Saturday, September 17, 2016

Weekly Commentary: Risk Off, the BOJ and China

Is a meaningful de-risking/de-leveraging episode possible with global central banks injecting liquidity at the current almost $2.0 TN annualized pace?

Thus far, central bankers have successfully quashed every incipient Risk Off. Market tumult has repeatedly been reversed by central bank assurances of even more aggressive monetary stimulus. The flood gates were opened with 2012’s global concerted “whatever it takes.” Massive QE did not, however, prevent 2013’s “taper tantrum.” Previously unimaginable ECB and BOJ QE coupled with ultra-loose monetary policy from the Fed were barely enough to keep global markets from seizing up earlier in the year.

It’s my long-held view that market interventions and liquidity backstops work primarily to promote speculative excess and resulting Bubbles. While celebrated as "enlightened" policymaking throughout the markets, an “activist” governmental role (fiscal, central bank, GSE, etc.) is inevitably destabilizing. The upshot of now two decades of activism is a global marketplace dominated by speculation and leveraging.

I’ll posit that a given size of “liquidity backstop” fosters a commensurate speculative response in the marketplace, ensuring that a larger future backstop/intervention will be required come the next serious de-risking/de-leveraging episode. The essence of the current (global government finance) Bubble is that central banks have committed to doing “whatever it takes” – and this moving target “whatever it will take” has kept inflating right along with speculative market and asset Bubbles across the globe. This scheme has gone on for years. A Day of Reckoning cannot be postponed indefinitely.

This is clearly a more pressing issue for me than for other analysts. Speculative Bubbles tend to climax with a terminal flurry of exuberance, excess and dislocation. A final destabilizing tsunami of financial flows and attendant price spikes ensure that grossly inflated market confidence and price levels turn untenable. Then comes the painful Reversal.

Global sovereign debt and bond markets this year were overwhelmed by “blow-off” excess. The biggest cash markets in the world along with the biggest derivative markets in the world dislocated in historic “melt-up.” Effects became systemic. Price impacts were extreme – historic. Virtually all asset classes were significantly disrupted by Bubble Dynamics. To be sure, there was newfound exuberance in the power and sustainability of “whatever it takes.”

From my analytical perspective, it appears we’re again nearing another “critical juncture,” yet another potential major inflection point. And the probability that such prognostication ends up looking foolhardy is not small. After all, central bankers have repeatedly had their way – imposed their will upon the markets. On the other hand, if we have indeed reached a critical point for acutely vulnerable markets, few are prepared. Of course, almost everyone is convinced they have the answer to the opening question: “No, and this was proved earlier in the year.”

Let’s take a different tack. Would $167bn ($2TN/12), a month of global QE, be sufficient to hold Risk Off at bay? How about $38 billion during a week of intense market tumult? The proverbial drop in the bucket. I actually believe that the global Bubble has inflated to such precarious extremes that even $2.0 TN of central bank purchases would in rather short order be overwhelmed in the event of a major bout of speculative de-leveraging. Let me suggest that the almighty central bank liquidity backstop arsenal would wither in the face of a synchronized global liquidation across various asset classes. What’s more, the possibility of just such an outcome has greatly increased after the recent global bout of synchronized central bank-induced speculative excess.

By the look of markets over the past week or two, the six-month central bank-induced respite appears to be winding down. The ghosts of January and February have reawakened: Europe, global banks, energy, EM and China (to name a few). Some Friday headlines: “Oil Falls to 1-Month Low…” “Mexican Peso Slides to Record Low…”; ‘Cost of Insuring Deutsche Bank’s debt Rises 8 percent…”; “U.S. Stock Funds Post Largest Weekly Outflows in a Year…” “Monte Paschi Bonds Slide to Two-Month Low…” “China H Shares Go From Best to Worst…”; “Low-Volatility Funds Face Rougher Ride”. “Volatility Puts Some Funds at Risk.”

Europe suffered a rough week, especially at The Fragile Periphery. In general, unimpressive rallies gave way to serious selling. Greek 10-year yields surged 33 bps to 8.45%, the high going back to April. Portugal’s 10-year spread (to bunds) widened 26 bps this week to 339 bps, the widest level since February. Italian spreads widened 10 bps to a four-month wide 134 bps. Major equities indices dropped 2.8% in Germany and 3.5% in France. Stocks were slammed 4.3% in Spain and 5.6% in Italy.

September 16 – Wall Street Journal (Jenny Strasburg): “A legal settlement half the size of the U.S. Justice Department’s $14 billion opening bid in a mortgage-securities case would exceed Deutsche Bank AG’s litigation provisions and strain its already thin capital cushion. Even a $4 billion settlement ‘would put questions around capital position,’ J.P. Morgan… analyst Kian Abouhossein said in a research note this week.”

Ominously, European banks were back in the markets’ crosshairs. Deutsche Bank was hammered 12.3% this week, boosting y-t-d losses to 45%. Europe’s STOXX 600 Bank Index sank 5.6% (down 24% y-t-d). Italian banks were slammed 9.4% (down 50% y-t-d). Italy’s Monte dei Paschi was clobbered 9% Friday, while UniCredit sank 5.8%. It was not only European banks under pressure. Japan’s Topix Bank index dropped 4.3% this week (down 29% y-t-d), while Hong Kong’s Hang Seng Financials fell 4.2% (down 1.7% y-t-d). U.S. Banks dropped 1.6% (down 3.7% y-t-d).

