Saturday, October 8, 2016

Weekly Commentary: Matthew, Near Misses and Flash Crashes

Clearly, the National Hurricane Center, The Weather Channel, meteorologists and disaster consultants have succumbed to the cult of fear mongering. “Extremely dangerous” Matthew was poised to deliver death and vast destruction. A Thursday afternoon headline from CNBC: “Hurricane Matthew could inflict $200 billion in damage to coastal homes.”

While the damage will be significant, at least much of the Florida coastline dodged a bullet. The storm drifts 25 to 30 miles west and it’s a very different outcome. Yet most people will forget the seriousness of such a Close Call. Instead they’ll imbed the notion of “fear mongering” further into their thinking. The complacency that developed over a decade of no hurricane encounters will become only more instilled. Surely the next dangerous storm warning will be readily dismissed.

Going back to early CBBs, I have used a parable of a “Little Town on a River” that enjoyed booming growth and prosperity engendered by the newfound availability of cheap flood insurance. On the “financial” side, writing flood insurance during an extended drought was about as close to free money as one can get. It was exciting, sophisticated and lavishly rewarding. Truth be told, the insurance market was a rank speculative Bubble in disguise. On the real economy side, the building boom along the river powered a self-reinforcing generalized economic Bubble. The little town that got a lot bigger was wonderful and awe-inspiring. And it all came crashing down when torrential rains commenced and the undercapitalized “insurance” industry rushed to offload flood exposure (into an illiquid market).

As an analyst of risk, I was struck by a key hurricane Matthew data point. Apparently, five million new residents have relocated along the SE coast since the last major hurricane back in 2004. So the risk of a catastrophic event has risen significantly. Matthew’s near miss notwithstanding, risk will continue to accumulate so long as affordable insurance is readily available.

It was a week to ponder risk, from the SE coast to global markets more generally. There are similarities and important differences between property casualty risks and market risks. Casualty losses are generally random and independent. Actuaries can use historical loss data to calculate insurance pricing and loss reserves to ensure sufficient wherewithal to pay future damage claims.

Market (and Credit) losses tend to arise unexpectedly and in waves. They are specifically neither random nor independent. For the most part, those writing derivative “insurance” don’t hold reserves against future losses, expecting instead to sell and buy securities (or other derivatives) when necessary to hedge exposures.

In contrast to the weather, government policymakers have the capacity to significantly impact market behavior. Cheap insurance coupled with a decade without a major hurricane ensures a much higher probability of a catastrophic event. Similarly, eight years of unprecedented government market intervention/manipulation with attendant cheap market “insurance” virtually ensures a market calamity. Going on 30 years of central banks ensuring liquid and continuous markets have nurtured hundreds of Trillions of derivatives and unprecedented market vulnerabilities. A historic market liquidity event would seem unavoidable. Occasional market dislocations – and hints of calamity potential - have come to be called “Flash Crashes.”

Five Friday headlines from the Financial Times: “Pound Struggles to Recover After Plunging 6% in 2 Minutes”; “How ‘All Hell Broke Loose’ on Flash Crash Friday”; “UK Chancellor Seeks to Reassure Market After Pound Plummets”; “Brexit Bliss Suffers Rude Awakening with Flash Crash”; “Pound’s Plunge Joins Growing List of ‘Flash Crashes’”.

And Friday from Bloomberg (Sarah McDonald): “Pound Is the Latest Flash Crash That Traders Won’t Easily Forget.” The article summarized some recent Flash Crashes: May 6, 2010: U.S. Stocks (“Dow Jones Industrial Average tumbled as much as 9.2%”); October 15, 2014: U.S. Treasuries (“37-basis-point range during a 12-minute period”); August 24, 2015: U.S. Stocks (“$1.2 trillion of market value… erased”); Aug. 25, 2015: New Zealand Dollar (“8.3% intraday”); January 11, 2016: South African Rand (“9% in 15 minutes”); May 31, 2016: China Index Futures (“suddenly dropped… 10% daily limit”). And let’s not forget “frankenshock,” the January 2015 dislocation (39% move) in Swiss franc trading as the SNB untethered the swissy peg from the euro.

Perhaps traders won’t forget the latest Flash Crash. Yet markets have enjoyed a remarkably short memory when it comes to market dislocations. There are these days extraordinarily serious market issues to contemplate. Clearly, algorithmic trading has evolved into a major problem across securities, currency and commodities markets. Market liquidity in general presents a huge vulnerability. Trend-following trading strategies have grown to overpower - and overhang - the marketplace. Moreover, the proliferation of derivative-related dynamic-hedging trading strategies (options and swaps, in particular) deserves special attention.

