Saturday, June 18, 2016

Weekly Commentary: Reminiscing about 2012

Credit booms are powerfully reinforcing. New Credit provides additional purchasing power that spurs spending, economic output, corporate earnings/cash-flow and income growth. Monetary expansions, as well, fuel inflating asset prices, most notably in securities and real estate. In both the Financial Sphere and the Real Economy Sphere, Credit expansion and its myriad inflationary effects beget more self-reinforcing Credit.

Importantly, the upside of a Credit Cycle feeds off the commanding forces of cooperation and integration. The economic pie is expanding, and it becomes easily-recognized that working together offers more than zero-sum outcomes. In prolonged booms, a “virtuous cycle” appears almost a certain, natural outcome.

Yet the inevitable Credit cycle downturn ensures a vicious sequel. The bursting of the Bubble sees so many rewarding boom-time endeavors turn infeasible, unprofitable or unworkable. Hopes are dashed and dreams are crushed. Confidence, flowing over-abundantly throughout the boom, is suddenly in such short supply; faith wanes in policymaking, the markets, finance and in institutions more generally. Meanwhile, the unfolding bust illuminates the inequities and nonsense from the Bubble-period. Powerful forces then shift to tearing at the fabric of cooperation, integration and good faith that were so crucial throughout the boom period. Yesterday’s partner is today’s competitor.

Nowhere did this historic global Credit Bubble have greater integrative influence than in Europe. The euphoria of the victory of democracy and free-market Capitalism, along with technological advancement, financial innovation and developments in contemporary monetary management, emboldened Europe’s leaders to take the fateful plunge toward unprecedented integration, including a common currency.

To appreciate the complexities of the current market, economic and geopolitical backdrop, it’s helpful to return back to that fateful summer of 2012. European integration was under existential threat, though the seriousness of the situation was appreciated by few. A potentially momentous crisis of confidence had gathered powerful momentum. Fear of a European periphery debt crisis was being transmitted to a more general questioning of the solvency of the European banking system. And with Europe’s banks major operators in derivatives and throughout EM, European travails had begun reverberating throughout global markets.

Markets were increasingly questioning the viability of the euro currency – and such concerns invariably raised doubts as to the stability of global finance and, accordingly, economic prospects around the globe. As I chronicled the seriousness of developments back in 2012 (in the face of the media and pundits that generally downplayed associated risks), my analysis appeared extremist and misguided. It was only later that inside accounts (notably from the Financial Times) confirmed the extent to which European policymakers had worked to avert acute financial and economic crisis.

Bond manager Jeffrey Gundlach made headlines this week with his comment that “central banks are losing control.” I would suggest that central bankers actually lost control back in 2012. Mario Draghi’s “whatever it takes” pledge was the cornerstone of desperate measures to save the euro. Yet “whatever it takes” actually amounted to concerted central bank intervention to shield global markets and economies from the intensifying forces of the downside of a historic Credit Cycle. The global Credit boom persevered for a few more years, right along with epic market distortions and economic maladjustment. Downside risks have grown significantly.

European bank stocks (European Stoxx 600) this week traded to the lowest level going back to those dark days of 2012. It’s worth noting that European Banks rallied 90% from summer 2012 lows to July 2015 highs. During this period, Italy’s FTSE Italia All-Share Banks Sector Index surged from 6,000 to a high of 15,557. “Whatever it takes” fueled an almost doubling of Italian and Spanish equities indices. Germany’s DAX index traded at 6,000 in the summer of 2012, then more than doubled to 12,374 by April 2015.

“Whatever it takes” stock gains may have been spectacular, yet they have been overshadowed by the phenomenal collapse in European bond yields. Excerpted from my July 26, 2012 CBB: “Spain's 10-year yields jumped 62 bps to 6.91% (up 187bps y-t-d). Italian 10-yr yields rose 20 bps to 6.01% (down 102bps). Ten-year Portuguese yields rose 8 bps to 10.01% (down 277bps). The new Greek 10-year note yield declined 19 bps to 25.19%.”

“Whatever it takes” became a global phenomenon, both from the standpoint of central bank policies and securities market inflation. Replicating Draghi, BOJ head Haruhiko Kuroda unleashed shock and awe monetization and currency devaluation. The dollar/yen was trading at 78 in the summer of 2012, before extraordinary BOJ stimulus worked to devalue the yen to 124 (to the dollar) by mid-2015. After trading below 8,500 in the summer of 2012, Japan’s Nikkei surged to above 20,700 by August 2015. Japan’s TOPIX Bank Stock Index rallied from 100 in the summer of 2012 to 246 by June 2015. And while the S&P 500 rose 66% from summer 2012 lows to record highs, it’s worth noting that the U.S. broker/dealers (XBD) surged from 80 to 203.

