Saturday, July 30, 2016

Weekly Commentary: Bubble Battles

July 29 – Wall Street Journal (Anjani Trivedi): “The Bank of Japan is retreating into some much-needed introspection. And while it prepares to do this, it threw markets a not very meaty bone to chew on. The central bank on Friday underwhelmed overexcited expectations for yet another big bang of monetary stimulus. The Bank of Japan announced a paltry 3 trillion yen ($28.5 billion) increase to its purchases of exchange-traded funds to 6 trillion yen in a bid to boost asset prices. It also doubled down on a relatively minor U.S. dollar lending facility to give Japanese companies a nudge to buy assets overseas. Markets seem to have taken the disappointment in stride…”

Currency markets broke stride awkwardly. The yen responded immediately to the BOJ and ended Friday’s session up 3.05% at session highs. The Japanese currency has rather briskly recovered much of its recent pullback.

A sampling of major headlines: “Bank of Japan Takes Modest Easing Action”; “Timid Bank of Japan Move Raises Alarm for Other Economies”; “Bank of Japan Plays for Time with Weak Stimulus”; “Is Bank of Japan Signaling That It’s Running Out of Ammo?”. Disappointing BOJ action elicited comments such as “limp measures”, “dipped into a bag of small tricks” and “cautious step.”

The markets – and apparently the financial media – beckon not for limp and cautious, but rather for unyielding and radical. If monetary stimulus is not working as prescribed, that obviously means it must be executed more frenetically. If the most aggressive monetary stimulus ever is increasingly ineffective, the only solution is to go completely radical, nuclear and helicopter. Of course it’s reckless and doesn’t make good sense. So markets are especially sensitive to any indication that central bankers might be losing their nerve or contemplating a reassessment.

BOJ governor Haruhiko Kuroda: “I don’t believe we’re approaching the limits of negative interest rates or qualitative and quantitate easing. We’ve been pursuing an aggressive monetary policy for three years, and it’s a natural time for a review.”

Coming two days after Prime Minister Shinzo Abe revealed a gigantic $265 billion stimulus package, in what has become serial “special” stimulus, the Bank of Japan’s announcement took on greater significance. The BOJ might move aggressively in September, but Friday’s disappointment is a timely reminder that there is underlying unease in Japanese policymaking circles.

Prolonged massive stimulus has helped push Japan’s jobless rate down to a modern day record low 3.1%. At the same time, the primary objective of forcing consumer price inflation up to 2% remains elusive. With aggregate consumer prices down 0.4% over the past year, the Bank of Japan Friday slashed their CPI forecast for the current fiscal year to 0.1% from 0.4%. Global downward pricing pressures – including sinking crude prices – suggest little relief is in the offing. At this point, BOJ monetization is like pounding one’s head against a wall.

Japan has been fighting deflationary headwinds since the bursting of their Bubble more than 25 years ago. It was a major Bubble exacerbated by a loosening of monetary conditions in the U.S. back in the late-eighties coupled with intense pressure from the U.S. to stimulate Japan’s economy to help rectify ballooning U.S. trade deficits. And it’s somewhat ironic that in 2016 Japan’s biggest adversary in its post-Bubble deflation fight is engaged in its own Bubble Battle across the East China Sea.

One could argue that Japan lost all control of its Bubble with the onset of post-1987 crash aggressive monetary accommodation. Chinese control was lost with the massive post-2008 stimulus, and it’s been awhile since I’ve read reference to Chinese officials having learned from the Japanese experience. Indeed, seeds for today’s runaway global finance Bubble were planted in Japan and came to full bloom with China’s historic Credit expansion. And for 25 years, global central bankers have chanted “deflation” as enemy number one. But it’s been Bubbles all along. They remain the dominant risk today, as they’ve been all the way back to the late-eighties.

The global government finance Bubble can at this point be simplified into six powerful intertwined forces: 1) Near zero rates and record low bond yields virtually across the globe contributing to generally loose fiscal spending and ever rising country indebtedness; 2) Near $1.0 TN annual market liquidity injections from the ECB; 3) Near $1.0 TN annual market liquidity injections from the BOJ; 4) Annual Chinese Credit growth of about $3.0 TN, powered by state-directed bank lending; 5) Ongoing ultra-dovish Federal Reserve policy – with attendant loose financial conditions and booming perceived wealth in U.S. asset markets (exacerbated by strong foreign-sourced flows); 6) The deeply engrained perception throughout global markets that central bankers in concert are committed to doing “whatever it takes” to ensure that markets remain liquid and levitated, a backdrop the promotes risk-taking and leveraged speculation (in the face of mounting risks).

Going back to the earliest CBBs, it’s been a central argument that the transformation to securitized Credit was both a momentous and precarious development. History is unequivocal: Credit is inherently unstable. The thesis that contemporary market-based Credit is highly unstable should not at this point be contentious. And the greater the expansion of contemporary market-based finance, with cumulative latent vulnerabilities, the more overpowering the impetus for governments and central bankers to monkey with and backstop unsound markets. And now decades of backstops, bailouts and reflations have nurtured dysfunctional markets that have regressed to total dependency to ongoing government market manipulation, monetization and reckless monetary inflation.