Rather abruptly, Brexit risk this week returned to the forefront. The June Brexit vote amounted to a market Close Call. Markets recovered almost immediately, further emboldened that global policymakers have no tolerance for market instability. Additional QE from the Bank of England – along with as much extra as needed from the ECB and BOJ. More ultra-dovishness from the Fed. Clearly, UK and EU policymakers would work closely together to ensure the best possible outcome for, of course, the securities markets.

Global markets became so conditioned to assume the best. Today, there remains an underlying denial that the global backdrop is rapidly evolving. I wrote at the time that I believed Brexit marked an important inflection point. Complacent markets would be forced to recognized that they were no longer in control. The good old days of markets holding sway over policymakers had given way to an exasperated electorate majority ready to dictate real political and economic change. But with QE infinity and the tidal surge of liquidity, markets were determined to move briskly past the Close Call and reject any notion that the backdrop had fundamentally changed.

The pound was clobbered 4.1% this past week, in alarming trading action for one of the world’s most actively traded currencies. Suddenly, the markets have turned their attention to the potentially far-reaching consequences of a “hard Brexit.” Currency traders pointed to tough comments from French President Francois Holland: (Deutsche Welle) “’There must be a threat, there must be a risk, there must be a price, otherwise we will be in negotiations that will not end well and, inevitably, will have economic and human consequences,’ he said, adding that he believed Britain had voted for a ‘hard Brexit.’”

October 5 – Financial Times (George Parker): “Theresa May has denounced a rootless ‘international elite’ and vowed to make capitalism operate more fairly for workers, as she promised profound change to reunite Britain after June’s vote to leave the EU. In a speech to the Conservative party conference, Mrs May said the Brexit vote was a cry for a new start, setting out an agenda of state intervention, more workers’ rights, an assault on failing markets and a crackdown on corporate greed. The prime minister’s speech drew comparisons with the supposedly anti-business rhetoric of former Labour leader Ed Miliband, but one Tory official said: ‘Perhaps only a Tory government can save capitalism from itself.’ Mrs May told activists that the Conservatives would respond to the Brexit vote by putting ‘the power of government squarely at the service of ordinary working-class people…’”

Further from the FT: “But [the Prime Minister’s] comments also reflect her view that the Brexit vote was a symptom of a widening divide in Britain between London and the rest of the country, between a relatively affluent older generation and the young, and between a ‘privileged few’ and millions of ordinary voters struggling to ‘get by’. She suggested the Bank of England’s quantitative easing programme should draw to a close, saying that it had caused some ‘bad side effects’, pumping up asset prices but leaving people without assets, or living on savings, worse off.”

Is Britain’s new Tory Prime Minister challenging the global order? Is a conservative leader of a G7 country calling for the end of QE? Is Mark Carney’s job leading the Bank of England in jeopardy? To be sure, the world is changing fast, and the balance of power is shifting away from the securities markets and market-pleasing monetary stimulus.

Especially since 2012, global central bankers have fully embraced “whatever it takes.” This historic gambit just didn’t work, and this unfolding failure is proving extraordinarily divisive. Societies and political parties are deeply divided. Central banks from Tokyo to Frankfurt to Washington are deeply divided. This ensures an extraordinarily uncertain future. Things are simply no longer lined up for markets to always get their way.

The pound was not the week’s only notable market development. The Japanese yen declined 1.6%. Gold dropped 4.5% ($59) and Silver sank 8.7%. Natural gas surged 9.6%. Brazil’s Bovespa index surged 4.7%. While the S&P500 ended the week down less than 1%, markets had the feel of heightened vulnerability.

Some of the week’s most consequential moves were in global bond yields. German bund yields jumped 14 bps this week to 0.02%. Italian yields surged 20 bps, and Portuguese yields rose 25 bps to an almost eight-month high. UK gilt yields jumped 23 bps. Ten-year Treasury yields rose 13 bps to an almost four-month high.

Rising yields provided global financial stocks somewhat of a tailwind. Deutsche Bank rallied 4.4%, with Europe’s STOXX 600 Bank Index recovering 2.4%. Italian banks gained 2.4%. Japanese bank stocks rallied 3.4%. Hong Kong’s Hang Seng Financials jumped 3.2%. US Banks (BKX) jumped 2.8%. Indicative of the pressure on “low risk” equity yield plays, U.S. utilities (UTY) sank 3.6% this week.

