Saturday, August 13, 2016

Weekly Commentary: Inflation

(Email from reader T.B.) “These various stages of capitalism, or finance, are interesting and descriptive. But I think the progression is rather simply explained as an ongoing perversion of capitalism caused by inflation: credit expansion or any kind of money-supply inflation.

Have you seen Henry Hazlitt's colorful statement about the consequences of inflation? If not, just consider this: “It [Inflation] discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.” Henry Hazlitt, Economics in One Lesson, page 176

Isn’t this a nearly perfect short description of what is happening to us?”

Yes, it is. Henry Hazlitt (1894-1993) was a brilliant thinker and prolific writer. He was a noted journalist throughout the “Roaring Twenties” and Great Depression periods. Hazlitt learned his economics from some of the masters. He was friends with Benjamin Anderson (“Chase Economic Bulletin” and “Economics and the Public Welfare”). From Wikipedia: “According to Hazlitt, the greatest influence on his writing in economics was the work of Ludwig von Mises, and he is credited with introducing the ideas of the Austrian School of economics to the English-speaking layman.”

As an admirer of Hyman Minsky, I view “Minskian” analysis as the authority on critical aspects of financial evolution and institutional and Capitalistic development. At the same time, when it comes to economic analysis more generally, I'm an “Austrian” at heart. Minsky seemed to hesitate when it came to discussing the profound impact finance and financial evolution had on the underlying economic structure. From the standpoint of my analytical framework, this void is filled superbly by Austrian thinking. When it comes to understanding the nature and destructive capacities of inflation, the “Austrians” put the “Keynesians” to shame.

A couple conventional definitions: “Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.” “Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value of money.”

Yet a rise in consumer prices is just one of myriad possible inflationary manifestations. Mises viewed inflation as a general increase in the money supply. Simple enough, except for the layers of complexity inherent to both money and inflation. What comprises this so-called supply of “money”? We’re surely addressing more than just currency, but how much more? Bank reserves? Deposits? How about “repos,” money market funds or perhaps even liquid short-term debt instruments more generally? Then what about highly liquid funds invested in equity and bond instruments? Derivatives?

Mises, viewing monetary inflation in broad terms, wrote of “fiduciary media,” or instruments with the economic functionality of “narrow money”. In our age of globalized digitized/electronic finance, I’ve always taken the view that “money is as money does.” Generally, the broader the definition the better. And we must accept that contemporary “money” is certainly not what it should be; it’s not what we wish it were.

I was introduced to “Austrian” economic thinking back in 1990, when I began my monthly ritual of studying “The Richebacher Letter.” It was love at first reading. Then I had the good fortune to work with the great German economist, Dr. Kurt Richebacher, assisting with his publication from 1996 through 2001 or so. It was an especially rich period for financial and economic analysis – S.E. Asia, Russia, LTCM, “The Committee to Save the World,” “The New Paradigm,” the “tech Bubble,” etc. Contemporary finance – with it’s unfettered “money” and Credit – was wreaking increasing havoc. Central bankers and others seemed to go out of their way to misdiagnose the problem.

From Dr. Richebacher and my own analysis, it became clear that contemporary inflation was really a Credit phenomenon. Expand (inflate) Credit and monitor for consequences. These might include a rise in aggregates of consumer and producer prices - traditional “inflation.” But the creation of new purchasing power also inflated asset prices. “Austrian” analysis becomes even more powerful with the understanding of how Credit inflation feeds through to the real economy. Inflation begets distortions in spending and business investment - and over time exerts increasingly deleterious effects upon the underlying economic structure. Inflation and Bubbles redistribute and destroy wealth. Inflation alters decisions, perceptions and behavior, including the nurturing of subtle mayhem throughout saving and investment, the bedrock of Capitalism. You’d think by now the entire world would have adopted “Austrian” thinking.

Dr. Richebacher argued that of all the various consequences of Credit inflation, the rise in consumer prices was one of the least pernicious. With sufficient determination, policymakers could (Chairman Volcker did) tighten financial conditions and break inflationary processes and psychology. Expect an attentive constituency when it comes to reining in destabilizing CPI.

But how about asset price inflation and Bubbles? Well, there is a powerful proclivity for letting asset prices run. An inflationary bias in asset markets certainly “makes it more profitable to speculate than to produce.” And the larger the speculative Bubble the more powerful the constituencies that arise to demand government involvement, intervention and manipulation to sustain Bubble Dynamics. Misguided policymakers will endorse destabilizing asset inflation as confirmation of sound policies (Greenspan, Bernanke, Draghi, Kuroda…). In one of financial history’s most misconceived policy blunders, central bankers specifically targeted asset price inflation as the primary mechanism for post-crisis system reflation.

