Credit Bubble Bulletin : August 2016

“The Global Financial Crisis and Great Recession posed daunting new challenges for central banks around the world and spurred innovations in the design, implementation, and communication of monetary policy. With the U.S. economy now nearing the Federal Reserve's statutory goals of maximum employment and price stability, this conference provides a timely opportunity to consider how the lessons we learned are likely to influence the conduct of monetary policy in the future. The theme of the conference, ‘Designing Resilient Monetary Policy Frameworks for the Future,’ encompasses many aspects of monetary policy, from the nitty-gritty details of implementing policy in financial markets to broader questions about how policy affects the economy.” The introduction to Janet Yellen’s speech, “The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future,” Jackson Hole, August 26, 2016

Bloomberg: “Yellen Says Rate-Hike Case ‘Strengthened in Recent Months.’” The FT was almost identical to Bloomberg. It was hardly different at the WSJ: “Fed Chairwoman Janet Yellen Sees Stronger Case for Interest-Rate Increase.” And from CNBC: “Yellen says a rate hike is coming—but markets say not now.” And this from Zerohedge: “Best Reaction Yet: ‘Yellen Speech A Whole Lot Of Nothing.’”

I have a different take: Yellen provided more content for history books. In today’s short-term focused world, analysts and pundits remain fixated on clues to the next policy move. And while Yellen included language unbecoming of ultra-dovishness for the near-term, the Fed chair’s presentation was zany-dovish for the intermediate- and longer-term.

The Yellen Fed has begun methodically laying the analytical foundation for a Federal Reserve (and global central banks) balance sheet of unthinkable dimensions. It’s right there in her writing, as explicit as it is astounding. Before it’s too late, the Fed’s power – and their runaway policy experiment – need to be reined in. Contemporary Central bankers have been operating with blank checkbooks only because it was never contemplated that they would actually exploit their capacity to print “money” with reckless abandon. Who cannot see that these central bankers need clear rules and well-defined restraints? Their judgment is not trustworthy.

The WSJ’s Jon Hilsenrath penned an interesting pre-Jackson Hole piece, “Years of Fed Missteps Fueled Disillusion With the Economy and Washington.” “Once-revered central bank failed to foresee the crisis and has struggled in its aftermath, fostering the rise of populism and distrust of institutions. In the past decade Federal Reserve officials have been flummoxed by a housing bubble that cratered the financial system, a long stretch of slow growth they failed to foresee and inflation persistently undershooting their goal. In response they engineered unpopular financial rescues, launched start-and-stop bond buying and delayed planned interest-rate boosts. ‘There are a lot of things that we thought we knew that haven’t turned out quite as we expected,’ said Eric Rosengren, president of the Federal Reserve Bank of Boston. ‘The economy and financial markets are not as stable as we previously assumed.’”

Yellen’s above speech introduction refers to “lessons we learned.” It is, however, rather obvious that the Federal Reserve has completely failed to recognize how a flawed monetary policy framework was fundamental to a financial Bubble that collapsed into the “worst financial crisis since the Great Depression.”

This year’s Jackson Hole summit is to consider “broader questions about how policy affects the economy.” What’s conspicuously absent from Yellen’s (and others’) analytical framework is the extraordinary impact policy continues to have in the securities and derivatives markets – and over time through the markets to the overall economic structure.

Over the years I’ve detailed how the GSEs, acting as quasi-central banks, in the early nineties began backstopping market liquidity. Having ended 1993 at $1.9 TN, GSE securities (debt and MBS) in just ten years more than tripled to $6.0 TN. Revelations of serious accounting fraud at Fannie and Freddie ended their capacity for “buyer of first and last resort” liquidity support.

I argued at the time that going forward only the Fed would retain the wherewithal to engineer market liquidity backstop operations to counter a serious de-risking/de-leveraging episode, though this would require a major expansion of Fed’s holdings. The mortgage finance Bubble inflated much longer and to far greater excess than I had expected, which ensured that its bursting triggered a historic Trillion plus doubling of Fed holdings. Later, in 2011 the Fed detailed its “exit strategy”, yet proceeded to again double assets to $4.5 TN.

I have posited that the Fed’s balance sheet is likely on course to reach $10 Trillion. This rough guesstimate stems from the view that there is no alternative to the Fed’s balance sheet for future liquidity backstop operations. Moreover, the unprecedented inflation of Bubble excess (securities and asset markets, economic maladjustment) ensures that only another doubling of the Fed’s balance sheet could possibly hold financial collapse at bay.

“In the simulations reported by Reifschneider, ‘Gauging the Ability of the FOMC to Respond to Future Recessions,’ in note 8, overcoming the effects of the zero lower bound during a severe recession would require about $4 trillion in asset purchases and pledging to stay low for even longer if the average future level of the federal funds rate is only 2 percent.”

The above zinger is footnote #24 embedded in Yellen’s speech. The Fed chair’s inflationist reasoning culminates with her focus on Fed staffer David Reifschneider’s recent paper (cited above). The gist of the analysis is that if the Fed lacks the typical capacity to slash interest rates, policy can compensate with more aggressive asset purchases and forward rate guidance. Undoubtedly, the Fed will face minimal rate flexibility the next time it employs further monetary stimulus. So get ready. Bonds seem ready.