Rising financial stocks notwithstanding, I’d be remiss for not suggesting that this week’s big movers (pound, yen, bunds, European periphery debt, Treasuries, gilts and gold) all have big derivatives markets. So are markets now more vulnerable to illiquidity and so-called “Flash Crashes” because of heightened stress (and risk aversion) at Deutsche Bank and the other big derivatives operators, more generally?

I’ll posit that to sustain the global government finance Bubble at this point requires both ongoing securities market inflation and ever-increasing monetary inflation. Rather suddenly it seems that global central banks are much less confident in QE infinity. There is serious disagreement in Japan as to how to move forward with monetary policy. And there were even this week rumors of ECB “tapering” ahead of the March 2017 designated end to its QE program. Say what? Are the ECB “hawks” ready to take control?

Meanwhile, markets seem to be pointing to an important downside reversal following this year’s historic melt-up in global bond prices. With Italian, Portuguese and UK bonds leading this week’s losers list, it’s tempting to imagine that fundamentals might start to matter again. And it’s going to be a real challenge to sustain global Credit growth in the face of rising bond yields. All bets are off if China’s latest attempt to tighten mortgage Credit actually works. That’s one scary Credit Bubble, and there are already indications that outflows are picking up again from China.

For the Week:

The S&P500 declined 0.7% (up 5.4% y-t-d), and the Dow slipped 0.4% (up 4.7%). The Utilities sank 3.6% (up 9.6%). The Banks rallied 2.8% (down 0.3%), and the Broker/Dealers recovered 1.7% (down 0.8%). The Transports slipped 0.3% (up 7.3%). The broader market was weaker. The S&P 400 Midcaps declined 1.2% (up 9.7%), and the small cap Russell 2000 fell 1.2% (up 8.9%). The Nasdaq100 dipped 0.2% (up 5.9%), while the Morgan Stanley High Tech index was little changed (up 11.1%). The Semiconductors added 0.2% (up 26.2%). The Biotechs fell 2.9% (down 14.1%). With bullion down $59, the HUI gold index was hit 13.8% (up 79.2%).

Three-month Treasury bill rates ended the week at 32 bps. Two-year government yields rose seven bps to 0.83% (down 22bps y-t-d). Five-year T-note yields gained 11 bps to 1.26% (down 49bps). Ten-year Treasury yields jumped 13 bps to a four-month high 1.72% (down 53bps). Long bond yields rose 13 bps to 2.45% (down 57bps).

Greek 10-year yields increased five bps to 8.15% (up 83bps y-t-d). Ten-year Portuguese yields surged 25 bps to an almost eight-month high 3.55% (up 103bps). Italian 10-year yields jumped 20 bps to an almost four-month high 1.38% (down 21bps). Spain's 10-year yields rose 13 bps to 1.01% (down 76bps). German bund yields jumped 14 bps to 0.02% (down 60bps). French yields gained 13 bps to 0.31% (down 68bps). The French to German 10-year bond spread narrowed one to 29 bps. U.K. 10-year gilt yields surged 23 bps to 0.97% (down 99bps). U.K.'s FTSE equities index rallied 2.1% (up 12.8%).

Japan's Nikkei 225 equities index jumped 2.5% (down 11.4% y-t-d). Japanese 10-year "JGB" yields rose three bps to negative 0.07% (down 33bps y-t-d). The German DAX equities index slipped 0.2% (down 2.3%). Spain's IBEX 35 equities index fell 1.8% (down 9.6%). Italy's FTSE MIB index was unchanged (down 23.4%). EM equities were mostly higher. Brazil's Bovespa index surged 4.7% (up 41%). Mexico's Bolsa added 0.7% (up 10.7%). South Korea's Kospi rose 0.5% (up 4.7%). India’s Sensex equities gained 0.7% (up 7.4%). China’s Shanghai Exchange was closed for holiday (down 15.1%). Turkey's Borsa Istanbul National 100 index gained 1.9% (up 8.7%). Russia's MICEX equities index was little changed (up 12.4%).

Junk bond mutual funds saw inflows of $1.9 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates were unchanged last week at 3.42% (down 34bps y-o-y). Fifteen-year rates were unchanged at 2.72% (down 27bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 3.58% (down 32bps).