It’s no coincidence that European and Japanese equities have led the developed world on the downside over the past year. There’s no mystery surrounding the poor performance of global financial stocks. Bullion’s almost 2% rise this week boosted 2016 gains to 22%. The yen has gained about 14% against the dollar so far this year. Ten-year bund yields traded with negative yields for the first time this week. U.S. 10-year Treasury yields fell to the lowest level since 2012.

Despite shoring up reflationary efforts earlier in the year, extraordinary ECB and BOJ monetary stimulus has not been successful. Underlying economic and inflation trends remain problematic in the face of major securities markets inflations. Indeed, the wide divergence between securities market prices and economic prospects ensures acute vulnerability to market risk aversion and risk-off speculative dynamics.

Despite Friday’s 4.1% surge, European bank stocks declined another 1.4% this week (down 25% y-t-d). Friday’s 6.7% rally (reminiscent of U.S. financial stocks in 2008) still left Italian banks down 1.9% for the week - increasing 2016 losses to 44%. In Asian trading, Japan’s TOPIX Bank Stock Price Index sank 5.1% (down 34.3% y-t-d), trading almost back to April lows. Hong Kong’s Hang Seng Financial Index dropped 2.9% (down 15.1%).

Italian sovereign spreads (to bunds) ended the week 13 bps wider to a one-year high 149 bps. Italian spreads have now widened 28 bps in three weeks. Spain’s 10-year bond spread also widened 13 bps this week to a more than one-year high 153 bps. Portugal’s 10-year bond spreads surged 22 bps this week to an 18-week high 327 bps. Greek yields surged 60 bps.  Credit spreads widened significantly throughout Europe this week, sometimes spectacularly.

The murder of a pro-“Remain” UK politician further clouds analysis of next Thursday’s referendum. Recent polling had Brexit in a narrow but widening lead. Yet London’s bookies place odds slightly in favor of Remain. Recall that polls had the Scots favoring independence a week prior to their referendum, although the actual vote broke strongly against independence. The Scottish experience has likely influenced Brexit betting.

Markets have grown comfortable that electorates will bitch and moan but will, at the end of the day, side with the best interest of the financial markets. At some point, I would expect increasingly disillusioned voters to disregard much of the fear mongering. The interests of voters and markets might very well part ways.

The Brexit vote is a serious potential “risk off” catalyst. Significant amounts of currency and risk market hedging have transpired. This portends a period of unstable markets. If Brexits wins, derivative-related exposures could foment illiquidity and market dislocation, as traders are forced to dynamically hedge their derivative books into unsettled markets. Victory for Remain would entail the abrupt unwind of hedges across various markets. At least in the very short-run, this would equate to yet another destabilizing short-squeeze.

Still, a vote to Remain would do little more than remove a near-term catalyst. European leaders are understandably nervous that a successful Brexit campaign would embolden independent and anti-Europe movements throughout the continent. Yet few believe a Remain vote will diminish animosities and hostility toward integration and European leadership.

Back in 2012, Mario Draghi recognized how even the notion that a country might exit the euro could unleash market dynamics that would rather quickly place Europe’s markets and banking system in peril. “Whatever it takes” was orchestrated specifically to expel any market doubt with regard to the viability and sustainability of European monetary integration. On the back of a wall of liquidity and attendant inflating securities markets, Draghi’s gambit held things together for a few years. That said, the ECB bet the ranch – and was compelled to further ante up in response to market instability earlier this year. The outcome of the game is very much in doubt.

While Britain is not even a member of the euro, Brexit provides a test of ECB policymaking. Is Europe robust or fragile? Has relative financial stability been nothing more than a brittle ECB-fabricated fa├žade? Are the forces mounted against integration and cooperation now too powerful to disregard? Is European integration – along with the euro currency - viable long-term? It’s an untimely test, with confidence in Europe’s banks already waning. This test is furthermore untimely because of faltering confidence in the ECB and contemporary global central banking more generally. Global market instability has again resurfaced and there will be no resolution next week.