And this helps explain diametrically opposed global markets views: The bullish perspective sees an unusually stable backdrop (VIX closed the week below 12!), with notably resilient markets having repeatedly persevered through brief bouts of market tumult and various geopolitical developments. Monetary management is “enlightened.” The bearish view sees an acutely vulnerable global financial “system” at this point patched together with “whatever it takes” liquidity injections and market manipulation the likes of which the world has never previously experienced. Policymakers are perpetrating history’s most destructive monetary inflation.

The hope has always been that aggressive global fiscal and monetary stimulus would raise inflationary expectations and spur more generalized Credit and economic booms. It had worked previously, although nothing from the past was comparable to the scope of the mortgage finance Bubble and the subsequent post-Bubble global reflationary free-for-all. The combined inflation of national debt and central bank Credit was so enormous that there would be no turning back from resulting epic Bubbles.

Levitated securities markets and maladjusted economic structures around the world would be sustained by nothing less than perpetual ultra-loose finance, the type that only governments and central banks were capable of providing. Private Credit would be insufficient in scope and too unstable. Securities markets without government support would be too volatile and susceptible to crashes. Perhaps they were unaware that there could be no retreat, but governments did take full control. And the more unstable the financial and economic underpinnings, the more egregious the government interventions required to impose (transitory) stability. Markets reacted positively to this extraordinary imposition, ensuring overbearing Bubbles with only deeper addiction to loose finance. Desperate policymakers accommodated with regrettable pronouncements of “whatever it takes.”

Bubbles always require rapid and increasing Credit expansion. The global government finance Bubble is no exception. The world is generally at near zero rates, negative sovereign yields, large deficit spending and about $2.0 TN of annual global QE. Yet effects have dissipated, ensuring what was originally “shock and awe” overwhelming force is near the brink of not being enough. Crude has sunk back to near $40. Growth has slowed again in Europe, the U.S. and throughout Asia. With the French economy flat-lining, Eurozone Q2 GDP (0.3%) was half of Q1’s. Considering that some sectors and locations are in powerful Bubbles, 1.5% (annualized) Q2 GDP growth speaks poorly for the overall U.S. economy. Ten-year Treasury yields dropped 10 bps this week to 1.45%, clearly betting against Federal Reserve tightening.

Global markets beckon for more loosening. Markets demand that the Bank of Japan turns crazy reckless, even as evidence mounts that now routine reckless hasn’t worked. The markets need Chinese policymakers to ensure $3.0 TN of annual Credit growth, even though it’s apparent to communist leadership that such a course is fraught with major risks. The markets stipulate that the Draghi ECB must continue printing at a Trillion annualized pace, in the face of unprecedented market distortions, internal policy discord and great financial, economic, social and geopolitical risks.

July 26 – Bloomberg: “China’s stock market calm has been shattered. Shares plunged Wednesday, with a gauge of smaller companies sinking 5.5%, as people familiar with the matter said the China Banking Regulatory Commission is discussing stricter curbs on wealth-management products. A measure of the Shanghai Composite Index’s short-term volatility doubled, after sinking to a two-year low on Monday… ‘Many banks have been investing in WMPs to funnel money into the stock market,’ said Francis Cheung, head of China and Hong Kong strategy at CLSA… ‘It’s non-transparent, so I understand why regulators would try to act. But if this causes too much correction, then they will get worried. The No. 1 priority is to maintain a relatively stable stock market.’”

The truth of the matter is that Chinese officials these days have bigger concerns than stock prices. At this point, No. 1 priority should be stability for an incredibly bloated banking sector currently enveloped in “Terminal Phase” dynamics (i.e. it’s self-destructing). So-called “Wealth Management Products” (WMPs) have been a concern for several years now. And how did the timid regulatory approach play out in Bubbleland? From Bloomberg: “The outstanding value of China’s WMPs rose to 23.5 trillion yuan, or 35% of the country’s gross domestic product, at the end of 2015, from 7.1 trillion yuan three years earlier…”

“Terminal Phase” excess sees rapid expansion of increasingly risky Credit. A hypothetical graph of systemic risk grows exponentially skyward. Accordingly, the risk intermediation task turns burdensome and fraught with great risk. Somehow the financial sector must transform (Trillions of) increasingly risky loans into financial instruments with appealing (money-like) attributes. Chinese “shadow banking” is an intermediation accident in the making, and it’s rational that spooked regulators would now target WMPs. It’s not clear how China at this stage can move to rein in egregious excess without inciting a tightening of financial conditions and resulting Credit and economic slowdown.

It was an interesting week in the markets. Global sovereign yields retreated back to within striking distance of recent historic lows. Gold jumped 2.2% and silver surged 3.6%. Yet copper posted a slight decline, while WTI crude sank 6.3%. Examining this week’s developments in Japan and China, as a trader I’d have greater concern for the global financial and economic outlook. It’s fascinating – as opposed to confusing - to watch gold and crude diverge. The yen bears – and dollar bulls – had the rug again pulled out this week. I see ongoing currency market volatility as a harbinger of general market instability. Sinking crude had high-yield energy debt under pressure, along with Mexican stocks and the peso. The Russian ruble declined 1.8% and the Colombian peso sank 4.1%. Equities were determined to retain their strong July gains, while the VIX holds confidently to the view that “whatever it takes” remains in firm control. Could be an interesting August.