Federal Reserve Credit last week declined $6.2bn to $4.418 TN. Over the past year, Fed Credit contracted $28.4bn (0.6%). Fed Credit inflated $1.607 TN, or 57%, over the past 204 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt recovered $9.0bn last week to $3.152 TN. "Custody holdings" were down $176bn y-o-y, or 5.3%.

M2 (narrow) "money" supply last week surged $37.3bn to a record $13.126 TN. "Narrow money" expanded $949bn, or 7.8%, over the past year. For the week, Currency increased $1.1bn. Total Checkable Deposits added $1.1bn, and Savings Deposits jumped $33.7bn. Small Time Deposits were little changed. Retail Money Funds gained $1.3bn.

Total money market fund assets dropped $25bn to a one-year low $2.655 TN. Money Funds fell $33bn y-o-y (1.2%).

Total Commercial Paper sank another $30.3bn to a multi-year low $916bn. CP declined $128bn y-o-y, or 12.2%.

Currency Watch:

The U.S. dollar index gained 1.1% to 96.48 (down 2.2% y-t-d). For the week on the upside, the Brazilian real increased 1.3% and the Mexican peso gained 0.4%. For the week on the downside, the British pound declined 4.1%, the New Zealand dollar 1.8%, the Japanese yen 1.6%, the Canadian dollar 1.3%, the Australian dollar 1.1%, the South African rand 1.1%, the Norwegian krone 0.8%, the Swiss franc 0.6%, the Swedish krona 0.6% and the euro 0.3%. The Chinese yuan was unchanged versus the dollar (down 2.7% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 2.0% (up 19.3% y-t-d). Spot Gold sank 4.5% to $1,257 (up 19%). Silver lost 8.7% to $17.58 (up 27%). Volatile Crude rose $1.57 to $49.81 (up 35%). Gasoline slipped 0.7% (up 16%), while Natural Gas surged 9.6% (up 36%). Copper fell 2.1% (up 1%). Wheat dropped 1.8% (down 16%). Corn gained 0.9% (down 5%).

China Bubble Watch:

October 6 – Bloomberg (Kana Nishizawa): “Tai Hui is experiencing deja vu. China’s surge in home prices reminds JPMorgan Asset Management’s chief Asia market strategist of last year’s stock market mania. Spiraling leverage and implicit state support are among the common denominators, he says. Shanghai property values jumped 31% in August from a year earlier… In 2015, a 60% rally in the city’s equities through June 12 was followed by a $5 trillion rout. Deutsche Bank… warned last month that China’s housing market is in a bubble, while Goldman Sachs… said this week it sees growing risks across the real estate industry. Home prices started to take off last year in the wake of the stock market crash after the governments eased curbs on property purchases.”

October 7 – Bloomberg (Robin Ganguly): “China’s foreign-exchange reserves declined more than expected in September, amid speculation the central bank resumed selling dollars to support the yuan. The stockpile shrank to $3.17 trillion last month… That’s the lowest since April 2011 and below the median estimate of $3.18 trillion… Declines in the world’s biggest currency stockpile have slowed this year after falling from a record $4 trillion in June 2014…”

September 30 – Bloomberg (Justina Lee and Molly Wei): “The yuan took on the mantle of a global reserve currency Saturday, a milestone that is seen breathing life into China’s bond markets by prompting estimated inflows of as much as $1 trillion over the next five years. The currency’s entry into the International Monetary Fund’s Special Drawing Rights -- alongside the dollar, euro, pound and the yen -- comes amid China’s efforts to boost its international usage and ambitions of providing an alternative to the dollar.”

October 5 – Reuters (Kevin Yao and Sue-Lin Wong): “China's southern megacities of Guangzhou and Shenzhen are the latest centres to impose new measures to cool their overheated real estate markets, including higher mortgage downpayments and home purchase restrictions. A property boom has given a welcome boost to China's economy this year, fuelling demand for everything from construction materials to furniture, but a growing buying frenzy is adding to worries about ever-rising debt and risks to the banking system. The new measures are the latest steps to tighten credit flowing into the property sector as the government tries to balance the need to prevent bubbles while stimulating economic growth.”

October 5 – Bloomberg (Jasmine Ng): “Goldman Sachs… has sounded a warning about the outlook for China’s property market, saying it sees growing risks across the industry and that any downturn will pose a challenge for metals, especially iron ore and steel. ‘We see growing vulnerability in the Chinese property market,’ the bank said in a commodities report, citing possible overbuilding, concern some people now can’t afford homes and rising speculation. ‘Policy-driven housing booms tend to be followed by slumps due to the payback effect,’ it said.”

