Saturday, October 15, 2016

Weekly Commentary: The Perils of a Resurgent China Credit Boom

There’s this uneasiness – an eeriness – in the markets; in the world (I’m not touching politics). Seemingly out of nowhere, the U.S. dollar index surged 1.7% this week. Notably, the Chinese currency fell 0.8% versus the dollar, the biggest weekly decline since January. Copper dropped 2.4%. Most EM currencies were under pressure. I suspect fears of heightened Chinese vulnerability have again become a major force behind unstable global markets.

We’re all numb to the big numbers. China’s debt has rapidly inflated to over 250% of GDP (Bloomberg at 247% to end ’15 from ‘07’s 150%), in what has evolved into history’s greatest Credit Bubble. Total Social Financing, China’s aggregate of total Credit (excluding government bonds) is on pace to expand almost $3.0 TN this year. A headline from Bloomberg TV: “China’s Total Debt Grew 465% Over Past Decade”

Global markets were troubled earlier in the year by fears of a faltering China Bubble – a stock market collapse, destabilizing outflows and a fledgling crisis of confidence. Market recovery owed much to the visibly heavy hand of Beijing frantically plugging holes and spurring a Credit resurgence. Those efforts ensured ongoing China economic expansion that, when coupled with $2.0 TN of QE, supported a short squeeze turned major rally throughout EM and commodities markets. Surging commodities and EM took pressure off troubled sectors, bolstering U.S. and developed market rallies generally. Highly leveraged speculators, commodity producers, companies, countries and continents were granted new leases on life.

The downside of ongoing massive QE and negative rates has of late become a market concern, and with concern comes heightened vulnerability. This ensures keen focus on the other major source of 2016 market support: The Resurgent China Boom. Here as well, the downside of egregious inflationism has become increasingly conspicuous. China’s Credit Bubble is completely out of control – and it’s become deeply systemic. We’re numb to how dangerous circumstances have become.

The banking system continues to balloon uncontrollably, as does so-called “shadow banking.” Reported bank assets have reached $30 TN, having more than tripled since 2008. According to Moody’s, shadow banking has expanded from from 40% to 78% of GDP - in just the past two years. Contemporary Chinese finance is nothing if not incredibly convoluted.

October 12 – Financial Times (Gabriel Wildau): “What is the true size of China’s debt load, and how fast is it growing? The answer has significant implications for the global economy. Global watchdogs including the International Monetary Fund and the Bank for International Settlements… have become increasingly shrill in their warnings that China’s rising debt load poses global risks. Estimates of Chinese debt based on official figures are frightening enough — an FT analysis put the figure at 237% of GDP at the end of March — but an increasing number of analysts now believe that the true figure may be higher. The reason is not… that China’s government statisticians are intentionally cooking the books. Instead, financial engineering and rising complexity in the shadow banking system are outstripping the ability of traditional indicators to track debt flows from all sources. In focus is a once-obscure data series that tracks bank lending to non-bank financial institutions (NBFIs)… Bank claims on NBFIs… have increased massively, from to Rmb11.2tn at the end of 2014 to Rmb25.2tn at the end of August.”

As the banking system self-destructs, the problematic local government debt situation only worsens. What's more, Corporate Credit continues to expand rapidly, in the face of an increasingly hostile pricing and earnings backdrop. Corporate debt has ballooned to $18 TN, or to almost 170% of GDP (from Reuters).

Meanwhile, real estate finance is today a full-fledged “Terminal Phase” disaster in the making. Various government efforts over recent years to rein in an aged Credit cycle have failed, repeatedly shoved to the back burner by fear of an unacceptable bust. Last month from the WSJ (Anjani Trivedi): “More than 70% of new loans in August were to households, much of that in the form of mortgages… a remarkable shifting of the fire hose of credit… 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…”

A Thursday headline from Bloomberg: “Global Stocks Slide, Treasuries Gain as China Concern Resurfaces.” Various articles pointed to the worse-than-expected 10% y-o-y drop in September Chinese exports, the largest decline since February (imports down 1.9%). More important, the People’s Bank of China weakened the yuan seven straight days to a new six-year low. Most importantly, Beijing is – once again - intensifying its push to rein in debt growth. There is an acute need to act, as well as lurking fragility that ensures acting is a high-risk proposition.

When markets are in a bullish mood, faith comes easy that enlightened central bankers have mastered QE infinity. Similarly, astute Chinese authorities have become exceptionally proficient at financial and economic tinkering. Reality is a different story. Whether it is global central bankers or Chinese communist leadership, once monetary inflation really gets heated up there will be no cataclysm-free resolution. There remains a complacent view that patient central bankers will successfully wean the world off this torrent of cheap liquidity. Beijing will cautiously take its time in resolving structural Credit and economic issues. The harsh reality is that all these central planners badly missed their timing. At this point, the consequence of patience and caution is deeper maladjustment.

Mortgage Credit booms are dangerously prone to the type of prolonged excess that ensures deep structural (financial, economic and social) impairment. Systemic risk rises exponentially late in the Credit cycle. Rapid Credit growth, much of it from weak borrowers, inflates home prices to precariously unsustainable levels. To be sure, China’s mortgage finance Bubble is putting U.S. subprime to shame. China essentially has unlimited numbers of borrowers. Inflating apartment prices continue to provide owners unprecedented increases in (perceived) wealth, providing the resources for larger down-payments for more expensive units (and/or more units). And keep in mind that this is more of an apartment rather than a “real estate” Bubble – and, for the most part, shoddily constructed apartments. There is also basically endless supply.

