Saturday, February 4, 2017

Weekly Commentary: The Wrath

It’s not the first time that a non-farm payrolls rally wiped away inklings of market anxiety. Coming early in the month – and on Fridays – the jobs report typically makes for interesting trading dynamics. By the end of another interesting week, the timely reemergence of “goldilocks” along with Trump The Deregulator were propelling stocks higher. Long forgotten were Monday’s “Stocks Fall Most in Month…” and “Trump Rally Hits Speed Bump on Immigration Concern.” Indeed, markets were grateful to let a number of developments slip from memory.

It’s still worth mentioning a few indicators that were beginning to lean away from “Risk On”. Prior to Friday’s jump, the powerful bank stock rally had stalled. The BKX was down almost 2% from Thursday to Thursday (Italian and Japanese banks down 3.4% and 2.9%). Small cap stocks have underperformed, with the Russell 2000 down slightly y-t-d as of Thursday’s close. Many “Trump Rally” stocks and trades have recently underperform. Equity fund flows were negative for three straight weeks. In high-yield debt, the rally had similarly lost momentum. Also noteworthy, Treasuries rallied only tepidly on Monday’s equity market selloff. European bonds continue to trade poorly (Greek yields up 33 bps; French spreads to bunds widened another 10bps). This week saw bullion jump $29. The dollar Index is now down 2.5% y-t-d.

The dollar/yen has for a while now been a key market indicator. After trading as low as 101.2 on election night market drama, Trump-induced king dollar euphoria had the dollar/yen surging to almost 119 by early January. The dollar/yen traded down to almost 112 on Thursday, to a two-month low. And similar to Treasuries, the dollar/yen these days struggles to participate during “Risk On” days. Trading slightly higher Friday, the yen jumped 2.2% against the dollar this week.

February 1 – Reuters (Sinead Carew and Jamie McGeever): “U.S. President Donald Trump and a top economics adviser on Tuesday unleashed a barrage of criticism against Germany, Japan and China, saying the three key U.S. trading partners were engaged in devaluing their currencies to the harm of American companies and consumers. The comments from Trump at the end of a White House meeting with pharmaceutical executives, as well as from trade adviser Peter Navarro…, were the starkest indication yet that the first-term Republican president is prepared to jettison two decades of ‘strong dollar’ policies advocated by predecessors dating back to the Clinton administration. The criticism also signals a weakening of the U.S. commitment to an agreement among the financial leaders of the world's top 20 economies, struck after the 2008 financial crisis, that countries would not pursue policies to target exchange rates for competitive purposes.”

February 2 – Nikkei Asian Review (Mikio Sugeno): “By accusing Germany and Japan of intentionally devaluing their currencies, the Donald Trump administration has attacked normal monetary policy designed to maintain healthy inflation, a dangerous step that could upend an understanding long shared by major economic powers. It was a moment Haruhiko Kuroda had been dreading. The Bank of Japan governor told reporters Tuesday after the central bank's two-day policy meeting that the new U.S. administration is still taking its first steps, and that the BOJ ‘will see how things play out.’ He knew anything he said could be misconstrued. Several hours later, the president called out China and Japan by name as having devalued their currencies over the course of years: ‘They play the money market, they play the devaluation market’ while the U.S. sits idly by, Trump said.”

This week offered some important clarity: Trump is no devotee of king dollar, while he views QE as a mechanism for currency devaluation. Oh, how the world is changing. Throughout the markets, king dollar has been integral to recent global risk embracement. I’ll assume global “Risk On” has been fueled in part by significant carry-trade speculative leveraging (short yen, euro, swissy instruments to provide financing for higher-yielding securities elsewhere). There are now major uncertainties that should ensure heightened currency market volatility going forward. This creates a less compelling risk vs. return calculus for carry trade leverage, increasing the probability that, once commenced, a de-risking/de-leveraging dynamic could become self-reinforcing.