June 17 – Financial Times (Sam Fleming): “Close watchers of the Federal Reserve were bemused this week after an unidentified policymaker forecast just a single increase in official interest rates over the coming years. On Friday James Bullard, the president of the St Louis Federal Reserve, revealed that he was the rate-setter behind that unexpectedly low dot on the Fed’s ‘dot plot’ of rate forecasts, as he executes a big shift in his views of the economy that puts him at odds with other rate-setters who see a gradual series of increases. The former hawk said in a statement that he expects rates will remain unchanged in 2017 and 2018 following a single rate rise, in a leap towards an ultra-dovish outlook.”

The FOMC has confounded Fed watchers with its abrupt pivot back to ultra-dovishness. There shouldn’t be much confusion. Global market fragility has reemerged, and the Fed’s rapid retreat has confirmed the seriousness of what’s unfolding. Central banks have thrown everything at the problem, yet markets remain as vulnerable as ever. At least the world was not facing the downside of China’s historic Credit Bubble back in 2012.

The Fed has never admitted that global concerns have been dictating U.S. monetary policy since 2012. It has now become clear, throwing the analysis of policymaking into disarray. The harsh reality is also increasingly apparent: global monetary management is dysfunctional and central bankers have become perplexed - and without a backup plan. Such an uncertain backdrop is pro-currency market instability and pro-de-risking/deleveraging.

In a replay of 2012, U.S. markets have remained resilient in the face of rapidly escalating European and global risks. Our markets back then ended up being positioned well for “whatever it takes.” They’re again well positioned, it's just that whatever it takes is proving not to be enough.

For the Week:

The S&P500 declined 1.2% (up 1.3% y-t-d), and the Dow fell 1.1% (up 1.4%). The Utilities added 0.8% (up 16.6%). The Banks sank 3.2% (down 9.6%), and the Broker/Dealers lost 2.0% (down 12.5%). The Transports dropped 2.3% (up 1.1%). The S&P 400 Midcaps declined 1.3% (up 5.8%), and the small cap Russell 2000 fell 1.7% (up 0.8%). The Nasdaq100 dropped 1.9% (down 4.8%), and the Morgan Stanley High Tech index slipped 0.5% (down 1.1%). The Semiconductors declined 1.4% (up 3.9%). The Biotechs sank 4.0% (down 21.1%). Bullion jumped $24, though the HUI gold index declined 1.6% (up 104%).

Three-month Treasury bill rates ended the week at 25 bps. Two-year government yields fell four bps to 0.69% (down 36bps y-t-d). Five-year T-note yields dropped six bps to 1.11% (down 64bps). Ten-year Treasury yields slipped three bps to 1.61% (down 64bps). Long bond yields declined three bps to 2.42% (down 60bps).

Greek 10-year yields surged 60 bps to 7.94% (up 62bps y-t-d). Ten-year Portuguese yields jumped 22 bps to 3.29% (up 77bps). Italian 10-year yields rose 13 bps to 1.51% (down 8bps). Spain's 10-year yields gained 13 bps to 1.55% (down 22bps). German bund yields were unchanged at 0.02% (down 60bps). French yields rose three bps to 0.42% (down 57bps). The French to German 10-year bond spread widened three to 40 bps. U.K. 10-year gilt yields dropped nine bps to 1.14% (down 82bps).

Japan's Nikkei equities index sank 6.0% (down 18% y-t-d). Japanese 10-year "JGB" yields recovered a basis point to negative 0.16% (down 42bps y-t-d). The German DAX equities index fell 2.1% (down 10.3%). Spain's IBEX 35 equities index dropped 1.5% (down 12.4%). Italy's FTSE MIB index declined 1.1% (down 21%). EM equities were mixed to lower. Brazil's Bovespa index increased 0.2% (up 14.3%). Mexico's Bolsa added 0.3% (up 5.4%). South Korea's Kospi index sank 3.2% (down 0.4%). India’s Sensex equities index was unchanged (up 1.9%). China’s Shanghai Exchange declined 1.4% (down 18.5%). Turkey's Borsa Istanbul National 100 index fell 1.9% (up 5.2%). Russia's MICEX equities index declined 1.4% (up 6.6%).

Junk funds saw outflows of a chunky $1.8 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell six bps to 3.54% (down 46bps y-o-y). Fifteen-year rates declined six bps to 2.74% (down 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down eight bps to 3.67% (down 39bps).

Federal Reserve Credit last week expanded $8.7bn to $4.432 TN. Over the past year, Fed Credit contracted $20bn. Fed Credit inflated $1.621 TN, or 58%, over the past 188 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week declined $3.1bn to $3.238 TN. "Custody holdings" were down $127bn y-o-y, or 3.8%.