Chinese authorities have initiated attempts to tighten mortgage Credit going back in 2010. Beijing and local governments have to this point not been willing to inflict the type of pain necessary to break entrenched inflationary psychology. Ill-conceived efforts to tighten mortgage Credit in 2014, while permitting loose finance to fuel an ongoing Credit Bubble, ensured a spectacular stock market boom and bust. And last year’s equities bust – and resulting stimulus-induced Credit/liquidity surge - incited speculative “blow-off” dynamics into “safe haven” real estate. Mania.

Markets have good reason to fear the consequences from the latest round of tightening. System Credit has exploded since 2010. Financial and economic fragilities are much more acute. From Thursday’s WSJ: “China Sees ‘New Challenges’ in Mortgage Surge;” followed with Friday’s: “China’s Ballooning Mortgage Debt Built on Shaky Foundation.”

In the unfolding worst-case scenario, the rapid buildup of household sector debt has compounded systemic vulnerability from already heavily leveraged corporate and local government sectors.

October 12 – CNBC (Huileng Tan): “China's economic transition has caused a problem for the government—how to avert a sharp slowdown while keeping a lid on ballooning debt. In a report Thursday, rating agency Standard and Poor's highlighted the ‘tough choice between supporting growth and controlling debt sustainability’ as China tries to find new ways to fund public investments. ‘Although aggregate and provincial GDP growth stabilized in the first two quarters of 2016, we believe the fiscal conditions of Chinese local governments are under more pressure given the weakened economy,’ S&P wrote… The rising debt pile of local government financing vehicles (LGFV) raised questions on credit risks, said S&P.”

October 12 – Bloomberg: “Finance firms that help keep cash flowing to China’s towns, cities and provinces face rising risks of landmark bond defaults just as they turn to global markets for funds. China’s economic slowdown is weighing on revenue at regional governments, hampering their ability to support the 5.3 trillion yuan ($789bn) of outstanding onshore notes from local-government financing vehicles, which have yet to suffer nonpayments. Such issuance fell 18% last quarter as regulators curbed sales, forcing some to seek funds overseas. Financing units in provinces including Hunan, Jiangsu, Hubei and Sichuan are considering or planning U.S. currency notes, people familiar with the matters have said.”

Corporate debt is arguably China’s most precarious sector Bubble. In conjunction with the release of a new report on Chinese corporate Credit, Terry Chan – head of Asia-Pacific Analytics and Research - S&P Global Ratings – appeared Monday evening on Bloomberg TV:

Chan: “We estimate at the end of 2015 [there was] 5.6% problem credit. We use credit rather than loans because it’s a broader definition. If it slows down, as we expect, by 2020 it will be about 10%. It’s manageable given the returns they have. But if the rate doesn’t stop – if credit still grows around 15-16% - we think problem credit could reach 17% by 2020. And that’s basically ‘the straw that breaks the camels back.’ So what the banks would have to do is actually raise fresh capital – we estimate about $1.7 TN, or about 16% of China GDP. So those are big numbers… Obviously the state-owned enterprises are a massive part of the economy. In our sample of the 200 top corporates, for example, 70% are state-owned and they have 90% of the debt. So it’s a really big problem… At least for the next two years it is going to get worse. We see the momentum already in our study of the top 200 corporates. 2016 is as bad as 2015 was. It’s going to take a while. They are pressing the brakes slowly. They’re not going to slam on it. If credit doesn’t really slow down by the end of next year, we could be in a bit of strife.”

I would argue that a tremendous amount of global strife unfolds when the Chinese Credit boom succumbs. Chinese banks now lead the list of the world’s largest financial institutions. The performance of China’s economy now has major global ramifications. Reporters were quick to point to China to explain Friday’s global market rally. “Economic Data Signals Turnaround, Stability in China;” “China’s Days of Exporting Deflation May Be Drawing to a Close.”

There is great instability in China, masked by historic Credit expansion. It’s important to appreciate that China is new to this Capitalism thing. They’re completely inexperienced when it comes to mortgage finance Bubbles – and that goes for apartment owners, bankers and regulators. They are novices with massive corporate debt booms. They are newcomers in the face of a $30 TN banking system. They have outdone even the U.S. in mismanaging “shadow banking.” The Chinese have followed the “developed world” lead in repo, derivatives and “sophisticated” structured finance.

Years of exceptionally loose finance have surely nurtured unprecedented amounts of fraud and malfeasance – not the recipe for a sound financial system. Worse yet, they grabbed the Credit Bubble baton at the worst possible time – the conclusion of a historic global Credit Bubble, with all the associated economic, financial, social and geopolitical risks. Chinese rulers saw their juggernaut economy as ensuring global power and prestige. Things – at home and abroad – are developing much differently than they had anticipated.

New realities were discussed in a Friday FT article, “China Rethinks Developing World Largesse as Deals Sour.” With clients such Venezuela, Zimbabwe and Sudan, China developed into the world’s subprime lender. Form the FT: “Six of the top 10 recipients of Chinese development finance commitments between 2013 and 2015 were classified alongside Venezuela in the highest category of default risk ranked by the… OECD.”