From Yellen: “A recent paper takes a different approach to assessing the FOMC's ability to respond to future recessions by using simulations of the FRB/US model. This analysis begins by asking how the economy would respond to a set of highly adverse shocks if policymakers followed a fairly aggressive policy rule, hypothetically assuming that they can cut the federal funds rate without limit. It then imposes the zero lower bound and asks whether some combination of forward guidance and asset purchases would be sufficient to generate economic conditions at least as good as those that occur under the hypothetical unconstrained policy.

Figure 2 in your handout illustrates this point. It shows simulated paths for interest rates, the unemployment rate, and inflation under three different monetary policy responses--the aggressive rule in the absence of the zero lower bound constraint, the constrained aggressive rule, and the constrained aggressive rule combined with $2 trillion in asset purchases and guidance that the federal funds rate will depart from the rule by staying lower for longer…

But despite the lower bound, asset purchases and forward guidance can push long-term interest rates even lower on average than in the unconstrained case (especially when adjusted for inflation) by reducing term premiums and increasing the downward pressure on the expected average value of future short-term interest rates. Thus, the use of such tools could result in even better outcomes for unemployment and inflation on average.

Of course, this analysis could be too optimistic. For one, the FRB/US simulations may overstate the effectiveness of forward guidance and asset purchases, particularly in an environment where long-term interest rates are also likely to be unusually low. In addition, policymakers could have less ability to cut short-term interest rates in the future than the simulations assume. By some calculations, the real neutral rate is currently close to zero, and it could remain at this low level if we were to continue to see slow productivity growth and high global saving. If so, then the average level of the nominal federal funds rate down the road might turn out to be only 2 percent, implying that asset purchases and forward guidance might have to be pushed to extremes to compensate… (footnote 24)”

If a 2% Fed funds rate equates to $4.0 TN of Fed purchases, what about 1%? How about 50 bps? Using the Fed’s own framework, a $10 TN Federal Reserve balance sheet no longer seems all that “lunatic fringe.”

Of course, chair Yellen is not about to espouse the stunningly audacious without the obligatory tinge of caution: “Moreover, relying too heavily on these nontraditional tools could have unintended consequences. For example, if future policymakers responded to a severe recession by announcing their intention to keep the federal funds rate near zero for a very long time after the economy had substantially recovered and followed through on that guidance, then they might inadvertently encourage excessive risk-taking and so undermine financial stability.”

My comment: “…Future policymakers… might inadvertently encourage excessive risk-taking and so undermine financial stability.” You think?? Might it be worthwhile contemplating the past and present?

“Finally, the simulation analysis certainly overstates the FOMC's current ability to respond to a recession, given that there is little scope to cut the federal funds rate at the moment. But that does not mean that the Federal Reserve would be unable to provide appreciable accommodation should the ongoing expansion falter in the near term. In addition to taking the federal funds rate back down to nearly zero, the FOMC could resume asset purchases and announce its intention to keep the federal funds rate at this level until conditions had improved markedly--although with long-term interest rates already quite low, the net stimulus that would result might be somewhat reduced.”

If markets are willing to cooperate, the Fed may bump up rates 25 bps in September. Friday evening from the WSJ’s Heard on the Street column: “Janet Yellen Cries Wolf - Fed chairwoman tries to convince market that a rate rise is coming, but investors aren’t listening.” Could it be instead that they listened intently and came away even more persuaded? Perhaps the WSJ (and others) is missing the point: it’s not about crying wolf or a lack of credibility with respect to rate hikes. After all, a second little baby-step would be trivial in the context of rising odds of a Fed balance sheet on its way to $10 TN. Global bond markets continue to trade as if there’s a very credible threat of monstrous QE/central bank purchases to eternity. And the greater the scope of the world’s most spectacular asset Bubble, the higher the odds that central bankers will be forced into even more preposterous desperate measures – aka ever larger QE purchases of a widening variety of securities.

Somehow the Fed completely disregards the prominent role loose monetary policy has played in inflating serial financial and economic Bubbles. It gets worse. Revisionism somehow has Yellen expounding analysis that policy was “tight” heading into the 2008 crisis period. Mortgage debt doubled in less than seven years, for heaven’s sake. Unprecedented leverage, speculative excess and financial shenanigans…

From Yellen: “…The federal funds rate at the start of the past seven recessions was appreciably above the level consistent with the economy operating at potential in the longer run. In most cases, this tighter-than-normal stance of policy before the recession appears to have reflected some combination of initially higher-than-normal labor utilization and elevated inflation pressures. As a result, a large portion of the rate cuts that subsequently occurred during these recessions represented the undoing of the earlier tight stance of monetary policy.”

We’re now eight years into history’s greatest monetary stimulus. Global markets have deteriorated to Desolate Bizarro World. After a respite, some volatility has begun to creep back into the markets. It appeared to be another tough week for the leveraged speculator crowd. Some favored shorts significantly outperformed. Periphery Europe was a lovefest. Spanish equities jumped 2.5%. Italian stocks surged 3.3%, led by the banking sector’s almost 10% melt-up. European banks stocks jumped 4.9%. Financials outperformed in the U.S. as well, with the banks up 1.1% and the broker/dealers gaining 1.3%. Utilities and dividend stocks underperformed.