February 3 – Bloomberg (Randall Jensen): “Asia’s two biggest central banks moved in opposite directions on Friday. In Beijing, the People’s Bank of China tightened monetary policy by raising the interest rates it charges in open market operations. In Tokyo, the Bank of Japan intervened in the bond market to reassert control over 10-year yields it has promised to anchor around zero… The backdrop: growing tensions with the U.S. as President Donald Trump accuses both China and Japan of unfair trading practices and keeping currencies low, and expectations the Federal Reserve is gearing up for multiple rate increases this year. ‘The world’s no longer synchronized, with the Fed’s tightening posing challenges for central bankers across Asia and beyond,’ said Frederic Neumann, co-head of Asian economic research at HSBC… ‘Asia’s got one foot on the gas, and one on the brake.’”

February 3 – Wall Street Journal (Shen Hong): “China’s central bank raised key interest rates in the money market Friday, reinforcing a shift toward tighter monetary policy aimed at deflating asset bubbles and reducing long-term financial risk. The latest effort by the People’s Bank of China follows a similar decision shortly before the weeklong Lunar New Year holiday to increase the borrowing cost on special loans to a select group of commercial lenders, a move widely interpreted as an effective policy interest-rate increase.”

February 2 – Bloomberg (Chikako Mogi and Masaki Kondo): “The Bank of Japan whipsawed markets as it fought to assert control over rising bond yields. The Japanese central bank first disappointed with a smaller-than-expected increase in bond purchases Friday morning, which spurred the 10-year yield and the yen to advance. Its unscheduled offer later to buy an unlimited amount of debt for some maturities sent rates and the currency falling. ‘The operation was a surprise aimed at definitely stopping the rise in yields,’ Takenobu Nakashima, quantitative strategist at Nomura… ‘What’s astonishing is that the BOJ is offering to buy at yields lower than where the markets are. In other words, the BOJ will pay to buy, showing that it wants to halt the yield even at its cost.’”

The overarching thesis for 2017 holds there's a high probability for a tightening of global monetary conditions that would catch inflated markets extraordinarily vulnerable. In short, the Crowded King Dollar Trade is exposed to Trump Administration antipathy toward dollar strength, with potential implications for market de-leveraging (waning liquidity). Secondly, the two major sources of global QE/liquidity – the ECB and BOJ – are more susceptible to policy reassessment than generally perceived by complacent markets. Both central banks are trapped in flawed policies, and both are poised to be on the receiving end of The Wrath of Trump. What’s more, the Japanese have traditionally accepted U.S. direction with obedience. (The BOJ must be wondering what happened to Bernanke’s “enrich thy neighbor”.) Third, Beijing officials seem seriously determined to try to rein in China’s out of control Credit Bubble. This increases the odds of a major Credit event unfolding in China in 2017, with all the associated policy, market and economic uncertainties.

When it comes to the late-stage of a major Credit Bubble, the analysis in a way simplifies: The Bubble bursts or it inflates to only more perilous extremes. Recalling 2007, well-entrenched Bubbles develop powerful momentum with the capacity to brush off even significant shocks. Such resilience works to bolster already powerful bullish market sentiment, associated flows and speculative impulses (and “inflationary biases” more generally). This dynamic helps explain why Bubbles can go to such extremes before catching almost everyone by surprise when they eventually falter. The VIX dropped 10% during Friday’s rally, punishing those that were tempted to play for a market reversal with cheap option trades. The VIX closed the week at 10.79, trading Friday at the lowest level since early 2007.

To be sure, option pricing fails to reflect political uncertainties. This week our President put many “on notice”, foe and friend alike. The Wrath list included Iran, China, Germany, Mexico, the ECB and BOJ, and even our dear friends in Australia. A U.S. television commentator quipped that it really takes a lot to get Australians upset with America, yet President Trump found a way. If the stock market had been under significant pressure this week, the rumblings questioning our President’s competence and emotional stability would have ratcheted up.

So many fascinating developments and perspectives:

February 2 – UK Independent (Ben Chu): “‘In many respects we’re coming to the last seconds of central bankers’ fifteen minutes of fame which is a good thing,’ Mr Carney told the Bank of England Inflation Report press conference, referencing Andy Warhol’s line about everyone in the world being famous for fifteen minutes in their lives in the future.”