October 13 – Financial Times: “When China signed up to build Venezuela’s Tinaco-Anaco Railway in 2009, the scheme was hailed as proof of the effectiveness of socialist brotherhood. Gleaming new Chinese trains were envisaged, whisking passengers and cargo along at 137mph on about 300 miles of track. Hugo Chávez, the late Venezuelan president, called the $800m project ‘socialism on rails’ and said the air-conditioned carriages would be available to everyone, rich or poor. But the endeavour has become what locals call a ‘red elephant’, the vandalised and abandoned symbol of Venezuela’s deepening economic crisis… For China, the project represents more than just an isolated example of a dream turned to dust. Over the past decade, the country has transformed itself from a marginal presence to the dominant player in international development finance with a loan portfolio larger than all six western-backed multilateral organisations put together. Outstanding loans from the two big Chinese ‘policy’ banks and 13 regional funds are well in excess of the $700bn owed to the western-backed institutions…”

As we closely monitor the Chinese Credit Bubble over the coming weeks and months, let’s be mindful of the central role China has come to play in the greatest global Bubble the world has ever experienced. There is tremendous uncertainty as to how this will play out.

As I’ve argued in the past, China is one enormous EM Credit system and economy. EM Credit Bubbles notoriously end with a destabilizing “hot money” exodus. A crashing currency then limits the central banks ability to reflate, and the whole thing turns sour.

In contrast, Beijing has orchestrated this strange dynamic of aggressive “money” and Credit inflation, while significantly restricting the capacity for this liquidity to exit the Bubble. Might this have only created a wall of “hot money” to be let loose once the dam breaks? How much leverage has accumulated with funds borrowed cheap overseas to speculate in higher yielding Chinese securities and financial instruments? Lots of questions and few answers. I’m not so sure Chinese policymakers have the answers either. They just recognize they have a major problem. We all share the problem.

For the Week:

The S&P500 declined 1.0% (up 4.4% y-t-d), and the Dow dipped 0.6% (up 4.1%). The Utilities gained 1.3% (up 11.1%). The Banks dropped 2.2% (down 2.5%), and the Broker/Dealers fell 1.8% (down 2.7%). The Transports slipped 0.2% (up 7.1%). The S&P 400 Midcaps declined 0.9% (up 8.7%), and the small cap Russell 2000 dropped 2.0% (up 8.8%). The Nasdaq100 fell 1.2% (up 4.7%), and the Morgan Stanley High Tech index lost 2.0% (up 8.8%). The Semiconductors dropped 3.3% (up 22%). The Biotechs sank 7.4% (down 20.5%). While bullion declined $6, the HUI gold index was little changed (up 79%).

Three-month Treasury bill rates ended the week at 29 bps. Two-year government yields were unchanged at 0.83% (down 22bps y-t-d). Five-year T-note yields gained three bps to 1.29% (down 46bps). Ten-year Treasury yields jumped eight bps to an almost five-month high 1.80% (down 45bps). Long bond yields surged 11 bps to 2.56% (down 46bps).

Greek 10-year yields rose seven bps to 8.22% (up 90bps y-t-d). Ten-year Portuguese yields dropped 28 bps to 3.27% (up 75bps). Italian 10-year yields were unchanged at 1.38% (down 21bps). Spain's 10-year yields gained 11 bps to 1.12% (down 65bps). German bund yields rose three bps to 0.05% (down 57bps). French yields increased two bps to 0.33% (down 66bps). The French to German 10-year bond spread narrowed one to 28 bps. U.K. 10-year gilt yields jumped another 12 bps to a three-month high 1.09% (down 87bps). U.K.'s FTSE equities index slipped 0.4% (up 12.4%).

Japan's Nikkei 225 equities index was about unchanged (down 11.4% y-t-d). Japanese 10-year "JGB" yields increased a basis point to negative 0.06% (down 32bps y-t-d). The German DAX equities index gained 0.9% (down 1.5%). Spain's IBEX 35 equities index jumped 1.7% (down 8.1%). Italy's FTSE MIB index rose 1.1% (down 22.5%). EM equities were mixed. Brazil's Bovespa index advanced 1.1% (up 42.5%). Mexico's Bolsa added 0.2% (up 11%). South Korea's Kospi fell 1.5% (up 3.1%). India’s Sensex equities declined 1.4% (up 6.0%). China’s Shanghai Exchange rallied 2.0% (down 13.4%). Turkey's Borsa Istanbul National 100 index slipped 0.5% (up 8.1%). Russia's MICEX equities index declined 0.7% (up 11.6%).

Junk bond mutual funds saw outflows of $72 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose five bps last week at 3.47% (down 35bps y-o-y). Fifteen-year rates gained four bps to 2.76% (down 27bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up six bps to an almost three-month high 3.64% (down 24bps).

Federal Reserve Credit last week dipped $0.9bn to $4.417 TN. Over the past year, Fed Credit contracted $34bn (0.8%). Fed Credit inflated $1.607 TN, or 57%, over the past 205 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $6.3bn last week to $3.146 TN. "Custody holdings" were down $168bn y-o-y, or 5.1%.

M2 (narrow) "money" supply last week declined $8.0bn to $13.094 TN. "Narrow money" expanded $915bn, or 7.5%, over the past year. For the week, Currency increased $1.1bn. Total Checkable Deposits jumped $68.3bn, while Savings Deposits sank $73.2bn. Small Time Deposits were little changed. Retail Money Funds fell $4.4bn.

Total money market fund assets declined $6.2bn to a one-year low $2.649 TN. Money Funds fell $49bn y-o-y (1.8%).

Total Commercial Paper dropped another $13.4bn to a multi-year low $903bn. CP declined $146bn y-o-y, or 13.9%.

