaker-than-expected employment growth in the U.S. last month…”

The U.S. dollar index was up 0.8% this week to 94.66 (down 4.1% y-t-d). For the week on the upside, the Brazilian real increased 3.1%, the New Zealand dollar 1.4%, the Canadian dollar 1.2%, the Swiss franc 1.1% and the Australian dollar 0.1%. For the week on the downside, the Swedish krona declined 2.1%, the British pound 1.8%, the Norwegian krone 1.2%, the euro 1.0%, the South African rand 0.9%, the Japanese yen 0.4% and the Mexican peso 0.2%. The Chinese yuan declined 0.2% versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.9% (up 22.3% y-t-d). Spot Gold surged 2.4% to $1,274 (up 20%). Silver popped 5.5% to $17.33 (up 33%). WTI Crude gained 28 cents to $49.07 (up 33%). Gasoline dropped 3.1% (up 23%), while Natural Gas surged 6.7% (up 9%). Copper sank 4.2% (down 5%). Wheat slipped 0.5% (up 5%). Corn advanced 1.1% (up 18%).

Fixed-Income Bubble Watch:

June 5 – Bloomberg (Wes Goodman): “Global bond yields tumbled to a record after the U.S. reported a weaker-than-expected May jobs gain and as polls showed more Britons favor leaving the European Union. The yield on the Bloomberg Global Developed Sovereign Bond Index dropped to 0.62% at the end of last week, the least in data going back to 2010. Australian 10-year yields fell to an all-time low of 2.15%. Japan’s slid to minus 0.125%, approaching the record of minus 0.135%. Treasuries fell for the first time in five days Monday after yields declined the most in four months on Friday.”

June 8 – Bloomberg (Tracy Alloway): “‘Give me your tired, your poor/Your underperforming managers yearning for returns...’ The global dearth of yield was on full display this week by Toyota Motor Corp.'s sale of yen bonds with a coupon that boasted a decimal place preceded by multiple zeros — at 0.001 percent. Hans Mikkelson, Bank of America Corp. credit strategist, points out that the scarcity of yield in Japan and elsewhere has prompted a fresh wave of investors searching for returns on U.S. shores, where investment-grade bonds sold by companies with stronger balance sheets are now paying $180 billion worth of yields annually — or eight times the amount available in the equivalent euro market.”

June 9 – Bloomberg (John Gittelsohn): “Bill Gross, the manager of the $1.4 billion Janus Global Unconstrained Bond Fund, warned central bank policies that pushed trillions of dollars into bonds with negative interest rates will eventually backfire violently. ‘Global yields lowest in 500 years of recorded history,’ Gross, 72, wrote Thursday… ‘$10 trillion of neg. rate bonds. This is a supernova that will explode one day.’ A supernova is a star at the end of its life that suddenly increases greatly in brightness because of a catastrophic explosion that ejects most of its mass.”

June 8 – Bloomberg (Stefan Nicola): “Billionaire investor and Facebook Inc. board member Peter Thiel said government bond yields and negative interest rates are signs of an asset bubble that reflect the slowing of technological change… ‘If there is a bubble today, then it’s a bubble in government bonds, in negative interest rates -- that’s the real bubble,’ Thiel said. What’s needed is economic growth, in part because ‘politics only works when there’s growth,’ he said.”

Global Bubble Watch:

June 8 – Financial Times (James Shotter and Claire Jones): “Lenders in Europe and Japan are rebelling against their central banks' negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults. The move by Commerzbank to consider stashing cash in costly deposit boxes instead of keeping it with the European Central Bank came at the same time as Tokyo's biggest financial group warned it was poised to quit the 22-member club of primary dealers for Japanese sovereign debt. The ECB and the Bank of Japan have for months imposed negative rates for holding bank deposits in an attempt to push lenders to deploy their cash in the real economy through more aggressive lending to businesses. The policy in effect taxes banks for storing excess liquidity.”