Let there be no doubt, Credit Bubbles are an inflationary phenomenon. Having badly mismanaged domestic Credit, the U.S. proceeded to export asset inflation and Credit Bubbles to the entire world. And as the global Credit inflation aged, broadened and became deeply entrenched, the consequences evolved. Limitless cheap finance on a global basis ensured a historic investment boom and resulting overcapacity in just about everything. Meanwhile, the myth persisted that central bankers were in control of a general price level. Accordingly, monetary stimulus had to be ratcheted up to counteract downward price pressures and insufficient aggregate demand. And then with the protracted inflationary boom having reached the point of acute financial and economic fragility, desperate global central bankers embarked on unprecedented “money” printing (only exacerbating asset Bubbles and speculative excess).

It was the evolution to securitization and market-based finance that fundamentally – and fatefully - transformed inflationary dynamics. For one, the tantalizing New Age Credit apparatus was inherently unstable. This ensured progressive government meddling. Government guarantees and backstops further incentivized speculation, in the process exacerbating speculative leveraging and Bubble Dynamics. Faltering Bubble mayhem then fostered QE, where central bankers intervened directly in the marketplace with massive buy programs. Central bankers then became hostage to unwieldy global Bubbles dependent upon ongoing massive monetary stimulus.

Inflation Dynamics have created a world of record high securities prices, including $13.4 TN (per FT) of negative-yielding government bonds. The most hopelessly indebted governments in the world now borrow at a cost of about nothing. Negative yields in Japan. Italian 10-year yields ended the week at a record low 1.04%. In blow-off dynamics that rival Internet stocks and subprime CDOs, “money” is flooding into bond ETFs. Meanwhile, U.S. stock prices are at all-time highs, with real estate prices essentially back to highs.

August 12 – Financial times (Robin Wigglesworth and Eric Platt): “The value of negative-yielding bonds swelled to $13.4tn this week, as negative interest rates and central bank bond buying ripple through the debt market. The universe of sub-zero yielding debt — primarily government bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds — has grown from $13.1tn last week… ‘It’s surreal,’ said Gregory Peters, senior investment officer at Prudential Fixed Income. ‘It’s clear that central banks are dominating markets. There’s a race to the bottom. Central banks are the main drivers of this, it’s not fundamental.’”

August 12 – Financial Times (Joe Rennison and Eric Platt): “Investors have poured more money into US fixed income exchange traded funds so far this year than for the whole of 2015, as the hunt for returns intensifies with nearly $13tn of global bond yields trades below zero. US fixed income ETFs have attracted more than $60bn of money this year — outstripping 2015, when the funds lured just under this year’s current total, according to… Deutsche Bank. International investors seeking fixed rates of return via bonds are targeting the higher yields on US government and corporate debt via fixed income ETFs, which track bonds and trade like a stock price on an exchange… Large bond ETFs like the iShares Core US aggregate bond fund, which gives exposure to US investment grade debt, have outstripped inflows to larger equity ETFs.”

This week’s tiny move in the S&P500 masked ongoing global market instability. It appears short squeeze dynamics remain in force, although they now shift around the globe and between markets. Global financial stocks rallied sharply this week. Hong Kong’s Hang Seng Financials surged 5.3%. Japan’s TOPIX Banks Stock Index jumped 3.9% (Nikkei 225 up 4.1%). The STOXX Europe 600 Bank Index rose 3.2%. Italian Banks surged 4.0%. Overall, European equities were strong. Germany’s DAX surged 3.3%, with major indices up about 2% in France, Spain and Italy. EM markets were on a tear. Mexican equities jumped 2.5%, with Turkish stocks up 2.8% and the Shanghai Composite 2.5% higher. The Mexican peso surged 2.6%.

It’s ironic. As market participants and global central bankers over recent decades fretted the prospect of deflation, global debt and asset markets experienced history’s greatest inflationary Bubble. It’s my view that global markets are these days dominated by a historic dislocation in debt trading. There are hundreds of Trillions of interest-rate derivatives outstanding. And global bond yields have done this year what no one thought possible. As was the case with previous derivative-related melt-ups (i.e. mortgages 1993, SE Asia 1996, Nasdaq 1999, subprime 2006/7), these types of dislocations foment extraordinary underlying leverage (i.e. levered bond holdings as hedges against derivative exposures).

This leveraging creates marketplace liquidity, while spurring self-reinforcing short-covering and speculation. These kinds of speculative blow-offs also tend to take on lives of their own. The squeeze that propelled U.S. stock indices to record highs has now fully engulfed corporate Credit and EM more generally. A couple of Friday evening FT headlines make the point: “Record-Breaking US Stocks are a Sideshow Next to Bond Bonanza” and “Emerging Market Monetary Conditions Ease Dramatically”.

It is not hyperbole to posit that global securities markets are in the midst of a historic short squeeze and the greatest ever market dislocation. And it’s not unreasonable to suggest that this is a sadly fitting climax to the world’s most spectacular inflationary Bubble.

Yet through the façade of unprecedented perceived global wealth, one can begin to more clearly identify the the Scourge of Inflationism: “It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls.”

