Saturday, July 2, 2016

Weekly Commentary: Greenspan on Bubbles

Bloomberg’s Tom Keene (Monday, June 27, 2016): “If I take Paul Krugman and Alan Greenspan’s primal cry, ‘we want simple models.’ Is our solution now to think simple or is there a value to the complexity of globalization and the complexity of institutions? Which way should we turn now?”

Alan Greenspan “You want to have as simple a model as you can get that actually captures the complexity of the forces in play… The FRBUS (Federal Reserve Board US) model… that model works exceptionally well for the non-financial area… The financial model was awful. It captured nothing. It didn’t grasp what the issue is. And I tried to reproduce what I would do in ‘The Map and the Territory 2.0’… And I demonstrate what we have going - that we don’t measure correctly - are bubbles and their implications. Bubbles per se are not toxic. The 2000 bubble collapsed. We barely could see a change in economic activity. On October 19, 1987, the Dow Jones went down 23% in one day. You will not find the slightest indication of that collapse of that bubble in the GDP number – or in industrial production or anything else. So I think that you have to basically decide what is causing what. I think the major issue in the financial models has got to be to capture the bubble effect. Bubbles are essentially part of of the fact that human nature is not wholly rational. And you can see it in the data very clearly.”

As Mr. Greenspan spoke on Bloomberg Radio Monday morning, the UK’s FTSE 100 Index was trading just above 6,000. Europe’s STOXX 600 Banks Index was down 7.2% for the session at 120. Germany’s DAX index was quoted at 9,370. Also suffering post-Brexit effects, S&P500 futures were trading just above 2000. Bloomberg ran the headlines: “Greenspan: Brexit ‘Terrible Outcome in All Respects.’” “Greenspan: Euro is Unstable Currency.” The former Fed chairman was extraordinarily gloomy on the UK, Europe and the world. Markets that morning appeared wholly rational.

Yet market rationality was not wholly apparent the rest of the week. The FTSE rallied a full 10% off of Monday’s lows. European banks jumped almost 7.0%. The DAX ended the week at 9,776, up 6.2% from Monday’s lows. The S&P500 rose 5.0% from the Monday low, and the biotechs rallied more than 10%.

I’m no fan of Alan Greenspan, but he remains impressively sharp for a man of 90. I appreciate his analytical focus on Bubbles, though his framework is deeply flawed. At their core, Bubbles are about Credit excess and market distortions. Major Bubbles almost certainly have a major government component. They are indeed toxic, seductively so. Had the Greenspan Fed not backstopped the markets and flooded the system with liquidity post the ’87 Crash, Credit would have tightened and bursting Bubble effects would have been readily apparent throughout the data. Instead, late-eighties (“decade of greed”) excess ensured spectacular Bubbles in junk debt, M&A and coastal real estate. It’s been serial Bubbles ever since.

One could reasonably argue that Bubble toxicity has for almost 30 years been diluted with the tonic of recurring Credit and speculative excess. Non-financial debt expanded 9.2% in 1988, a slight increase from ‘87’s 9.0%. Corporate borrowings accelerated to a blistering 10.9% the year following the crash, as much of the economy maintained a strong inflationary bias. After slipping to 4.8% with the bursting of the "tech" Bubble in 2000, non-financial debt growth jumped to 5.8% in 2001, 6.7% in 2002, 7.7% in 2003 and 9.2% in 2004. Beginning in 2001, household mortgage debt expanded at a double-digit annual pace for six straight years, as mortgage finance and housing demonstrated powerful Bubble Dynamics.

Alan Greenspan these days laments public anger, entitlements and stagnant productivity growth – all on a global basis. But what should we expect after decades of Bubble-induced resource misallocation, malinvestment and wealth redistribution? Myriad Bubble-related issues have finally risen to surface. The dilemma for policymakers is that there’s no New New Bubble of sufficient proportions to reflate the global economy. Frantic efforts to reflate through securities markets inflation have at this point nurtured interminable financial and economic fragilities.

Conventional analysis views the U.S. equities market as notably resilient, with trading action confirming the ongoing bull market. From my perspective, this week’s trading is further evidence of dysfunctional markets. The U.S. stock market casino in particular has reached the point of being incapable of discounting the deteriorating fundamental backdrop.  Pressures keep building.  And any doubt that securities markets are now virtually commanded by global central banks can be put to rest. Policymakers continue to foment dangerous Bubble Dynamics. Is it human nature and the markets that have a propensity toward irrationality, or is the culprit instead hopelessly flawed monetary management?

There’s surely no better mechanism available for quick gains in the marketplace than a short squeeze. Throw in a global pool of speculative finance of now unimaginable dimensions – coupled with heavy hedging and shorting activity and a proliferation of Crowded Trades – and one has the firepower necessary for wildly unstable markets with a propensity for destabilizing melt-ups. That’s where we’re at. Performance pressure has become so intense that no rally can be missed.

It’s been Only 19 Weeks since I titled a CBB “Crisis Management.” Market tumult back in January and February forced global central bankers into ever more desperate measures. Risk markets rallied strongly, though policy measures have demonstrated notably shorter half-lives. Moreover, policies are clearly having much more pronounced impacts on the Financial Sphere than upon the Real Economy Sphere.

June 30 – Financial Times (Adam Samson): “The universe of negative-yielding government debt has increased by more than $1tn in the last month to reach a high of almost $12tn in one of the most tangible results of Britain’s decision to leave the EU… Low sovereign bond yields reflect gloomy economic outlooks and expectations of central bank stimulus. In turn a record $11.7tn of global sovereign debt has now entered sub-zero territory — an increase of $1.3tn since the end of May…”

UK yields (along with bunds, JGBs and Treasuries) sank to record lows this week, with 10-year gilt yields ending down 22 bps this week to 0.86%. And despite the big equities rally and surging risk markets generally, the British pound has taken Brexit seriously, sinking 3.0% this week to a 30-year low. With London as Europe's and much of the world’s financial center, investors needn’t be bothered with fundamental factors such a perpetual Current Account Deficits and massive external debts. Suddenly many things have changed.