A negative tone is gaining momentum in Asia. Intrigue is returning to China, with policymakers gearing up for yet another shot at curbing Bubbles (bonds, real estate, shadow banking, etc.) and general financial excess. The Shanghai Composite dropped 1.2% this week. The Nikkei 225 index dropped 1.1%, with Japanese banks losing 1.7%. Stocks were down 1.0% in India and 1.3% in Turkey. Generally, instability reemerged in EM and commodities. The South African rand was slammed for 6.3%. The Brazilian real and Mexican peso dropped about 2%, while a list of EM currencies declined around 1% (Russia, Turkey, Singapore, Colombia, Chile). Brazil’s equities were slammed 2.5% and Mexico’s stocks dropped 1.9%. In commodities, copper sank 4.3% and silver fell 3.5%. The soft commodities were under heavy selling pressure as well.

The U.S. dollar index rallied 1% this week. It was as if Fed officials were determined to don hawkish-like garb hoping to draw attention away from Yellen’s QE Eternity Unveiling. I’ve expected currency market stability to be a leading (observable) casualty of heightened global monetary disorder. Over recent months a short squeeze in EM currencies morphed into a dysfunctional trend-following and performance-chasing fracas. This type of dynamic tends to reverse abruptly and, often, dramatically.

Meanwhile, developed currencies oscillate sporadically, as perceptions swing between perpetual king dollar and the prospect of permanent Fed-induced dollar devaluation. A similar dynamic is behind the return of wild commodities trading. Natural gas surged 11% this week. Everyone’s favorite currency short, the British pound, was the only major currency this week to appreciate versus the dollar. Going forward, it will be interesting to see how Bubble markets attempt to reconcile a short-term Fed rate increase versus the Federal Reserve committing itself to boundless QE.

For the Week:

The S&P500 declined 0.7% (up 6.1% y-t-d), and the Dow fell 0.8% (up 5.6%). The Utilities dropped 2.2% (up 13.6%). The Banks gained 1.1% (down 2.8%), and the Broker/Dealers advanced 1.3% (down 4.2%). The Transports fell 1.3% (up 4.2%). The S&P 400 Midcaps slipped 0.2% (up 11.5%), while the small cap Russell 2000 added 0.1% (up 9.0%). The Nasdaq100 declined 0.5% (up 4.1%), while the Morgan Stanley High Tech index increased 0.2% (up 9.2%). The Semiconductors gained 0.5% (up 20.8%). The Biotechs slipped 0.6% (down 13.5%). With bullion down $20, the HUI gold index sank 11.5% (up 111%).

Three-month Treasury bill rates ended the week at 32 bps. Two-year government yields jumped nine bps to 0.84% (down 21bps y-t-d). Five-year T-note yields rose seven bps to 1.23% (down 52bps). Ten-year Treasury yields gained five bps to 1.63% (down 62bps). Long bond yields slipped a basis point to 2.28% (down 74bps).

Greek 10-year yields added a basis point to 7.87% (up 55bps y-t-d). Ten-year Portuguese yields increased another three bps to 3.01% (up 49bps). Italian 10-year yields were unchanged at 1.13% (down 46bps). Spain's 10-year yield slipped a basis point to 0.94% (down 83bps). German bund yields fell three bps to negative 0.07% (down 69bps). French yields declined a basis point to 0.17% (down 82bps). The French to German 10-year bond spread widened two bps to 24 bps. U.K. 10-year gilt yields fell six bps to 0.56% (down 140bps). U.K.'s FTSE equities index slipped 0.3% (up 9.5%).

Japan's Nikkei 225 equities index fell 1.1% (down 14% y-t-d). Japanese 10-year "JGB" yields increased a basis point to negative 0.08% (down 34bps y-t-d). The German DAX equities index added 0.4% (down 1.4%). Spain's IBEX 35 equities index jumped 2.5% (down 9.3%). Italy's FTSE MIB index surged 3.3% (down 21.4%). EM equities were mostly under pressure. Brazil's Bovespa index dropped 2.5% (up 33%). Mexico's Bolsa fell 1.9% (up 10.2%). South Korea's Kospi index declined 0.9% (up 3.9%). India’s Sensex equities lost 1.0% (up 6.4%). China’s Shanghai Exchange dropped 1.2% (down 13.2%). Turkey's Borsa Istanbul National 100 index lost 1.3% (up 7.5%). Russia's MICEX equities index advanced 1.7% (up 13.2%).

Junk bond mutual funds saw inflows of $162 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates were unchanged at 3.43% (down 54bps y-o-y). Fifteen-year rates had no change at 2.74% (down 52bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 3.57% (down 51bps).

Federal Reserve Credit last week slipped $0.7bn to $4.438 TN. Over the past year, Fed Credit declined $9.2bn. Fed Credit inflated $1.627 TN, or 58%, over the past 198 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $3.3bn last week to $3.207 TN. "Custody holdings" were down $135bn y-o-y, or 4.0%.

M2 (narrow) "money" supply last week rose $22.9bn to a record $12.994 TN. "Narrow money" expanded $875bn, or 7.2%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits surged $48.1bn, while Savings Deposits fell $12.1bn. Small Time Deposits were little changed. Retail Money Funds dropped $15.2bn.

Total money market fund assets jumped $24.6bn to $2.735 TN. Money Funds rose $40bn y-o-y (1.5%).