Currency Watch:

October 10 – Bloomberg (Lananh Nguyen and Andrea Wong): “The inexplicable volatility that roiled the British pound last week came as no surprise to Bank of America Corp., which just days earlier warned that liquidity in the $5.1 trillion-per-day global currency market was far worse than anyone imagined. Sterling sank 6.1% in a span of minutes in early Asian trading Oct. 7, following at least three other bouts of puzzling foreign-exchange turbulence in the past two years. The latest episode involved the fourth-most-traded currency, serving up a stark reminder of the pitfalls that investors face in the world’s biggest financial market as banks -- the traditional middlemen -- step back amid post-crisis regulations. The currency market is growing more fragile because ‘phantom liquidity’ is undermining investors’ ability to buy and sell when they need to, Bank of America analysts wrote…”

The U.S. dollar index surged 1.7% to 98.09 (down 0.6% y-t-d). For the week on the upside, the Mexican peso increased 1.5% and the Brazilian real added 0.5%. For the week on the downside, the South African rand declined 3.2%, the Swedish krona 2.5%, the Norwegian krone 2.2%, the British pound 2.0%, the euro 2.0%, the Swiss franc 1.3%, the Japanese yen 1.2% and the Australian dollar 0.5%. The Chinese yuan fell 0.8% versus the dollar (down 3.6% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.0% (up 20.5% y-t-d). Spot Gold slipped 0.5% to $1,251 (up 18%). Silver fell 0.8% to $17.44 (up 26%). Crude added 54 cents to $50.35 (up 36%). Gasoline gained 1.1% (up 18%), and Natural Gas jumped 3.1% (up 41%). Copper sank 2.4% (down 1%). Wheat jumped 6.6% (down 10%). Corn rose 4.3% (down 1%).

China Bubble Watch:

October 13 – Reuters (Yawen Chen and Kevin Yao): “China's September exports fell 10% from a year earlier, far worse than expected, while imports unexpectedly shrank after picking up in August, suggesting signs of steadying in the world's second-largest economy may be short-lived. The disappointing trade figures pointed to weaker demand both at home and aboard, and deepened concerns over the latest depreciation in China's yuan currency… ‘This comes on the heels of weak South Korean trade data, and it definitely make us worry about to what extent global demand is improving,’ said Luis Kujis, head of Asia economics at Oxford Economics…”

October 11 – Bloomberg (Paul Panckhurst): “S&P Global Ratings said China’s banks may need to raise as much 11.3 trillion yuan ($1.7 trillion) of fresh capital from 2020 because of troubled credit, should a corporate debt binge fail to slow. The potential cost… equals 16% of last year’s nominal gross domestic product, S&P said. The warning adds to a drumbeat of concern over a surge in Chinese corporate credit since the global financial crisis and dwindling economic returns as the nation gets less bang for its buck and companies spend more on servicing debt… The rate of growth in China’s debt is ‘not sustainable for long,’ the ratings company said. The $1.7 trillion scenario is based on problem credit rising to 17% of outstanding credit by 2020, S&P said. The firm’s base case is for an increase to 10% from an estimated 5.6% in 2015.”

October 12 – Bloomberg (Jonathan Browning): “The Chinese account statement had all the trappings of the real thing: a red oval seal bearing Bank of Jiangsu Co.’s name, a balance printed to the last decimal (852,468,304.56 yuan) and a time stamp of 4:14 p.m. on April 25. Provided by a little-known Chinese investor group during early-stage acquisition talks with AC Milan, the document was among paperwork purporting to show the consortium’s ability to buy Silvio Berlusconi’s storied Italian soccer club… The only problem? The statement wasn’t true, according to Bank of Jiangsu. The lender told Bloomberg News last month that it hadn’t issued any such record… False bank records may be an extreme example of the risks from this year’s record wave of overseas Chinese acquisitions, but the episode highlights the challenge for Western firms who increasingly find themselves across the table from buyers with little to no international track record.”

October 13 – Bloomberg: “Actions by China’s policy makers to rein in property prices in the bubble-prone nation may prove so effective that the economy’s growth rate could be affected next year. At least 21 cities have introduced purchase restrictions and toughened mortgage lending since late September, reversing two years of easing to support home buyers. Goldman Sachs… says more tightening is likely to follow if prices keep soaring… ‘This is a round of substantial and high-profile property tightening, whose national impacts should not be underestimated,’ Harrison Hu, chief greater China economist at Royal Bank of Scotland Group…, wrote… ‘A full-fledged property downturn will bring significant downward pressures on the real economy’ and increase the potential for a hard-landing, he said.”

October 12 – Bloomberg (Narae Kim): “For Beijing's policy makers, taming the country's ever-growing property sector presents a challenge. While problems with China's overheating housing sector are nothing new, the fact that real-estate prices are climbing so fast when wider economic growth is slowing raises a big red flag. In a country where stock markets are underdeveloped and capital is tightly controlled, abundant liquidity injected by previous monetary stimulus has flowed into alternative assets including bonds, commodities, and the housing market. Weak investment appetite due to a slowdown in the real economy has accelerated cash flows into the real-estate market… This poses a serious policy conundrum for Beijing. Considering that the real-estate sector makes up about a quarter of the country's GDP, a property meltdown could be disastrous for the world's second-largest economy.”

October 11 – Bloomberg: “China’s currency outflows may be bigger than they look, with Goldman Sachs… warning that a rising amount of capital is exiting the country in yuan rather than in dollars. While the nation’s foreign-exchange reserves have stabilized and lenders’ net foreign-exchange purchases for clients have fallen close to a one-year low, official data show that $27.7 billion in yuan payments left China in August. That’s compared with a monthly average of $4.4 billion in the five years through 2014. Such large cross-border moves can’t be explained by market-driven factors and need to be taken into account when measuring currency outflows, according to MK Tang, …senior China economist at Goldman… Any sign of increased capital outflows could disturb a recent calm in China’s foreign-exchange market… The yuan fell to a six-year low on Monday, adding to outflow pressures.”