In a way, the UK is the poster child for financial Bubble maladjustment. I would strongly argue that it’s no coincidence that after residing at the center of contemporary finance, it is the UK that now finds itself at the epicenter of disenchantment with European integration and globalization more generally. The UK economy deindustrialized, as the economic focus shifted to finance and services. As a global financial hub, enormous amounts of wealth have gravitated to London, enriching the fortunate few while papering over deep structural deficiencies. Meanwhile, with much of the population suffering from economic stagnation and egregious wealth disparities, the backlash against “globalization” has reached a turning point.

I would contend that globalization is not the true culprit, just as I argue that Capitalism is certainly not the root of all evil. The problem lies with unfettered finance and monetary mismanagement. Pricing mechanisms and resource allocation, the lifeblood of free-market Capitalism, will not function well within a backdrop of unlimited cheap finance. Similarly, so-called “globalization” is destined for failure in a backdrop of limitless financial claims.

I remain a proponent of “free trade.” Yet in the long-term it’s imperative that trading relationships involve exchanging things for things, rather than IOUs for things. I would go so far as to argue that this simple concept would go a long way toward nurturing healthy trading relationships, sound economic underpinnings and a more stable global financial backdrop.

For decades now, the U.S. and UK became accustomed to exchanging IOUs for goods and services. It has worked miraculously, or seemingly so. Consequences have included deep economic maladjustment and a world inundated with debt/financial claims. Look no further for the root cause of endemic financial instability and serial boom and bust dynamics that now afflict the entire world.

I wish to be clear: I am not arguing for barter between individual nations. Trade deficits and surpluses can exist between individual countries. But overall, countries should avoid running persistently large overall Current Account Deficits. Deficits with some countries should be offset by surpluses with others. Persistent trade deficits should be countered with tighter monetary policy.

The pound closed Friday trading near 30-year lows. British IOUs, in currency terms, have been devalued about 10% since Brexit. How robust is Britain’s economic structure if it loses the benefits associated with being Europe’s financial hub and with it financialization more generally? Benefiting from the prospect of aggressive monetary stimulus and devaluation, UK stocks participated in this week’s global equities rally. Notably, UK bank stocks were slammed hard again Monday and closed Friday down for the week.

Bank stocks again badly lagged during this week’s global rally. Deutsche Bank (the IMF’s “most important net contributor to systemic risks”) dropped another 7% this week (to a 30-year low), increasing 2016 losses to almost 44%. Italian bank stocks sank another 5.4% (down 54% y-t-d), as talk turned to contentious issues such as rescue packages and measures to avert bank runs. While European equities indices rallied, Europe’s STOXX Bank index declined 2.4% (down 31% y-t-d). And despite Japan’s Nikkei 225 equities index rallying 4.9%, the TOPIX Banks Index slipped 0.4% (down 37% y-t-d). The S&P500 jumped 3.2% this week approaching record highs, while the banks (BKX) rallied only 1.1% and the broker/dealers (XBD) ended the week little changed.

Central banks lined up this week to offer support for vulnerable financial markets. Post-Brexit mayhem created a critical juncture, and policymakers got the market bounce they desperately needed. Clearly, central bankers retain the capacity to incite powerful short squeezes. There was considerable hedging going into the UK referendum, and the unwind of derivative trades and short positions provided fuel for this week’s recovery.

But it’s one things inciting higher prices in an over-liquefied Financial Sphere and quite another stimulating sustainable activity in the maladjusted Real Economy Sphere. Indeed, I’ve argued that a fundamental risk associated with inflationist monetary policies is the widening divergence between inflated securities markets and deflating economic prospects. This schism widened meaningfully this week.

Certainly, fixed income, the precious metals and global bank stocks view the world much differently than equities. Pondering such an extraordinary backdrop, I’ll return to Greenspan. Bubbles are toxic and, regrettably, toxicity has been accumulating for several decades. Fissures in global finance – the Financial Sphere - have uncovered pernicious forces undermining economies and societies around the world.

It was also a fascinating week in commodities and currencies. Gold stocks (HUI) surged 8.9%. Silver jumped 11.6% and copper rose 5.0%. The commodities currencies caught bids versus the dollar, with the Brazilian real gaining 4.1%, the South African rand 3.5%, the Mexican peso 3.0%, the Norwegian krone 1.1%, the Canadian dollar 0.7%, the New Zealand dollar 0.7% and the Australian dollar 0.4%. EM equities were notably strong. Stealth U.S. dollar weakness and/or anticipation of QE4?

Everyone knows the U.S. economy is the “least dirty shirt.” We all appreciate that U.S. financial markets win by default in such a messed up world. “Money” has to go somewhere. London may be Europe’s financial hub and the UK the poster child for globalization/financialization. But a strong case can be made that the U.S. economy is more dependent on Wall Street and securities market inflation than anyone. More than ever before, take away asset price inflation and the U.S. economic structure will reveal serious deficiencies. Meanwhile, even after succumbing to desperate measures, global central bankers are at this point failing at global reflation.

I remain comfortable with the view that Brexit is a catalyst for a crisis of confidence for Europe and European integration. And despite a surprising burst of equity market exuberance, I suspect Brexit will, as well, be recognized as a key inflection point in the realm of globalization/financialization. This bodes ill for U.S. and Chinese economies.

Global markets at this point seem rather convinced that a lot more QE is in the offing. Bond markets are confident that this liquidity deluge will have minimal lasting real economy impact. It’s a replay of 2007/08: mortgage finance, global M&A and equities were determined to keep dancing, while safe haven bonds knew the party couldn’t last. Objectively, $12 TN of negative yielding bonds is about the strongest evidence I could have imagined that central bank inflationism and a multi-decade global Bubble are nearing the end of the line.