Also reminiscent of January/February, EM selling pressure intensified. The Mexican peso sank 3.8% this week to a record low. It’s easy to blame Trump, but clearly the markets are increasingly concerned with Mexico’s large current account deficit (3% of GDP), economic vulnerability and susceptibility to “hot money” outflows. Mexico – along with indebted energy companies and countries around the world - were not helped by crude’s $2.85 drop to $43.03, a one-month low. Russian stocks dropped 2.3%, with the ruble down 0.7%. No help from geopolitical either. The South Korean won dropped 2.1%, with Korean stocks down 1.9%. Mexico’s stocks lost 1.2%, and Brazil’s Bovespa fell 1.7%.

September 11 – Reuters (Silvio Cascione): “Brazilian prosecutors launched a preliminary investigation into an alleged corruption scheme at the national development bank BNDES, weekly magazine Veja reported… The prosecutors have been gathering documents for at least two months and are in talks with a former BNDES executive about a potential collaboration… BNDES is the largest source of long-term corporate credit in Brazil and is one of the world's largest development banks. The bank ramped up lending under the administrations of the Workers' Party between 2003 and 2015 as part of government efforts to boost economic growth, offering subsidized credit to several of Brazil's largest firms across sectors.”

It was another interesting week in the currencies. The dollar caught a bid, especially versus EM and Europe. And as the marketplace turns its focus back to risk and liquidity, it’s notable that the British pound was hit 2.0% against the dollar this week. The Japanese yen gained 0.4% versus the dollar.

The much anticipated Fed and BOJ meetings are now just days away (Sept. 20/21). Market odds for the FOMC raising rates next week have dropped down to about 10%. Significantly more uncertainty surrounds the Bank of Japan meeting.

September 15 – Wall Street Journal (Takashi Nakamichi): “The world’s leading experiment in monetary easing is floundering, and its engineers are divided over how to get it on track. The Bank of Japan has tried radical measures for 3½ years to reflate the country’s sagging economy, resorting this year to negative interest rates. Growth and inflation remain elusive. Now the bank’s board, while still in favor of easing, has some members wanting to revise the methods for doing so—likely sparking uncertainty for economy-watchers and worries for investors. Japan’s financial regulator, big banks, insurers and advisers to Prime Minister Shinzo Abe have all piled into the fray with policy prescriptions, in a ferment that comes less than a week before the BOJ meets to decide its next move. ‘The BOJ’s policy has become a ‘cloudy cocktail’—nontransparent and difficult to understand,’ said Nobuyuki Nakahara, a former BOJ board member who advises Mr. Abe… The suspicion that central-bank firepower is reaching its limits finds support in Japan, where the BOJ has yet to generate steady inflation despite buying nearly $800 billion of bonds annually since late 2014, plus billions of dollars worth of exchange-traded funds.”

One could surmise that there’s been sufficient pre-meetings market volatility to hold hesitant central bankers at bay – in Washington and Tokyo. The now typical modus operandi finds central bankers attempting to muster some courage (“trial balloons” floated along the way) ensuring market conniption fits leading up to policy decision time. Unsettled markets needle dovish central bankers to “beat expectations” – and markets rally. Clockwork.

The problem is that it’s no longer easy for central bankers to placate an increasingly disordered market backdrop. BOJ stimulus was already unprecedented, even before QE was again supersized earlier in the year. Interest rates are already negative. There are heightened fears that negative rates are harming the banks, insurance companies and pension funds, and that the BOJ risks running short of bonds to purchase. As for the FOMC, the markets are already confident the diffident Fed will again stand pat.

All eyes will be fixated on the Bank of Japan. Indication of a loss of nerve would have an immediate impact on global yields and currencies. More likely, policy measures will be convoluted. At this point, efforts to manipulate a steeper yield curve could prove too cute by half. Markets are somewhat indifferent to negative rates, but would look quite unkindly to any uncertainty with respect to future “whatever it will take” QE.

The markets have grown so accustomed to Kuroda’s game of dovish surprises. These days there’s recognition that going on four years of BOJ stimulus have failed to bear fruit – while risk proliferates like weeds (tall with nettles). One more round of mindlessly “beating expectations” could very well propel a reflex rally. It also risks an alarming – policy at the “end of the rope”! - market seizure.

A few months back I wrote that the latest round of central bank reflationary measures would prove unsuccessful. I’m sticking with this view, notwithstanding the strong rallies experienced almost across the board. A policy-induced short squeeze took on a life of its own. Sovereign bonds dislocated spectacularly, unleashing a liquidity outburst. “Money” flooded into EM and anything with a yield. “Melt-up.” “Money” flooded into perceived low-risk equity products. “Money” flooded into the indexes – equities and corporate debt. Within the hedge fund community, “money” flooded into the hot strategies – risk-parity and “managed futures”/CTA. “Money” flooded into instruments profiting from a collapse in market volatility.

Central banks ensured that enormous amounts of “money” simultaneously flowed across various – now highly correlated - asset classes. “Funny” how things work. Just when it was becoming apparent that monetary stimulus was losing its punch, desperate policy measures spurred one final destabilizing “whatever it will take” speculative whirlwind. This has created an extraordinary backdrop of markets set up for disappointment and dislocation.

My view holds that Global Risk Off has likely commenced. It’s reemerging in Europe, in EM, in energy and in global financials. China remains a major unknown. Their economy stumbles along on record Credit expansion, Credit that turns more problematic by the month. A mortgage lending Bubble is increasingly dominating Credit growth, creating serious issues for regulators, the financial sector and the overall maladjusted Chinese economy. And Global Risk Off risks triggering another bout of destabilizing outflows and China currency angst, which would be an even bigger problem for the world today than it was at the beginning of the year.