Total Commercial Paper declined another $8.4bn to $1.004 TN. CP declined $46bn y-o-y, or 4.4%.

Currency Watch:

The U.S. dollar index rallied 1.0% to 95.48 (down 3.3% y-t-d). For the week on the upside, the British pound increased 0.5%. For the week on the downside, the South African rand declined 6.3%, the Mexican peso 2.0%, the Brazilian real 1.9%, the Swiss franc 1.8%, the Japanese yen 1.6%, the Swedish krona 1.2%, the euro 1.1%, the Canadian dollar 1.0%, the Australian dollar 0.8%, the Norwegian krone 0.6% and the New Zealand dollar 0.5%. The Chinese yuan declined 0.2% versus the dollar (down 2.7% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.0% (up 16.5% y-t-d). Spot Gold declined 1.5% to $1,321 (up 24%). Silver was hit 3.5% to $18.63 (up 35%). WTI Crude fell 93 cents to $47.64 (up 29%). Gasoline slipped 0.4% (up 19%), while Natural Gas jumped 11.2% (up 23%). Copper sank 4.3% (down 2.4%). Wheat lost 8.4% (down 13%). Corn fell 5.5% (down 9%).

Europe Watch:

August 21 – Wall Street Journal (Christopher Whittall): “The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy. In two instances, the ECB has bought bonds directly from European companies through so-called private placements, in which debt is sold to a tight circle of buyers without the formality of a wider auction. It is a startling example of how banks and companies are quickly adapting to the extremes of monetary policy in what is an already unconventional age.”

August 22 – Bloomberg (Lorenzo Totaro): “The odds are stacked against Matteo Renzi’s economic ambitions for Italy. The prime minister needs to see a blistering pace in the second half of this year to meet his goal of a 1.2% expansion in 2016. Economists say that’s not happening, spelling trouble for Renzi… With Renzi facing a referendum in the autumn that could decide his political future, a stagnant economy and banks hobbled by bad debt are adding to his challenges.”

August 23 – Reuters (John Geddie and Francesco Canepa): “The European Central Bank will have to bump up its monthly purchases of government bonds if it decides to continue buying beyond March 2017, just to ensure maturing paper does not reduce the pace of its money printing. J.P. Morgan estimates 320 billion euros ($363bn) worth of bonds will mature between 2017 and 2019, and will need to be invested again to honour an ECB pledge to redeploy the money it receives when bonds are repaid. This additional buying could compound liquidity problems that have created unpredictable price swings in the bond market…”

Fixed-Income Bubble Watch:

August 25 – Bloomberg (Claire Boston): “U.S. companies feeling pain in short-term debt markets are seeking relief by borrowing longer term, pushing already-high levels of corporate bond issuance toward fresh records. Google… and… Archer-Daniels-Midland Co. are among the companies that have sold more than $5 billion of corporate bonds in the past two months to pay off at least part of their short-term debt… They’re looking to tame their interest expenses after new regulations have lifted some issuers’ borrowing costs for near-term debt to seven-year highs. The changes underscore how money-market rules that take effect in October are distorting debt markets. Total sales for corporate bonds maturing in more than eighteen months are around $950 billion this year… on track to beat the full-year record of about $1.3 trillion… Commercial-paper markets… have shrunk by $108 billion since May…”

August 24 – Associated Press: “U.S. companies are sitting on hundreds of billions of cash, so you might think they are in great financial shape. The reality is different, and worrisome. Most of the cash is held by precious few companies, a mere 1% of 2,000 tracked by S&P Global Ratings. At the remaining 99%, finances have generally gotten worse in recent years. Many have increased debt dramatically while their cash has barely risen, or even fallen, among other signs of potential trouble.”

August 22 – Bloomberg (Selcuk Gokoluk and Sally Bakewell): “Riskier companies are increasingly getting credit agreements that allow them to raise the amount of future cost savings to appear more creditworthy, boosting potential losses for investors. The tweaks make it easier for borrowers to stay in compliance with their loan terms and add more debt, according to Charles Tricomi, a senior analyst at covenant research firm Xtract Research. ‘There is too much money chasing too few loans… Lenders are really at a disadvantage and have to agree to these terms significantly against their own interest, terms that they should be fighting off.’ Whittling away standards that keep a lid on leverage levels may leave investors with soured assets, according to Tricomi.”

Global Bubble Watch:

August 25 – Reuters (Jeff Cox): “The head of Germany's embattled Deutsche Bank believes negative interest rates are posing an imminent danger to the economy, savers and pension funds. Deutsche CEO John Cryan warned of ‘fatal consequences’ that could occur should the European Central Bank continue down the road of negative rates. The ECB is holding its deposit rate at -0.4%; government debt yields through large swaths of Europe are carrying negative rates as well. ‘Monetary policy is thwarting goals to strengthen the economy and to make banks safer by now,’ Cryan told German newspaper Handelsblatt…”

August 24 – Bloomberg (John Detrixhe and Richard Partington): “Derivatives users are the latest group to be hurt by negative interest rates as they get penalized for the cash they park at Europe’s biggest clearinghouses. Traders can thank European Central Bank President Mario Draghi. Futures and swaps are used to hedge or speculate on everything from German interest rates to oil prices. To avoid taking a loss if a counterparty to a trade defaults, they post collateral, such as government bonds or cash, at a clearinghouse. In Europe, the biggest ones are in Frankfurt and London. But with German and U.K. debt yields so low, or even negative, clearinghouse customers are sometimes losing money on those assets.”