For the Week:

The S&P500 was little changed (up 6.3% y-t-d), while the Dow slipped 0.7% (up 5.8%). The Utilities declined 1.2% (up 20.8%). The Banks increased 0.7% (down 7.0%), and the Broker/Dealers rose 1.4% (down 8.3%). The Transports dropped 1.5% (up 4.5%). The S&P 400 Midcaps added 0.5% (up 11.5%), and the small cap Russell 2000 gained 0.6% (up 7.4%). The Nasdaq100 advanced 1.4% (up 3.0%), and the Morgan Stanley High Tech index gained 1.0% (up 5.6%). The Semiconductors jumped 3.3% (up 15.6%). The Biotechs surged 4.4% (down 11.1%). With bullion gaining $29, the HUI gold index jumped 5.9% (up 147%).

Three-month Treasury bill rates ended the week at 25 bps. Two-year government yields declined four bps to 0.66% (down 39bps y-t-d). Five-year T-note yields fell 10 bps to 1.02% (down 73bps). Ten-year Treasury yields sank 12 bps to 1.45% (down 80bps). Long bond yields dropped 10 bps to 2.18% (down 84bps).

Greek 10-year yields jumped 16 bps to 7.98% (up 66bps y-t-d). Ten-year Portuguese yields dropped 12 bps to 2.90% (up 38bps). Italian 10-year yields declined seven bps to 1.16% (down 43bps). Spain's 10-year yield fell 10 bps to 1.01% (down 76bps). German bund yields dropped nine bps to negative 0.12% (down 74bps). French yields sank 11 bps to 0.10% (down 89bps). The French to German 10-year bond spread narrowed two bps to 22 bps. U.K. 10-year gilt yields dropped 11 bps to 0.68% (down 128bps). U.K.'s FTSE equities index was little changed (up 7.7%).

Japan's Nikkei equities index slipped 0.3% (down 12.9% y-t-d). Japanese 10-year "JGB" yields increased three bps to negative 0.20% (down 46bps y-t-d). The German DAX equities index jumped 1.9% (down 3.8%). Spain's IBEX 35 equities index was about unchanged (down 10.0%). Italy's FTSE MIB index added 0.4% (down 21.3%). EM equities were mixed. Brazil's Bovespa index increased 0.5% (up 32%). Mexico's Bolsa dropped 1.8% (up 8.6%). South Korea's Kospi index added 0.3% (up 2.8%). India’s Sensex equities increased 0.9% (up 7.4%). China’s Shanghai Exchange fell 1.1% (down 15.8%). Turkey's Borsa Istanbul National 100 index rallied 5.1% (up 5.1%). Russia's MICEX equities gained 0.9% (up 10.4%).

Junk bond mutual funds saw outflows of $175 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained three bps to 3.48% (down 50bps y-o-y). Fifteen-year rates increased three bps to 2.78% (down 39bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 3.69% (down 40bps).

Federal Reserve Credit last week declined $4.3bn to $4.435 TN. Over the past year, Fed Credit declined $21.7bn. Fed Credit inflated $1.624 TN, or 58%, over the past 194 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $8.0bn last week to $3.220 TN. "Custody holdings" were down $108bn y-o-y, or 3.2%.

M2 (narrow) "money" supply last week jumped $34.7bn to a record $12.884 TN. "Narrow money" expanded $841bn, or 7.0%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits dropped $36bn, while Savings Deposits surged $68.5bn. Small Time Deposits were unchanged, and Retail Money Funds were little changed.

Total money market fund assets were about unchanged at $2.715 TN. Money Funds rose $67bn y-o-y (2.5%).

Total Commercial Paper sank $26.9bn to a 2016 low $1.026 TN. CP declined $32.2bn y-o-y, or 3.0%.

Currency Watch:

The U.S. dollar index declined 1.8% to 95.57 (down 3.2% y-t-d). For the week on the upside, the Japanese yen increased 3.8%, the New Zealand dollar 2.9%, the South African rand 2.9%, the euro 1.8%, the Australian dollar 1.8%, the Norwegian krone 1.2%, the Swedish krona 1.1%, the British pound 0.9%, and the Brazilian real 0.2%. For the week on the downside, the Mexican peso declined 1.1%. The Chinese yuan rallied 0.7% versus the dollar (down 2.2% y-d-t).

Commodities Watch:

July 29 – Bloomberg (Grant Smith): “The bullish spirit that gripped oil traders as industry giants from Saudi Arabia to Goldman Sachs Group Inc. declared the supply glut over is rapidly ebbing away. Oil is poised for a drop of 20% since early June… While excess crude production is abating, inventories around the world are brimming, especially for gasoline, and a revival in U.S. drilling threatens to swell supplies further. As the output disruptions that cleared some of the surplus earlier this year begin to be resolved, crude could again slump toward $30 a barrel, Morgan Stanley predicts. ‘The tables are turning on the bulls, who were prematurely constructive on oil prices on the basis the re-balancing of the oil market was a done deal,’ said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas…”

The Goldman Sachs Commodities Index dropped 2.8% to a three-month low (up 8.9% y-t-d). Spot Gold gained 2.2% to $1,351.3 (up 27%). Silver jumped 3.6% to $20.39 (up 48%). WTI Crude sank $2.81 to a three-month low $41.45 (up 12%). Gasoline declined 2.9% (up 4%), while Natural Gas gained 2.9% (up 22%). Copper slipped 0.3% (up 4%). Wheat was down 4.1% (down 13%). Corn increased 0.3% (down 5%).