M2 (narrow) "money" supply last week jumped $12.7bn to $12.757 TN. "Narrow money" expanded $821bn, or 6.9%, over the past year. For the week, Currency increased $2.0bn. Total Checkable Deposits fell $19bn, while Savings Deposits jumped $33.6bn. Small Time Deposits slipped $1.1bn. Retail Money Funds declined $2.9bn.

Total money market fund assets dropped $18.6bn to a two-month low $2.707 TN. Money Funds rose $108bn y-o-y (4.2%).

Total Commercial Paper declined $8.7bn to a six-month low $1.044 TN. CP expanded $69bn y-o-y, or 7.1%.

Currency Watch:

The U.S. dollar index declined 0.5% this week to 94.15 (down 4.6% y-t-d). For the week on the upside, the Japanese yen increased 2.6%, the British pound 0.7%, the Swiss franc 0.5%, the South African rand 0.5%, the Australia dollar 0.2%, the euro 0.2% and the Brazilian real 0.1%. For the week on the downside, the Mexican peso declined 1.1%, the Norwegian krone 1.1%, the Canadian dollar 0.9%, the Swedish krona 0.3% and the New Zealand dollar 0.1%. The Chinese yuan declined 0.4% versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index declined 1.2% (up 20.9% y-t-d). Spot Gold rose 1.9% to $1,299 (up 22%). Silver added 0.5% to $17.41 (up 26%). WTI Crude fell $1.09 to $47.98 (up 30%). Gasoline dropped 3.5% (up 18%), while Natural Gas gained 2.3% (up 12%). Copper recovered 1.0% (down 4%). Wheat fell 2.8% (up 2%). Corn jumped 3.5% (up 22%).

Brexit Watch:

June 17 – Nikkei Asia Review: “Central banks in Japan, the U.S. and Europe are discussing an emergency supply of dollars to financial markets, seeking to ensure continued access to the currency even if the pound plunges in the event that the U.K. votes to exit the European Union. The Bank of England provided 2.46 billion pounds ($3.46bn) to banks Tuesday, while the European Central Bank will on Wednesday begin a new round of open market operations to supply euros. But the risk remains that European financial institutions with dollar-denominated debt will have a tougher time accessing the American currency.”

June 15 – Bloomberg (Marianna Duarte De Aragao): “Britain’s European Union referendum is redrawing old lines in the European bond market. As demand for safety in the run-up to the vote pushed Germany’s 10-year yields below zero for the first time on record on Tuesday, those on Spanish two-year notes were turning positive. Meanwhile the yield difference between Italian and German 10-year bonds reached the highest since February… The split in the market is redolent of moves during the region’s debt crisis, a relationship which had been largely disrupted by the European Central Bank’s quantitative easing program.”

June 12 – Reuters (Andrea Shalal and Jonathan Gould): “A British vote to leave the European Union would hit large German banks, given their heavy exposure to London, the head of German financial watchdog Bafin said… Bafin President Felix Hufeld told the newspaper in an article… that he hoped Britons would vote to remain in the European Union. If not, ‘the biggest banks would have the biggest problems,’ the newspaper quoted Hufeld as saying. ‘They have the most activities in, and with, London,’ he said.”

Fixed-Income Bubble Watch:

June 16 – Reuters (Gertrude Chavez-Dreyfuss): “Foreign investors sold a record amount of U.S. Treasury bonds and notes for the month of April…, as investors priced in a few more rate increases by the Federal Reserve this year. Foreigners sold $74.6 billion in U.S. Treasury debt in the month, after purchases of $23.6 billion in March. April's outflow was the largest since the U.S. Treasury Department started recording Treasury debt transactions in January 1978. Private offshore investors sold $59.1 billion in U.S. government bonds, while foreign official institutions, which include central banks, sold $12.3 billion.”

Global Bubble Watch:

June 16 – Bloomberg (Jan-Henrik Foerster and Roxana Zega): “Europe’s largest banks slumped, with Deutsche Bank AG and Credit Suisse Group AG hitting new lows, after the Federal Reserve’s decision to scale back its interest-rate outlook partly because of risks tied to Brexit, fueled concerns about Europe’s economic outlook. ‘The trajectory of European banks is really worrying,’ said Lorne Baring, a fund manager… at B Capital in Geneva. ‘If banks are a main indicator of the health of a region, it gives you another reason to think ‘what the hell is going on in Europe?’ Deutsche Bank, Europe’s largest investment bank, dropped 3.5%... after hitting the lowest since at least 1992, when Bloomberg first started compiling data. Credit Suisse slumped as much as 5.3%, bringing losses this year to about 48%...”