And there was the Bloomberg article, “Finance Makes America Great, Say Larry Summers, Joe Ricketts.” “…Finance and economic life work best when they are based on openness, transparency, principle and are free from political motivation,’ Summers said, adding that independent central banks, strong currency, common rules, and ‘no ad hoc threats or bribes from public officials, no matter how powerful, are what make the market system function best… There’s something else you learn at the Museum of American Finance,’ Summers said. The U.S. is an exceptional nation ‘because of what it has strived to achieve for the last 75 years in the global system.’”

The problem is that finance doesn’t make America great. The global “system” today is nothing as imagined 75 years ago and, for good reason, most people in the world have little trust in international finance. Central banks are not independent and “finance and economic life” have been anything but free from “political motivation.” Instead, unfettered global finance and central bank-led inflationism have created serial booms and busts that evolved into today’s perilous financial, economic, social and geopolitical discord. The unprecedented inflation of finance is fundamental to the problem - and not, as should be abundantly obvious by now, constructive when it comes to finding a lasting solution.

I could only chuckle at the headline: “Dan Loeb: Trump Will Make Hedge Funds Great Again.” In a meeting with pharmaceutical executives earlier in the week, a delightful President Trump promised to slash regulation and red tape. But he just needs a little something in return from the industry: Dramatically Lower Prices. The Art of the Deal.

Our new President and his Administration are at this point an enigma. Folks are beginning to accept that he’s not going to change, which is none too comforting to many. Shock and dismay understate reactions both at home and abroad. Yet when it comes to financial markets, when anxiety begins to strike simply repeat, “de-regulation, tax cuts, de-regulation, tax cuts…” The President certainly has everyone’s attention, with Wall Street and corporate America having donned kid gloves.

But I don’t believe anyone is comfortable that they understand what the President and his inner circle really have in mind. Whatever it may be, they’re going to be in your face tough and idiosyncratic. How big of a conflict are they willing to accept early in the new Administration? At the end of the day, I suspect they don’t share the view that America will be made great again through hedge funds, inflated securities prices and ever greater quantities of “money” and Credit. Sure, they’ll play the game so long as they see it to their advantage.

Markets, of course, remain convinced that buoyant securities prices are more indispensable than ever - and that Trump will bluster but knows better than to mess with the markets or their benefactor, central banking. Not that they’re in any hurry to burst Bubbles, but the Trump folks have their own perspectives, ideas and ambitions. I suspect that Carney’s “15 minutes of fame” comment resonates within The Inner Circle. A new era has commenced, and these central bankers and Wall Street icons have occupied the limelight for too long already.


For the Week:

The S&P500 (up 2.6% y-t-d) and the Dow (up 1.6%) were little changed. The Utilities added 0.8% (up 0.2%). The volatile Banks increased 0.3% (up 1.5%), and the Broker/Dealers jumped 1.7% (up 7.4%). The Transports dropped 2.1% (up 2.2%). The S&P 400 Midcaps gained 0.6% (up 2.8%), and the small cap Russell 2000 increased 0.5% (up 1.5%). The Nasdaq100 (up 6.1%) and the Morgan Stanley High Tech index (up 7.2%) were about unchanged. The Semiconductors added 0.2% (up 6.3%). The Biotechs jumped 3.7% (up 7.4%). With bullion surging $29, the HUI gold index rose 4.6% (up 16.4%).

Three-month Treasury bill rates ended the week at 50 bps. Two-year government yields slipped two bps to 1.20% (up one basis point y-t-d). Five-year T-note yields fell four bps to 1.91% (down 2bps). Ten-year Treasury yields declined two bps to 2.46% (up 2bps). Long bond yields rose three bps to 3.09% (up two bps).