It’s been akin to a wreaking ball. We’ve seen the general population unknowingly surrender wealth to Inflationism. In the face of so-called disinflation, millions have suffered at the hand of inflating costs for housing, health care, tuition and insurance, to name a few. We’ve seen these serial booms and busts take a terrible toll on many workers, families and communities. We witnessed many lose much of their retirements – and faith in the markets - in two major stock market busts. Millions lost much of their life’s savings during the collapse of the mortgage finance Bubble. Millions of students have taken on tremendous loads of debt to finance higher education and vocational training. Millions have been lured by (years of) low monthly payments into purchasing homes, automobiles, vacation properties, recreation vehicles, etc. that they cannot afford.

Inflationism has seen real wages for much of the workforce stagnate or worse over the past decade. Inflationism and his accomplice malinvestment are the culprits behind pathetic productivity trends and declining living standards. Worse yet, Inflationism and his many cohorts are fomenting disturbing social, political and geopolitical turmoil. And reminiscent of the Weimar hyperinflation, central bankers somehow remain oblivious that their operations are of primary responsibility. If people don’t these days trust central bankers, politicians, Wall Street, and governments and institutions more generally, just wait until the Bubble bursts.

For the Week:

The S&P500 was little changed (up 6.9% y-t-d), while the Dow added 0.2% (up 6.6%). The Utilities were unchanged (up 17.7%). The Banks declined 1.3% (down 5.5%), and the Broker/Dealers fell 0.9% (down 7.3%). The Transports lost 0.8% (up 4.0%). The S&P 400 Midcaps slipped 0.3% (up 11.4%), while the small cap Russell 2000 was little changed (up 8.3%). The Nasdaq100 added 0.3% (up 4.7%), and the Morgan Stanley High Tech index increased 0.7% (up 7.7%). The Semiconductors gained 0.8% (up 17.5%). The Biotechs sank 3.4% (down 12.4%). Though bullion ended unchanged, the HUI gold index added another 1.5% (up 151%).

Three-month Treasury bill rates ended the week at 27 bps. Two-year government yields declined two bps to 0.70% (down 35bps y-t-d). Five-year T-note yields fell five bps to 1.09% (down 66bps). Ten-year Treasury yields dropped eight bps to1.51% (down 74bps). Long bond yields sank nine bps to 2.23% (down 79bps).

Greek 10-year yields dropped 13 bps to 7.99% (up 67bps y-t-d). Ten-year Portuguese yields dropped 17 bps to a seven-month low 2.67% (up 15bps). Italian 10-year yields fell nine bps to a record low 1.04% (down 88bps). Spain's 10-year yield dropped nine bps to a record low 0.92% (down 85bps). German bund yields declined four bps to negative 0.11% (down 73bps). French yields fell four bps to 0.11% (down 88bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields sank 15 bps to a record low 0.52% (down 144bps). U.K.'s FTSE equities index jumped 1.8% (up 10.8%).

Japan's Nikkei equities index rallied 4.1% (down 11.1% y-t-d). Japanese 10-year "JGB" yields declined two bps to negative 0.12% (down 38bps y-t-d). The German DAX equities index surged 3.3% (down 0.3%). Spain's IBEX 35 equities index gained 2.1% (down 8.7%). Italy's FTSE MIB index jumped 2.2% (down 20.6%). EM equities were strong. Brazil's Bovespa index gained 1.1% (up 34.5%). Mexico's Bolsa jumped 2.5% (up 12.5%). South Korea's Kospi index gained 1.2% (up 4.5%). India’s Sensex equities added 0.3% (up 7.8%). China’s Shanghai Exchange jumped 2.5% (down 13.8%). Turkey's Borsa Istanbul National 100 index rose 2.8% (up 9.1%). Russia's MICEX equities index advanced 1.2% (up 11.7%).

Junk bond mutual funds saw inflows of $1.655 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates added two bps to 3.44% (down 49bps y-o-y). Fifteen-year rates increased two bps to 2.76% (down 41bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 3.58% (down 46bps).

Federal Reserve Credit last week expanded $1.8bn to $4.428 TN. Over the past year, Fed Credit declined $22.3bn. Fed Credit inflated $1.617 TN, or 58%, over the past 196 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt sank $18.7bn last week to a six-year low $3.200 TN. "Custody holdings" were down $161bn y-o-y, or 4.8%.

M2 (narrow) "money" supply last week jumped another $32bn to a record $12.965 TN. "Narrow money" expanded $911bn, or 7.6%, over the past year. For the week, Currency increased $1.2bn. Total Checkable Deposits dropped $38.1bn, while Savings Deposits surged $68.1bn. Small Time Deposits and Retail Money Funds were each little changed.

Total money market fund assets gained $6.0bn to $2.745 TN. Money Funds rose $70.1bn y-o-y (2.6%).