June 8 – Wall Street Journal (Gregory Zuckerman): “After a long hiatus, George Soros has returned to trading, lured by opportunities to profit from what he sees as coming economic troubles. Worried about the outlook for the global economy and concerned that large market shifts may be at hand, the billionaire hedge-fund founder and philanthropist recently directed a series of big, bearish investments… Soros Fund Management LLC, which manages $30 billion for Mr. Soros and his family, sold stocks and bought gold and shares of gold miners, anticipating weakness in various markets.”

June 9 – CNBC (Fred Imbert): “We might be at the very end of this economic cycle, and the remarks by legendary investors Carl Icahn and George Soros signal it, said Jeff Rosenberg, BlackRock's chief investment strategist for fixed income. ‘I think the message there is that this is a very late part of current cycle. Nobody knows how far that cycle will go, but it's clear that you're seeing many signals,’ Rosenberg said… on CNBC's ‘Squawk on the Street.’ ‘You're seeing them in the fixed income markets, you're seeing it in the credit markets, you see it in profits, in the equity markets — that this is the later part in the economic cycle.’”

June 6 – Bloomberg (Luke Kawa): “The world's governments are stepping up to the plate to relieve monetary policymakers of some of the burden of supporting persistently slow-growth economies, according to HSBC Holdings PLC. Around the world, government spending is poised to grow by more in 2016 than any year since 2009, when fiscal authorities embarked upon a coordinated plan of boosting expenditures to deal with the damage wrought by the financial crisis.”

Federal Reserve Watch:

June 7 – Wall Street Journal (Kate Davidson and Jon Hilsenrath): “Federal Reserve Chairwoman Janet Yellen affirmed… that the central bank won’t be raising short-term interest rates until new uncertainties about the economic outlook are resolved. Her comments, delivered at the World Affairs Council of Philadelphia, echoed conclusions investors drew Friday after the release of disappointing job market data. Ms. Yellen and other officials still believe they will be gradually lifting rates because they expect the economy to improve. However, a rate increase at the Fed’s policy meeting next week is now effectively off the table. An increase in July is possible but has become less likely, and a September move is possible if economic data show the economy is rebounding by then.”

June 7 – CNBC (Jeff Cox): “If Fed policy was a fairy tale, the title might be ‘The Central Bank That Cried Wolf.’ Investors have watched in bemusement as Fed officials throughout the past several years have warned that policy would change, only to back down at the slightest sign of turbulence. It now appears the market is no longer taking the Fed's threats seriously. In a speech Monday, Fed Chair Janet Yellen gave only modest signals that she was reconsidering policy, which just a few months ago was geared for as many as four interest rate increases this year. Nevertheless, a market bracing for a high likelihood of a summer hike now is considering that ‘we may well not see one,’ said David Rosenberg, chief economist and strategist at… Gluskin Sheff.”

U.S. Bubble Watch:

June 9 – Bloomberg (Elizabeth Campbell): “Illinois had its bond ratings dropped to levels not seen for a U.S. state in over a decade because of a protracted political deadlock that’s left it veering toward its second straight year without a budget. Moody’s… cut its grade on about $28.8 billion of general-obligation and sales-tax debt by one level to Baa2, its lowest for a state since Massachusetts in 1992… Moody’s and S&P have negative outlooks on Illinois, signaling more downgrades may follow if the standoff between Governor Bruce Rauner and the legislature isn’t resolved.”

June 9 – CNBC (Diana Olick): “Mortgage rates may be hovering near record lows, but it's not enough to counter the sky-high, and still rising, prices in many of the nation's largest housing markets. Big-city rents have been soaring, but now the outlying areas where residents flee to find affordability are seeing even bigger rent gains, too. For homebuyers, the picture is not much better. A very tight supply of homes for sale is pushing home values higher and pricing potential buyers out, both first-time and move-up buyers. Big cities have always been expensive, but in a troubling new twist — suburban areas are becoming unaffordable faster than their urban neighbors, according to… Trulia.”