October 10 – Bloomberg: “China’s financial regulators plan to further tighten control on funds flowing into the property market in violation of current rules, according to people familiar with the matter. Authorities including the central bank, the China Banking Regulatory Commission and the China Securities Regulatory Commission aim to tighten control on speculative real-estate investments and money involved in land transactions, said the people, who asked not to be identified…”

October 13 – Wall Street Journal (Lingling Wei): “Recent rapid increases in property loans in China pose ‘new challenges’ for the government as it seeks to ensure the nation’s financial stability at a time of rising bad debt, a senior banking regulator said. …Wang Shengbang, a deputy director at the China Banking Regulatory Commission, said the surge in real-estate loans, which was triggered by a homebuying frenzy in many Chinese cities in recent months, has both ‘positive and negative sides.’ While the increased leverage has helped reduce housing inventory in some cities, it represents ‘new challenges’ to the regulator in its efforts to safeguard the financial system, Mr. Wang said.”

October 10 – Bloomberg: “China released guidelines for reducing corporate debt while also saying that the government won’t bear the final responsibility for borrowing by companies, the latest sign that policy makers are stepping up their fight against excessive leverage. The State Council, China’s cabinet, issued guidelines for reducing corporate debt and for how banks may swap bad debt to equity. At the same time, officials from the central bank and other government regulators held a briefing at which they described corporate leverage as high among major global economies.”

October 11 – Wall Street Journal (Loingling Wei): “China unveiled a controversial loan-relief plan that could help companies reduce their mounting debt loads but leave banks more strapped for capital. The continued economic slowdown has made it harder for businesses to repay debts that have been piling up at an alarming rate in recent years as leaders have encouraged lending to revive growth. Analysts estimate that corporate debt now accounts for 160% of China’s gross domestic product, up from less than 100% in 2008. The plan announced Monday by the State Council, China’s cabinet, lets companies give their lenders equity stakes in return for debt forgiveness.”

October 11 – Bloomberg: “Passenger-vehicle sales surged 29% in China last month… as consumers seeking to beat an expiring tax cut helped clear inventory on dealer lots. Deliveries of sedans, minivans, sport utility and multipurpose vehicles to dealerships rose to 2.27 million units in September…”

October 12 – Financial Times (Tom Mitchell): “The secretive billionaire who launched a hostile takeover bid for China’s largest property developer has emerged as one of the country’s richest people, illustrating how leveraged financial investments are propelling huge increases in private wealth. According to the Hurun Report’s annual China Rich List, Yao Zhenhua’s net worth surged more than nine times to $17.2bn last year, making him the country’s fourth richest person. Last year he was ranked 204th. Wang Jianlin, the entertainment mogul behind a series of high-profile acquisitions in Hollywood, and internet tycoon Jack Ma retained their spots at the top of the list, with fortunes of $32.1bn and $30.6bn respectively.”

Europe Watch:

October 10 – Financial Times (Laura Noonan, Caroline Binham and James Shotter): “Deutsche Bank was given special treatment in the summer EU stress tests that promised to restore faith in Europe’s banks by assessing all of their finances in the same way. Germany’s biggest lender… has been using the results of the July stress tests as evidence of its healthy finances. But the Financial Times has learnt that Deutsche’s result was boosted by a special concession agreed by its supervisor, the European Central Bank.”

October 10 – CNBC (Spriha Srivastava): “The problems surrounding Deutsche Bank are front and center in investors' minds… But while it is still unclear if the ailing German lender will need state aid to sail through this crisis, there is a regulation that could stop the German government from ending the misery by injecting equity into the bank. The Banking Recovery and Resolution Directive (BRRD), that came into force earlier this year - requires an 8% bail-in of a bank's creditors, including very large foreign banks and hedge funds — be applied before taxpayers get put on the hook. The directive has a well-laid out structure for resolving a troubled or failing European bank, irrespective of whether it is a small lender in Italy or a national champion in Germany.

October 9 – Wall Street Journal (Giovanni Legorano and Andrea Thomas): “When shares in Deutsche Bank AG, Germany’s largest lender, tanked last month, sparking rumors of a state-funded bailout, Italian politicians couldn’t help indulging in a bit of schadenfreude. Scolded by Berlin for years for his apparent failure to sort out Italy’s endemic bank problems, Premier Matteo Renzi showed evident pleasure in wagging the finger back at Germany. ‘I am sure German authorities will do everything needed to prevent Deutsche Bank’s crisis from worsening,’ he told Italian state television… ‘We have always said that as far as the issue of credit is concerned, Europe has to do everything needed to fix the situation of banks and that the main concern comes from German banks.’”

October 14 – Bloomberg (Giovanni Salzano and Lorenzo Totaro): “Italy’s public debt would exceed 150% of the value of all goods and services produced in the country without the contribution of the illegal and underground economy to national wealth. The ratio of debt-to-gross domestic product this year would amount to 152.6%, according to Bloomberg News calculations based on new data…”

Brexit Watch:

October 12 – Bloomberg (Robert Hutton): “Prime Minister Theresa May accepted that Parliament should be allowed to vote on her strategy for taking Britain out of the European Union as lawmakers who want to keep closer ties to the bloc began to assert themselves. The pound climbed against all of its 31 major peers as May’s move was seen as a conciliatory gesture, calming investor concern that she was taking a gung-ho approach to negotiations with the EU. Sterling had tumbled, losing more than 6% this month through Tuesday, after May signaled her intention to put immigration curbs before free trade and the City of London’s interests in pulling Britain out of the bloc.”