Turkey Watch:

July 29 – Bloomberg (Constantine Courcoulas and Tugce Ozsoy): “Turkey’s bonds headed for the biggest monthly drop in emerging markets as a failed coup that left more than 250 dead prompted S&P Global Ratings to downgrade the nation’s debt and sent the currency to a record low. The yield on 10-year local currency bonds climbed three bps…, extending the increase this month to 54 bps. The rate on Turkey’s 4.25% 2026 dollar bonds rose 60 basis points in July to 4.66%...”

July 26 – Bloomberg (Phil Kuntz and Ahmed A Namatalla): “Turkey’s failed coup and President Recep Tayyip Erdogan’s crackdown could hardly have come at a worse time for investors worried about the riskiness of the country’s bonds. Now they may get even dicier. Even before rogue generals tried to seize control on July 15, the country had a relatively high default probability. It was greater than about 80% of nations, according to Bloomberg’s sovereign risk model… The country’s short-term external debt as a percentage of gross domestic product… was trending into riskier territory even before the current turmoil. Debt with an original maturity of a year or less has almost tripled to more than 18% of the economy since 2007… Turkey’s 12-month forward debt obligations soared to a record 30% of economic output at the end of 2015, having risen for four years from 19%... S&P pointed to similar statistics in explaining its downgrade of Turkey. The country’s net foreign exchange reserves of an estimated $32 billion cover only about two months of current-account payments, giving it little room to maneuver… Turkey will likely have to roll over about 42% of its external debt, more than $170 billion worth, in the next year…”

July 25 – Reuters (Daren Butler and Seda Sezer): “Turkey ordered the detention of 42 journalists on Monday…, under a crackdown following a failed coup that has targeted more than 60,000 people and drawn fire from the European Union. The arrests or suspensions of soldiers, police, judges and civil servants in response to the July 15-16 putsch have raised concerns among rights groups and Western countries, who fear President Tayyip Erdogan is capitalizing on it to tighten his grip on power.”

Europe Watch:

July 29 – Financial Times (Claire Jones, Anne-Sylvaine Chassany and Ian Mount): “The eurozone’s economic recovery has lost some of the momentum it took into the opening months of 2016, with growth across the single currency area slowing after France’s economy ground to a halt. The eurozone economy expanded by 0.3% between the first and second quarters of this year, against the 0.6% figure recorded for the previous three months. The preliminary GDP estimate from Eurostat released on Friday was in line with analysts’ estimates, but came after the publication of a worse than expected figure for France. The eurozone’s second-largest economy failed to grow at all in the second quarter as households held off spending and companies delayed investment amid strikes that caused big disruptions.”

July 26 – Financial Times (Joel Lewin): “Share in European banks are under the cosh again today, and for a change Italian lenders aren’t the epicentre of the wobbles (although the country’s sovereign debt is one of the drivers). The whole sector is nursing some heavy losses this morning after Commerzbank warned its capital position has weakened in an unscheduled announcement on Monday night, prompting its shares to slide more than 6% this morning.”

July 29 – Financial Times (Eric Platt): “The sprint out of European equity funds entered its 25th consecutive week, draining portfolios of $76bn since the year began as uncertainty over the implications of the Brexit vote and a crisis in the Italian banking sector weigh on investors. The past week saw more than $4bn pulled from portfolio managers invested in European stocks…, according to fund flows tracked by EPFR…”

July 25 – Bloomberg (Alastair Marsh): “Europe's credit markets are relatively insulated from the turmoil in Turkey. Unfortunately, according to analysts at JPMorgan…, where exposure exists it's in all the wrong places. Following an unsuccessful coup attempt earlier this month, Turkey's markets have been rocked by both political unrest and the threat of downgrade. From UniCredit SpA to Thomas Cook Group Plc, the risk is being shouldered by companies already battling problems at home. ‘In general, European credit does not carry much exposure to Turkey,’ the analysts led by Matthew Bailey said… Yet in almost all cases, the ‘names which are affected by the political situation were already facing other risks.’”

Italy Watch:

July 29 – UK Guardian (Jill Treanor and Stephanie Kirchgaessner): “A rescue package of the world’s oldest bank has been announced after a health check of the biggest banks across the EU showed that Banca Monte dei Paschi di Siena’s financial position would be wiped out if the global economy and financial markets came under strain. The much-anticipated result of the stress tests – for which there was no pass or fail mark – of 51 banks showed that Italy’s third largest bank emerged weakest from the assessment.”

Central Bank Watch:

July 24 – Bloomberg (Jana Randow): “The European Central Bank will be able to cope with any problems that might emerge in the implementation of its asset-purchase program, Governing Council member Ignazio Visco said… So far, policy makers have ‘no evidence’ that there is a shortage of government bonds that may jeopardize the completion of a 1.7 trillion-euro ($1.9 trillion) quantitative easing program, Visco told Bloomberg... ‘We have not seen problems so far. If we find problems, we will find solutions.’”