August 24 – Wall Street Journal (Selina Williams and Bradley Olson): “Some of the world’s largest energy companies are saddled with their highest debt levels ever as they struggle with low crude prices, raising worries about their ability to pay dividends and find new barrels. Exxon Mobil Corp., Royal Dutch Shell PLC, BP PLC and Chevron Corp. hold a combined net debt of $184 billion—more than double their debt levels in 2014... The soaring debt levels are a fresh reminder of the toll the two-year price slump has taken on the oil industry. Just a decade ago, these four companies were hauled before Congress to explain ‘windfall profits’ but now can’t cover expenses with normal cash flow… The companies spent more than 100% of their profits on dividends last year. This year, the problem got worse.”

U.S. Bubble Watch:

August 23 – Reuters (David Morgan): “The U.S. budget deficit is expected to grow to $590 billion in fiscal year 2016 due to slower than expected growth in revenues and higher spending for programs including Social Security and Medicare, the Congressional Budget Office said… The estimate, which is $56 billion larger than CBO's forecast in March, shows the deficit increasing in relation to economic output for the first time since 2009. CBO said the deficit is expected to be $152 billion higher than in 2015 and will equal 3.2% of economic output. The deficit peaked at $1.4 trillion in 2009 and shrank to $485 billion in 2014.”

August 23 – Washington Examiner (Joseph Lawler): “The national debt this year will jump to the highest level since 1950 relative to the size of the economy, the Congressional Budget Office reported… The agency projected that the debt held by the public will rise 3 percentage points to 77% of U.S. gross domestic product by the end of fiscal year 2016 in September. Debt has not hit that ratio since 1950, when the government was still in the middle of paying down the debt it incurred paying for World War II.”

August 21 – Wall Street Journal (Justin Lahart): “Two of this year’s best stock strategies have a major downside: They are pulling investors into the same crowded and increasingly expensive trade. Johnson & Johnson is hardly the world’s most thrilling company, but the health-care giant’s stock has been an exciting place to be this year, rising 16.7% versus the S&P 500’s 6.8%. AT&T shares, up 19.2%, have been another pleasant one. One thing those companies have going for them is that their share prices don’t bounce around nearly as much as most other companies’ shares do. They count as some of the least volatile stocks in the S&P 500 over the past three years… Low-volatility strategies have been popular this year as investors have sought to protect themselves from market fluctuations. Money has been pouring into exchange-traded funds such as the PowerShares S&P 500 Low Volatility ETF and the iShares Edge MSCI Min Vol USA ETF.”

August 23 – Wall Street Journal (James Mackintosh): “Calm has descended on the U.S. stock market. The past 30 days have been the least volatile of any 30-day period in more than two decades. Only five days during the most recent stretch saw the S&P 500 move by more than 0.5% in either direction, the lowest since the fall of 1995. Back then, the Federal Reserve was paused between rate cuts. This time around, a combination of the summer lull in trading and super-easy global monetary policy has helped drive volatility to levels seen only a dozen times in the past half-century.”

August 23 – Bloomberg (Patrick Clark): “In the late 1990s, Americans started referring to tract-built luxury homes popping up in the suburbs as McMansions, a biting portmanteau implying that the structures were mass-produced and ugly. There was also the implied snark that their denizens, however wealthy, lacked the sophistication to tell filet mignon from a Big Mac. Lately, these homes have been the subject of fresh scorn, thanks to an anonymously authored blog that breaks down the genre’s design flaws in excruciating detail… It’s fun reading that nevertheless raised the question: How well have these homes kept their value? Not well, compared with the rest of the U.S. housing market. The premium that buyers can expect to pay for a McMansion in Fort Lauderdale, Fla., declined by 84% from 2012 to 2016, according to data compiled by Trulia. In Las Vegas, the premium dropped by 46% and in Phoenix, by 42%.

August 25 – Wall Street Journal (Nick Timiraos): “One of the thorniest tasks awaiting a seven-member board charged by Washington with cleaning up Puerto Rico’s debt crisis is deciding how to balance a $70 billion debt load with nearly $43 billion in unfunded pension liabilities. The issue is coming to a head now because the White House is set to name as soon as next week the members of that oversight board… Puerto Rico’s three public pensions have about $2 billion in assets against $45 billion in liabilities, a shortfall far worse than any U.S. state pension system. The pensions are on track to exhaust their assets by 2019.”

August 24 – Bloomberg (Katia Dmitrieva): “Home prices in the U.S. rose 5.6% in the second quarter from a year earlier, extending gains that have cut into affordability for many buyers. Prices increased 1.2% on a seasonally adjusted basis from the previous three months...”