For the Week:

The S&P500 recovered 0.5% (up 4.7% y-t-d), and the Dow increased 0.2% (up 4.0%). The Utilities rallied 2.2% (up 14.4%). The Banks were hit 1.6% (down 3.7%), while the Broker/Dealers were little changed (down 4.0%). The Transports declined 0.7% (up 3.5%). The S&P 400 Midcaps fell 0.5% (up 8.8%), while the small cap Russell 2000 gained 0.5% (up 7.8%). The Nasdaq100 jumped 2.9% (up 4.9%), and the Morgan Stanley High Tech index rose 1.7% (up 9.1%). The Semiconductors surged 4.3% (up 20.8%). The Biotechs rose 1.3% (down 12%). With bullion down $17, the HUI gold index dropped 1.9% (up 103%).

Three-month Treasury bill rates ended the week at 28 bps. Two-year government yields declined two bps to 0.76% (down 29bps y-t-d). Five-year T-note yields slipped two bps to 1.20% (down 55bps). Ten-year Treasury yields rose two bps to 1.69% (down 56bps). Long bond yields gained six bps to 2.45% (down 57bps).

Greek 10-year yields surged 33 bps to 8.45% (up 113bps y-t-d). Ten-year Portuguese yields jumped 25 bps to 3.39% (up 87bps). Italian 10-year yields rose 10 bps to 1.34% (down 25bps). Spain's 10-year yields were unchanged at 1.07% (down 70bps). German bund yields declined a basis point to 0.00% (down 62bps). French yields were unchanged at 0.30% (down 69bps). The French to German 10-year bond spread widened one to 30 bps. U.K. 10-year gilt yields increased a basis point to 0.87% (down 109bps). U.K.'s FTSE equities index declined 1.0% (up 7.5%).

Japan's Nikkei 225 equities index sank 2.6% (down 13.2% y-t-d). Japanese 10-year "JGB" yields declined three bps to negative 0.05% (down 31bps y-t-d). The German DAX equities index fell 2.8% (down 4.3%). Spain's IBEX 35 equities index slid 4.3% (down 9.5%). Italy's FTSE MIB index sank 5.6% (down 24.4%). EM equities were under pressure. Brazil's Bovespa index dropped 1.7% (up 31.6%). Mexico's Bolsa was down 1.2% (up 6.9%). South Korea's Kospi declined 1.9% (up 1.9%). India’s Sensex equities slipped 0.7% (up 9.5%). China’s Shanghai Exchange fell 2.5% (down 15.2%). Turkey's Borsa Istanbul National 100 index declined 1.3% (up 6.0%). Russia's MICEX equities index fell 2.3% (up 12.5%).

Junk bond mutual funds saw outflows surge to $2.5 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped six bps to 3.50% (down 41bps y-o-y). Fifteen-year rates added a basis point to 2.77% (down 34bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates jumping eight bps to 3.62% (down 35bps).

Federal Reserve Credit last week declined $4.7bn to $4.423 TN. Over the past year, Fed Credit declined $22.4bn. Fed Credit inflated $1.612 TN, or 57%, over the past 201 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt sank $19.5bn last week to a two-year low $3.165 TN. "Custody holdings" were down $173bn y-o-y, or 5.2%.

M2 (narrow) "money" supply last week declined $7.5bn to $13.040 TN. "Narrow money" expanded $873bn, or 7.2%, over the past year. For the week, Currency dipped $0.8bn. Total Checkable Deposits dropped $38.1bn, while Savings Deposits jumped $31.2bn. Small Time Deposits added $1.2bn. Retail Money Funds slipped $1.0bn.

Total money market fund assets sank $38.5bn to an almost one-year low $2.659 TN. Money Funds increased $13bn y-o-y (0.5%).

Total Commercial Paper dropped $19bn to $964bn. CP declined $75bn y-o-y, or 7.2%.

Currency Watch:

September 15 – Bloomberg (Kevin Buckland and Netty Idayu Ismai): “Volatility has reawakened in the $5.1 trillion foreign-exchange market, as traders start to imagine life without ultra-easy monetary policy. The impact is greatest in the currencies with most at stake from an end to years where stimulus only got more generous -- the so-called high yielders. A gauge of expected swings in emerging-market currencies has surged above an equivalent measure for developed markets by the most since May.”

September 14 – Wall Street Journal (Anjani Trivedi): “A yuan credit crunch isn’t what Beijing had in mind when it promoted trading of its currency offshore. But that’s what it has achieved in Hong Kong of late. For the second time this year, short-term borrowing costs in the yuan have skyrocketed. In recent days, the rate on one-week interbank yuan loans in Hong Kong surged over 8 percentage points to 10.15%. That again makes betting against the yuan an expensive proposition. It’s also a reminder that just because the yuan’s recent behavior has been seemingly anodyne, markets shouldn’t get too complacent.”

September 14 – Bloomberg: “The Chinese central bank’s yuan positions -- which reflect the amount of foreign currency held on its balance sheet -- fell to the lowest since 2011 in August, a sign that it sold dollars to support the yuan. The People’s Bank of China has been seen intervening in the market to stem the currency’s slide…”

The U.S. dollar index rallied 0.7% to 96.04 (down 2.7% y-t-d). For the week on the upside, the South African rand increased 1.6%, the Japanese yen 0.4% and the Brazilian real 0.3%. For the week on the downside, the Mexican peso declined 3.8%, the British pound 2.0%, the Canadian dollar 1.2%, the Swedish krona 0.9%, the New Zealand dollar 0.8%, the Norwegian krone 0.7%, the euro 0.7%, the Australian dollar 0.7% and the Swiss franc 0.5%. The Chinese yuan increased 0.2% versus the dollar (down 2.8% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 1.9% (up 11.7% y-t-d). Spot Gold declined 1.3% to $1,310 (up 24%). Silver dropped 2.7% to $18.84 (up 37%). Volatile Crude sank $2.85 to $43.03 (up 16%). Gasoline surged 7.4% (up 15%), and Natural Gas rose 5.4% (up 26%). Copper jumped 3.2% (up 1%). Wheat was little changed (down 14%). Corn declined 1.2% (down 6%).