Greek 10-year yields surged 33 bps to 7.44% (up 42bps y-t-d). Ten-year Portuguese yields added three bps to 4.17% (up 43bps). Italian 10-year yields gained four bps to 2.27% (up 45bps). Spain's 10-year yields jumped 10 bps to 1.68% (up 30bps). German bund yields fell five bps to 0.41% (up 21bps). French yields rose five bps to 1.08% (up 40bps). The French to German 10-year bond spread widened another 10 to 67 bps. U.K. 10-year gilt yields fell 12 bps to 1.35% (up 12bps). U.K.'s FTSE equities index was little changed (up 0.6%).

Japan's Nikkei 225 equities index dropped 2.8% (down 1.0% y-t-d). Japanese 10-year "JGB" yields increased two bps to 0.10% (up 6bps). The German DAX equities index fell 1.4% (up 1.5%). Spain's IBEX 35 equities index slipped 0.4% (up 1.2%). Italy's FTSE MIB index declined 1.1% (down 0.6%). EM equities were mixed. Brazil's Bovespa index fell 1.6% (up 7.8%). Mexico's Bolsa dipped 0.4% (up 3.5%). South Korea's Kospi declined 0.5% (up 2.3%). India’s Sensex equities index gained 1.3% (up 6.1%). China’s Shanghai Exchange declined 0.6% (up 1.2%). Turkey's Borsa Istanbul National 100 index surged 5.4% (up 13.1%). Russia's MICEX equities index fell 1.7% (down 0.3%).

Junk bond mutual funds saw inflows of $413 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.19% (up 47bps y-o-y). Fifteen-year rates added a basis point to 3.41% (up 40bps). The five-year hybrid ARM rate added three bps to 3.23% (up 38bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.31% (up 54bps).

Federal Reserve Credit last week declined $4.1bn to $4.415 TN. Over the past year, Fed Credit contracted $29.8bn (down 0.7%). Fed Credit inflated $1.604 TN, or 57%, over the past 221 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt fell $5.3bn last week to $3.165 TN. "Custody holdings" were down $108bn y-o-y, or 3.3%.

M2 (narrow) "money" supply last week jumped $197 billion to a record $13.299 TN. "Narrow money" expanded $832bn, or 6.7%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits were about unchanged, while Savings Deposits rose $16.0bn. Small Time Deposits and Retail Money Funds were little changed.

Total money market fund assets declined $5.7bn to $2.680 TN. Money Funds declined $72bn y-o-y (2.6%).

Total Commercial Paper added $2.1bn to $965bn. CP declined $99.5bn y-o-y, or 9.3%.

Currency Watch:

February 1 – Wall Street Journal (Saumya Vaishampayan, Ian Talley and Chelsey Dulaney): “Major currencies are posting their largest swings in months, highlighting a growing difficulty for investors and traders to discern the likely path of Trump administration policy. The U.S. currency rallied in the weeks following Donald Trump’s election Nov. 8, reflecting in part investor expectations that deregulatory, tax-reduction and stimulus plans will push up U.S. growth. But since the New Year, the dollar has declined and volatility has picked up, driven by statements by administration officials that have been interpreted by investors as advocating a lower dollar.”

The U.S. dollar index declined 0.7% to 99.87 (down 2.5% y-t-d). For the week on the upside, the Mexican peso increased 2.6%, the Japanese yen 2.2%, the Australian dollar 1.7%, the Norwegian krone 1.6%, the South African rand 1.6%, the Singapore dollar 1.5%, the South Korean won 1.1%, the Taiwanese dollar 1.0%, the Canadian dollar 1.0%, the Swedish krona 1.0%, the euro 0.8%, the New Zealand dollar 0.8%, the Swiss franc 0.6% and the Brazilian real 0.6%. For the week on the downside, the British pound declined 0.6%. The Chinese yuan increased 0.2% versus the dollar (up 1.1% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index added 0.7% (up 0.5% y-t-d). Spot Gold jumped 2.4% to $1,220 (up 5.9%). Silver gained 2.0% to $17.479 (up 9.4%). Crude increased 66 cents to $53.83 (unchanged). Gasoline rose 1.7% (down 7.0%), and Natural Gas dropped 8.8% (down 18%). Copper fell 2.7% (up 4.3%). Wheat gained 2.3% (up 5.5%). Corn added 0.8% (up 3.8%).