Europe Watch:

October 5 – Wall Street Journal (Mike Bird): “Shares in Deutsche Bank AG have fallen by more than 48% this year amid concerns that the lender faces a hefty fine from the Justice Department and as its core lending business suffers from low interest rates and weak economic growth. But some analysts also worry about the exposure at Germany’s largest bank by assets to derivatives and the large pool of hard-to-value assets that the bank holds on its books. Derivatives are financial contracts that draw their value from the performance of an underlying asset, index or interest rate. They can be used to hedge risks. In its 2015 annual report, Deutsche Bank said its exposure to derivatives was €41.940 trillion ($46.994 trillion). As a comparison, Germany’s gross domestic product was €3.032 trillion in 2015.”

October 5 – Reuters (Paul Carrel and Noah Barkin): “The German government is pursuing discreet talks with U.S. authorities to help Deutsche Bank secure a swift settlement over the sale of toxic mortgage bonds, according to sources in Berlin. Until now, German officials have played down their role in the standoff, saying it is up to Deutsche to work out a deal with the U.S. Department of Justice… But government officials in Berlin, speaking on condition of anonymity, told Reuters they hoped to facilitate a quick deal that would buy Deutsche Bank time to regain its footing.”

October 5 – Reuters (Francesco Canepa): “Money flowed into Germany and out of Italy and Spain in August…, showing a gap between the euro zone's strongest economy and the struggling periphery was wide open. The ECB is buying 80 billion euros ($89.26bn) worth of bonds every month but data from the bloc's bank payment system shows most of that money ends up in German banks… The Target 2 data showed net payments made to German banks from their peers in other euro zone countries exceeded flows in the opposite directions by 17.2 billion euros in August. Germany's net claims towards the rest of the bloc since 2008 stood at 677.5 billion euros. The opposite was true in Italy and Spain, which saw their net liabilities hit new three-year highs in August, when they rose by 34.9 and 20.5 billion euros each to 326.9 and 313.6 billion euros respectively.”

October 2 – Bloomberg (Karin Matussek): “Leaders of Germany’s biggest companies rallied behind Deutsche Bank AG, saying in newspaper interviews that the lender now facing a hefty U.S. fine and a court fight in Italy is crucial for the country and its businesses in a globalized world. In interview… leaders of DAX corporations, including Daimler AG, Munich Re, Siemens AG and Deutsche Boerse AG, underscored that nationality still plays an important role when it comes to the choice of lenders. ‘The German industry needs a German bank that accompanies us out into the world,’ BASF SE Chairman Juergen Hambrecht told the newspaper. ‘The power games out there in the market aren’t transparent, but they’re there.’”

October 5 – Reuters (Francesco Canepa and John O'Donnell): “Euro zone banks borrowed $2.8 billion from the European Central Bank's emergency line on Wednesday, one of the biggest weekly take-ups since the financial crisis, as Deutsche Bank's woes and tighter U.S. rules made market funding more difficult. The nine banks were not identified and their reasons for tapping relatively expensive ECB funding are unknown.”

October 5 – Bloomberg (Boris Groendahl, John Glover and Birgit Jennen): “When it comes to speculation about German government support for Deutsche Bank AG, Chancellor Angela Merkel has no good answer. After years spent leading the push for new European Union rules to contain banking crises without putting taxpayers on the hook, you might expect Merkel to rule out state aid for Deutsche Bank. She hasn’t… Confronted with ailing banks, Merkel and other EU leaders face a quandary. Markets assume they won’t deploy their biggest weapon -- bail-in, or imposing losses on private investors -- when it comes to a giant like Deutsche Bank because of the risk of contagion. Yet policy makers are also increasingly ambivalent about the bloc’s solution for too-big-to-fail banks… ‘There’s a good chance if Deutsche Bank were to go under there would be a series of bail-ins that would affect not just the German economy and the German financial system, but the entire European financial system as well,’ said Megan Greene, chief economist at Manulife Asset Management. As a result, ‘you could end up seeing leaders decide they’re not going to comply with bail-in rules,’ she said.”

Brexit Watch:

October 5 – Bloomberg (Fergal O'Brien): “U.K. Prime Minister Theresa May said central banks and their ultra-loose monetary policies helped to widen inequality and vowed her government will act to reverse that course… ‘There have been some bad side effects,’ she told Tory delegates… ‘People with assets got richer, people without them have suffered, people with mortgages have found their debt cheaper, people with savings have found themselves poorer. A change has got to come and we are going to deliver it.’”