China Bubble Watch:

September 14 – Bloomberg: “China’s broadest measure of new credit exceeded estimates in August as a property boom in the nation’s biggest cities fuels near-term growth and adds to longer-term worries about the expansion’s sustainability. Aggregate financing was 1.47 trillion yuan ($220bn) in August compared with a median estimate of 900 billion yuan in a Bloomberg survey… New yuan loans stood at 948.7 billion yuan, versus a projected 750 billion yuan. M2 rose 11.4% from a year earlier versus 10.5% seen by economists.”

September 15 – Wall Street Journal (Anjani Trivedi): “China’s credit engines were at it again last month and, worryingly, instead of sprinkling debt evenly across the financial system, mortgages took an outsize share. More than 70% of new loans in August were to households, much of that in the form of mortgages, going by historical averages, a remarkable shifting of the fire hose of credit. It also helps explain why China’s property market has raced higher despite broader economic worries. China’s stock of mortgages stood at 16.9 trillion yuan ($2.5 trillion) as of June 30. Almost a quarter of that was built up in just the past year…”

September 13 – Bloomberg: “China’s economy strengthened after July’s hiccup as factory output, investment and retail sales all exceeded economist estimates, amid a boost from property that’s added to concern that price gains may prove unsustainable. Industrial production rose 6.3% from a year earlier in August… Retail sales climbed 10.6% last month, from 10.2% on July. Fixed-asset investment increased 8.1% in first eight months of the year.”

September 12 – Reuters (Kevin Yao): “China should take steps to curb the flow of capital into the property market and state-owned companies to help slow the rise of debt levels in the economy, Ma Jun, the central bank's chief economist, told the China Business News… China's total debt load rose to 250% of gross domestic product (GDP) last year, and the IMF has warned that the high corporate debt ratio of 145% of GDP could lead to slower economic growth if not addressed… Ma identified the property sector and state-owned enterprises as key drivers of high debt levels in the economy over recent years. ‘We should take a lot of measures to curb excessive bubbles in the real estate sector, curb the flow of excessive financial resources into the real estate sector," Ma said.”

September 11 – Bloomberg: “China has proposed measures to tighten leverage rules in the onshore bond market, highlighting concern that investors’ borrowings are overextended after a series of defaults. The China Securities Depository and Clearing Corp. said… investor’s outstanding repurchase contracts shouldn’t exceed 70% of debt holdings in the person’s account…If an investor uses a security rated AA or AA+ as collateral, the amount shouldn’t be more than 10% of the bond’s total issuance… The CSDC is seeking public opinions on the proposed regulations… Chinese regulators have sought to cut leverage in the bond market after at least 18 notes defaulted so far this year, already exceeding the tally for 2015. The outstanding amount of repurchase agreements in China’s interbank market, used by debt traders to amplify their buying power, declined 1.8% in August to 8.5 trillion yuan ($1.3 trillion) from July. Still, that’s 37% higher than the level a year earlier.”

September 11 – Bloomberg: “China should take steps to restrain bubble-like expansion in housing markets and tame excessive financial inflows into property, according to a central bank economist. ‘Measures should be taken to put a brake on the excessive bubble expansion in the property sector, and we should curb excessive financing into the real estate sector,’ Ma Jun, chief economist of the People’s Bank of China’s research bureau, said… A third of the financial-system leverage added over the past decade has come from the surge of housing prices, Ma said.”

Europe Watch:

September 11 – Wall Street Journal (Giovanni Legorano): “For UniCredit SpA, the summer of discontent for Italy’s banks looks likely to stretch well into the fall—and possibly beyond. UniCredit, Italy’s largest lender by assets, emerged as one of the weakest big banks in Europe in July’s stress tests, showcasing the failure of its attempts to respond to rock-bottom interest rates and a huge pile of bad loans. Now, as Jean-Pierre Mustier, the bank’s new chief executive, readies a big-bang plan to revive UniCredit’s fortunes, he faces a series of unpalatable choices: Aggressive action to cut the bank’s €80 billion ($89.9bn) in bad loans…, while an asset sale could help bolster its capital position but would hurt already thin profit.”

September 11 – Bloomberg (Nikos Chrysoloras): “Prime Minister Alexis Tsipras said Greece will only be able to lure investors once a quarrel between creditors over how to lower the country’s debt burden is resolved, which he said should lead the European Central Bank to include Greek government bonds in its asset purchase program. ‘What is currently causing a delay in regaining the trust of markets and investors isn’t debt decisions in themselves, as what the Eurogroup decided was in the right direction, but the constant quarrel and clash between the International Monetary Fund and European institutions,’ Tsipras said… “

Fixed-Income Bubble Watch:

September 13 – Bloomberg (Beth Jinks): “Elliott Management Corp.’s Paul Singer said investors should sell out of longer-term bonds, warning that even debt securities of G7 nations aren’t a safe haven. Speaking at the CNBC Institutional Investor Delivering Alpha Conference…, the hedge fund billionaire said he sees a risk that inflation may ‘surprise everyone’’ and ‘blow through targets’’ even during poor economic conditions. Singer, 72, said the world is experiencing a ‘very dangerous’ time in global economies and financial markets.”