Total Commercial Paper added $0.9bn to $1.023 TN. CP declined $36bn y-o-y, or 3.4%.

Currency Watch:

The U.S. dollar index declined 0.6% to 95.68 (down 3.0% y-t-d). For the week on the upside, the Norwegian krone increased 3.5%, the Mexican peso 2.6%, the South African rand 1.8%, the Canadian dollar 1.7%, the Swedish krona 1.3%, the euro 0.7%, the New Zealand dollar 0.7%, the Swiss franc 0.6%, the Japanese yen 0.5% and the Australian dollar 0.4%. For the week on the downside, the British pound declined 1.2% and the Brazilian real fell 0.8%. The Chinese yuan increased 0.4% versus the dollar (down 2.2% y-d-t).

Commodities Watch:

The Goldman Sachs Commodities Index jumped 3.2% (up 13.3% y-t-d). Spot Gold was unchanged at $1,336 (up 26%). Silver was little changed at $19.72 (up 43%). WTI Crude surged $2.51 to $44.49 (up 20%). Gasoline slipped 0.3% (up 8%), while Natural Gas sank 6.2% (up 11%). Copper declined 0.9% (unchanged). Wheat rallied 1.6% (down 10%). Corn declined 0.4% (down 7%).

Turkey Watch:

August 10 – Reuters (Ebru Tuncay and Asli Kandemir): “Turkish President Tayyip Erdogan took aim at banks on Wednesday, saying they shouldn't be charging high interest rates in the aftermath of a failed coup and promising to take action against lenders who ‘go the wrong way’ on interest rates. High borrowing costs are a familiar target for Erdogan, who favours consumption-driven growth and says that interest rates cause inflation… But the comments… were some of his sharpest yet directed at lenders. In a speech to members of Turkey's exporters assembly, Erdogan said he would consider it ‘treason’ if banks do not ‘pave the way for investors’. ‘We will not shy away from noting down and questioning banks where we see banks go the wrong way on interest rates and credit policies,’ he said… ‘If the banking sector tries to turn this into an opportunity they will deal with us.’”

Brexit Watch:

August 9 – Bloomberg (Anooja Debnath and Marianna Duarte De Aragao): “The Bank of England’s expanded quantitative-easing program ran into a stumbling block on just its second day as investors proved unwilling to part with their holdings of longer-dated bonds. The central bank failed to buy enough gilts to reach its stated goal at an operation on Tuesday -- the first such failure since it initially started quantitative easing in 2009. The yield on 10- and 30-year bonds fell to records after the operation.”

August 10 – Bloomberg (Neil Callanan): “The value of land for luxury homes in central London fell 6.9% in the second quarter, broker Knight Frank LLP said… Shares of developers with large residential projects in the U.K. capital’s best districts have lagged behind commercial-property landlords since the Brexit referendum vote after the companies began to write down the value of their holdings on slowing sales and falling prices.”

August 10 – Bloomberg (Thomas Seal): “Brexit is undermining the near-term outlook for the U.K. housing market, with both demand and sales dropping in July, according to the Royal Institution of Chartered Surveyors. The… group said new buyer inquiries fell for a fourth month, while its index of sales is pointing to the fastest decline in transactions since the global financial crisis in 2008. Prices continued to rise, but at the slowest pace in three years.”

Europe Watch:

August 12 – Bloomberg (Lorenzo Totaro): “Italy’s economy unexpectedly stalled in the second quarter, which will further weigh on Prime Minister Matteo Renzi as he prepares for a referendum on which he has staked his political future. Gross domestic product was unchanged in the three months through June… The economy grew 0.7% from a year earlier.”

Fixed-Income Bubble Watch:

August 8 – Financial Times (Eric Platt): “Record-low interest rates are no barrier for US companies finding buyers for their debt thanks to a relentless global quest for fixed returns that shows little sign of easing. The pace of US corporate debt sales… is expected to continue unabated driven by foreign buyers in a world where roughly $13tn of sovereign and corporate debt trades in negative territory… More than $2.3tn of dollar-denominated debt has been issued by companies and banks since the year began, including three of the ten largest corporate bond sales on record, Dealogic data show.”

August 9 – Bloomberg (Joe Mayes and Julie Edde): “There’s no sign of a summer holiday in the corporate-bond market. Companies worldwide are poised to raise more than $100 billion so far this month, the most for the period in Bloomberg data going back to 1999.”

August 9 – Bloomberg (Emma Orr): “The worst may be yet to come for some strained oil services companies as $110 billion in debt, most of it junk rated, creeps closer to maturity. More than $21 billion of debt from oilfield services and drilling companies is estimated to be maturing in 2018, almost three times the total burden in 2017, according to… Moody’s… More than 70% of those high-yield bonds and term loans are rated Caa1 or lower, and more than 90% are rated below B1. Speculative-grade debt is becoming increasingly risky, as the default rate is expected to reach 5.1% in November… The 12-month global default rate rose to 4.7% in July, up from its long-term average of 4.2%, Moody’s wrote. Of the 102 defaults this year, 49 have come from the oil and gas sector, Moody’s noted.”