June 5 – Wall Street Journal (Josh Mitchell): “The U.S. government over the last 15 years made a trillion-dollar investment to improve the nation’s workforce, productivity and economy. A big portion of that investment has now turned toxic, with echoes of the housing crisis. The investment was in ‘human capital,’ or, more specifically, higher education. The government helped finance tens of millions of tuitions as enrollment in U.S. colleges and graduate schools soared 24% from 2002 to 2012, rivaling the higher-education boom of the 1970s… The government financed a large share of these educations through grants, low-interest loans and loan guarantees. Total outstanding student debt—almost all guaranteed or made directly by the federal government—has quadrupled since 2000 to $1.2 trillion today. The government also spent tens of billions of dollars in grants and tax credits for students.”

China Bubble Watch:

June 6 – Bloomberg: “The two rating companies that cut China’s debt outlook in March say efforts to bring transparency to regional finances haven’t eradicated risky fundraising methods. Direct sales of local government bonds have surged to a record 2 trillion yuan ($304bn) since March 31, up from 906 billion yuan in the first quarter, fueled by a program to swap expensive debt for cheaper municipal securities. Moody’s… and S&P Global Ratings say that while municipal notes are a more transparent way of raising money than the previous practice of using private financing vehicles, the concern is that authorities are still resorting to off-balance-sheet funding methods… ‘Our negative outlook on the Chinese sovereign ratings reflect both slow economic rebalancing and growing financial risks,’ said Kim Eng Tan, …senior director of sovereign ratings at S&P Global Ratings. Non-government debt is still growing relatively quickly and ‘off-balance-sheet financing increases uncertainties in the financial system that could worsen the impact of any potential economic or financial shock on China,’ he said.”

June 5 – Bloomberg (Tracy Alloway): “Count total social financing (TSF) as another Chinese statistic of increasingly dubious value, according to analysts at Goldman Sachs… With many investors grappling to understand the degree to which China's economic growth has been fueled by debt, efforts to get a grip on measures of new credit creation have gained fresh urgency. To date, many have relied on the TSF invented by the Chinese authorities in 2011 as a way of capturing a larger slice of the country's shadow banking activity, but Goldman analysts led by M.K. Tang cast fresh doubt… on the measure's ability to gauge credit creation… Of particular issue is the rise in opaque loans given noises surrounding China's circular financing schemes, which involve banks lending to nonbank financial institutions (NBFIs) as opposed to directly to companies… Faced with an increasingly tangled system of financing and a money supply measure that doesn't fully encapsulate new credit creation, the Goldman analysts opt to take a slightly different approach to gauge the strength of China's recent credit boom. They look at the (adjusted) flow of money emanating from households and companies and going into various financial investments. On that basis, China's credit creation came in at 24.6 trillion yuan ($3.7 trillion) last year—far outstripping the 16 trillion yuan increase in money supply and the 19 trillion yuan of TSF.”

June 7 – Bloomberg: “China’s foreign-exchange reserves slipped to the lowest level since late 2011 as a rallying dollar ate into the value of its holdings. The world’s largest currency hoard fell by $28 billion to $3.19 trillion in May, the People’s Bank of China said in a statement Tuesday. That was almost in line with the $3.2 trillion median forecast of economists surveyed by Bloomberg.”