September 12 – Wall Street Journal (Richard Barley): “The bond market has been turned on its head by central banks—and the market’s tantrum shows it. Last week brought a string of events that could be read as clear signals of overheating in credit markets. There was the bizarre sight of French drugmaker Sanofi and German consumer-goods company Henkel issuing debt at negative yields. And in the European high-yield market, bearings maker Schaeffler and packaging group Ardagh sold large payment-in-kind notes where interest can be paid in additional debt under certain circumstances, traditionally a sign of a frothy market. Yields on ‘junk’-rated euro-denominated debt hit a record low of 3.35% last week.”

September 14 – Bloomberg (Eliza Ronalds-Hannon): “The $13.6 trillion Treasury market is sending a signal it hasn’t flashed in more than four years. The message: Shorter-dated debt is the place to be as traders gain confidence the Federal Reserve will keep interest rates on hold, at least through next week’s policy meeting. The extra yield investors demand to own 30-year rather than five-year securities, a measure of the yield curve, increased for a ninth straight day Wednesday. That’s the longest streak since 2012,”

September 16 – Bloomberg (Scott Lanman): “China’s holdings of U.S. Treasuries fell in July to the lowest level in more than three years, as the world’s second-largest economy pares its foreign-exchange reserves to support the yuan. The biggest foreign holder of U.S. government debt had $1.22 trillion in bonds, notes and bills in July, down $22 billion from the prior month, in the biggest drop since 2013… The portfolio of Japan, the largest holder after China, rose $6.9 billion to $1.15 trillion. Saudi Arabia’s holdings of Treasuries declined for a sixth straight month, to $96.5 billion.”

September 12 – Bloomberg (Luca Casiraghi): “Bonds that allow issuers to defer interest payments are nosediving less than a week after they were sold amid a sell-off of fixed-income assets. Ardagh Group SA’s 845 million euros ($948 million) payment-in-kind toggle notes due September 2023 are indicated at 95.5 cents on the euro, down 4.5 cents from when the… packaging company sold them on Wednesday… German auto components maker Schaeffler AG’s 750 million euros of notes due September 2026 are quoted 97.2 cents down from a sale price of 100 cents on Thursday… Both companies increased the size of their payment-in-kind note sales last week amid surging demand for higher-yielding assets, which pushed borrowing costs for junk-rated companies to a record low.”

September 14 – Bloomberg (Liz McCormick): “With a seismic overhaul of the $2.6 trillion money-market industry weeks away from kicking in, money managers are bracing for a last-minute exodus of as much as $300 billion from funds in regulators’ cross hairs. Prime funds, which seek higher yields by buying securities like commercial paper, are at the center of the upheaval. Their assets have already plunged by almost $700 billion since the start of 2015, to $789 billion… The outflow has rippled across financial markets, shattering demand for banks’ and other companies’ short-term debt and raising their funding costs… The key date is Oct. 14, when rules take effect mandating that institutional prime and tax-exempt funds end an over-30-year tradition of fixing shares at $1. Funds that hold only government debt will be able to maintain that level.”

September 15 – Wall Street Journal (Ben Eisen and Min Zeng): “Yield tourism is getting expensive. For much of the year, strong demand from Japanese and European investors seeking better returns for their money than they could get at home pushed up prices of U.S. Treasurys. Now, the rising cost of borrowing dollars overseas and investing them in the U.S. is amplifying the selloff. The culprit is the cost of hedging against foreign-exchange swings in markets for cross-currency basis swaps and foreign-exchange forwards. The additional cost has all but erased the extra income Japanese investors could gain from buying Treasurys instead of lower-yielding assets at home.”

Global Bubble Watch:

September 15 – Bloomberg (Wes Goodman and Eliza Ronalds-Hannon): “Speculation that the Japanese central bank is about to undertake a shift in monetary policy is changing the shape of bond markets around the globe. The difference between short- and long-term yields is widening globally on bets the Bank of Japan’s next monetary twist at its Sept. 20-21 policy meeting will steepen the yield curve. Japan would achieve that by cutting its negative interest rate further, while simultaneously reducing purchases of long-term bonds, according to Morgan Stanley MUFG Securities… Such moves have the potential to ripple across the globe by reversing this year’s collapse in Japan’s longest-dated yields, and the attendant flows of money from the world’s second-biggest bond market to the U.S. and its juicier yields.”

September 12 – Financial Times (Robin Wigglesworth): “The summer tranquility is ending with a bang, as markets convulse with the most severe bout of turmoil since the UK’s Brexit vote. Some analysts say an old bogeyman might have exacerbated the turmoil. The primary trigger for the sell-off over the last two days was disappointment with the European Central Bank not extending its bond-buying programme… Yet some analysts say the severe reaction might have been worsened by forced selling by vehicles such as commodity trading advisers (CTAs), risk parity funds and other computer-driven strategies that respond automatically and dynamically to market turbulence. ‘If you think of an impartial, impassionate machine just grinding away, hitting bids trying to identify weakness and stops, then I think you have the CTA situation about right for now,’ Peter Tchir of Brean Capital wrote… ‘Then there are the risk parity funds who I think are hitting a trifecta of problems, rising volatility, correlations becoming more positive and a couple of days of everything going down.’ CTAs are trend-following, algorithmic hedge funds that tend to buy securities that have already gone up in price, and sell falling ones.”

September 13 – Wall Street Journal (Corrie Driebusch and Aaron Kuriloff): “Broad selling rattled stock and bond markets again Tuesday, intensifying concerns that the surge in volatility could force sales by a breed of hedge funds that use borrowed money to boost returns. So-called risk-parity funds seek to produce above-market gains with lower risk by using futures or other derivatives to increase their returns on safer assets such as bonds. This leverage has at times resulted in strong performance by the funds… But it also leaves them vulnerable when stock and bond prices fall suddenly, as happened both on Friday and Tuesday.”