August 11 – Bloomberg (Angelina Rascouet): “While shale drilling in the U.S. is on the rise again, prices need to climb nearer to $60 a barrel for U.S. producers to have a ‘substantial’ boost in activity, the International Energy Agency said. Producers remain ‘cautious on outlook,’ and further drilling increases this year may be ‘limited,’ the IEA said in its monthly report.”

Global Bubble Watch:

August 11 – Bloomberg (Natasha Doff): “Investors who piled into some of the world’s riskiest bonds to escape near-zero interest rates got a reality check this week as signs of an economic crisis in Mongolia and a flare up in the conflict in Ukraine sent their bonds tumbling. Mongolia’s $1 billion of notes due in six years fell the most on record on Wednesday after the finance minister went on television to say his critical goal was to avoid default as growth slows and the debt burden soars... A slump in Ukrainian Eurobonds sent yields toward their biggest one-day increase since February on Thursday after officials in Kiev warned Russia is seeking to escalate a military conflict over the disputed Crimean peninsula.”

August 10 – Financial Times (Attracta Mooney): “Fund managers that attempt to beat the market are losing significant ground to cheaper rivals as investors shun stockpickers amid concerns over bad performance and high fees. Assets managed in passive mutual funds, which provide lower-cost exposure to markets by tracking an index, have grown four times faster than traditional active products since 2007, according to… Morningstar… According to Morningstar, assets under management in passive mutual funds have grown 230% globally, to $6tn, since 2007. In contrast, assets held in active funds, where stock pickers try to beat the market, have grown 54%, to $24tn.”

August 10 – Financial Times (Attracta Mooney): “The amount of new money raised by exchange traded funds exposed to global stock markets has dropped 85% in the first half of 2016… Equity ETFs that track an index attracted a net $15bn from investors in the first half of this year, a significant decline on the $102bn invested over the same period in 2015, according to ETFGI… Just $1.2bn was invested in ETFs focused on Asia-Pacific stocks, down 96% on the $33.4bn invested in the first six months of 2015. However, emerging market-focused ETFs and those investing in North American stocks experienced greater inflows this year than during the same period last year. Total assets invested in ETFs and exchange traded products rose to $3.2tn at the end of June 2016, due to strong flows into fixed income products.”

August 10 – Bloomberg (Joseph Ciolli and Lu Wang): “A year that’s brought little but pain for bearish traders is getting worse. Not only is the rising market punishing shorts, it’s lifting their favorite targets at a rate that is by some measures three times as great as everything else. As a result, the 50 most-shorted stocks -- that is, the ones bears had bet would fall -- have instead rallied as much as 16% since the end of June, on track for the biggest quarterly gain in more than five years… Unlucky stock selection is making a tough year worse for the group, who’ve watched the value of U.S. stocks swell by more than $2 trillion since late June.”

August 8 – Wall Street Journal (Veronica Dagher): “Whatever the world’s economic and market turbulence last year, one group has held up well: billionaires. The combined wealth of the world’s billionaires, defined as individuals with a net worth of $1 billion or above, increased by 5.4% to a record $7.7 trillion, according to Wealth-X’s 2015-2016 billionaire census… The world’s billionaire population grew by 6.4% to 2,473 in 2015.”

August 10 – Bloomberg (Robert Frank): “The world's billionaires are holding more than $1.7 trillion in cash — the highest amount since one firm began recording the measure in 2010. Because of what they perceive to be growing risks in the economy and world, the world's 2,473 billionaires are keeping 22.2% of their total net worth in cash, according to the Wealth-X Billionaire Census… Altogether, their cash hoard is now roughly the size of the Brazil's GDP. ‘Billionaires are taking money off the table where available, while uncertainties in the economy and the historical highs found in deals have resulted in cash-flush portfolios,’ the report said.”

August 8 – Bloomberg (Shahien Nasiripour): “Hong Kong-based Bitfinex said all users will lose 36% of their deposits after the bitcoin exchange concluded its review of a $71 million hacking attack. To compensate its customers, Bitfinex said users will receive tokens that may later be redeemed or exchanged for shares in its parent company… ‘After much thought, analysis, and consultation, we have arrived at the conclusion that losses must be generalized across all accounts and assets,’ the exchange wrote…”

U.S. Bubble Watch:

August 9 – Bloomberg (Michelle Jamrisko): “The productivity of American workers unexpectedly declined for a third straight quarter, deepening efficiency woes that have characterized the economic expansion. The measure of employee output per hour decreased at a 0.5% annualized rate in the three months through June after dropping 0.6% in the prior quarter… Expenses per worker climbed at a 2% pace after being revised to a decline in the previous period. Productivity compared with a year earlier fell for the first time since 2013…”