June 7 – Wall Street Journal (Shen Hong and Mia Lamar): “China’s vast corporate bond market may be opening up to foreign investors as never before. But many are worried companies that issue debt here remain too much of a closed book. When Evergreen Holding Group Co., a shipbuilder from eastern China, defaulted on a 400 million yuan ($60.9 million) 1-year bond last month it wasn’t just the chance of losing money that angered its bondholders, but also the company’s failure to tell them about some major problems beforehand. Evergreen had already failed to repay a 49.4 million yuan ($7.52 million) bank loan in December, a fact the company didn’t disclose for more than three months…. The problems at Evergreen point to broader concerns among bondholders in China about how much they are being told about companies in which they invest… ‘Because of poor information disclosure, land mines are everywhere in the corporate bond market. You never know when you’d step on one,’ said Peter Zhao, chief executive of Eagle Investments (Shanghai)… The drama is also playing out as Beijing is giving foreign investors unprecedented access to its $8.5 trillion bond market… Already this year, there has been $1.6 trillion of new bond issuance in China…”

June 7 – Reuters (John Ruwitch, Laura Lin and Lu Jianxin): “China's central bank slashed its forecast for exports on Wednesday, predicting a second straight annual fall in shipments, but said the economy will still grow 6.8 percent this year. The People's Bank of China (PBOC) also warned in its mid-year work report that the government's push to reduce debt levels and overcapacity could increase bond default risks and make it more difficult for companies to raise funds… It upgraded its forecast for fixed-asset investment growth to 11%, an increase of 0.2 percentage points from estimates it made late last year. A government spending spree on major infrastructure projects and a continuing recovery in the housing market have boosted demand for materials from cement to steel…”

June 7 – Bloomberg (Enda Curran and Justina Lee): “As China’s stock market boomed in early 2015, financial services provided a fillip to an ailing economy. What a difference a year makes: share trading is down more than 80% and the number of companies selling stock for the first time has plunged 65%. The fading impact on growth from the nation’s financial sector is adding to a list of economic headaches that includes weak demand for exports and a glut of spare capacity in the steel and coal industries.”

June 7 – Bloomberg: “Curbing excesses in corporate credit can harm economic growth for two or three years, according to Ma Jun, chief economist of the People’s Bank of China’s research bureau. While corporate deleveraging is a long process requiring seven years or longer, it can hurt growth in the early stages of addressing the issues, Ma said in a working paper… ‘In any country, the intensity of efforts to cut credit determines its spillovers to the economy,’ said Ma… The short-term impact can be effectively controlled if accompanied by reforms such as orderly closures of unprofitable zombie companies and better equity financing, he said.”

June 7 – Bloomberg: “China’s exports stabilized in May, with a weakening currency giving some support to growth in the world’s biggest trading nation, while imports signaled improvement in domestic demand. Overseas shipments fell 4.1% in dollar terms from a year earlier… Imports slipped 0.4% -- the smallest drop since late 2014 -- to leave a trade surplus of $50 billion. Reflecting a weaker yuan, both exports and imports fared better when measured in local currency terms. Stocks pared losses in Shanghai.”

June 7 – Reuters (Samuel Shen and Elias Glenn): “Chasing the promise of outsized returns, 48-year-old businessman He Xiaolun started trading oil last August on a platform developed by the Shaanxi Non-ferrous Metal Exchange. Over the next five months, he lost nearly 3 million yuan ($455,000). ‘Initially, I lost several thousand yuan,’ He said. ‘The exchange's trading advisor told me to put in more money, and guided me into trading more frequently.’ …He and other investors say they were duped by online commodity trading platforms that have cropped up over the last few years in China. Some have been using internet dating sites to lure customers. The country's securities regulator has said trading on such plarforms is highly speculative and therefore risky… The China Securities Regulatory Commission (CSRC) also warned the ‘large number of complaints and disputes’ against such exchanges were a threat to ‘social harmony and stability’. Outrage among China's growing class of retail investors over the disappearance of their life savings has become a big headache for the stability-obsessed Communist Party after a series of financial scandals in recent years.”