For the Week:

The S&P500 (up 2.9% y-t-d) and the Dow (up 3.0%) each jumped 3.2%. The Utilities surged 4.4% (up 21.5%). The Banks recovered 1.1% (down 12.2%), while the Broker/Dealers were little changed (down 16%). The Transports advanced 3.2% (up 0.7%). The S&P 400 Midcaps rallied 2.9% (up 7.3%), and the small cap Russell 2000 gained 2.6% (up 1.8%). The Nasdaq100 rose 3.5% (down 3.4%), and the Morgan Stanley High Tech index gained 2.0% (down 2.1%). The Semiconductors increased 1.4% (up 3.2%). The Biotechs surged 5.7% (down 18.7%). With bullion up $26, the HUI gold index advanced 8.9% (up 133%).

Three-month Treasury bill rates ended the week at 25 bps. Two-year government yields declined four bps to a one-year low 0.59% (down 46bps y-t-d). Five-year T-note yields fell eight bps to a multi-year low 0.99% (down 76bps). Ten-year Treasury yields dropped 12 bps to 1.44% (down 81bps). Long bond yields sank 18 bps to a record low 2.23% (down 79bps).

Greek 10-year yields sank 63 bps to 7.68% (up 36bps y-t-d). Ten-year Portuguese yields fell 32 bps to 2.98% (up 46bps). Italian 10-year yields dropped 32 bps to 1.23% (down 36bps). Spain's 10-year yields collapsed 48 bps to a record low 1.14% (down 63bps). German bund yields declined eight bps to negative 0.13% (down 75bps). French yields dropped 23 bps to 0.15% (down 84bps). The French to German 10-year bond spread narrowed 15 bps to 28 bps. U.K. 10-year gilt yields fell 22 bps to a record low 0.86% (down 110bps).

Japan's Nikkei equities index surged 4.9% (down 17.6% y-t-d). Japanese 10-year "JGB" yields dropped nine bps to a record low negative 0.29% (down 53bps y-t-d). The German DAX equities index increased 2.3% (down 9.0%). Spain's IBEX 35 equities index surged 6.2% (down 13.4%). Italy's FTSE MIB index rallied 3.6% (down 23.9%). EM equities rallied. Brazil's Bovespa index surged 4.4% (up 21%). Mexico's Bolsa gained 3.0% (up 7.5%). South Korea's Kospi index rose 3.2% (up 1.3%). India’s Sensex equities index jumped 2.8% (up 3.9%). China’s Shanghai Exchange advanced 2.7% (down 17.1%). Turkey's Borsa Istanbul National 100 index jumped 3.4% (up 8.7%). Russia's MICEX equities index added 0.6% (up 7.7%).

Junk funds saw outflows of $1.628 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell eight bps to 3.48% (down 49bps y-o-y). Fifteen-year rates declined five bps to 2.78% (down 48bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 3.67% (down 41bps).

Federal Reserve Credit last week declined $2.1bn to $4.436 TN. Over the past year, Fed Credit declined $4.8bn. Fed Credit inflated $1.625 TN, or 58%, over the past 190 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $13.5bn last week to $3.225 TN. "Custody holdings" were down $154bn y-o-y, or 4.6%.

M2 (narrow) "money" supply last week rose $18.1bn to a record $12.817 TN. "Narrow money" expanded $812bn, or 6.8%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits rose $16.8bn, and Savings Deposits increased $2.8bn. Small Time Deposits were little changed. Retail Money Funds declined $4.1bn.

Total money market fund assets gained $14.9bn to $2.718 TN. Money Funds rose $104bn y-o-y (4.0%).

Total Commercial Paper expanded $11.9bn to $1.051 TN. CP expanded $99bn y-o-y, or 10.4%.

Currency Watch:

June 30 – Bloomberg (Chikako Mogi and Susanne Barton): “The yen is approaching its biggest monthly advance since 1998 as financial turmoil sparked by the U.K.’s decision to leave the European Union spurs a global flight to haven assets. Japan’s currency strengthened on refuge demand after Bank of England Governor Mark Carney said the bank is likely to loosen monetary policy within months… During Thursday’s session, Japan’s currency swung between its strongest monthly performance since a 7.8% rise in October 2008 and an 8.2% surge in December 1998.”

The U.S. dollar index was little changed this week at 95.64 (down 3.1% y-t-d). For the week on the upside, the Brazilian real increased 4.1%, the South African rand 3.5%, the Mexican peso 3.0%, the Norwegian krone 1.1%, the Canadian dollar 0.7%, the New Zealand dollar 0.7%, the Australian dollar 0.4%, the Swedish krona 0.3% and the euro 0.2%. For the week on the downside, the British pound declined 3.0%, the Japanese yen 0.3% and the Swiss franc 0.1%. The Chinese yuan declined another 0.6% versus the dollar.

Commodities Watch:

The Goldman Sachs Commodities Index gained 2.0% (up 20.8% y-t-d). Spot Gold advanced 1.9% to $1,341 (up 26%). Silver surged 11.6% to $19.86 (up 44%). WTI Crude gained $1.64 to $49.28 (up 33%). Gasoline slipped 0.3% (up 20%), while Natural Gas jumped 12.4% (up 28%). Copper advanced 5.0% (up 4%). Wheat sank 7.5% (down 9%). Corn dropped 7.5% (unchanged).

Europe Watch:

June 27 – Bloomberg (Caroline Hyde, Rainer Buergin and Arne Delfs): “German Chancellor Angela Merkel’s government urged European Union leaders to avoid encouraging ‘centrifugal forces’ after the U.K. voted to leave the bloc, while saying that a joint response will take time. ‘We should be patient, we should allow the necessary time for this consideration,’ Peter Altmaier, Merkel’s chief of staff, said… Meantime, ‘I expect a strong signal by all Europeans that we want to reassure markets.’”