August 9 – Bloomberg (Christopher Olsen): “U.S. companies have taken on so much debt that they’re at least as vulnerable to defaults and downgrades as they were leading up to the 2008 financial crisis, according to… S&P Global Ratings… Corporate leverage in the U.S., excluding financial firms, is at the highest level in 10 years, driven by a combination of low interest rates and slowing profits, S&P analysts Jacob Crooks and David Tesher wrote. This has resulted in record leverage ratios across a universe of 2,200 companies, they wrote… ‘With the level of leverage that we’re seeing, some of these more-peripheral stressed sectors are going to experience some challenges to obtain new financing as well as refinancing,’ Tesher said… ‘It’s not a question of if, it’s a question of when.’ Meanwhile, bondholders who are searching for yield are increasingly willing to accept less compensation and weaker protections than than in the past…’”

August 9 – Bloomberg (Prashant Gopal): “Fewer U.S. housing markets are seeing double-digit gains in prices as affordability becomes more of a challenge in some areas. In the second quarter, prices rose 10% or more from a year earlier in 25 metropolitan areas, down from 28 markets in the first quarter and 34 in the second quarter of 2015, the National Association of Realtors said… Home prices have been outpacing income gains, making it harder for some buyers to compete in many of the strongest markets across the U.S. The median price of an existing single-family home rose from a year earlier in 83% of the 178 markets measured…”

August 11 – Wall Street Journal (Annamaria Andriotis): “The bill is coming due for many homeowners on a type of loan that was widely popular in the run-up to the housing bust, causing a rise in delinquencies at banks. More homeowners are missing payments on their home-equity lines of credit, or Helocs, a type of loan that allows borrowers to withdraw cash from their house to pay for renovations, college tuition or almost any other expense. These loans typically require interest-only payments for the first 10 years, but then principal payments kick in for the next 15 or 20 years… Roughly 840,000 Helocs taken out in 2006 are resetting this year, with principal payments on an additional nearly one million loans expected to hit in 2017… Resets can lead to payments jumping by hundreds, or in some cases thousands, of dollars a month.”

August 8 – Bloomberg (Shahien Nasiripour): “When it comes to collecting on student loans, the U.S. Department of Education treats college dropouts the same as Ivy League graduates: They just want the money back. New data show the perils of that approach. Dropouts who took out loans to finance the degrees they ultimately didn't obtain often end up worse off for attending college... The typical college dropout experienced a steep fall in wealth from 2010 to 2013…, and an 11% drop in income—the sharpest decline among any group in America. It should therefore come as no surprise that half of federal student loan borrowers who dropped out of school within the past three years are late on their payments…”

August 10 – Wall Street Journal (Laura Kusisto): “The housing recovery that began in 2012 has lifted the overall market but left behind a broad swath of the middle class, threatening to create a generation of permanent renters and sowing economic anxiety and frustration for millions of Americans. Home prices rose in 83% of the nation’s 178 major real-estate markets in the second quarter…. Overall prices are now just 2% below the peak reached in July 2006, according to S&P CoreLogic Case-Shiller Indices… The lopsided recovery has shut out millions of aspiring homeowners who have been forced to rent because of damaged credit, swelling student loans, tough credit standards and a dearth of affordable homes, economists said. In all, some 200,000 to 300,000 fewer U.S. households are purchasing a new home each year than would during normal market conditions, estimates Ken Rosen, chairman of the Fisher Center of Real Estate and Urban Economics at the University of California at Berkeley.”

August 11 – Wall Street Journal (Josh Barbanel): “Vacancy rates for Manhattan rental apartments reached their highest level for any July in at least 14 years, the latest evidence that the market is softening, according to… Citi Habitats. The report also said deals that include landlord concessions more than doubled from July 2015. July is usually a strong month for New York City landlords, as college graduates move in and families scramble to find apartments in time for the fall semester.”

August 9 – Bloomberg (Joe Light): “Fannie Mae and Freddie Mac could need as much as $125.8 billion in bailout money from taxpayers in a severe economic downturn, according to stress test results released Monday by their regulator. The Federal Housing Finance Agency said that the government-controlled companies, which back nearly half of new mortgages, would need at least $49.2 billion.”

August 10 – Bloomberg (Melissa Mittelman): “As venture capitalists exercise more caution and place fewer bets, they’re leaving media startups behind. Venture funding to media-tech companies slid for the third consecutive quarter to $91.7 million, the lowest amount since mid-2013, according to… industry researcher CB Insights. Investment activity followed a similar trend, declining to the fewest number of deals since the second quarter of 2012. While U.S. venture deals were down overall in the first half of the year, the drop in funding to media companies has outpaced declines in other sectors, said Garrett Black, an analyst at researcher PitchBook.”