Japan Watch:

June 9 – Wall Street Journal (Atsuko Fukase): “Japan’s biggest bank delivered a fresh message of frustration over negative interest rates to the Bank of Japan, confirming… that it might stop acting as a primary dealer of Japanese government bonds. Bank of Tokyo-Mitsubishi UFJ… would become the first Japanese bank to relinquish that role in the JGB market. The possible action, which the bank has been discussing with the Ministry of Finance, underscores Japanese lenders’ rising tensions with the central bank over negative rates. Banks say negative rates haven’t created more demand for loans but have hit their stock prices and threaten to cut their profits.”

Central Bank Watch:

June 9 – Bloomberg (Jiyeun Lee and Cynthia Kim): “South Korea’s central bank unexpectedly cut the benchmark interest rate to a new record low Thursday, citing growing risks to the economy including slowing global trade and the government’s push to restructure indebted companies. The decision to cut the seven-day repurchase rate to 1.25%, which was unanimous, was projected by only one of 18 economists surveyed…”

ECB Watch:

June 7 – Bloomberg: “The European Central Bank is about to break its own record for total assets on the balance sheet after 20 months of buying bonds in a bid to revive the region’s economy. When the purchase program began in October 2014, its aim was to steer total assets back toward the previous peak level of 3.1 trillion euros ($3.46 trillion) reached at the height of Europe’s debt crisis in 2012. The ECB is set to start buying corporate bonds on Wednesday.”

June 7 – Bloomberg (Katie Linsell, Alastair Marsh and Sally Bakewell): “The European Central Bank entered new territory in its efforts to stimulate the euro region’s flagging economy, plunging into the corporate bond market on Wednesday and buying the debt of some of the continent’s biggest companies… ‘Draghi knows the ECB needed to come out with a big punch on the first day of its corporate purchase program to maintain credibility and confidence in his willingness to act,’ said Regina Borromeo, a London-based money manager at Brandywine Global Investment Management…”

June 9 – Bloomberg (Tracy Alloway): “The European Central Bank's ‘shock and awe’ corporate bond buying has failed to impress one corner of the credit market. Bank of America Corp. analysts led by Ioannis Angelakis point out that while the corporate-sector purchase program (CSPP) has suppressed risk premiums in the market for cash debt, it's done little to tighten spreads in the synthetic market composed of credit default swap (CDS) indexes… ‘CDS indices are macro risk indicators that we believe reflect broader risk trends. We think that the risks for the future trend for the synthetics market is more attached to broader risk appetite than solely the ECB corporate-quantitative easing program,’ the analysts write.”

Europe Watch:

June 7 – Bloomberg (Adam Haigh and Anuchit Nguyen): “Brexit is back, and investors from Australia to Thailand are ducking for cover. The pound fell and currency volatility surged on Monday after two polls showed more Britons favor a vote to leave the European Union at a June 23 referendum than those who want to stay… ‘I don’t want to sound scary, but the market isn’t prepared for this,’ said Nader Naeimi at AMP Capital Investors Ltd. in Sydney… He’s been buying futures contracts on European and U.S. equity volatility, even as he forecasts voters will choose to stay in the EU. ‘It makes sense to buy some protection. Fear, worry and volatility are likely to intensify as we get closer.’”

June 7 – New York Times (Steven Erlanger): “As Britain prepares to vote on June 23 on whether to remain in the European Union, skepticism about the bloc is on the rise across Europe, with about two-thirds of Britons wanting some powers returned to their national government, according to an opinion poll… by the Pew Research Center… The survey of respondents in 10 European countries showed increasing dissatisfaction with the European Union since last year, a period of low growth and during a migrant crisis, particularly in France and Spain. In France, 38% of respondents viewed the European Union favorably and 61% viewed it unfavorably. In Greece, 27% viewed it favorably and 71% unfavorably.”

June 6 – Reuters (Crispian Balmer and Gavin Jones): “Italy's anti-establishment 5-Star Movement looked likely to take charge of Rome after country-wide municipal elections at the weekend, piling pressure on Prime Minister Matteo Renzi ahead of a vital constitutional referendum due in October. With the Rome count almost complete, 5-Star candidate Virginia Raggi, a 37-year-old lawyer running her first campaign, led with just over a third of the vote, ahead of the candidate from Renzi's center-left Democratic Party (PD) with a quarter. The race will be decided by a run-off vote on June 19.”