June 16 – Bloomberg (Matthew Boesler and Liz McCormick): “Money markets are flashing warning signals as rising credit risk, spurred in part by fears of Brexit, makes it harder for big banks to obtain U.S. dollar funding. A gauge of bank borrowing costs -- the FRA/OIS spread -- hit the most extreme level since 2012 on Thursday, and the premium to swap foreign currencies into dollars reached the highest since late last year as deteriorating investor sentiment ahead of Britain’s June 23 referendum on European Union membership strained the financial system… Banks, facing higher costs to make markets, aren’t stepping in as they did in the past to take advantage of arbitrage opportunities in funding markets, leading to bigger price movements.”

June 16 – Bloomberg (Wes Goodman): “Japanese, German and Swiss bond yields fell to records, as government debt around the world extended its best gains in two decades, with the prospect of Britain leaving the European Union boosting demand for havens. Federal Reserve Chair Janet Yellen fueled the rally by saying Wednesday slow productivity growth and aging societies may keep interest rates at depressed levels… The Bank of Japan said inflation in the nation may be zero or negative, while holding monetary policy unchanged… ‘It’s the new abnormal,’ said Park Sungjin, the head of principal investment in Seoul at Mirae Asset Securities Co., which oversees $7.7 billion. ‘The abnormal is normal now.’”

June 15 – Bloomberg (Andrea Wong and Oliver Renick): “For the past year, Chinese selling of Treasuries has vexed investors and served as a gauge of the health of the world’s second-largest economy. The People’s Bank of China, owner of the world’s biggest foreign-exchange reserves, burnt through 20% of its war chest since 2014, dumping about $250 billion of U.S. government debt and using the funds to support the yuan and stem capital outflows. While China’s sales of Treasuries have slowed, its holdings of U.S. equities are now showing steep declines. The nation’s stash of American stocks sank about $126 billion, or 38%, from the end of July through March, to $201 billion…”

Federal Reserve Watch:

June 15 – Wall Street Journal (Jon Hilsenrath and Kate Davidson): “The Federal Reserve held short-term interest rates steady and officials lowered projections of how much they’ll raise them in the coming years, signs that persistently slow economic growth and low inflation are forcing the central bank to rethink how fast it can lift borrowing costs. Wednesday’s moves marked a stark reversal from just a few weeks ago, when several Fed officials, including Chairwoman Janet Yellen, dropped strong hints they might raise rates in June or July. Instead, she emphasized the central bank’s uncertainty about when they’ll act and where rates are headed in 2018 and beyond. ‘I can’t specify a timetable,’ about when rates will next be raised, she said… ‘We are quite uncertain about where rates are heading in the longer term.’ Federal Reserve Chairwoman Janet Yellen on Wednesday cast doubt on a significant interest-rate increase in the near future, saying turmoil in global markets and a sluggish U.S. economy will likely keep rates low. The uncertainty was striking in part because the Fed’s forecasts for the economy didn’t change much…”

June 12 – Wall Street Journal (Harriet Torry): “While Federal Reserve officials debate when to next raise short-term interest rates, they also are wrestling with the question of how high to lift them in coming years. Signs point toward the new normal being much lower than in the past, which has broad implications for when the Fed should tighten monetary policy, how quickly, and how far. Fed officials disagree about their likely end point, in part because they are struggling to understand why another underlying interest rate—the mysterious natural rate—has fallen in recent years. And for that many are turning to the musings of Knut Wicksell, a Swedish expert on the subject who died 90 years ago.”

U.S. Bubble Watch:

June 16 – Reuters (Lucia Mutikani): “The U.S. current account deficit widened to a more than seven-year high in the first quarter as goods exports fell and investment from abroad declined. The Commerce Department said… the current account deficit, which measures the flow of goods, services and investments into and out of the country, increased 9.9% to $124.67 billion, the largest since the fourth quarter of 2008.”