August 25 – Reuters (Tetsushi Kajimoto): “August U.S. auto sales will be 5.2% below a year ago, adding to evidence that the peak of industry sales was in 2015, consultancies J.D. Power and LMC Automotive said…”

Federal Reserve Watch:

August 21 – Wall Street Journal (Jon Hilsenrath): “For much of the post-financial-crisis era, U.S. Federal Reserve officials have held to a belief that they could get back to their old way of doing things. Growth would resume at a modest pace, annual inflation would climb to 2% and interest rates would gradually rise from near zero to a normal level near 4% or higher. As they prepare to gather at their annual retreat in Jackson Hole, Wyo., officials are grimly coming to a view that it isn’t going to happen that way… In this world, unconventional tools used after the financial crisis—including purchases of long-term Treasurys to push down long-term interest rates and assurances of low short-term rates into the future—could be rolled out when another downturn hits. A portfolio of securities, now $4.2 trillion, could grow. Unpopular interest payments to banks for their deposits at the central bank could persist. The new normal, in short, could look a lot like what the Fed has been doing for the past several years.”

August 23 – Reuters (Lindsay Dunsmuir): “The number of regional Federal Reserve banks calling on the central bank to raise the rate it charges commercial banks for emergency loans rose to eight in July, minutes from the Fed's discount rate meeting… showed. That compared to six in June…”

August 24 – Wall Street Journal (Kevin Warsh): “The conduct of monetary policy in recent years has been deeply flawed. U.S. economic growth lags prior recoveries, falling short of forecasts and deteriorating in the most recent quarters. This week in Jackson Hole, Wyo., the Federal Reserve Bank of Kansas City hosts the world’s leading central bankers and academics to consider monetary reform. The task is timely and consequential, but the Fed needs a broader reform agenda. Policy makers around the world neither predicted nor can adequately explain the reasons for current inflation readings below their targets. So it is puzzling that so many academics are pushing to raise the current 2% inflation target to a higher target of 3% or 4%.”

August 25 – Reuters (Howard Schneider): “While markets wait for Janet Yellen's latest message about the direction of monetary policy, the Federal Reserve chief and her colleagues already have one for politicians: the U.S. economy needs more public spending to shift into higher gear. In the past few weeks, Yellen and three of the Fed's other four Washington-based governors have called in speeches and Congressional hearings for government infrastructure spending and other efforts to counter weak growth, sagging productivity improvements, and lagging business investment. The fifth member has supported the idea in the past.”

Central Bank Watch:

August 20 – Bloomberg (Lorenzo Totaro): “Prime Minister Narendra Modi promoted a deputy governor to lead India’s central bank, ensuring that sweeping reforms initiated under Raghuram Rajan would continue. Urjit Patel, who oversees the monetary policy department at the Reserve Bank of India under Rajan, has been appointed for three years from Sept. 4… Patel, 52, has been a key architect of the central bank’s biggest overhaul in eight decades, including a shift to a consumer-price inflation target and the creation of a rate-setting panel.”

August 23 – Bloomberg (Onur Ant): “The Turkish central bank’s decision to lower a benchmark rate amid climbing inflation is fueling expectations that regulators will keep cutting. The bank trimmed its overnight lending rate by 25 bps to 8.5% on Tuesday, the sixth consecutive reduction… The cut comes amid renewed pressure by President Recep Tayyip Erdogan to boost growth with lower lending costs.”

China Bubble Watch:

August 24 – Bloomberg: “The shadow financing that is fueling China’s economic growth is unsustainable and ‘eerily similar’ to developments in the U.S. before the global financial crisis, says Logan Wright at research firm Rhodium Group. The nation has at most about 18 months before this funding -- derived largely from wealth-management products offering higher returns on riskier underlying investments -- hits a wall, says Wright… Banks will then be unable to generate new credit needed to maintain the current pace of economic growth, which is likely to slow to a range of 5 to 5.5%¬¬¬¬ for about two years, he says. ‘It’s pretty shocking just how important this has become and how the funding structures for this type of asset creation have changed… Everyone assumes it’s a stable system, it’s deposit-funded. It’s just not true any more.’ The financial engineering being employed to generate credit needed to fuel growth is reminiscent of the notorious structured investment vehicles and special purpose vehicles that played a central role in triggering the U.S. and global financial crisis in 2007-2008…”

August 24 – Wall Street Journal (Shen Hong): “China’s central bank has made a subtle change to the way it supplies the financial system with cash, a move that market watchers see as an attempt to cool investments in assets such as bonds, which have ballooned on an influx of cheap, short-term money. For the past two weeks, the People’s Bank of China has been decreasing the amount of the cheap seven-day loans—known as reverse repurchase agreements, or repos—that it makes to commercial banks in its daily money-market operations.”

August 25 – Reuters (Lu Jianxin and Nathaniel Taplin): “China's central bank has urged banks to spread out the tenors of their loans, hinting at its displeasure with a recent trend of banks focusing on overnight lending, banking sources told Reuters… Imbalances in China's financial system are increasing as the economy slows, complicating challenges facing policymakers as they try to clamp down on riskier lending practices without roiling markets. The People's Bank of China (PBOC) met with major banks on Wednesday to discuss management of liquidity in Chinese money markets amid rising speculation over whether Beijing would continue its monetary policy easing or not, the sources said… On Thursday, the bank again conducted both seven and 14-day reverse repos, adding 220 billion yuan ($33.05bn) of money market liquidity in the largest single-day injection since June 27 to ease fears of a credit crunch.”