June 28 – Financial Times (Jim Brunsden and Anne-Sylvaine Chassany): “The City of London should no longer be able to clear euro-denominated trades, the French president said…, adding to post-Brexit fears. François Hollande said at the end of a summit in Brussels… that it would be unacceptable for the crucial stage in the trading of derivatives and equities to take place in the UK. ‘The City, which thanks to the EU, was able to handle clearing operations for the eurozone, will not be able to do them,’ he said. ‘It can serve as an example for those who seek the end of Europe … It can serve as a lesson.’”

June 30 – Wall Street Journal (Paul Hannon): “Eurozone consumer prices were slightly higher on the year in June, but that left the European Central Bank no closer to meeting its inflation target than when it launched the first of a series of stimulus measures intended to achieve that goal two years ago. Figures released by the European Union’s statistics agency Thursday underline the difficulty of boosting inflation at a time of weak demand growth not just in the eurozone, but around the world. And with the U.K.’s decision to leave the European Union threatening to slow the eurozone’s modest recovery further, the ECB has indicated it may have to provide yet more stimulus to meet its objective. The ECB’s June 2014 stimulus program came as the annual rate of inflation hit 0.5%. It has never been higher since then.”

June 30 – Bloomberg (Abhijith Ganapavaram): “Standard & Poor's Global Ratings said on Thursday it had cut its long-term credit rating on the European Union to 'AA' from 'AA+' but raised its outlook to ‘stable’ from ‘negative’ after the United Kingdom voted to leave the bloc. S&P is the first major ratings agency to cut rating on the EU… ‘After the decision by the UK electorate to leave the EU...we have reassessed our opinion of cohesion within the EU, which we now consider to be a neutral rather than positive rating factor,’ S&P said.”

Brexit Watch:

June 25 – New York Times (Jim Yardley, Alison Smale, Jane Perlez and Ben Hubbard): “Britain’s historic vote to leave the European Union is already threatening to unravel a democratic bloc of nations that has coexisted peacefully together for decades. But it is also generating uncertainty about an even bigger issue: Is the post-1945 order imposed on the world by the United States and its allies unraveling, too? Britain’s choice to retreat into what some critics of the vote suggest is a ‘Little England’ status is just one among many loosely linked developments suggesting the potential for a reordering of power, economic relationships, borders and ideologies around the globe. Slow economic growth has undercut confidence in traditional liberal economics, especially in the face of the dislocations caused by trade and surging immigration. Populism has sprouted throughout the West. Borders in the Middle East are being erased amid a rise in sectarianism. China is growing more assertive and Russia more adventurous. Refugees from poor and war-torn places are crossing land and sea in record numbers to get to the better lives shown to them by modern communications.”

June 27 – New York Times (Neil Irwin): “Sometimes, something bad happens, and it creates huge financial market swings and long-lasting economic ripples. The Sept. 11 terrorist attacks were an example, as was the 2011 Japanese nuclear disaster. But the so-called Brexit is different. The immediate financial downturn after Britain voted Thursday to leave the European Union resembles the fallout from those disasters. But the other events were largely disconnected from the broader economic currents of their time. They were one-off events, at least in terms of their economic ramifications. What makes Brexit so concerning is that it accentuates and deepens global forces that have been building for years. So far, governments have been unable to limit any of it. And those forces have self-reinforcing, vicious-cycle dimensions that make it a particularly perilous time for the global economy, even though the type of full-scale panic that followed the collapse of Lehman Brothers in 2008 looks unlikely.”

June 30 – Bloomberg (Neil Callanan): “Britain’s decision to leave the European Union has ‘unleashed’ a crisis in financial markets similar to the global financial crisis of 2007 and 2008, George Soros told the European Parliament… ‘This has been unfolding in slow motion, but Brexit will accelerate it. It is likely to reinforce the deflationary trends that were already prevalent,’ the billionaire investor said… He has warned that a hard landing in China is ‘practically unavoidable,’ arguing that its debt-fueled economy resembles the U.S. at the onset of the financial crisis. Continental Europe’s banking system hasn’t recovered from the financial crisis and will now be ‘severely tested,’ Soros said.”

June 27 – UK Guardian (Jill Treanor and Katie Allen): “The UK has been stripped of its last AAA rating as credit agency Standard & Poor’s warned of the economic, fiscal and constitutional risks the country now faces as a result of the EU referendum result. The two-notch downgrade came with a warning that S&P could slash its rating again. It described the result of the vote as ‘a seminal event’ that would ‘lead to a less predictable stable and effective policy framework in the UK’. The agency added that the vote to remain in Scotland and Northern Ireland ‘creates wider constitutional issues for the country as a whole’.”

June 28 – Financial Times (Martin Arnold): “Moody’s has become the latest institution to give a thumbs down to the prospects for the UK’s banking system after the country voted to leave the EU, changing its outlook for the sector from stable to negative. The credit rating agency also adopted a more pessimistic view on Britain’s main life insurers… and several infrastructure and project finance issuers. The moves follow the agency’s decision to lower its outlook for the UK government after the Brexit result was announced on Friday. ‘We expect lower economic growth and heightened uncertainty over the UK’s future trade relationship with the EU to lead to reduced demand for credit, higher credit losses and more volatile wholesale funding conditions for UK financial institutions,’ said Laurie Mayers, associate managing director at Moody’s.”

June 29 – Financial Times (Alex Barker, Jim Brunsden and Guy Chazan): “Europe’s leaders have dug in their heels over uncontrolled migration in the single market, scotching UK hopes for a favourable deal in a direct snub to prime minister David Cameron’s plea to recognise British voters’ concerns. The move to damp Westminster expectations to curb free movement came after the EU’s remaining 27 members met in Brussels for the first time without the UK — a political watershed after 43 years of British membership. ‘There will be no single market à la carte,’ said Donald Tusk, the EU Council president…”

June 29 – Bloomberg (Karl Lester M Yap, Andrew Mayeda and Chiara Albanese): “The pound is at risk of fading from the top ranks of central-bank asset holdings following Britain’s decision to leave the European Union. The world’s foremost reserve currency a century ago, sterling has been overtaken by the dollar and the euro, mirroring the U.K.’s waning influence in the global economy. Now its 5% share of foreign-exchange reserves is in danger of shrinking further because of Brexit, compounded by forces including China’s push to bolster the international role of the yuan.”