June 10 – CNN (Tami Luhby): “But 31% of American adults, or 76 million people, say they are struggling to get by or just barely making it, according to the Federal Reserve Bank's latest survey on Americans' economic well-being… And that's actually good news. Two years earlier, the Fed found that 38% of Americans were in weak financial shape. Seven years after the end of the Great Recession, millions of Americans have yet to find firm financial footing… The Fed survey highlights many of Americans' continuing economic worries. Some 46% of adults say they can't cover an unexpected $400 expense or would have borrow or sell something to do so.”

June 15 – Wall Street Journal (Annamaria Andriotis): “Consumer credit is starting to fray at the edges. Lenders and credit-ratings firms are warning that credit cards, auto loans and student loans are weakening, suggesting that a new round of borrower delinquencies and losses for financial institutions could be on the way. Synchrony Financial, the largest U.S. issuer of retail-store credit cards, increased its forecast for credit losses over the next year, saying some customers were failing to catch up on overdue payments. The increase in expected losses wasn’t huge—0.2 to 0.3 percentage point—but it rattled investors who are nervously watching for a peak in the credit cycle.”

June 16 – Bloomberg (Eric Balchunas): “It’s the end of an era. Since 2008, the vast majority the flows in and out of certain exchange-traded funds (ETFs) have been driven by what the Federal Reserve was doing or saying. One word spoken by Former Fed Chair Ben Bernanke or his successor, Janet Yellen, would send billions in and out of the same ETFs in the same patterns. But this year is different as the Fed—and the fear of rising interest rates—have taken a back seat to a more natural cause: the fear of a collapse in the stock market. The evidence of this is widespread but perhaps best symbolized by the asset levels of a couple of leveraged ETFs. The ProShares UltraShort S&P 500 ETF (SDS), which provides 200% inverse exposure to the S&P 500 index, has just regained its former status as the largest leveraged ETF…”

China Bubble Watch:

June 10 – Reuters (Alexandra Harney): “China must act quickly to address mounting corporate debt, a major source of worry about the world's second-largest economy, a senior International Monetary Fund (IMF) official said… David Lipton, first deputy managing director of the IMF, warned in a speech to a group of economists in the southern city of Shenzhen that companies' indebtedness is a ‘key fault line in the Chinese economy’. ‘Company debt problems today can become systemic debt problems tomorrow. Systemic debt problems can lead to much lower economic growth, or a banking crisis. Or both,’ Lipton said…”

June 15 – Bloomberg: “China’s banks turned on the lending spigot again last month -- a boost for the near-term economic outlook, but a longer-term drag as the nation’s debt pile keeps on swelling. New yuan loans rebounded to 985.5 billion yuan ($150 billion) in May, the People’s Bank of China said… Aggregate financing was 659.9 billion yuan last month, missing all but one of 28 forecasts and below the median for 1 trillion yuan, as short-term bill financing slumped and net issuance of corporate bonds turned negative. The two-speed data illustrate the tightrope being walked by the central bank: on the one hand it’s seeking to curb financial and debt risks, while on the other it needs to keep credit flowing so that economic growth isn’t derailed. Mortgages led the bank lending increase last month amid a recovering property market.”

June 13 – Financial Times (Gabriel Wildau and Tom Mitchell): “China’s central bank has burnt through nearly half a trillion dollars in foreign reserves to support its currency since August, despite criticism it has betrayed its commitment to let market forces drive the exchange rate. Yet sources close to the central bank say the intervention, while costly, was necessary to maintain economic confidence and prevent a disorderly depreciation that could have ripple effects far beyond the currency. The People’s Bank of China has spent about $473bn in foreign exchange reserves since it surprised global markets last August by changing the way it sets its daily guidance rate for the currency…”

June 14 – Financial Times (Lucy Hornby): “China’s Communist party is moving to tighten its grip on state-owned enterprises, reversing nearly two decades of attempts to remodel them along the lines of western corporations. The new push, outlined in recent state media articles and party documents, comes amid a tightening of controls over civil society, the military and media as President Xi Jinping seeks to consolidate power within the party. By giving greater power to the party cells within every SOE, the new direction undermines efforts to establish boards of directors to push SOEs to make decisions based on market conditions, profitability and hard budget constraints… ‘All the major decisions of the company must be studied and suggested by the party committees,’ according to an article by the State-owned Assets Supervision and Administration Commission in the influential party magazine Qiushi… ‘Major operational management arrangements involving macro-control, national strategy and national security must be studied and discussed by the party committees before any decision by the board of directors or company management.’”