August 22 – Bloomberg: “The best-performing bank in China is in a struggling city in the northeast where weeds sprout alongside the concrete skeletons of high rises in an industrial zone that mostly looks like a ghost town. Steel plants have laid off tens of thousands of workers. Cranes stand idle on construction sites. Wipe away a spiderweb on a dirty glass door at an empty complex with smashed windows and there’s a notice from the local government demanding rent unpaid since November 2014. Yet the Bank of Tangshan’s financial statements hardly reflect these realities. Instead, this small lender reports the fastest growth of 156 Chinese financial institutions and the lowest level of bad loans, a mere 0.06%. Its profit jumped 436% in two years and assets soared almost 400% since the start of 2014 to 177.9 billion yuan ($26.7bn). It’s largely driven by shadow lending.”

August 24 – Bloomberg (Elena Popina): “Yirendai Ltd., a Chinese company that connects borrowers with lenders similarly to LendingClub Corp. in the U.S., plunged the most on record after authorities imposed limits on the peer-to-peer platforms to curb risks in the loosely regulated shadow-banking sector.”

August 22 – Reuters (Sumeet Chatterjee): “Hit by bad loans, Chinese banks are expected to show a weakening in their capital strength in first-half earnings, raising the prospect that government might have to inject more than $100 billion to shore them up, according to some analysts. There are early signs that government is already taking action to help some of the smaller banks, which are struggling to maintain their capital ratios as China's economy slows, interest margins fall, and bad debts climb. ‘We believe the recapitalisation and bailout process is already discretely underway. However, it has gone unnoticed as it has started with the smaller, unlisted banks,’ said Jason Bedford, sector analyst with UBS. ‘We expect this process to accelerate sharply in 2017, particularly among listed joint stock banks,’ Bedford told Reuters, adding closing the capital shortfall would require an infusion of $172 billion.”

August 24 – Financial Times (Mansoor Mohi-uddin): “China’s renminbi seems largely resilient one year after its sudden devaluation. The currency has weakened by only a couple of per cent against the dollar this year... The People’s Bank of China’s foreign reserves have stopped falling and the spread between China’s onshore and offshore exchange rates has almost vanished. The currency’s resilience, however, is unlikely to last. In particular, the amount of offshore renminbi deposits… has continued to shrink this year despite the exchange rate becoming more stable again. The diminishing size of the offshore market is the canary in the mine... Holding the currency outside the mainland, however, allows investors to gain exposure to China’s economy without incurring its capital controls. The persistent decline in offshore deposits — down by nearly a third to $180bn over the past year — thus shows confidence in the currency remains fragile.”

August 24 – Bloomberg: “China imposed limits on lending by peer-to-peer platforms to individuals and companies in an effort to curb risks in one part of the loosely-regulated shadow-banking sector. An individual can borrow as much as 1 million yuan ($150,000) from P2P sites, including a maximum of 200,000 yuan from any one site, the China Banking Regulatory Commission said… Corporate borrowers are capped at five times those levels.”

August 21 – Bloomberg: “Cracks are starting to show in China’s labor market as struggling industrial firms leave millions of workers in flux. While official jobless numbers haven’t budged, the underemployment rate has jumped to more than 5% from near zero in 2010, according to Bai Peiwei, an economics professor at Xiamen University. Bai estimates the rate may be 10% in industries with excess capacity, such as unprofitable steel mills and coal mines… Many state-owned firms battling overcapacity favor putting workers in a holding pattern to avoid mass layoffs that risk fueling social unrest.”

August 22 – Bloomberg: “As China’s sovereign bond yields tumble to decade-lows, investors are piling into the most defensive part of the stock market in search of returns. The Shanghai Stock Exchange Dividend Index, composed largely of banks, utilities and expressway operators, has rallied 5.6% in the past month and climbed to the highest level versus the Shanghai Composite Index in a year…”

August 21 – Reuters (Ben Blanchard): “China has issued new rules demanding the establishment of Communist Party panels in non-government bodies, aiming to beef up the ruling party's role in such social groups, amid a broad crackdown on civil society. Western governments and rights groups have already lambasted a law passed in April, saying it treats foreign non-governmental organizations (NGOs) as a criminal threat and would effectively force many out of the country. The new guidelines… say party committees must be set up to ensure ‘effective cover’ in all NGOs. ‘Strengthen political thought education for responsible people at social groups, and guide them to actively support party building,’ the guidelines said. ‘Promote the place of party building in the social group's charters.’”

Japan Watch:

August 21 – Reuters (Tetsushi Kajimoto): “Japanese companies overwhelmingly say the government's latest stimulus will do little to boost the economy and the Bank of Japan should not ease further, a Reuters poll showed… Prime Minister Shinzo Abe this month unveiled a 13.5 trillion yen ($135bn) fiscal package of public works projects and other measures, vowing a united front with the BOJ to revive the economy and raising speculation of a surge in government spending essentially financed by the central bank. But less than 5% of companies believe the steps will boost the economy near-term or raise its growth potential, according to the Reuters Corporate Survey…”

August 22 – Reuters (Hideyuki Sano and Tomo Uetake): “The Bank of Japan's near doubling of its purchases of Tokyo shares is causing investors to worry the central bank will dominate financial markets, which could lead to price distortions as it continues to grease the economy… More than three years of massive monetary stimulus has already resulted in the central bank cornering the Japanese government bond (JGB) market and distorting interest rates. ‘The increased BOJ purchasing provides a very favorable demand environment for listed equities,’ said Michael Kretschmer, chief investment officer at Pelargos Capital… ‘Nevertheless, in the long run we strongly doubt these type of monetary gimmicks aimed at price setting of risk assets can have a sustained positive impact on economic growth.’”