Fixed-Income Bubble Watch:

July 28 – Financial Times (Eric Platt): “An accelerating drop in oil prices threatens a five-month rally in high-yield energy bonds, reigniting the relationship between the two asset classes as crude approaches bear market territory. Prices for high-yield energy bonds have fallen for eight consecutive days — following a decline in the price of US oil towards $41 a barrel, its lowest level since April. Rising stocks of gasoline, alongside an increase in the number of rigs drilling for oil, has increased pressure on crude prices and lifted the risk premium investors are demanding to own junk energy debt.”

July 26 – Financial Times (Eric Platt): “Verizon is finalising a $6.15bn bond sale to repay some of its near term maturities just days after it agreed to a purchase beleaguered internet group Yahoo for nearly $5bn. The five-part sale drew roughly $30bn of investor orders…, as portfolio managers search out income in a world where $13tn of debt trades with a yield below zero.”

July 27 – Bloomberg (Molly Smith): “The Virgin Islands Water and Power Authority, the Caribbean archipelago’s utility, had the credit rating on its most secure debt cut below investment grade Wednesday by S&P Global Ratings. The rating company cited its low levels of cash and a backlog of unpaid bills, some owed by the government. ‘The downgrade reflects weakened debt service coverage and liquidity, due in part to delayed payments on government-related accounts,’ said S&P credit analyst Peter Murphy…”

Global Bubble Watch:

July 24 – Bloomberg: “Finance chiefs from the world’s biggest economies signaled escalating concern about a wave of anti-globalization sentiment that threatens core principles long embraced by the group. Meeting in China one month after a shock decision by U.K voters to exit the European Union, finance ministers and central bankers from the Group of 20 put a stepped-up emphasis on fiscal and structural policies to boost growth, and renewed a pledge to promote inclusiveness.”

July 28 – CNBC (Jeff Cox): “The corporate debt pile is continuing to pile up, with a $10 trillion bill coming due over the next several years. That's how much of the $51 trillion in global company IOUs is maturing between now and 2021, according to data from S&P Global Ratings, which warns of potential dangers ahead. ‘In recent years, credit conditions have been largely favorable, and corporate issuers have actively issued record levels of debt, much of which has been used to refinance existing debt, lower funding costs, and extend maturities,’ the agency said… ‘Funding conditions began tightening last year as falling commodity prices and volatile equity markets contributed to investor unease and a flight to quality.’”

July 26 – CNBC (Catherine Boyle): “Deutsche Bank, the German bank which is an important part of the global financial system, announced revenue and income falls Wednesday which could add further concerns for investors made jittery by a combination of Brexit and previous issues at the bank. Deutsche's share price fell by 4% in early trading Wednesday after it announced second-quarter net income was down 98% from the same period in the previous year, to 20 million euros ($22 million), as it exited parts of its business while revenues were down 20% to 7.4 billion euro.”

July 26 – Bloomberg (Javier Blas): “If Big Oil was a two-engine airplane, you could say it’s been flying on a single engine since energy prices crashed in 2014. Now, the second motor is sputtering. The major integrated oil companies… have relied on their so-called downstream businesses, which include refining crude into gasoline, oil trading and gas stations, to cushion the losses on their upstream units, which pump crude and natural gas. ‘The crash in oil prices in late 2014 brought refineries worldwide a pleasant surprise: booming margins,’ said Amrita Sen, chief oil analyst at consulting firm Energy Aspects… ‘But now, the market is changing.’”

July 25 – Financial Times (Robin Wigglesworth): “The investor shift from active asset management to cheaper passive strategies will accelerate in the coming years and weigh on the earnings and credit ratings of investment groups unable to adapt to the new realities of the money management industry, according to Moody’s. The worsening ability of many fund managers to beat their benchmarks, coupled with their costs, has led to an investor exodus in favour of cheaper investment strategies such as exchange-traded funds, that seek to merely mimic the performance of a market at the cheapest possible cost… ‘Large traditional asset managers that lack a core competency in passive investing, or that are unable to deliver outperformance to justify their fees, are at risk of seeing their business profiles weaken further, increasing the likelihood of ratings deterioration,’ the rating agency’s report said.”

U.S. Bubble Watch:

July 29 – Financial Times (Rachel Witkowski): “Risky lending by Wall Street banks has risen sharply despite some improvements in underwriting from years past, warned U.S. regulators… Credit deemed ‘special mention’ and worse jumped 13% based on exams for the last 12 months ended in April from the previous 12-month period to $421.4 billion, according to the annual review of bank’s major loan portfolios conducted by the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. The review said the greatest levels of risk remain in ‘leveraged loans’ that are extended to highly indebted companies, such as those bought by private-equity firms, as well as oil and gas portfolios.”