Italy Watch:

June 30 – Bloomberg (Aoife White): “Italy was given the go-ahead by the European Commission to supply as much as 150 billion euros ($166bn) in government liquidity guarantees for its struggling banks until the end of the year, according to an EU official. Liquidity support for solvent banks is a ‘precautionary measure’ requested by Italy, the EU said… The guarantees of senior debt allow lenders to maintain access to financing… ‘There is no expectation that the need to use this’ should arise, the commission said... Saddled with some 360 billion euros in soured loans and a sputtering economy, Italy’s lenders have been sliding toward the type of crisis that other European countries dealt with years ago.”

June 28 – Wall Street Journal (Viktoria Dendrinou and Laurence Norman): “The European Commission will do everything to avoid a run on Italian banks following the turmoil in global markets spurred by the U.K.’s vote to leave the European Union, commission President Jean-Claude Juncker said… Speaking at the end of a summit of EU leaders here, Mr. Juncker said he discussed the state of Italian banks with Italian Prime Minister Matteo Renzi, and that the bloc must make sure that the banking sector in Italy and elsewhere is well protected. ‘The commission will do everything to avoid any kind of bank run,’ Mr. Juncker said. ‘This is not a danger for Italy for now but we have to make sure given the uncomfortable global circumstances we are in that the banking sector in Italy and elsewhere will be protected in the best way possible.’”

June 29 – Reuters (Francesco Guarascio): “Germany and the European Commission told Italy on Wednesday to follow the rules after Italy made preliminary plans to prop up its banks in the wake of volatility caused by Britain's vote to leave the European Union. Rome says it is concerned that Italian banks, which hold 360 billion euros ($400bn) of bad loans, a third of the euro zone's total, risk attack by hedge funds betting that market turmoil could tip them into full-blown crisis. Banking and government sources said Italy was preparing to protect its banking industry by requesting more flexibility from the EU on both public spending and state aid for its lenders. The Italian initiative did not go down well in Germany, the main contributor to the EU budget and a staunch supporter of fiscal discipline and strict rules. ‘On the banking union we established specific rules as far as the winding down of banks, the recapitalization of banks is concerned,’ German Chancellor Angela Merkel told a news conference… ‘We can't come up with new rules every two years,’ she said…”

June 29 – Financial Times (Rachel Sanderson): “An attempt by Matteo Renzi to use Brexit-driven market turmoil to secure EU approval for Italy’s plans to recapitalise its banks without triggering bail-in rules has been rebuffed by Germany and the European Central Bank. ‘We wrote the rules for the credit system, we cannot change them every two years,’ Angela Merkel, Germany’s chancellor, said on Wednesday in her first public comments since the Italian prime minister floated his idea on Monday. Mr Renzi had sought to rally support from Ms Merkel and French leader François Hollande for a suspension of bail in rules to allow Italy to recapitalise its banking sector.”

Central Bank Watch:

June 25 – Reuters (John Revill): “Central banks are ready to cooperate to support financial stability in the wake of Britain's vote to leave the European Union, the Bank for International Settlements said… Central bankers gathered at the organization's global economy meeting in Switzerland discussed the implications of the referendum. ‘Governors endorsed the contingency measures put in place by the Bank of England and emphasized the preparedness of central banks to support the proper functioning of financial markets,’ said Agustín Carstens, chairman of the global economy meeting.”

June 28 – Wall Street Journal (Tom Fairless and Jon Hilsenrath): “European Central Bank President Mario Draghi urged central banks to better coordinate policies to confront the problem of ultralow inflation in an era of slow global growth, underscoring the conundrum he and his associates face in the wake of Britain’s vote to leave the European Union. The guardians of the global monetary system face conflicting pressures as they seek to support their economies amid new turbulence. They also run the risk that their efforts will work at odds with each other and destabilize the financial system. Central banks should examine whether their policies are ‘properly aligned,’ Mr. Draghi said… He further warned that currency devaluations aimed at boosting national competitiveness are a ‘lose-lose’ for the global economy.”

June 30 – Bloomberg (Piotr Skolimowski): “The European Central Bank is considering loosening the rules for its bond purchases to ensure enough debt is available to buy in the aftermath of the Brexit vote… Policy makers are concerned that the pool of securities eligible for quantitative easing has shrunk after investors piled into the region’s safest assets and pushed down yields on some sovereign debt too far to meet current criteria, said the people, who asked not to be identified… Some Governing Council members now favor changing the allocation of bond purchases away from the size of a nation’s economy toward one more in line with outstanding debt… Such a move risks controversy because securities issued by highly leveraged governments such as Italy -- the world’s third-largest debtor after the U.S. and Japan -- would benefit.”

July 1 – Reuters (Balazs Koranyi and Francesco Canepa): “The European Central Bank is not currently considering buying government debt out of proportion to euro zone countries' shareholding in the bank and the hurdle for abandoning this capital key is high, sources close to the ECB said... Bond markets rallied on Friday after Bloomberg reported that the ECB was considering giving up the capital key due to a shortage of German paper, which investors see as safe and have piled into in the aftermath of Britain's vote to leave the European Union.”