Fixed-Income Bubble Watch:

October 4 – Bloomberg (Alastair Marsh): “Holdings in bond exchange-traded funds climbed to records in Europe and the U.S., spurred by ease of trading and the lure of higher yields in emerging markets. Bond ETFs now manage $428 billion in the U.S. and $150 billion in Europe, according to BlackRock Inc. The iShares Core U.S. Aggregate Bond ETF also became the first fixed-income ETF to surpass $40 billion in assets… Globally, bond ETFs have had the fastest growth since 2012, with $99.7 billion of inflows…”

Global Bubble Watch:

October 5 – Bloomberg (Steve Matthews): “Eight years after the financial crisis, the world is suffering from a debt hangover of unprecedented proportions. Gross debt in the non-financial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion last year, and it’s still rising, the International Monetary Fund said. The figure includes debt held by governments, non-financial firms and households. Current debt levels now sit at a record 225% of world gross domestic product, the IMF said…, noting that about two-thirds of the liabilities reside in the private sector. The rest of it is public debt, which has increased to 85% of GDP last year from below 70%.”

October 5 – Wall Street Journal (Ian Talley): “In recent years, the global financial system has weathered Brexit, China’s deceleration and emerging market mayhem. But there’s no reason to be complacent, the International Monetary Fund warns in its latest reports on global financial stability and the fiscal health of economies around the world. ‘The passing of these near-term risks has seen volatility fall and equity prices in advanced economies rise,’ says Peter Dattels, deputy director of the fund’s monetary and capital markets department. ‘But medium-term risks are building because we are entering a new era of challenges.’ An unprecedented era of ultralow interest rates and feeble growth has led to a record buildup in global debt levels. Anemic global growth is ‘setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown,’ the emergency lender warned.”

October 5 – Bloomberg (Enda Curran): “Two of the world’s most accommodative central banks are starting to think about ways out of the bond-buying maze. Long after their U.S. counterpart ended asset purchases and started raising interest rates, the Bank of Japan and the European Central Bank continue to rely on massive quantitative easing in a battle to revive consumer-price growth. But what worked once won’t necessarily work forever. The glow of QE is fading amid negative side effects including financial-stability concerns and reduced earnings for commercial lenders, and especially the simple difficulty of finding sufficient suitable assets to acquire.”

October 6 – Financial Times (Elaine Moore): “European bond markets are being rattled by talk that the European Central Bank is considering ways to call time on its €80m-a-month bond-purchase programme before the March 2017 end date. While the ECB has denied the reports, bonds across the eurozone are selling off… On Tuesday, Bloomberg published a story citing unnamed sources who claimed that the ECB was thinking of winding down its bond purchases in steps of €10bn a month ahead of its plans for QE to end in March, triggering an immediate jump in yields across bond markets. The ECB is adamant that QE tapering is not up for discussion…”

October 2 – Bloomberg (Phil Kuntz): “The unprecedented worldwide surge in the market for bonds that are certain to lose money if held to maturity regained strength last month. The total face value of negative-yielding corporate and sovereign debt in the Bloomberg Barclays Global Aggregate Index of investment-grade bonds jumped to $11.6 trillion as of Sept. 30... That sum had fallen for two months in a row from June’s $11.9 trillion peak.”

October 7 – Financial Times (Gavyn Davies): “Until recently, the rate of expansion in global central bank balance sheets seemed likely to remain extremely high into the indefinite future. Although the US Federal Reserve had frozen its balance sheet, both the European Central Bank and the Bank of Japan were pursuing open-ended programmes of asset purchases, and the Bank of England actually increased its intended stock of assets by £50bn in August. Global central bank balance sheets were rising by about 2 percentage points of GDP per annum – a similar rate to that seen since 2012… …It seems that policy makers are moving away from QE because it is no longer effective and no longer necessary. ‘QE infinity’ is coming to an end, not with a bang but with a whimper. Surprisingly, one of the most enthusiastic proponents of QE, the UK, now seems to be in the vanguard of the change. Another proponent, the BoJ, has already declared an armistice. The Fed is moving in the opposite direction from QE infinity. Only the ECB still seems to be ‘with the programme’, and even that is increasingly dubious.”