Trump Administration Watch:

February 2 – Reuters (Jamie McGeever): “If visibility and predictability are two foundations upon which stable financial markets are built, comments from the White House this week on the U.S. dollar suggest investors should brace for increased foreign exchange volatility. President Donald Trump and his top trade adviser waded into the debate over the currency's strength and the damage they say it is doing to U.S. competitiveness, drawing rebuffs from Germany and Japan and casting doubt over the strength of global cooperation on foreign exchange policy. On the one hand, this should come as little surprise. A key pillar of Trump's election campaign was to reinvigorate U.S. manufacturing and bring back what he sees as lost jobs. A weaker dollar would be instrumental to achieving that goal. But his desire to boost U.S. economic growth - via tax cuts, increased spending and encouraging U.S. firms to repatriate billions of dollars of cash held overseas - is consistent with higher interest rates and a stronger dollar.”

February 2 – Reuters (Parisa Hafezi): “President Donald Trump’s ‘America First’ policy aimed at shrinking the trade deficit represents a fundamental change in the country’s dollar strategy, says the former currency chief of Japan’s Ministry of Finance. The U.S. has traditionally favored a strong dollar to attract funds from abroad and reinvested the money overseas to reap returns from dividends and interest income, said Hiroshi Watanabe, president of the Institute for International Monetary Affairs… For this reason, the U.S. has sought to avoid weakening the dollar but this business model seems to be changing, he said. ‘What interests Trump is the size of the U.S. trade deficit, the amount of exports from the U.S., and not the exchange rate or whether the U.S. needs a strong dollar… While refraining from favoring a weak dollar, the U.S. Treasury Secretary may eventually say the dollar needn’t be strong.’”

January 31 – Bloomberg (Patrick Donahue and Arne Delfs): “Chancellor Angela Merkel rejected an accusation by President Donald Trump’s top trade adviser that Germany is gaming foreign-exchange markets as European leaders grapple with the new U.S. administration. Peter Navarro, the head of the White House National Trade Council, told the Financial Times that Germany’s excessive surplus is a sign of a ‘grossly undervalued’ currency. Merkel pushed back, saying the exchange rate was the province of the European Central Bank and that the German government has long upheld the ECB’s independence.”

February 1 – Financial Times (Shawn Donnan, Robin Harding and Katie Martin): “The Trump administration’s willingness to break with tradition and comment about currency valuations has raised fears that the US might lead the world into a new round of currency wars, angering and unnerving allies. Shinzo Abe, Japan’s prime minister, complained on Wednesday after Mr Trump attacked China and Japan for ‘play[ing] the devaluation market’. In response, Mr Abe told the Japanese parliament: ‘The kind of criticism they are making of yen manipulation is incorrect.’ The previous day Angela Merkel… denied that Berlin was seeking to influence the valuation of the euro — after a top Trump adviser… accused Berlin of exploiting a ‘grossly undervalued’ euro. The administration’s comments were the latest sign of a dramatic departure from past practice…”

February 1 – Reuters (Howard Schneider and David Lawder): “For seven years, the United States has fought to keep the euro zone intact, urging European officials toward action and supporting international bailout programs to keep the 17-nation currency union from cracking apart. That appears to have changed less than two weeks into Donald Trump's new administration. A sharp shift in tone toward Germany, casting the euro as fuel for that country's massive trade surplus, has raised concerns that the U.S. president's trade-centric world view may see the euro not as a geopolitical plus, but as another needless bit of multilateralism. While Trump has refrained from commenting directly on the euro, he praised Britain's decision to exit the European Union as a ‘great thing’ and predicted that others would leave the bloc as the result of an influx of refugees.”