Geopolitical Watch:

June 4 – Reuters (David Brunnstrom and Greg Torode): “The United States stepped up pressure on China on Saturday to rein in its actions in the South China Sea, with top defense officials underlining Washington's military superiority and vowing to remain the main guarantor of Asian security for decades to come. Defense Secretary Ash Carter said the U.S. approach to the Asia-Pacific remained ‘one of commitment, strength and inclusion’, but he also warned China against provocative behavior in the South China Sea. Any action by China to reclaim land in the Scarborough Shoal, an outcrop in the disputed sea, would have consequences, Carter said.”

June 5 – CNN (Tim Hume): “A senior Chinese admiral strongly defended his country's activities in the South China Sea Sunday, restating Beijing's sovereignty in the region and warning it ‘had no fear of trouble.’ Admiral Sun Jianguo, deputy chief of general staff of the Chinese People's Liberation Army, addressed the tensions… Sun said that the issue had ‘become overheated because of provocations of certain countries for their own selfish interests.’ He also reiterated that Beijing would not recognize a pending decision of an international tribunal in The Hague in a case brought by the Philippines contesting China's claim to some territory in the region. ‘We do not make trouble, but we have no fear of trouble,’ he said. ‘China will not bear the consequences, nor will it allow any infringement upon its sovereignty and security interests or stay indifferent to the irresponsible behavior of some countries in and around the South China Sea.’”

June 4 – Reuters (Yeganeh Torbati): “U.S. Secretary of State John Kerry said… the United States would consider any Chinese establishment of an air defense zone over the South China Sea to be a ‘provocative and destabilizing act’. U.S. officials have expressed concern that an international court ruling expected in coming weeks on a case brought by the Philippines against China over its South China Sea claims could prompt Beijing to declare an air defense identification zone, or ADIZ, as it did over the East China Sea in 2013.”

June 6 – New York Times (Chris Buckley and Jane Perlez): “The Chinese finance minister jabbed back on Monday at complaints from his American counterpart that China’s glut of factories making mountains of steel, aluminum and other products was overwhelming foreign markets and makers. The finance minister, Lou Jiwei, suggested that foreign officials should curb their complaints about industrial production surpluses because their governments had cheered on China’s investment spree during the global financial crisis that began in 2008. That spree helped create the production gluts now worrying policy makers in Beijing and, increasingly, around the world. ‘At that time, the whole world applauded and thanked China,’ Mr. Lou told a news briefing… ‘Now they’re saying that China has a production glut that is a drag upon the world. But what did they say at the time?’”

June 9 – Reuters (Tetsushi Kajimoto, Nobuhiro Kubo and Ben Blanchard): “Japan summoned the Chinese ambassador early on Thursday to express concern after a Chinese navy ship sailed close to what Japan considers its territorial waters in the East China Sea for the first time, increasing tensions over the disputed area.”

June 6 – Reuters (J.R. We): “Taiwan's new defense minister said… the island would not recognize any air defense zone declared by China over the South China Sea, as the island's top security agency warned such a move could usher in a wave of regional tension. U.S. officials have expressed concern that an international court ruling expected in coming weeks on a case brought by the Philippines against China over its South China Sea claims could prompt Beijing to declare an air defense identification zone, or ADIZ, as it did over the East China Sea in 2013.”

June 7 – Reuters (Anton Zverev): “Russia is building an army base near its border with Ukraine, the latest in a chain of new military sites along what the Kremlin sees as its frontline in a growing confrontation with NATO. While there have been no clashes between the former Cold War rivals, Russia is building up forces on its western frontiers at a time when the NATO alliance is staging major military exercises and increasing deployments on its eastern flank.”