September 16 – Bloomberg (Dakin Campbell, Tom Schoenberg and Jan-Henrik Foerster): “Deutsche Bank AG’s shares and its riskiest bonds dropped the most since the Brexit vote after the lender said the U.S. Justice Department is seeking $14 billion to settle a probe tied to mortgage-backed securities, more money than the bank is willing to pay. ‘Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited… The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.’”

September 11 – Bloomberg (Sid Verma and Luke Kawa): “Global current-account imbalances are back, bringing with them deflationary forces and slamming the brakes on global growth. That's the sobering conclusion of an HSBC… report…, which laments that an effective, international policy response to the problem is likely to be a long way off. Last year represented an inflection point for the global economy according to Janet Henry, the bank's global chief economist. After moderating slightly after the financial crisis, current-account imbalances have started to widen once more, with the surpluses of Germany, China, and Japan – the world’s three largest surplus nations — increasing both in dollar and GDP-share terms. By the former metric, HSBC calculates that this year global imbalances will be close to 2007's record highs.”

September 14 – Wall Street Journal (Greg Ip): “For years, the world has looked to central banks to deploy whatever tools they had to prop up economic growth. Now, just as those tools reach their limits, governments are quietly stepping up. Fiscal policy across the developed world is collectively turning more stimulative for the first time since the end of the recession… While the scale of the stimulus is modest in dollar terms, it signals a more profound shift in the political winds. Globally, the rise of political populism has pushed deficits down the list of priorities while elevating tax cuts and benefits for the working class.”

September 15 – Bloomberg (Greg Quinn): “Canadian household debt exceeded the country’s gross domestic product for the first time as liabilities climbed to a fresh record relative to disposable income. Household debt rose to 100.5% of gross domestic product in the second quarter from 98.7% previously... Credit-market debt such as mortgages increased to 167.6% of after-tax income…”

September 13 – Bloomberg (Katia Dmitrieva): “A tax on foreign homebuyers in Vancouver cut luxury purchases in Canada’s priciest housing market by more than half last month… Meanwhile, high-end sales in Toronto surged. Transactions in Vancouver of at least C$1 million ($759,000) slid 65% from a year earlier to 95 units in August, the month that a 15% transfer tax on deals by non-Canadian homebuyers took effect, according to Sotheby’s International Realty Canada. At the same time, luxury-home sales in Toronto and its suburbs doubled to 1,459 units…”

U.S. Bubble Watch:

September 13 – Reuters (Lindsay Dunsmuir): “The U.S. government posted a $107 billion budget deficit in August, a 66% increase from the same month last year… This compared to a deficit of $64 billion in August 2015… The fiscal year-to-date deficit was $621 billion through August, up 17% from a $530 billion deficit at the same time last year.”

September 14 – CNBC (John W. Schoen): “Years of underfunding and lackluster investment returns have left state pubic pensions even deeper in the hole — a shortfall taxpayers will eventually have to make up. Some states are in much better shape than others, according to the latest data from S&P Global Ratings. In New Jersey, for example, the state has set aside just 38% of what it needs to make good on promises to current and future retirees, which leaves a shortfall that works out to $10,648 per person… After years of not setting aside enough money, state pension funds are looking at a $1 trillion shortfall in what they owe workers in benefits…”

September 15 – Financial Times (Nicole Bullock and Robin Wigglesworth): “Low volatility investment funds have been one of the year’s hottest trends. But the recent stock market ructions have underscored that they may not be the ‘killer app’ that some investment experts think. Low or minimum volatility exchange traded funds seek stock investments with less volatility than overall equities…Their genesis came after academics showed how these more boring stocks actually tend to sharply outperform the stock market over time. ‘Low-vol’ ETFs naturally had a receptive audience when they were first introduced in 2011. And lately they have been on a red hot streak, against a backdrop of nervousness about global growth and burgeoning interest in so-called ‘smart beta’, the next generation of passive investment, with ETFs focusing on one or several so-called factors, such as low-vol, cheap valuations or momentum, in an effort to outperform the wider market.”

September 14 – Bloomberg (Lu Wang and Oliver Renick): “Two investor obsessions, volatility and exchange-traded notes, are being taken to increasingly extreme lengths in the U.S. stock market. For the first time on record, the iPath S&P 500 VIX Short-Term Futures ETN recorded more volume on Tuesday than any company in the S&P 500 Index, with a record 110 million shares changing hands. The closest was Bank of America Corp., with 89.3 million shares trading. The note fell 0.5% Wednesday, trimming a rout that topped 5% as the S&P 500 Index erased gains… Among ETPs, VXX ranked the third-most active yesterday after SPDR S&P 500 ETF Trust and iShares MSCI Emerging Markets ETF.”

September 16 – Wall Street Journal (Riva Gold and Art Patnaude): “Real-estate funds just posted their biggest-ever weekly inflows, a sign of investors’ continued appetite for income-providing holdings in an era of ultra-low interest rates. Despite a rough week in terms of performance, mutual fund investors poured the most money on record into real estate in the second week of September… The net $2.9 billion committed trounced the previous record of $1.68 billion set earlier this year.”