August 22 – Reuters (Stanley White and Ami Miyazaki): “Japan should spend 10 trillion yen (75.64bn pounds) on fiscal stimulus both in fiscal 2017 and in fiscal 2018 to offset a lack of demand in the economy and eliminate the risk of deflation, an adviser to Prime Minister Shinzo Abe said… Abe has already compiled a stimulus package for the current fiscal year with 7.5 trillion yen in spending, but the government needs to spend more and do so quickly to boost demand, Satoshi Fujii, an adviser to Abe, told Reuters… ‘We need to spend 10 trillion yen next fiscal year and another 10 trillion yen the following fiscal year to eliminate the deflationary gap,’ he said.”

EM Watch:

August 23 – Wall Street Journal (Anjani Trivedi): “As the hunt for yield stretches into emerging-market bonds, investors are finding there isn’t a lot of game to shoot. Such crowded terrain spells danger. The gusher of money into emerging-market bonds has hit extraordinary levels of late. In July, over $18 billion flooded in, and as of last week, $5 billion had entered emerging-market bond funds this month, according to… EPFR… If anything, the balance of flows are looking a lot like the 2009 post-financial crisis world. And like 2009, bond supply is scarce. So even as some investors are driven by negative rates into higher yielding emerging-market bonds, they are meeting a dearth of product.”

August 24 – Bloomberg (Ye Xie, Natasha Doff and Elena Popina): “Currency traders basking in the relative calm of August markets just received a jarring reminder of the dangers of chasing high yields. Recent flare-ups in political risk in emerging markets weakened their currencies and helped send returns on carry trades -- borrowing in locales with relatively low interest rates and investing the proceeds in places where they’re higher -- tumbling from the highest in a year. Turmoil among South Africa’s political leadership this week prompted such a drop in the rand against the dollar that it cut the return on this quarter’s best carry trade in half.”

August 23 – Bloomberg (Eric Martin and Nacha Cattan): “Mexico cut its growth forecast for the second time this year after Latin America’s second-largest economy shrank last quarter, dragged down by a slowdown in the services industry and falling exports. Gross domestic product will grow 2% to 2.6% in 2016, down from a previous estimate of 2.2% to 3.2%...”

August 23 – Bloomberg (Christine Jenkins and Nacha Cattan): “Mexico is at risk of a credit-rating cut after S&P Global Ratings revised its outlook to negative, citing ‘disappointing’ economic growth and a rising debt load. Stocks and the peso extended losses and the cost to hedge against losses in the country’s bonds rose after S&P said there’s at least a one-in-three chance of a downgrade over the next two years if the government’s debt increases more than forecast. S&P’s BBB+ rating for Mexico, three steps above junk, is already one level lower than Moody’s… Mexico cut its 2016 growth forecast for a second time this year Monday after the economy shrank in the second quarter.”

August 23 – Bloomberg (Ahmed A Namatalla and Ahmed Feteha): “According to Egypt’s president, the country’s future is at stake. With its currency trading near a record low in the black market, reserves to cover just three months of imports and a widening current-account deficit, pressure is mounting on the most populous Arab state to devalue the pound to alleviate a dollar shortage that prompted officials to seek help from the International Monetary Fund. Egypt is moving to end the exchange-rate problem within ‘months’ as part of its plan to implement economic reforms, President Abdel-Fattah El-Sisi said…”

Leveraged Speculator Watch:

August 24 – Bloomberg (Hema Parmar): “For hedge funds, the news is getting worse. Investors pulled an estimated $25.2 billion from hedge funds last month, the biggest monthly redemption since February 2009, according to… eVestment… The monthly withdrawals were the second straight for the beleaguered industry, which saw $23.5 billion pulled in June. They bring total outflows this year to $55.9 billion, driven by ‘mediocre’ performance after a number of funds lost money last year… ‘Unless these pressures recede, 2016 will be the third year on record with net annual outflows, and the first since the outflows in 2008 and 2009 -- a result of the global financial crisis,’ eVestment said… Industrywide, funds returned an average of 1.2% this year through July…, compared with about 7.6% for the S&P 500 Index.”

August 24 – Bloomberg (Dani Burger): “The computers seem confused. After trouncing their human counterparts in the first half of the year, equity managers that rely on automated processes are having a rough third quarter. The proportion of quantitative funds whose return exceeds their benchmark has dropped to 28% since July, data from JPMorgan… show. Compare that to fundamental equity managers, where 52% are outperforming.”

Geopolitical Watch:

August 25 – New York Times (Rick Gladstone): “Iranian naval boats made dangerous maneuvers around United States warships in the Persian Gulf area on at least four occasions this week, Pentagon officials said Thursday, including one episode in which the Americans fired warning shots from a 50-caliber deck gun to prevent a collision. It was unclear whether the confrontations — one near the Strait of Hormuz on Tuesday and three in the northern Persian Gulf on Wednesday — were deliberate efforts to send a hostile message about American naval activity. Still, they underscored the risk of an armed clash between Iran and the United States in an area that has been a perennial source of tension for the two countries.”

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