June 15 – Bloomberg (Kyoungwha Kim): “China’s asset managers are preparing for a regulatory crackdown in an area of their business that’s become a dark alleyway for shadow financing. Subsidiaries of mutual funds need to adjust leverage ratios for investing in equities, fixed income and non-standardized products… Once the limits on risk-taking come into effect, units of public mutual funds will need to hold around $300 million in net capital for every $1 billion under management, consulting firm Z-Ben Advisors Ltd. estimates. Because these subsidiaries are allowed to invest in assets that are off limits to their parents, including high-yield debt, they have been able to grow by receiving loans in exchange for taking riskier investments off commercial banks’ books. The curbs could send ripples through markets because Z-Ben estimates the units managed 9.8 trillion yuan ($1.5 trillion) at the end of March, more than doubling from a year earlier… Total banking assets stood at 296% of gross domestic product in 2015 and shadow lending counts for 23% of those assets, up from 3.8% in 2007, Barclays Plc estimated…”

June 15 – Reuters (Kevin Yao and Elias Glenn): “China is cranking up state spending on infrastructure to support economic growth as private-sector investment falters, raising concerns that reforms to the inefficient state sector are being kicked further down the road by the resulting build-up in debt. Policy insiders say the slowdown in private investment is particularly worrying, since Beijing's extra spending was designed to shore up investor confidence and spur private spending… ‘We are relying on infrastructure investment to support growth, but we cannot rely too much on this. We need to motivate private investors,’ said an influential economist at a top government think-tank…”

June 15 – Bloomberg: “Chinese investors used more borrowed money last month to buy bonds amid a note market rebound, as authorities try to balance efforts to revive economic growth with steps to staunch excessive leverage. The outstanding amount of repurchase agreements in China’s interbank market, used by bond traders to amplify their buying power, jumped 17% in May to 7.8 trillion yuan ($1.2 trillion) from April… Last month’s increase was the sharpest since December, when the measure hit a record high of 9.7 trillion yuan.”

June 12 – Bloomberg: “China’s new home sales rose at the slowest pace so far this year amid policymakers’ moves to cool the property market. New home sales climbed 32.9% to 773 billion yuan ($117bn) last month from a year earlier… The increase compares with a 63.5% surge in April. Home sales fell 2.6% in May from April.”

Brazil Watch:

June 11 – Bloomberg (Mario Sergio Lima): “Brazil’s fiscal accounts were in worse shape than initially thought after the suspension of Dilma Rousseff, underscoring the challenge facing the country’s new economic team, acting President Michel Temer said. ‘It was surprising, in a negative way, what we encountered,’ Temer told the Folha de S. Paulo newspaper… ‘The fiscal accounts were worse than we imagined, Petrobras was broken, the Postal Office broken, Eletrobras broken, and I still have faced an aggressive campaign against me.’”

June 15 – Bloomberg (David Biller): “Rio de Janeiro state received a two-notch credit rating downgrade from Fitch Ratings after it failed to make good on international debt obligations and as its liquidity deteriorates rapidly. Fitch cut Rio’s rating to B- from B+, saying in a statement that ‘pension payment should consume an increasing portion of the state’s revenues at least in the following 10 years’ and that Rio has been ‘resorting to nonrecurring revenues to cover for operating expenditures.’”

Japan Watch:

June 16 – Reuters (Leika Kihara and Stanley White): “The Bank of Japan refrained from offering additional monetary stimulus on Thursday despite anemic inflation and weak global growth, sending the yen spiking to a two-year high that clouds an already darkening outlook for the economy… BOJ Governor Haruhiko Kuroda joined a chorus of jawboning by Japanese policymakers aimed at dissuading investors from pushing up the yen too much, stressing his readiness to ease policy again if excessive yen gains threaten prospects for achieving the bank's ambitious 2% inflation target.”

June 13 – Reuters (Stanley White): “Fitch Ratings warned on Monday that it could downgrade Japan's sovereign rating after Prime Minister Shinzo Abe delayed an increase in the nationwide sales tax by two-and-a-half years… Japan's anemic growth is also a credit weakness because Abe's attempts to reflate the economy, known as ‘Abenomics,’ have not raised potential growth, Fitch said… The government could avoid a downgrade if it lays out new steps to meet its fiscal discipline targets, but a lack of measures to bolster confidence in its fiscal policy could lead to a downgrade, Fitch said.”

ECB Watch:

June 17 – Bloomberg (Jan-Henrik Foerster): “The European Central Bank has turned government bonds into one of the riskiest asset classes, prompting Swiss Re AG to move more of its investments into corporate debt, according to the reinsurer’s chief investment officer. ‘If you’re looking for a bubble, here you go,’ CIO Guido Fuerer said… ‘With government bonds, you’re not adequately compensated for the risk you’re taking.”