June 30 – Bloomberg (Scott Hamilton): “Mark Carney signaled the Bank of England could cut interest rates within months as the central bank tries to shield an economy rattled by the shock of Brexit and the chaos engulfing Britain’s political classes. In his second televised address since the country voted to leave the European Union, the governor said… that officials won’t hesitate to act when it comes to safeguarding the economy or the resilience of the financial system. The BOE will also continue its liquidity auctions for banks on a weekly, rather than monthly, basis and consider a ‘host of other measures.’ The pound slumped…”

June 27 – Reuters (Minami Funakoshi and Tetsushi Kajimoto): “Japanese Prime Minister Shinzo Abe on Monday instructed Finance Minister Taro Aso to watch currency markets ‘ever more closely’ and take steps if necessary, in the wake of Britain's historic vote to leave the European Union. Abe made the comments at an emergency meeting with Aso and Bank of Japan Deputy Governor Hiroshi Nakaso... While Abe ordered the BOJ to ensure ample liquidity in markets, his government is ready to provide the economy fiscal support, with an eye on expanding planned stimulus steps to total more than 10 trillion yen ($98.03bn), sources told Reuters.”

June 28 – Bloomberg (Liz McCormick and Matthew Boesler): “Circle Jan. 31, 2018, on the calendar. That’s the soonest the Federal Reserve hikes next. At least if money market derivatives are to be believed. Traders, who have consistently been better at projecting the path of interest rates than the Fed itself, are now pricing in a greater probability that policy makers will cut rates in upcoming meetings than raise them. They don’t assign more than a 50 percent chance of an increase until the beginning of 2018…”

June 29 – Bloomberg: “Chinese authorities intervened via banks to support the offshore yuan in morning trading, according to people with knowledge of the matter. The People’s Bank of China wants to maintain stability in the currency, the people said… The yuan strengthened as much as 0.26% against the dollar in mid-morning in Hong Kong’s freely traded market, paring its discount to the onshore rate. The offshore yuan has fallen 1.2% since Britain unexpectedly voted to leave the European Union, the biggest loss among 12 Asian currencies.”

June 30 – Reuters (Elias Glenn): “Chinese Premier Li Keqiang said… he wouldn't allow the post-Brexit panic that roiled global currencies and stocks to send the country's financial markets into a tailspin, an indication authorities would intervene if needed to prevent market chaos. ‘It's hard to avoid short-term volatility in China's capital markets, but we won't allow rollercoaster rides and drastic changes in the capital markets,’ said Li, speaking at the World Economic Forum… ‘It's important for all of us to work together to strengthen confidence, prevent the spread of panic, and to maintain the stability of capital markets.’”

June 30 – Bloomberg (Nacha Cattan and Eric Martin): “Mexico broke with the Federal Reserve and raised its key interest rate by a half-point after the peso tumbled to a record low following the U.K.’s vote to leave the European Union. Banco de Mexico increased the overnight rate to 4.25% Thursday, compared to the 4% median forecast… ‘Banxico has been forced to act before it’s too late,’ Gabriel Lozano, chief Mexico economist at JPMorgan Chase & Co, said… ‘A lingering weak exchange rate increases the risk of further price revisions.’”

Fixed-Income Bubble Watch:

June 30 – Wall Street Journal (Heather Gillers): “Three major bond insurers are bracing for the possibility of a historic payout if Puerto Rico defaults on debt due Friday. Puerto Rico Gov. Alejandro Garcia Padilla… reiterated statements that the commonwealth cannot afford to make the payment and cited an April law that allows Puerto Rico to temporarily stop paying bond debt. Mr. Garcia Padilla has long said that the island would not be able cover the July 1 payment of nearly $2 billion. That could trigger as much as hundreds of millions in payments from insurers Ambac Financial Group, National Public Finance Guarantee Corp. and Assured Guaranty Ltd. to cover principal and interest, in what would be the biggest insurer payout to date in Puerto Rico.”

June 30 – Bloomberg (Michelle Kaske and Sowjana Sivaloganathan): “The rate for borrowing and lending government debt surged Thursday to the highest since the financial crisis as banks reined in collateral lending to shore up balance sheets ahead of the quarter-end. With fewer dealers borrowing cash and posting government debt as collateral, money funds -- the key lenders of cash in the repurchase agreement market -- gravitated to buying Treasury bills and parking cash with the Fed via their RRPs during quarter-end, driving overnight rates higher. General collateral repo rates opened Thursday at 0.85% and reached 1.1% by 12 p.m. in New York, twice Wednesday’s close… The average level of overnight general collateral repo traded with ICAP was 0.847% Thursday morning, the highest since October 2008.”

June 30 – Bloomberg (Michelle Kaske and Sowjana Sivaloganathan): “Puerto Rico Governor Alejandro Garcia Padilla says the island won’t pay general-obligation debt coming due on Friday even with President Obama poised to sign a bill that enables the commonwealth to restructure its $70 billion debt load. Puerto Rico and its agencies owe $2 billion of principal and interest. It may mark the island’s biggest default yet and the first time it’s skipped payments on general-obligation bonds.... The federal bill, called Promesa, enables the commonwealth to restructure its debt through a control board that will also weigh in on its spending plans.”

June 27 – Financial Times (Adam Samson): “The risk premium investors demand to hold the debt of the lowliest-rated US companies jumped on Friday by the most since Standard & Poor’s cut America’s credit rating in 2011 as investors sold junk bonds… The spread on high-yield US bonds jumped by 47 bps to 6.39%, according to the BofA Merrill Lynch US high-yield index. The climb was the biggest since August 8, 2011, when the S&P 500 index plummeted by 6.7% as investors reacted to ratings company S&P stripping the US of its top-notch ‘AAA’ rating. Prior to that, the spread, or the difference in yield between corporate bonds and US Treasury bonds of the same duration, had not risen by such a wide margin since the financial crisis in 2008, BofA data show.”

Global Bubble Watch:

June 30 – Financial Times (Adam Samson): “The universe of negative-yielding government debt has increased by more than $1tn in the last month to reach a high of almost $12tn in one of the most tangible results of Britain’s decision to leave the EU. Record lows yields… have produced outsize returns for bondholders in some of the world’s largest, safest and most liquid securities.”