July 27 – Bloomberg (Sonali Basak): “When all else fails, lend. That’s the strategy of some of the biggest U.S. insurers as they seek higher returns in an investment universe where buying bonds sometimes means guaranteed losses. The largest U.S. banks are constrained by post-2008 rules that make it tougher for them to extend loans. So companies such as MetLife Inc. and American International Group Inc. are grasping more market share. While many insurers have been in the commercial real-estate market for decades, the industry is branching out into home mortgages, small-business lending, car loans, renewable-energy financing and student debt… The quiet reshuffling of the lending industry is part of the transformation of American finance following the 2008 credit crisis. Together with hedge funds, private equity shops and tech startups, insurance companies have joined the ranks of shadow banks -- firms that act like banks without being regulated like them.”

July 25 – New York Times (Andrew Ross Sorkin): “Could the Glass-Steagall Act — the Depression-era legislation that forced the separation of investment banking from commercial banking, among other things — be coming back? In an extremely odd political dovetail, both the Democratic and the Republican platforms include planks that call for the restoration of the landmark 1933 law. Glass-Steagall aimed to protect the common folk who deposited money in their banks for safekeeping, and ordered that those banks decouple themselves from the business of placing the type of speculative stock market bets that caused the great crash of 1929. For decades, that law was a bedrock principle on Wall Street, where the peanut butter of lending and deposit-taking never mixed (legally) with the chocolate of playing the market. That bedrock was smashed in 1999, however, when the Gramm-Leach-Bliley Act undid much of Glass-Steagall, liberating banks like Citigroup and others to form what they called ‘financial supermarkets,’ all-in-one financial services shops.”

July 25 – Wall Street Journal (Timothy W. Martin): “Long-term returns for U.S. public pensions are expected to drop to the lowest levels ever recorded, portending deeper pain for states and cities as a $1 trillion funding gap widens. Twenty-year annualized returns for public pensions in the U.S. are poised to decline to 7.47% once fiscal 2016 results are released in coming weeks, according to an estimate from Wilshire Trust Universe Comparison Service... That would be the lowest-ever annual mark recorded by Wilshire, which began tracking the statistic 16 years ago. In 2001, near the height of the dot-com boom, pensions’ 20-year median return was 12.3%...”

July 27 – Bloomberg (Heather Perlberg and Prashant Gopal): “It turns out that even the well-off need help in a housing market as crazy as the one in the San Francisco Bay area, and lenders are elbowing each other in a rush to provide it. They’re courting Silicon Valley workers with tailored loans, guaranteed 24-hour approval and financial-planning services. Social Finance Inc. has deals with Google and other top technology companies that allow it to market to new hires. First Republic Bank -- which gave Facebook Inc. billionaire Mark Zuckerberg a 1.05% interest-rate mortgage -- has opened branches in Facebook and Twitter Inc. headquarters. San Francisco Federal Credit Union will finance 100% of houses costing up to $2 million. Michael Tannenbaum, senior vice president of SoFi’s mortgage group, calls it ‘white-glove service.’ Lenders often give special treatment to the wealthy, of course, but the tech industry has created a particularly ripe crop of clients who are rich or on their way. It’s a smart bet to cater to a sector that’s created thousands of millionaires and dozens of billionaires, says Glenn Kelman, chief executive officer of the brokerage Redfin. The downside is that the most expensive U.S. housing region is becoming ‘a no-fly zone for anyone outside technology’…”

July 26 – Bloomberg (Lillian Chen Jacob Gu): “For David Wong, the business of selling homes isn’t as good this year as it was in 2015, and he’s blaming that on a decline in customers from China. ‘The residential-property market here, especially for those priced between $2.5 million to $3 million, has been affected by China’s measures to control capital flight,’ said the New York City-based Keller Williams Realty Landmark broker. ‘You need to cut the price, or it may take a real long time.’ Wong is not the only one who has felt the cooling in the U.S. real estate market for foreign buyers. Total sales to Chinese buyers in the 12 months through March fell for the first time since 2011, to $27.3 billion from $28.6 billion a year earlier… The number of properties purchased by Chinese also declined to 29,195 units from 34,327 units.”

July 26 – Bloomberg (Oshrat Carmiel): “Apartment construction in New York and San Francisco is taking its toll on landlords, with Equity Residential, the largest publicly traded U.S. multifamily owner, cutting its revenue forecast for the third time this year. Equity Residential expects revenue growth from properties open at least a year to be 3.5% to 4% in 2016... The… real estate investment trust in late April lowered the upper limit to 5%, then reduced it again in June to 4.5%. ‘After five consecutive years of exceptional fundamentals, elevated levels of new supply and slowing growth of higher paying jobs in San Francisco and New York have created headwinds,’ Chief Executive Officer David J. Neithercut said…”

July 26 – Wall Street Journal (Eliot Brown): “Concerns about Silicon Valley’s housing shortage are turning the world’s leading social media company into an apartment developer. Fast-growing Facebook Inc. is in the midst of a push to expand its headquarters complex in its hometown of Menlo Park, Calif., a plan for 6,500 new employees that has rankled some locals frustrated with crowding. So in an effort to shore up city support, Facebook earlier this month made an unusual pledge for a tech company. It would build at least 1,500 units of housing, meant not specifically for Facebook employees, but for the general public.”