Europe Watch:

June 17 – Bloomberg (Rainer Buergin): “A proposed common deposit guarantee system isn’t possible under European Union law, and would have to be created by a treaty of participating countries, German Finance Minister Wolfgang Schaeuble said. The deposit-guarantee plan is part of Europe’s so-called banking union, which also comprises European Central Bank supervision of euro-area banks and the Single Resolution Board housed in Brussels. Germany has resisted moving forward with the initiative until risks in the banking sector are reduced.”

Leveraged Speculation Watch:

June 12 – Financial Times (Lindsay Fortado): “Investors may be fleeing hedge funds in droves but they are still allocating money to technology-driven strategies, despite more than a year of lacklustre performance. The move suggests investors are looking to position themselves for increased market swings or a possible crash as ‘quants’, which use computer algorithms to predict market moves, are not correlated to other strategies. The number of institutional investors who allocated funds to the most popular sub-strategy of quant known as commodity-trading advisers, or CTAs, hit a record of 1,067 in 2015, an addition of 50 from the previous year, according to… Preqin… Inflows to quants continued in the first quarter of this year, with investors allocating another $13.7bn in fresh capital, more than any other strategy…”

June 17 – Bloomberg (Simone Foxman): “The number of hedge funds continued to shrink last quarter as wild swings in stocks and commodities battered managers’ performance. More funds shut than started in the first quarter, with 291 liquidated while 206 started, according to… Hedge Fund Research Inc. It was the second consecutive quarter that closings exceeded openings. Investors exhibited ‘low tolerance for underperformance, resulting in an elevated number of liquidations,’ HFR President Kenneth Heinz said…”

Geopolitical Watch:

June 14 – Wall Street Journal (Andrew Browne): “In the countdown to a legal verdict on China’s sweeping claims to the South China Sea, an increasingly frantic Beijing is mobilizing a diplomatic offensive around three core arguments: that the U.N.-backed tribunal has no legal right to hear the case, that America has instigated all the trouble and that China is the victim. Pay special attention to the last of these. If, as expected, the panel rules against China there will be a powerful nationalist backlash. It will be heightened by China’s acute sense of victimhood—a conviction that the West, led by the U.S., is out to thwart its rise and once again enslave its people. That belief often stirs violent public emotion, such as when American warplanes accidentally bombed the Chinese Embassy in Belgrade in 1999. This time, a military response cannot be ruled out.”

June 15 – Bloomberg (David Tweed and David Roman): “A meeting in China of foreign ministers from Southeast Asian nations over the South China Sea ended in confusion after Malaysia released and then retracted a joint statement expressing ‘serious concerns’ over developments in the disputed waterway. The disarray raises fresh questions about unity within the 10-member Association of Southeast Asian Nations, ahead of an international court ruling on a Philippine challenge to China’s claims to more than 80% of the waterway.”

June 14 – Bloomberg (Ian Wishart): “NATO said it’s sending a ‘clear message’ to Russia by stepping up defensive forces in eastern Europe, as it tries to allay fears in former Soviet-bloc nations that they’re vulnerable to attack. A multinational group of 4,000 troops will be deployed in Poland and the three Baltic nations, all of which border Russia, following an agreement by North Atlantic Treaty Organization defense ministers at a meeting in Brussels… The decision is designed to provide reassurance to eastern European governments on top of a rapid-response force that NATO set up last year.”

June 15 – Reuters (Idrees Ali and David Brunnstrom): “The U.S. Navy's Third Fleet will send more ships to East Asia to operate outside its normal theater alongside the Japan-based Seventh Fleet, a U.S. official said…, a move that comes at a time of heightened tensions with China. The Third Fleet's Pacific Surface Action Group, which includes the guided-missile destroyers USS Spruance and USS Momsen, was deployed to East Asia in April.”

June 16 – Reuters (Andrea Shalal): “A major cyber attack could trigger a collective response by NATO, NATO Secretary General Jens Stoltenberg said in an interview… ‘A severe cyber attack may be classified as a case for the alliance. Then NATO can and must react,’ the newspaper quoted Stoltenberg as saying. ‘How, that will depend on the severity of the attack.’ He spoke after a decision this week by NATO ministers to designate cyber as an official operational domain of warfare, along with air, sea, and land.”