October 4 – Bloomberg (Simone Foxman): “Famed bond investor Jeffrey Gundlach said Deutsche Bank AG’s slumping share price highlights the impact of the negative-interest-rate policy in Europe on the region’s lenders and may help prompt central bankers to reconsider their approach. ‘You cannot save your faltering economy by killing your financial system and one of the clear poster children for this is Deutsche Bank’s stock price,’ Gundlach, 56, said… ‘If you keep these negative interest rate policies for a sufficient future period of time you are going to bankrupt these banks.’”

U.S. Bubble Watch:

October 3 – CNBC (Annie Pei): “Utilities stocks are safe havens no more and investors should be looking elsewhere for yield, according to some traders. The utilities-tracking ETF (XLU) was down for an eighth-straight session Monday, when it tumbled more than 1% in morning trading. This fall is in sharp contrast to the first half of the year, when the XLU surged more than 22% heading into July.”

September 30 – Wall Street Journal (Annamaria Andriotis): “Subprime auto loan losses rose again in August as more borrowers fell behind on payments. The share of subprime auto loans backing bonds that were at least 60 days behind on payments climbed to 4.86% in August, up from 3.98% a year earlier, according to Fitch… Annualized net losses reached 8.89%, up from 7.02% a year prior.”

October 4 – Bloomberg (Matt Scully): “The online consumer lender Prosper Marketplace Inc. is shutting its loan trading platform this month, a move that will effectively close a key liquidity outlet for retail investors. ‘Very few investors’ were using the trading system, Prosper said in a letter to stakeholders last week.”

October 2 – Wall Street Journal (Josh Barbanel): “A slowdown in the Manhattan apartment market deepened during the third quarter, and many brokers said uncertainty over the presidential election makes any imminent recovery unlikely. The number of sales fell by 15.3% from the same quarter in 2015. Particularly hard hit was sales volume for cooperative apartments, which fell 17.5%...”

Federal Reserve Watch:

October 5 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Richmond President Jeffrey Lacker defended the U.S. central bank’s structure as important for preserving monetary policy independence from politics, warning that the Fed Board of Governors in Washington has become less insulated from partisan influence. ‘The apolitical aspects of Reserve Bank governance seem especially useful given the potential for political influence on the publicly appointed parts of the Fed,’ Lacker said… Because governors now leave after a few years, ‘the composition of the Board of Governors is less insulated from the political process than was originally envisioned.’”

October 6 – Reuters (Howard Schneider): “Evidence that the so-called natural rate of interest has fallen to low levels could mean the economy is stuck in a low-growth rut that could prove hard to escape, Federal Reserve Vice Chair Stanley Fischer said… Speaking to a central banking seminar in New York, the Fed's second-in-command said he was concerned that the changes in world savings and investment patterns that may have driven down the natural rate could ‘prove to be quite persistent...We could be stuck in a new longer-run equilibrium characterized by sluggish growth.’ As a result, he said, central bankers may face a future where the short-term interest rates set by policymakers never get far above zero, and the unconventional tools used during the financial crisis become a ‘recurrent’ fact of life.”

Central Bank Watch:

October 6 – Wall Street Journal (Tom Fairless): “European Central Bank policy makers warned at their September meeting of growing challenges in sourcing bonds for their €1.7 trillion ($1.91 trillion) quantitative-easing program, and hinted that the program could be extended again. ECB officials haven’t previously acknowledged that they could face problems sourcing bonds. But President Mario Draghi said in September that ECB staff would review the design of the QE program, to ensure it didn’t run out of bonds—a move that could presage an extension. The details of the ECB’s Sept. 7-8 policy meeting…, reveal widespread concerns within the bank’s 25-member governing council over the failure of inflation to pick up more substantially much in the eurozone.”

October 7 – Bloomberg (Johan Carlstrom): “The Swedish central bank has limited room to significantly expand its unprecedented monetary stimulus, according to Deputy Governor Cecilia Skingsley. Luckily, the successes achieved by Riksbank’s monetary policy mean it now enjoys more independence from regional powerhouses such as the European Central Bank, Skingsley said... ‘We have all the tools but there are limits since the repo rate and additional bond purchases can produce undesired side-effects… We don’t really know for how long future interest rate cuts will work in an effective way.’”