June 30 – Reuters (Brian Chappatta): “The U.K.’s surprise vote to leave the European Union isn’t seen having fallout as severe as the 2008 financial crisis, but you wouldn’t know it from the rush to safety in the global market for sovereign debt. Government bonds worldwide have gained 2.3% in June, the most since December 2008… The effective index yield is down to 0.5%, from 0.74% at the end of May, as investors bet that a Brexit vote would curb economic expansion and make it tougher for central banks in the U.S., Europe and Japan to stoke inflation.”

June 26 – Reuters (Marc Jones): “Global economic policy urgently needs rebalancing, the Bank for International Settlements (BIS) said…, as the world faces a ‘risky trinity’ of high debt, low productivity growth and dwindling firepower at the world's big central banks. The BIS, an umbrella body for major central banks, said in its annual report that the global economy was highly exposed even before Thursday's vote by Britain to leave the European Union. ‘There are worrying developments, a sort of ‘risky trinity’, that bear watching,’ said the head of the BIS monetary and economic department, Claudio Borio. ‘Productivity growth that is unusually low, casting a shadow over future improvements in living standards; global debt levels that are historically high, raising financial stability risks; and room for policy maneuver that is remarkably narrow.’ He said the global economy cannot afford to rely any longer on the debt-fueled growth model that has brought it to the current juncture.”

June 26 – Bloomberg (Boris Groendahl): “Policy makers have to take tougher action to sever the link between banks and sovereigns that wreaked so much havoc during the last financial crisis, according to the Bank for International Settlements. The current regulatory treatment of government debt on banks’ balance sheets is ‘no longer tenable,’ the… lender said in its annual report… Financial crises are an immense cost to taxpayers, the BIS said… In advanced economies, the median increase in public debt was equivalent to 15% of economic output in the three years after the crisis. After the 2008 crisis, that debt increase was even bigger: In advanced economies, the median rise was 30% of output, and debt now stands at nearly 100%.”

June 30 – MarketWatch (Hans Bentzien): “Deutsche Bank AG is the riskiest financial institution in the world as a potential source of external shocks to the financial system, according to the International Monetary Fund. ‘Among the G-SIBs (globally systemically important banks), Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse,’ the IMF said in its Financial Sector Assessment Program. ‘In particular, Germany, France, the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country,’ the IMF added. The importance of Deutsche Bank emphasizes the need for risk management, intense supervision and monitoring cross-border exposure as well as the ability of globally systemic banks to carry out new resolution regimes, IMF said.”

June 30 – Reuters (Freya Berry and Elzio Barreto): “Global equity capital markets activity has sunk to a four-year low in 2016 according to quarterly ThomsonReuters data… The value of worldwide equity capital markets (ECM) activity has almost halved so far this year compared with the same period in 2015 as geopolitical uncertainty, the prospect of a U.S. rate rise and global growth concerns bite. Levels were down 46.5% at $280.8 billion, according to quarterly data from Thomson Reuters. Money raised by European initial public offerings (IPOs) sank 56% to $16.2 billion… London IPOs raised almost 60% less than the same period in 2015.”

June 29 – Financial Times (James Fontanella-Khan, Arash Massoudi and Laura Noonan): “Dealmakers have warned that uncertainty over Europe and fears of a Donald Trump presidency in the US are set to further slow merger and acquisition activity, after global deal volumes in the first half of the year fell 23%... ‘There have been a number of factors weighing on CEOs and boards in the current market: the regulatory environment, interest rate risk, the US elections and of course, most recently, Brexit.’”

June 28 – Bloomberg (Kimberley Painter and Narayanan Somasundaram): “Stand-alone house sales in New South Wales, Australia’s most populous state, dropped the most since August 2010 in May…, another indication the property boom is losing momentum. Detached house sales in the state… fell 11.5%... Record prices and tighter bank mortgage lending criteria are denting affordability and construction of new homes…”

U.S. Bubble Watch:

June 29 – CNBC (Katy Barnato): “Contagion from the U.K. financial sector poses a risk to the U.S. following Britain's decision to quit the European Union (EU), Goldman Sachs said… The investment bank said financial contagion was a greater threat to the U.S. than a hit to trade as a result of any falloff in British growth. ‘Although a U.K. contraction would be unhelpful for the U.S., trade-related contagion should remain manageable ... The risk of financial spillovers is greater,’ Goldman said in a report… The U.K. and the U.S. are among the most financially interconnected countries in the world… It said the U.S. banking system's total exposure to the U.K. amounted to $919 billion — far exceeding its exposure to any other country. U.K. banks hold an aggregate of $1.4 trillion of financial claims on U.S. borrowers…”

June 28 – CNBC (Scot Cohn): “Legislators in a handful of oil-rich states are struggling to do the seemingly impossible as the 2016 fiscal year draws to a close this week: balancing their budgets, as required by law, despite massive declines in revenues due to falling oil prices. The National Conference of State Legislatures says nearly a dozen states still had not enacted budgets for the new fiscal year as of mid-June. Some — including oil states Louisiana and Alaska — are facing a full-blown budget crisis. Even after painful cuts, budget gaps in those two states alone total nearly $4 billion.”

June 29 – Wall Street Journal (Josh Barbanel): “Manhattan apartment sales are tumbling, according to new market data, and several brokers said it is a sign that a significant correction is underway as buyers hold back. Sales in the second quarter were down more than 10% compared with the same quarter in 2015, the slowest pace since the recession year of 2009. Sales of co-ops fell by 26% and sales of lower priced apartments going for less than $1 million were down 20%... ‘I think it is a correction, a serious correction,’ said Hall F. Willkie, president of brokerage Brown Harris Stevens.”

China Bubble Watch:

June 29 – Bloomberg (Kyoungwha Kim): “The yuan’s worst quarterly performance on record is raising the risk of capital flight. China’s currency has slumped 2.9% since the end of March, the most since the nation unified the official and market rates at the start of 1994, to trade near its lowest level in five years. Losses deepened after the U.K.’s vote to secede from the European Union led to a jump in the dollar and dented the outlook for Chinese exports.”