July 29 – Bloomberg (Prashant Gopal): “The U.S. homeownership rate fell to the lowest in more than 50 years as rising prices put buying out of reach for many renters. The share of Americans who own their homes was 62.9% in the second quarter, the lowest since 1965… It was the second straight quarterly decrease, down from 63.5% in the previous three months.”

China Bubble Watch:

July 26 – Bloomberg: “China’s stock market calm has been shattered. Shares plunged Wednesday, with a gauge of smaller companies sinking 5.5%, as people familiar with the matter said the China Banking Regulatory Commission is discussing stricter curbs on wealth-management products. A measure of the Shanghai Composite Index’s short-term volatility doubled, after sinking to a two-year low on Monday… ‘Many banks have been investing in WMPs to funnel money into the stock market,’ said Francis Cheung, head of China and Hong Kong strategy at CLSA… ‘It’s non-transparent, so I understand why regulators would try to act. But if this causes too much correction, then they will get worried. The No. 1 priority is to maintain a relatively stable stock market.’”

July 26 – Bloomberg: “China’s banking regulator is proposing tighter rules for the nation’s $3.5 trillion market for wealth-management products, a person with knowledge of the matter said, as the government moves to rein in shadow-financing risks. The China Banking Regulatory Commission has drafted regulations designed to protect mass-market investors, limit the involvement of smaller banks and ensure that lenders have adequate capital to cushion against potential losses… Restrictions would be placed on banks with less than 5 billion yuan ($750 million) of net capital or fewer than three years of experience with wealth-management products, the person said. They would be required to invest the proceeds of any WMPs they issue in less-risky assets, such as government bonds and bank deposits, the person added… The outstanding value of China’s WMPs rose to 23.5 trillion yuan, or 35% of the country’s gross domestic product, at the end of 2015, from 7.1 trillion yuan three years earlier…”

July 23 – Reuters (Elias Glenn): “TAs China's economy notches up another quarter of steady growth, the pace of credit creation grows ever more frantic for every extra unit of production… The world's second-largest economy grew 6.7% in the first half of the year… testament to policymakers' determination to regulate the pace of slowdown… Analysts say that determination has come at the cost of a dangerous rise in debt, which is six times less effective at generating growth than a few years ago. ‘The amount of debt that China has taken in the last 5-7 years is unprecedented,’ said Morgan Stanley's head of emerging markets, Ruchir Sharma… ‘No developing country in history has taken on as much debt as China has taken on on a marginal basis.’ …From 2003 to 2008, when annual growth averaged more than 11%, it took just one yuan of extra credit to generate one yuan of GDP growth… It took two for one from 2009-2010, when Beijing embarked on a massive stimulus program… The ratio had doubled again to four for one in 2015, and this year it has taken six yuan for every yuan of growth…, twice even the level in the United States during the debt-fueled housing bubble… Total bond debt in China is up over 50% in the past 18 months to 57 trillion yuan ($8.5 trillion)…, and new total social financing, the widest measure of credit provided by China's central bank, rose 10.9% in the first half of 2016 to 9.75 trillion yuan.”

July 26 – South China Morning Post (Vivian Lin): “China’s shadow banking system continues to expand at a torrid clip amid strong demand for credit, with assets held by these less-regulated lenders equivalent to 78% of annual economic output at the start of the year, according to Moody’s… The credit rating agency’s July Shadow Banking Monitor report, showed credit growth – as measured by total social financing (TSF) – rose 11 percentage points in the first half of 2016 to 217% at the end of June, outpacing nominal GDP. ‘The increasing size of the shadow banking system means that during a disorderly contraction, banks could have difficulty replacing shadow banking credit, leaving borrowers who rely on such financing at risk of a credit crunch,’ Moody’s said. However, the report also said that TSF, in its measurement of credit growth in the financial system, fails to capture up to one-third of shadow banking activity… ‘We estimate that shadow banking assets grew by 30% in 2015, reaching almost 54 trillion yuan at end-year, equivalent to 78% of GDP,’ said the Moody’s report.”

July 25 – Financial Times (Tom Mitchell): “A front-page article in the People’s Daily in May sent shockwaves through the Chinese bureaucracy. It quoted an unidentified ‘authoritative figure’ warning readers… about the country’s dangerous addiction to debt. After a tumultuous start to the year..., the government had needed strong first-quarter growth to restore confidence in its ability to manage the world’s second-largest economy. So there was relief when it was announced, on April 15, that the economy had grown 6.7% in that period. The feeling soon evaporated, however, over concerns that the growth had been ‘bought’ at the expense of financial discipline. In January alone, banks had issued Rmb2.54tn ($380bn) in new loans, expanding China’s property bubble and giving rise to a new one on its commodity exchanges. According to party and government insiders, the article — a blunt warning that things had to change — was written by one of President Xi Jinping’s key economic advisers…”

July 25 – Bloomberg: “China’s top internet regulator ordered major online companies including Sina Corp. and Tencent Holdings Ltd. to stop original news reporting, the latest effort by the government to tighten its grip over the country’s web and information industries… The companies have ‘seriously violated’ internet regulations by carrying plenty of news content obtained through original reporting, causing ‘huge negative effects,’ according to a report… The sweeping ban gives authorities near-absolute control over online news and political discourse…”

Japan Watch:

July 27 – Reuters (Leika Kihara and Stanley White): “Japan's prime minister unveiled a surprisingly large $265 billion stimulus package… to reflate the world's third-largest economy, adding pressure on the central bank to match the measures with monetary stimulus later this week. The earlier-than-expected announcement to boost the flagging economy sent Japanese and other Asian stock markets higher while it weighed on the safe-haven yen, but lacked crucial details on how much of the package would be direct government spending. The size of the package, at more than 28 trillion yen ($265.30bn), exceeds initial estimates of around 20 trillion yen and is nearly 6% the size of Japan's economy. It will consist of 13 trillion yen in ‘fiscal measures,’ which likely includes spending by national and local governments, as well as loan program.”