Japan Watch:

October 2 – Bloomberg (Yoshiaki Nohara and Masahiro Hidaka): “Governor Haruhiko Kuroda has ruined his chances of getting a second full term, according to Nobuyuki Nakahara, who has advised the prime minister on the economy and was an intellectual father of the Bank of Japan’s first run at quantitative easing in 2001. The central bank’s switch to yield-curve targeting compounds its earlier error of adopting negative interest rates and is a disappointing move away from monetary-base expansion, Nakahara, 81, said... ‘They are trying to clean up the mess of negative rates. It’s impossible to do a stupid thing like keeping the yield curve under government control… They changed the regime to rates from quantity, meaning those who support quantitative easing were defeated. Reflationists on the BOJ policy board lost. An exit from deflation is going to be far away.’”

October 4 – Bloomberg (Isabel Reynolds and Takashi Hirokawa): “The Bank of Japan’s negative interest rate policy has stirred confusion among financial institutions and the public, the party leader of Prime Minister Shinzo Abe’s junior coalition partner said… ‘There was confusion, especially among private-sector financial institutions, and even more so among ordinary people’ when the rates were adopted, Yamaguchi, 64, said… ‘It was a blow to people who rely on savings, and financial institutions have had difficulty, especially in managing bonds.’

EM Watch:

October 6 – Wall Street Journal (Rachel Rosenthal): “Corporate-bond issuance in emerging markets hit a record high for the month of September, even as worries grew globally over soaring debt levels amid tepid growth. The amount of U.S.-dollar bonds issued by companies in emerging countries almost tripled to $34.7 billion in September from the month before… That total, nearly 70% of which came from Asia, is the highest in any September in data going back to 2000, and puts total emerging-market dollar bond issuance in the third quarter at $84.2 billion.”

Leveraged Speculator Watch:

October 6– Wall Street Journal (Laurence Fletcher): “Lansdowne Partners (UK) LLP, one of the world’s largest hedge funds, extended its losing run last month, missing out on a rebound enjoyed by many of its peers. Lansdowne’s flagship Developed Markets fund lost 2.3% in September... It means the fund, which has been one of the best-performing hedge funds of recent years and which is run by Peter Davies and Jonathon Regis, is now down 14.7% this year…”

October 5 – Bloomberg (Dakin Campbell, Katherine Burton and Saijel Kishan): “Goldman Sachs Group Inc.’s retirement plan is pulling about $300 million from Leon Cooperman’s Omega Advisors Inc., marking the second time this year it’s cutting ties with a famous alum who ran afoul of U.S. authorities.”

Geopolitical Watch:

October 2 – Financial Times (Guy Chazan): “German politicians have accused the U.S. of waging economic war against Germany as concern continues to rise among the country’s political and corporate elite over the future of Deutsche Bank, its biggest lender. Some of Germany’s top industrial chiefs have also rallied to the bank’s side following the market storm that last week threatened to engulf Deutsche, stressing its importance to the German economy and expressing confidence in the leadership of John Cryan, the bank’s chief executive.”

October 5 – Associated Press: “The Russian military is warning the United States against striking Syrian government forces, saying it's ready to use its air defense weapons to protect them. Russian Defense Ministry spokesman Maj. Gen. Igor Konashenkov warned Thursday that the Russian military won't have time to contact its U.S. counterparts if they see missiles on way to target —indicating it would strike back without warning should Syrian forces be attacked.”

October 5 – Reuters (Lidia Kelly): “Russia further curtailed its cooperation with the United States in nuclear energy on Wednesday, suspending a research agreement and terminating one on uranium conversion, two days after the Kremlin shelved a plutonium pact with Washington. The Russian government said that as counter-measures to the U.S. sanctions imposed on Russia over Ukraine, it was putting aside a nuclear and energy-related research pact with the United States.”

October 7 – Reuters (Dmitry Solovyov): “Russia is considering plans to restore military bases in Vietnam and Cuba that had served as pivots of Soviet global military power during the Cold War, Russian news agencies quoted Russian Deputy Defence Minister Nikolai Pankov as saying on Friday.”

October 1 - Reuters (Ben Blanchard): “The United States and South Korea are destined to ‘pay the price’ for their decision to deploy an advanced missile defense system which will inevitably prompt a ‘counter attack’, China's top newspaper said…”

October 5 – Reuters (Maher Chmaytelli, Ece Toksabay and Daren Butler): “Iraq has requested an emergency meeting of the United Nations Security Council to discuss the presence of Turkish troops on its territory as a dispute with Ankara escalates. Turkey's parliament voted last week to extend the deployment of an estimated 2,000 troops across northern Iraq by a year to combat ‘terrorist organizations’ - a likely reference to Kurdish rebels as well as Islamic State.”