Fixed-Income Bubble Watch:

October 10 – Bloomberg (Tracy Alloway): “There are no bargains left in U.S. corporate credit, according to Deutsche Bank AG. Ultra-low interest rates in Europe, Japan and the U.K. have spurred investors to seek returns by buying the debt sold by U.S. companies with investment-grade ratings, leading some analysts to label the market as ‘the only game in town.’ But the rush into the asset class and the rising cost of protecting against currency-risk on dollar-denominated securities means foreign investors are facing an increasingly unpalatable menu of options when it comes to generating higher returns by buying U.S. corporate debt. ‘The U.S. investment-grade market has earned a reputation as the source of global yield for overseas portfolio managers,’ wrote Deutsche Bank credit strategists Oleg Melentyev and Daniel Sorid… ‘But a combination of rising FX hedging costs, low U.S. yields and tight credit spreads is challenging that reputation.’ The toxic mix means that ‘the best days of the global reallocation to U.S. credit may be behind us,’ they added.”

October 9 – Financial Times (Thomas Hale): “Investors have piled more than $100bn into bond exchange traded funds so far this year, taking the global total to its highest ever level as fixed income investors adapt to a changing financial ecosystem… The total amount invested in ETFs, which allow investors to buy shares backed by underlying assets such as equities, bonds or commodities, rose to $3.4tn at the end of September, up from $3tn at the end of 2015. Of that $612bn — or just under a fifth of total ETF assets — is now backed by fixed income products, according to… BlackRock. That represents a rise of 24% on the end of last year, when $495bn was invested.”

October 14 – Financial Times (Eric Platt and Joe Rennison): “European bond funds suffered their largest withdrawals in more than a year and the redemptions from the continent’s equity funds inched closer to the $100bn mark as a turbulent pound highlighted the risks of the looming UK exit from the EU.”

October 11 – Financial Times (Joe Rennison): “And then there was one. A crucial US funding market will soon be dominated by just one bank, sparking concern over the integrity of the vast plumbing system that keeps fixed income trading flowing. The importance of the $1.6tn tri-party repurchase (repo) market was vividly illustrated during the financial crisis, and by next year BNY Mellon alone will settle transactions across both US government bonds and this short-term lending market, where banks borrow cash from investors in exchange for assets such as Treasuries. The tri-party repo market greases the wheels that keep financial markets rolling. It is fundamental to the sale of new Treasuries, as banks buy securities at auction using the credit of a settlement bank, before exchanging them for cash with investors in the repo market to pay back the credit line, usually with the same settlement bank standing in the middle. Now, JPMorgan is planning to stop settling Treasury transactions inside the next 18 months, which is expected to also drastically reduce their tri-party repo operations in the US due to how closely linked the businesses are.”

Global Bubble Watch:

October 10 – CNBC (Matt Clinch): “Axel Weber, UBS chairman and a former policymaker at the European Central Bank (ECB), has warned today's incumbents that monetary intervention is causing international spillovers and major disturbances in global markets. ‘They (central banks) have taken on massive interventions in the market, you could almost say that central banks are now the central counterparties in many markets. They are the ultimate buyer,’ Weber told CNBC… Weber, who was president of the German Bundesbank between 2004 and 2011…, referenced the housing bubble leading up to the 2008 financial crash and said central banks had strayed from their core mandate. ‘Investors have been driven into investments where they have very little capability for dealing with what is on their plate and I think that is a sure reminder of where we were in a different asset class in 2007… So I think the central bankers need to be very careful that they do not continue to produce disturbances in the markets, which they acknowledge - it's a known side effect - but the perception that the underlying impact of monetary policy outweighs the potential side effect in my view is starting to be wrong,’ he added.”

October 11 – Reuters: “Deutsche Bank pays more to borrow from other banks than its peers including stragglers in Greece and Italy, Euribor data showed on Tuesday, a trend that underscores the gravity of the problems facing Germany's flagship lender. Deutsche is the only bank to pay to borrow over a 9 or 12-month period of a group of 21 lenders, which are polled to determine the price of interbank borrowing for the wider sector. The reading puts Deutsche in a worse position even than Italy's embattled Monte dei Paschi or the National Bank of Greece, due to concerns over a likely multi-billion-euro legal penalty for misselling toxic mortgage securities.”

October 9 – Reuters (Carmel Crimmins and Olivia Oran): “It wasn't just Deutsche Bank that was grappling with big questions about the future at the International Monetary Fund meetings in Washington last week. The German bank is scrambling to overhaul its operations as it faces a multi-billion dollar fine for selling toxic mortgage-backed securities in the United States. But many others in the banking industry are also still figuring out what they should be doing, nearly a decade after the financial crisis, as they grapple with anemic economic growth, wafer-thin returns on lending and the possibility that regulators will further hike their cost of doing business. ‘This new world of low interest rates and even negative interest rates is something that is very difficult,’ said Frederic Oudea, the chief executive of French bank Societe Generale. ‘It is a game changer, not just for banks but for the whole financial industry,’ he told an audience from the Institute of International Finance (IIF)…”

October 13 – Wall Street Journal (Judy Shelton): “The International Monetary Fund last week sharply lowered its growth forecasts for the United States and other advanced economies. Only three months ago, in July, the IMF was predicting U.S. growth of 2.2% this year. But in the October edition of its World Economic Outlook report, that figure has been cut to 1.6%. The report’s authors blame ‘political discontent’ and policy uncertainty for the deteriorating prognosis… Meanwhile, the IMF is forecasting dismal 1.1% growth for the United Kingdom in 2017, which is half the 2.2% it predicted in April… The downgrade reflects the fund’s opinion that uncertainty over Brexit will depress consumer spending as well as business investment and hiring.”