June 29 – Reuters (Keven Yao, Nathaniel Taplin and Lu Jianxin): “China's central bank would tolerate a fall in the yuan to as low as 6.8 per dollar in 2016 to support the economy, which would mean the currency matching last year's record decline of 4.5%, policy sources said. The yuan is already trading at its lowest level in more than five years, so the central bank would ensure any decline is gradual for fear of triggering capital outflows and criticism from trading partners… said government economists and advisers involved in regular policy discussions… ‘The central bank is willing to see yuan depreciation, as long as depreciation expectations are under control,’ said a government economist, who requested anonymity due to the sensitivity of the matter. ‘The Brexit vote was a big shock. The market volatility may last for some time.’”

June 30 – MarketWatch (Sue Chang): “Andy Xie isn’t known for tepid opinions. The provocative Xie, who was a top economist at the World Bank and Morgan Stanley, found notoriety a decade ago when he left the Wall Street bank after a controversial internal report went public. Today, he is among the loudest voices warning of an inevitable implosion in China… Xie, now working independently and based in Shanghai, says the coming collapse won’t be like the Asian currency crisis of 1997 or the U.S. financial meltdown of 2008. …Xie said China’s trajectory instead resembles the one that led to the Great Depression, when the expansion of credit, loose monetary policy and a widespread belief that asset prices would never fall contributed to rampant speculation that ended with a crippling market crash… ‘The government is allowing speculation by providing cheap financing…’ China ‘is riding a tiger and is terrified of a crash. So it keeps pumping cash into the economy. It is difficult to see how China can avoid a crisis.’”

June 25 – Reuters (Sumeet Chatterjee): “Years of breakneck growth for China's top insurers has been partly fueled by a splurge on risky investment products that could punch multi-billion-dollar holes in their balance sheets if the slowing economy triggers heavy debt defaults. Industry premiums have increased by an average 13.4% a year since 2010, according to the China Insurance Regulatory Commission (CIRC), but in an environment of low interest rates and unreliable stock markets, insurers have increasingly looked to alternative investments to make the returns they need to service their growing business. A Reuters survey of the accounts of the top five listed insurers… showed their holding of assets other than shares, bonds and cash had more than quadrupled in five years to 984 billion yuan ($150bn). These alternative investments - which include opaque, risky shadow banking-linked assets such as trust schemes and wealth management products (WMP) - account for roughly 16% of the top five's total assets, up from 5% in 2011…”

June 30 – Bloomberg: “China’s corporate bond sales tumbled the most in almost five years in the second quarter as defaults surged, and Industrial Bank Co. expects the difficult market environment to continue. The nation’s companies sold 1.85 trillion yuan ($278bn) of onshore bonds, a 30% drop from the previous three months… That was the sharpest quarter-on-quarter decline since September 2011. Issuance is still more than twice of the level four years earlier after rapid expansion in the recent quarters.”

Brazil Watch:

June 29 – Bloomberg (David Biller and Tatiana Freitas): “Brazil’s broadest measure of inflation accelerated more than all economists estimated in June, further dimming prospects for a rate cut... Wholesale, consumer and construction prices as measured by the IGP-M index rose 1.69% in June after a 0.82% advance in May… That was above all estimates from 27 economists surveyed… The index, which is weighted 60% in wholesale prices, rose 12.2% in the past 12 months -- the most in nearly eight years.”

EM Bubble Watch:

June 28 – Bloomberg (Anto Antony): “Risks to India’s banking industry have ‘sharply increased’ since September as surging bad loans drag lenders’ profitability to the lowest since at least 1999, according to the Reserve Bank of India. Banks’ return on assets fell to 0.4% at the end of March from 0.8% a year earlier… The industry’s gross bad-loan ratio jumped to a 13-year high of 7.6%... Under a ‘baseline stress scenario,’ that ratio may rise to 8.5% by next March, the deadline set by RBI Governor Raghuram Rajan for banks to clean up soured credit… ‘Given the higher level of balance-sheet impairment, banks may remain risk averse for some more time as their focus would be on strengthening’ those balance sheets, according to the report.”

June 29 – Bloomberg (David Roman): “Moody’s… said it revised its outlook for Singapore’s banking industry to negative from stable, amid growing risks to profitability from exposure to energy-related industries and high levels of corporate leverage. Conditions for the lenders are worsening because of slower economic and trade growth in Singapore as well as more broadly in Asia, Moody’s said… The ratings firm expects economic growth in Singapore to slow to 1.6% in 2016 and 1.5% in 2017, below the average of 4.5% between 2011 and 2014.”

Leveraged Speculator Watch:

June 27 – Wall Street Journal (Gregory Zuckerman): “While some hedge funds have profited from the pain global markets have felt since Britons voted to exit the European Union, more funds may be facing potentially heavy losses. The reason: Many hedge funds were buying European shares in the days ahead of the vote, according to… Goldman Sachs. The note from the firm’s prime brokerage division… said Goldman saw ‘notable net buying’ ahead of the referendum. ‘Europe has been the most net bought region…for six straight weeks,’ Goldman said, referring to hedge-fund clients who both bought shares and ended bearish trades.”

July 1 – Bloomberg (Saijel Kishan): “The first six months of the year is turning out to be a period hedge fund managers want to forget. With China’s currency causing global market turmoil in January and the U.K. vote to quit the European Union doing the same in June, the $2.9 trillion industry is headed for its worst first-half performance since 2011… Funds lost 1.8% this year through June 28, according to Hedge Fund Research Inc.’s Global Hedge Fund Index, on pace for the worst first-half performance since 2011, when they slid 2.1%.”

Geopolitical Watch:

June 30 – Reuters (Tim Kelly): “Chinese military activity is escalating in the East China Sea, Japan's top military commander said on Thursday, with Japanese emergency scrambles to counter Chinese jets almost doubling in the past three months. Japanese air force jet scrambled around 200 times in the three months ending on Thursday compared with 114 times in the year-earlier period…”