August 11 – Bloomberg (Lu Wang): “Investors who scored big gains by swooping in at the bottom of the last two U.S. equity selloffs now are backing away from the market. The number of officers and directors of companies purchasing their own stock tumbled 44% from a year ago to 316 in July, the lowest monthly total ever… With 1,399 executives unloading stock, sellers outnumbered buyers at a rate that was exceeded only two other times. While companies themselves keep buying back shares, demand from their highest-ranking employees has dried up as the S&P 500 Index climbed to fresh highs after going for more than a year without surpassing its previous peak.”

August 9 – Bloomberg (David Wilson): “Day-to-day drama has been largely absent from this quarter’s record-setting advance in the S&P 500 Index. The gap between daily highs and lows averaged 0.64 percentage point as of Monday… This would be the narrowest spread for a full quarter since U.S. stocks started the current bull market, as shown in the chart, or at any other time since 1993.”

August 11 – Reuters (Tim McLaughlin and Heather Somerville): “Some U.S. mutual funds are boosting their performance with relatively big bets on private companies such as Uber and Pinterest, which they have been marking up at a rate far greater than the broad stock market. Relied upon by millions of Americans to save for their retirement, mutual funds emphasize that their investments in young tech companies ahead of their initial public offerings are relatively small. A Reuters analysis of fund filings and other data shows, though, that some have taken a more aggressive approach, boosting the share of these companies to more than 5% of assets and awarding them rich valuations that in some cases have helped them beat their benchmarks and peers by a wider margin.”

China Bubble Watch:

August 12 – Bloomberg: “China’s broadest measure of new credit and another key gauge of lending increased at the slowest pace in two years, suggesting monetary authorities are more concerned about swelling financial risks than giving more of a boost to old growth engines. Aggregate financing was 487.9 billion yuan ($73.4bn) in July, compared with a median estimate of 1 trillion yuan… New yuan loans stood at 463.6 billion yuan, versus a projected 850 billion yuan…. Both increased by the least since July 2014. The broad M2 money supply increased 10.2%, the slowest pace since April 2015.”

August 12 – New York Times (Keith Bradsher): “The deal could be hard to resist. A Shanghai investment firm is offering a fat return of up to 10% a year, handily beating both the local stock market and the paltry payouts from bank accounts. It requires a minimum deposit of about $15… Investors can pull out in as little as seven days. Best of all, the money is guaranteed. There is just one catch: Investors know surprisingly little about what they are buying. The firm, State Gold Treasure, said the money would be plowed into a real estate company building a luxury serviced-apartment complex here in Shanghai. But it will not release details, including the complex’s address… Over the last five years, Chinese investors have plowed at least $2.8 trillion into buying such funds from banks alone. After quintupling since 2011, these investments, known as wealth management products, now total an amount roughly equal to more than one-third of… annual economic output. Their growth has increased as China’s economy has slowed.”

August 9 – Reuters (Elias Glenn and Yawen Chen): “China's exports and imports fell more than expected in July in a rocky start to the third quarter, pointing to further weakness in global demand in the aftermath of Britain's decision to leave the European Union. Imports fell 12.5% from a year earlier, the biggest decline since February and suggesting China's domestic demand may be faltering despite a flurry of measures to stimulate economic growth… Exports fell 4.4% on-year…”

August 9 – Reuters (Elias Glenn and Yawen Chen): “China's factory price deflation moderated further in July, with prices falling at their slowest pace in two years… A government-led building spree has increased demand for construction materials, but higher prices are also due in part to speculation in China's commodities futures market, which has pushed up Shanghai rebar futures up by 50% this year. The producer price index (PPI) fell 1.7% in July from a year ago…”

August 11 – Bloomberg (Tracy Alloway): “The good news is that the capital raises have begun. The bad news is that they need to continue. An analysis of 765 banks in China by UBS Group AG shows that efforts to clean up the country's debt-ridden financial system are well underway, with as much as 1.8 trillion yuan ($271bn) of impaired loans shed between 2013 and 2015, and 620 billion yuan of capital raised in the same period. But the work is far from over, as to reach a more sustainable debt ratio the Chinese banking sector will still require up to 2 trillion yuan of additional capital as well as the disposal of 4.5 trillion yuan worth of bad loans… ‘Contrary to market perception, bank recapitalisation and bailouts have begun,’ said UBS's Jason Bedford. ‘Most interestingly, for the first time in a decade we note formal implementations of asset restructuring plans and recapitalisations and bailouts of individual — and large — institutions.’”

August 11 – Bloomberg: “China’s infrastructure investors have had a tough two weeks, with plugs being pulled on at least $15 billion of potential deals in nuclear power and electricity distribution. Britain and Australia refused to sign off on investments where state-owned Chinese companies were ready to provide much-needed funding. In both cases, the long-term utility programs were halted in the later stages, stunning participants. Those in the U.K. were all set to join a signing ceremony when the announcement came. ‘As China’s diplomatic policies become more and more assertive, there’s a trend that these countries are gradually enhancing their vetting on Chinese investment,’ said Tao Jingzhou, a managing partner at Dechert LLP in Beijing. ‘This is an attitude change.’”