October 13 – Reuters (Michael Shields): “Billionaires on average became poorer last year as their collective fortunes shrank, even as Asia continued to crank out a new billionaire nearly every three days, a study… found. Transfers of assets within families, falling commodity prices and a stronger dollar helped reduce total billionaire wealth by $300 billion in 2015 to $5.1 trillion. That meant the average billionaire -- there were 1,397 of them, a net gain of 50 over 2014 -- was worth only $3.7 billion, the survey of 14 big markets by Swiss wealth manager UBS and advisory group PwC discovered. ‘After more than 20 years of unprecedented wealth creation, the Second Gilded Age has stalled,’ the report found. The United States added only a net five billionaires as 41 joined and 36 dropped out of the ranks of the ultra-rich. China alone, buoyed by its tech sector, minted 80 new billionaires.”

U.S. Bubble Watch:

October 14 – Reuters (Lindsay Dunsmuir): “The U.S. budget deficit widened to $587 billion for the fiscal year 2016 on slower-than-expected revenues and higher spending for programs including Social Security and Medicare… The 2016 deficit increased to 3.2% of gross domestic product. It was the first time the deficit increased in relation to economic output since 2009… That year, the deficit peaked at $1.4 trillion amid the financial crisis.”

October 12 – Bloomberg (Matt Scully): “Subprime borrowers are falling behind on their car loan payments at the highest rate in more than six years, and some bonds backed by these loans are vulnerable to getting downgraded, according to S&P Global Ratings. Competition has spurred lenders to loosen standards and resulted in more delinquencies and default by people with weak credit… Subprime borrowers were behind by more than 60 days on about 4.85% of auto loans in August, the highest level since January 2010. The rate was 4.14% in August of last year…”

Federal Reserve Watch:

October 14 – Reuters (Howard Schneider and Svea Herbst-Bayliss): “The Federal Reserve may need to run a ‘high-pressure economy’ to reverse damage from the 2008-2009 crisis that depressed output, sidelined workers, and risks becoming a permanent scar, Fed Chair Janet Yellen said on Friday in a broad review of where the recovery may still fall short. Though not addressing interest rates or immediate policy concerns directly, Yellen laid out the deepening concern at the Fed that U.S. economic potential is slipping and aggressive steps may be needed to rebuild it.”

October 13 – Bloomberg (Craig Torres and Christopher Condon): “U.S. central bankers debating the merits of raising interest rates last month described the decision as a close call, with several saying a rate hike was needed ‘relatively soon,’ minutes of the September meeting showed. ‘Several members judged that it would be appropriate to increase the target range for the federal funds rate relatively soon if economic developments unfolded about as the committee expected,’ the minutes from the Sept. 20-21 gathering… showed. ‘It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation.’”

October 13 – Bloomberg (Sid Verma): “Citigroup… posed an unspeakable question: will a political storm sweep Federal Reserve Chair Janet Yellen after the election that will force her to quit before her term ends in February 2018? Amid one of the most polarized U.S. elections in living memory, monetary policy has been thrust firmly into the campaign limelight. Republican nominee Donald Trump has attacked Yellen in highly personal terms, questioned the independence of the Fed, and suggested the Chair could be replaced with a partisan choice under a Trump administration. That the Citi analysts indulge such an extreme scenario is a testament to the unprecedented nature of the current U.S. electoral cycle…‘Calls to limit the power and monetary policy independence of the Fed are not new,’ the analysts, led by Dana Peterson, wrote… ‘However, recently intensified scrutiny of Fed activities and policy decisions, especially amid the 2016 election season, has prompted speculation that Fed Chair Yellen may exit her position and the board itself, sooner rather than later.’”

Central Bank Watch:

October 12 – Reuters (Michael Shields): “The European Central Bank may discuss technical changes to its asset-buying scheme next week but a decision could be deferred until December when the bank will also decide whether to extend the scheme beyond March, sources… said. Compromise proposals could include relaxing, on a temporary and partial basis, a rule forcing the ECB to buy debt in proportion to the size of each euro zone economy, the sources familiar with the discussion added. That could potentially reduce the ECB's purchase of German debt, risking renewed conflict with Berlin, which has already argued that the ECB is subsidizing indebted countries. Other proposals may include buying a limited amount of bonds yielding less than the deposit rate, which the ECB currently rules out, and buying a bigger share of any individual bond issue, the sources added.”

Japan Watch:

October 12 – Reuters (Leika Kihara and Stanley White): “Bank of Japan policymakers signaled… they had raised the threshold for further easing after last month's policy revamp - keeping their pledge to expand stimulus if needed, but only to protect the economy from external shocks. Yutaka Harada, who has been among the most vocal advocates of aggressive money printing on the BOJ's nine-member board, said he saw no need to ease policy at the central bank's next rate review. ‘Job markets continue to improve as a trend so for now, additional easing may not be necessary,’ even though inflation was undershooting prior forecasts, Harada told… In an earlier speech… Harada said it would take a ‘sudden change in the global economy’ that threatened the achievement of the BOJ's price target for the central bank to consider easing.”

EM Watch:

October 11 – Bloomberg (Zainab Fattah and Matthew Martin): “Saudi Arabia’s austerity measures will slash capital spending this year by 71%, as the world’s biggest exporter of crude seeks to repair public finances damaged by low oil prices. Capital expenditure is projected to fall to 75.8 billion riyals ($20.6bn) this year compared with 263.7 billion in 2015… In 2014, capital spending amounted to 370 billion riyals.”