September 13 – Wall Street Journal (Josh Mitchell): “The industry warnings are urgent and often dire: The housing market could stall. Marriages are being postponed. Workers won’t have the savings to retire. The nation’s food supply will be disrupted. They point to one threat: soaring student debt. A tripling of student debt over the past decade to more than $1.3 trillion has unleashed a torrent of Washington lobbying from outside the education sector, with various industries describing a ‘crisis’ requiring federal intervention. Real-estate agents, farmers, architects, startup lenders, lawyers, tech companies, benefits administrators—even podiatrists—have sent lobbyists to Capitol Hill over the past two years to push for legislation to forgive or at least reduce what workers and consumers owe…”

September 14 – CNBC (Jon Marino): “Wall Street is hitting the brakes on car loans. The CEO of JPMorgan Chase's consumer and community banking segment, Gordon Smith, said this week at an industry conference… that his company is backing away from the longest types of auto loans... ‘We decided to do a lot less lending’ in the 84-month term loan category, he said… at the Barclays 2016 Global Financial Services Conference. ‘Should we see a downturn in the economy ... that will be an area that is more stressed,’ he added. At Wells Fargo, which also appeared at the event, the bank added $150 million to reserves in the second quarter, ‘primarily driven by loan growth in the commercial, auto and credit card portfolios.’”

September 14 – Wall Street Journal (Anna Wilde Mathews): “The average cost of health coverage offered by employers pushed above $18,000 for a family plan this year, though the growth was slowed by the accelerating shift into high-deductible plans… Annual premium cost rose 3% to $18,142 for an employer family plan in 2016, from $17,545 last year, according to the annual poll… by the nonprofit Kaiser Family Foundation along with the Health Research & Educational Trust…”

September 16 – Bloomberg (Dawn McCarty and Shahien Nasiripour): “ITT Educational Services Inc. began liquidation proceedings in an Indianapolis bankruptcy court Friday after closing 136 technical schools, leaving over 35,000 students stranded in one of the largest college shutdowns in U.S. history. The 50-year-old for-profit college operator, which had campuses in 38 states, said it was forced to close its doors after the U.S. Education Department demanded a steep increase in the security the company would have to post to guarantee federal student aid. More than 8,000 employees were affected…”

September 13 – Reuters (Olivia Oran): “As Goldman Sachs… has built its U.S. consumer bank, it has established a team to put its deposits to work on Wall Street, a telling development about Goldman's ambitions for the retail bank. Led by 40-year-old Goldman partner and credit trading veteran Gerald Ouderkirk, the team's job is to use consumer deposits and other types of funding for trades, investments and big loans to earn profits, people familiar with the matter told Reuters. The existence of the team, which has not been previously reported, was set up in mid-2015 and is formally known as the institutional lending group. Lately, it has ramped up activities as Goldman Sachs looks to do more lending broadly.”

September 13 – Bloomberg (Jeff Wilson): “Short-seller Jim Chanos said an announced $2.6 billion merger with SolarCity Corp. will make Tesla Motors Inc. a ‘walking insolvency.’ ‘The synergies are questionable at best,’ Chanos… said at the CNBC Institutional Investor Delivering Alpha Conference… He estimated that the combined company, which will depend on access to the capital market, could have a cash burn of roughly $1 billion per quarter.”

Federal Reserve Watch:

September 13 – Wall Street Journal (Jon Hilsenrath): “Federal Reserve officials, lacking a strong consensus for action a week before their next policy meeting, are leaning toward waiting until late in the year before raising short-term interest rates. It is a close call. But with inflation holding below the Fed’s 2% target and the unemployment rate little changed in recent months, senior officials feel little sense of urgency about moving and an inclination toward delay... Interest rates can affect stock valuations, the cost of financing a home and whether companies will take on big new projects, making the central bank the perpetual center of market attention. Wall Street is especially attuned to when the Fed will move after it has decided to hold rates steady so far this year.”

September 12 – Wall Street Journal (Harriet Torry): “Three Federal Reserve officials indicated Monday they’re in no hurry to raise short-term interest rates at their policy meeting next week. Fed governor Lael Brainard said in a speech the central bank’s recent caution on rates—leaving them unchanged since December—‘has served us well in recent months, helping to support continued gains in employment and progress on inflation.’”

September 12 – Bloomberg (Jeanna Smialek and Rich Miller): “Federal Reserve Governor Lael Brainard counseled continued prudence in tightening monetary policy, even as she said the economy is making gradual progress toward achieving the central bank’s goals. ‘The case to tighten policy preemptively is less compelling’ in an environment where declining unemployment has been slow to spur faster inflation, Brainard said…”

September 14 – CNBC (Jeff Cox): “Former Fed Chairman Ben Bernanke thinks policymakers should give serious thought to implementing negative rates. The man who led the U.S. central bank immediately before Janet Yellen doesn't believe his former colleagues should rush to that kind of ultra-aggressive policy stance. But of all the options the Fed has for stimulus, going to negative rates may not be as drastic as it seems, Bernanke said in a blog post this week.”

September 12 – Bloomberg (Hugh Son): “JPMorgan… Chief Executive Officer Jamie Dimon said the Federal Reserve should increase interest rates -- sooner, rather than later. ‘Let’s just raise rates,’ Dimon said Monday during a wide-ranging discussion at the Economic Club of Washington. ‘The Fed has to maintain credibility. I think it’s time to raise rates. Normality is a good thing, not a bad thing. The return to normal is a good thing.’”