Japan Watch:

August 11 – Reuters (Leika Kihara): “The Bank of Japan has already prepared a preliminary outline of a ‘comprehensive’ review of its policies due next month that will maintain a pledge to hit its 2% inflation target as soon as possible, sources familiar with its thinking said. In the draft, the BOJ identifies sharp falls in oil prices, a prolonged hit to growth from a sales tax hike in 2014 and Japan's inability to shake off its deflationary mindset as hampering achievement of its inflation target, the sources said. By blaming external factors for keeping inflation subdued, the BOJ could use the review to defend its policy framework from rising criticism that three years of heavy money printing had failed to achieve its price target, they added.”

EM Watch:

August 12 – Bloomberg (Jeanette Rodrigues): “India’s inflation accelerated more than estimated, narrowing room for monetary easing as investors wait to see who will replace hawkish central bank Governor Raghuram Rajan next month. Consumer prices rose 6.07% in July from a year earlier… The consumer food price index rose 8.35% in July…”

Geopolitical Watch:

August 10 – Reuters (Andrew Osborn and Gleb Stolyarov): “Vladimir Putin accused Ukraine… of using terrorist tactics to try to provoke a new conflict and destabilize annexed Crimea after Russia said it had thwarted two armed Ukrainian attempts to get saboteurs into the contested peninsula. Russia's FSB security service said two people were killed in clashes and its forces had dismantled a Ukrainian spy network inside Crimea. Kiev denied the assertions, calling them an attempt by Moscow to create an excuse to escalate towards a war.”

August 11 – Bloomberg (Kateryna Choursina and Stepan Kravchenko): “Russia said the deaths of servicemen in Crimea would carry ‘consequences’ and Ukraine put its troops on ‘high alert,’ warning that Vladimir Putin is seeking to reignite the conflict in the disputed territories. The Foreign Ministry in Moscow raised the threat of retaliation a day after the Russian president vowed to respond with ‘very serious’ measures and said Ukrainian agents had engaged in ‘terror’ tactics on the Black Sea peninsula… Poroshenko dismissed the accusations as ‘fiction’ that could be an ‘excuse for further military threats’ by Russia.”

August 6 – Reuters (Michael Martina): “China's air force sent bombers and fighter jets on ‘combat patrols’ near contested islands in the South China Sea, in a move a senior colonel said was part of an effort to normalize such drills and respond to security threats. The exercises come at a time of heightened tension in the disputed waters after an arbitration court in The Hague ruled last month that China did not have historic rights to the South China Sea.”

August 9 – Reuters (Kiyoshi Takenaka and Eric Beech): “Japan warned China… that ties were deteriorating over disputed East China Sea islets, and China's envoy in Tokyo reiterated Beijing's stance that the specks of land were its territory and called for talks to resolve the dispute. The diplomatic tussle comes amid simmering tension as China builds on outposts in the contested South China Sea, including what appear to be reinforced aircraft hangars, according to new satellite images. Ties between Asia's two largest economies have been strained in recent days since Japan saw a growing number of Chinese coastguard and other government ships sailing near the East China Sea islets, called the Senkaku in Japan and Diaoyu in China.”

August 11 – Washington Times (Carlo Munoz): “U.S. military officials are trying to pacify a furious China in the wake of Washington’s plan to deploy a battery of advanced missile defense systems in South Korea, insisting to angry military leaders in Beijing that the weapons would be solely targeting ballistic missile threats from North Korea and not undercut China’s own military deterrent. Beijing has denounced the planned deployment of the Terminal High Altitude Area Defense weapon in South Korea and has already retaliated in ways large and small, including blocking a U.N. Security Council resolution condemning a recent North Korean missile test…”

August 11 – Reuters (Adam Jourdan): “A newly launched satellite will help China protect its maritime interests, the official China Daily newspaper reported… amid growing tensions over disputed territory in the South China Sea. The ‘Gaofen 3’ satellite that was launched on Wednesday has a radar system that captures images from space with a resolution down to 1 meter (3 feet) and can operate in all weathers… The satellite will play an important role in monitoring the marine environment, islands and reefs, and ships and oil rigs,’ the China Daily said, citing project leader Xu Fuxiang…. ‘Satellites like the Gaofen 3 will be very useful in safeguarding the country's maritime rights and interest…”

August 10 – Reuters (Greg Torode): “Vietnam has discreetly fortified several of its islands in the disputed South China Sea with new mobile rocket launchers capable of striking China's runways and military installations across the vital trade route, according to Western officials. Diplomats and military officers told Reuters that intelligence shows Hanoi has shipped the launchers from the Vietnamese mainland into position on five bases in the Spratly islands in recent months, a move likely to raise tensions with Beijing.”