July 29 – Bloomberg (Enda Curran and Toru Fujioka): “After more than three years of pumping out wave after wave of cheap money that’s failed to secure its inflation target, the Bank of Japan has signaled a rethink. Instead of buying yet more government bonds, cutting interest rates or pushing further into uncharted territory, the BOJ disappointed some Friday when its policy meeting concluded with only a modest adjustment. Governor Haruhiko Kuroda, 71, and his colleagues declared it was time to assess the impact of their policies, which have variously spurred strong criticism from bankers, bond dealers and some lawmakers and former BOJ executives.”

July 29 – Bloomberg (Toru Fujioka Masahiro Hidaka): “The Bank of Japan kept its key monetary tools unchanged, and will mount a comprehensive review of its policy framework due to ‘considerable uncertainty’ about the outlook for inflation, which has consistently underperformed the central bank’s forecasts. The yen jumped. Governor Haruhiko Kuroda and his team did enlarge a program of buying exchange traded funds by 2.7 trillion yen ($26bn) a year, in a move to shore up confidence in light of post-Brexit volatility in financial markets and a slowdown in emerging markets. A dollar-lending facility was also expanded… Kuroda reiterated that further easing will be done if needed and said the central bank hasn’t hit a policy limit.”

July 23 – Reuters (Tetsushi Kajimoto): “Bank of Japan Governor Haruhiko Kuroda said… he would ease policy further if necessary to achieve its 2% inflation goal, while reiterating a commitment to continue with the current stimulus until prices are anchored there. Speaking to reporters on the sidelines of a G20 meeting of finance ministers and central bankers in the southwestern Chinese city of Chengdu, Kuroda maintained an upbeat view on the Japanese economy and price outlook in spite of rising market expectations for more BOJ monetary stimulus.”

Central Bank Watch:

July 29 – Financial Times (Mehreen Khan): “It’s not yet recovery by a thousand cuts, but the world’s central banks appear to be heading there. Although the Bank of Japan resisted cutting interest rates on Friday, the Bank of England is widely expected to do so next week in a move that would take the total number of post-crisis global central bank cuts to 673, according to figures from JPMorgan Asset Management. In the eight years since the collapse of Lehman Brothers, the world’s top 50 central banks have on average cut rates once every three trading days, notes Alex Dryden at the investment bank. Despite a moderate global recovery, central banks have barely had any time to breath since the summer of 2008 — carrying out mass asset purchases and entering into negative rate territory.”

EM Watch:

July 29 – Bloomberg (Anna Edgerton and Mario Sergio Lima): “Brazil’s former President Luiz Inacio Lula da Silva and six other people, including Andre Esteves of BTG Pactual, were formally charged by a federal judge for allegedly interfering in the country’s largest-ever corruption investigation. Lula, Esteves and the others are accused of trying to obstruct the graft probe known as Carwash that has rocked Brazil’s political establishment and led to the arrest of some of the country’s top business leaders. Extensive corruption in Brazilian public companies has been unveiled by police investigations with the help of dozens of plea bargain deals.”

July 29 – Bloomberg (Anto Antony): “ICICI Bank Ltd., India’s largest private sector lender by assets, posted a 25% drop in first-quarter profit as provisions for bad debt rose. Net income fell to 22.3 billion rupees ($333 million), or 3.83 rupees a share, in the three months ended June 30, from 29.8 billion rupees, or 5.09 rupees, a year earlier…”

Leveraged Speculator Watch:

July 26 – Financial Times (Mary Childs): “Global hedge funds suffered net outflows of $20.7bn in June, as investors pulled more of their money out despite improved performance from most managers. After inflows in April and May, the withdrawals took total aggregate net redemptions for the second quarter to $10.7bn, according… eVestment, marking the third consecutive quarter in which money has left the sector. This represents the longest sequence of quarterly outflows since the second quarter of 2009… In the first three months of 2016, hedge fund redemptions were the worst seen in any quarter for seven years, as investors withdrew more than $15bn, according to data from Hedge Fund Research.”

Geopolitical Watch:

July 27 – Reuters (Ben Blanchard, David Brunnstrom and Idrees Ali): “China and Russia will hold ‘routine’ naval exercises in the South China Sea in September, China's Defence Ministry said…, adding that the drills were aimed at strengthening their cooperation and were not aimed at any other country. The exercises come at a time of heightened tension in the contested waters after an arbitration court in The Hague ruled this month that China did not have historic rights to the South China Sea and criticized its environmental destruction there. China rejected the ruling and refused to participate in the case.”