Japan Watch:

September 14 – Reuters (Leika Kihara): “The Bank of Japan will consider making negative interest rates the centerpiece of future monetary easing by shifting its prime policy target to interest rates from base money at its review next week, sources familiar with its thinking say. The change would underscore growing concerns in the central bank and financial markets over the limits to the BOJ's economic stimulus efforts, as more than three years of aggressive bond buying is draining market liquidity. It would also be a shift away from the BOJ's unique monetary experiment that attempted to crush yields across the curve and try to convince the public that its massive money printing will boost economic activity and prices. ‘Among the BOJ's policy tools, the priority will likely shift more towards interest rates and away from huge bond purchases,’ said one of the sources…”

EM Watch:

September 13 – Bloomberg (Tracy Alloway): “How quickly things change in emerging markets. In early 2016, EM asset prices tanked as investors fretted about developing countries' and corporations' ability to service their debts, especially those denominated in U.S. dollars… Fast forward nine months, and EM investors seem to have given birth to a fresh bout of optimism thanks in part to a stable greenback and ultra-low interest rates in developed markets… Emerging market companies have been taking advantage of the sharp turnaround in sentiment to sell more dollar-denominated debt with year-to-date issuance totaling $153 billion... Meanwhile, risk premiums in emerging market bonds have also compressed…”

Brazil Watch:

September 14 – Reuters (Sergio Spagnuolo): “Brazilian prosecutors charged ex-President Luiz Inacio Lula da Silva… with being the ‘boss’ of a vast corruption scheme at state oil company Petrobras, in a major blow to the leftist hero's hopes of a political comeback. It was the first time that Lula, still Brazil's most popular politician despite corruption accusations against him and his Workers Party, was charged by federal prosecutors for involvement in the political kickbacks scheme at Petroleo Brasileiro…”

September 13 – Bloomberg (David Biller): “Brazil’s retail sales fell more than expected by analysts in July, marking the worst performance for that month in 15 years, as rising unemployment takes its toll on Latin America’s largest economy. Sales fell 0.3% after a revised 0.3% increase in June… Sales fell 5.3% versus the same month in 2015, the worst July since the series began in 2001.”

Leveraged Speculator Watch:

September 14 – Bloomberg (Saijel Kishan): “Andrew Law said the hedge fund business is too big -- and failing. Law, who runs Caxton Associates, said the growth in industry assets since the global financial crisis has been ‘both an exceptional and unwelcome development.’ Managers now need to generate gains of $350 billion a year to satisfy investor expectations, he said. That’s an annual return of about 12% from the $2.9 trillion industry, which has returned an average of 2.2% in the past five years. ‘Against a backdrop of comparatively sclerotic growth, S&P 500 valuations stretched on numerous metrics, and alongside approximately $10 trillion of negative-yielding debt, it is reasonable to conclude that the alternatives industry is inappropriately sized to deliver on clients’ return expectations,’ Law, 50, said…”

September 13 – Bloomberg (Saijel Kishan, Hema Parmar and Katherine Burton): “Some of the biggest and best-known hedge funds can’t hang on to client capital. Richard Perry, who started his hedge fund 28 years ago, has seen assets in his Perry Capital shrink to $4 billion, from $10 billion last September. That 60% drop comes as the firm’s main fund fell 18% from the end of 2013 through July. Perry isn’t the only manager struggling. John Paulson’s assets, on the decline since 2011, are down an additional 15% this year. And Dan Och… is now managing $39.2 billion at his Och-Ziff Capital Management Group, compared with $44.6 billion at the start of the 2016. Hedge funds have suffered their biggest withdrawals since the financial crisis, with investors pulling $23.3 billion in the first half of the 2016, according to… Hedge Fund Research…”

September 13 – CNBC (Jeff Cox): “The debt market is in a ‘dangerous situation’ as central banks around the world lose their ability to stimulate growth, hedge fund giant Ray Dalio said… As the world faces more than $11 trillion in negative-yielding debt, Dalio said central banks like the Fed, the European Central Bank and the Bank of Japan are facing a dilemma. ‘There's only so much you can squeeze out of the debt cycle, and we're there globally,’ the head of Bridgewater Associates said at the Delivering Alpha conference… ‘You can't lower interest rates more.’”

September 11 – Bloomberg (Katia Porzecanski and Neil Weinberg): “Bridgewater Associates LP, the world’s largest hedge fund manager, has attracted $22.5 billion in client money since it started a new strategy early last year… About three-quarters of the money went to the new fund… The remainder went into the firm’s main macro hedge fund, Pure Alpha, after Bridgewater opened that fund to select investors this year.”

Geopolitical Watch:

September 12 – Bloomberg: “China deflected criticism that it could do more to stifle North Korea’s nuclear ambitions, questioning the effectiveness of sanctions and saying the U.S. has a responsibility to fix a problem it created. ‘The crux of the Korean nuclear issue lies not in China but in the U.S. as this issue is nothing but conflict between the DPRK and the U.S.,’ China Foreign Ministry spokeswoman Hua Chunying said… She was responding to calls by President Barack Obama for China to tighten up sanctions against Kim Jong Un’s regime prior to its fifth -- and biggest -- nuclear test last week.”

September 12 – CNN (Brad Lendon and Katie Hunt): “Chinese and Russian naval forces began joint exercises in the South China Sea on Monday, adding a new twist to ongoing tensions over Chinese island-building in the region. The eight-day exercises will highlight marine corps units in ‘live-fire drills, sea crossing and island landing operations, and island defense and offense exercises,’ Chinese navy spokesperson Liang Yang said… Aside from the marines, Chinese and Russian surface ships, submarines, planes, helicopters and amphibious armored equipment would be used, Liang said.”

September 16 – Reuters (David Brunnstrom and Idrees Ali): “Japan will step up its activity in the contested South China Sea through joint training patrols with the United States and bilateral and multilateral exercises with regional navies, Japanese Defense Minister Tomomi Inada said… Japan also has its own dispute with China over territory in the East China Sea. Inada said that if the world condoned attempts to change the rule of law and allowed ‘rule bending’ to succeed, the ‘consequences could become global.’”

September 13 – Bloomberg (Jeff Wilson): “The U.S. brought a trade complaint to the World Trade Organization alleging China is offering excessive support for the production of corn, rice and wheat, in the process denying American farmers the ability to compete fairly for exports. The value of China’s price support for the commodities last year was an estimated $100 billion more than what it had committed to when the nation joined the WTO, the U.S. Trade Representative… said…”