Leveraged Speculator Watch:

October 13 – Bloomberg (Matt Robinson): “Wall Street’s top cop demanded that a resolution of its insider-trading case against Leon Cooperman include the billionaire investor accepting a temporary suspension from the hedge fund industry, according to people familiar with the matter. Before suing Cooperman last month, the U.S. Securities and Exchange Commission pushed the outspoken trader to agree to a settlement that would have required him to pay about $8 million in penalties and prevented him for some period of time from managing money for clients…”

October 11 – Bloomberg (Simone Foxman and Erik Schatzker): “Leon Cooperman, the hedge-fund manager accused of insider trading, said Tuesday that his Omega Advisors Inc. will continue investing money for clients even as its assets have dropped to $4 billion. ‘I have to make adjustments in the team but I’m prepared to run the business at a loss,’ Cooperman said… ‘We’re not retiring, we’re not sending back the money.’”

Geopolitical Watch:

October 14 – Bloomberg (Ting Shi and Ilya Arkhipov): “Chinese President Xi Jinping and his Russian counterpart, Vladimir Putin, will have more than vodka shots and gifts of ice cream to show for their warming relationship when they meet this weekend on the sidelines of a developing nations’ summit in India. Recent months have seen greater security cooperation between Russia and China as they find common ground against the U.S. The neighboring giants last month held their first joint naval drill in the South China Sea and both have condemned U.S. plans to deploy a U.S. missile shield in South Korea… ‘The fact that both countries started to talk about joint actions on the military level is a very serious development,’ said Vasily Kashin, a senior fellow of Russian Academy of Science’s Far Eastern Studies Institute. ‘The threat from U.S. missile defense pushes both China and Russia closer to each other. For Russia and China, the policy of containment is the containment of the U.S. first of all.’”

October 9 – Reuters (Maria Kiselyova): “Russian Foreign Minister Sergei Lavrov said… he had detected increasing U.S. hostility towards Moscow and complained about what he said was a series of aggressive U.S. steps that threatened Russia's national security. In an interview with Russian state TV likely to worsen already poor relations with Washington, Lavrov made it clear he blamed the Obama administration for what he described as a sharp deterioration in U.S.-Russia ties. ‘We have witnessed a fundamental change of circumstances when it comes to the aggressive Russophobia that now lies at the heart of U.S. policy towards Russia… It's not just a rhetorical Russophobia, but aggressive steps that really hurt our national interests and pose a threat to our security.’”

October 10 – AFP (Henry Meyer): “Former Soviet leader Mikhail Gorbachev warned… that the world has reached a ‘dangerous point’ as tensions between Russia and the United States spike over the Syria conflict. Relations between Moscow and Washington -- already at their lowest since the Cold War over the Ukraine conflict -- have soured further in recent days as the United States pulled the plug on Syria talks and accused Russia of hacking attacks. The Kremlin has suspended a series of nuclear pacts, including a symbolic cooperation deal to cut stocks of weapons-grade plutonium.”

October 10 – Bloomberg (Henry Meyer): “Russian state television is back on a war footing. This time, the ramped-up rhetoric follows the collapse of cease-fire efforts in Syria. As the U.S. and Russia accused each other of sinking diplomacy, Moscow increased its military presence in the Mediterranean and Baltic regions, and suspended a nuclear non-proliferation treaty. A prime-time news program warned that the U.S. wants to provoke a conflict… ‘Offensive behavior toward Russia has a nuclear dimension,’ Russian state TV presenter Dmitry Kiselyov said in his ‘Vesti Nedelyi’ program… ‘Moscow would react with nerves of iron to a Plan B,’ he said, referring to any possible U.S. military strike in Syria.”

October 11 – Bloomberg (Ilya Arkhipov): “Russia said it’s working with China to counter U.S. plans to expand its missile-defense network, which the two nations see as targeting their military assets. The upgrades aim to give Washington the ability to launch a nuclear strike ‘with impunity,’ Lieutenant General Viktor Poznikhir of the Russian Armed Forces General Staff said… at a security forum in Xiangshan, China… The Asian neighbors this year conducted a joint missile-defense exercise of their computer command staff, he said. ‘We are working together on ways to minimize possible damage to the security of our countries,’ Poznikhir said. ‘The illusion of invulnerability and impunity under the guise of missile defense will encourage Washington to make unilateral steps in dealing with global and regional issues. This could lead to a decrease in the threshold for using nuclear weapons to preempt enemy actions.’”

October 12 – Financial Times (Charles Clover): “Beijing could employ controversial measures to control the disputed airspace over the South China Sea, according to a leading expert with close ties to the Chinese government, as it seeks new ways to assert its authority in the contested region. Wu Shicun, head of the National Institute for South China Sea Studies, said Beijing ‘reserves the right’ to impose a so-called air defence identification zone (ADIZ) once it has finished building its second aircraft carrier.”

October 11 – Reuters (Michel Rose): “Europe should challenge the United States over its increasingly aggressive use of extraterritorial laws that have cost European companies - especially banks - billions in fines and other settlements, a French parliamentary report said. Still reeling from the $9 billion fine its biggest bank, BNP Paribas, had to pay U.S. authorities over violations of American sanctions against other countries, the French government has criticized in recent years what it considers the over-reach of the U.S. legal system. Paris's main objections center on the U.S. Department of Justice's broad interpretation of what it considers its jurisdiction. This sphere of influence can include transactions between non-Americans outside the U.S. where the U.S. dollar currency is involved. It can also cover deals and other actions taking place via the Internet using U.S. computer servers.”