February 2 – Bloomberg (David Tweed): “For the first time in decades, America’s oldest allies are questioning where Washington’s heart is. This week, President Donald Trump and his deputies hit out at some of America’s closest friends, blasting a ‘dumb’ refugee resettlement deal with Australia and accusing Japan and Germany of manipulating their currencies. Ties with Mexico have deteriorated to the point its government had to deny reports that Trump told President Enrique Pena Nieto he might send U.S. troops across the southern border. ‘When you hear about the tough phone calls I have, don’t worry about it,’ Trump said to an audience of religious and political leaders at the National Prayer Breakfast… ‘The world is in trouble -- but we’re going to straighten it out, OK? That’s what I do.’”

February 1 – Bloomberg (John Follain, Jeff Black, and Scott Hamilton): “World leaders aren’t taking Donald Trump’s trade barbs lying down. After the U.S. president said Germany and Japan are gaming foreign-exchange markets to win favorable trade terms, Japanese Prime Minister Shinzo Abe joined German Chancellor Angela Merkel… in pushing back and leading a global counter-charge to the accusations. ‘A massive clash is starting to emerge with Trump willing to get into major geopolitical spats with China and other countries to advance his ‘America First’ agenda,’ Mark Leonard, director of the European Council on Foreign Relations, said… The sparks that have dominated the initial days of Trump’s presidency have set the stage for increased tensions over global trade and currency regimes. Decades of economic ties are at stake.”

January 29 – Financial Times (Guy Chazan and Alex Barket): “The fate of European dual nationals banned from entering America — including leading British and German politicians — is set to become one of the first flashpoints of transatlantic relations in the Trump era. As Donald Trump stood by his ban on refugees and entry to the US from seven Muslim-majority countries, Angela Merkel, the German chancellor, on Sunday joined other world leaders in condemning the ban, saying it was no way to fight terrorism. The White House’s actions have caused alarm in Europe, where leaders see it as part of a broad offensive by Mr Trump against the world liberal order and the key common values underpinning transatlantic institutions that have ensured peace and security in Europe since the second world war.”

China Bubble Watch:

February 1 – Financial Times (Jamil Anderlini): “It reads like the plot of a bad thriller — a Chinese billionaire sits with his entourage of female bodyguards in his apartment in the Hong Kong Four Seasons in the early hours of Chinese new year’s eve. The women are employed not only to protect him but also to wipe the sweat from his brow and back. Suddenly, half a dozen public security agents from mainland China burst in, overpower the bodyguards, bundle the billionaire out of the luxury hotel and spirit him across the border to face the wrath of the Communist party. But this is not the script for a kung fu potboiler. The billionaire is Xiao Jianhua, one of China’s most politically connected and wealthy men, and his abduction from the heart of Hong Kong’s financial district last Friday has shaken the city to its core.”

Global Bubble Watch:

February 1 – Bloomberg (Marton Eder and Anooja Debnath): “Euro-region bonds handed investors the worst start to a year on record as heightened political risk across the currency bloc added to speculation the European Central Bank may bring its asset-purchase program to an abrupt halt in 2018. With general elections scheduled in France, Germany and the Netherlands this year amid an increase in support for anti-euro rhetoric, yields on French and Italian bonds climbed this week to their highest level relative to benchmark German debt since 2014. In the face of stronger growth and rising inflation, some investors aren’t listening to Mario Draghi when he says the ECB hasn’t considered tapering its bond-buying plan. Rising populism in the region’s biggest economies and speculation that the ECB’s stimulus plan may be nearing its endgame have clouded the horizon for bond investors…”

February 1 – Bloomberg (Randall Jensen): “Inflation across the world is beating analysts’ forecasts even before the potential effect from Donald Trump’s economic policies. The global Citi Inflation Surprise Index, which measures price surprises relative to market expectations, is at the highest in more than five years. The reading turned positive in December -- meaning inflation data were higher than expected -- for the first time since 2012.”

January 31 – Wall Street Journal (Mike Bird, Christopher Whittall and Ben Leubsdorf): “After years of fighting against deflation, the U.S., the eurozone and Japan show glimmerings of life in consumer prices and wages, evidence that an era of exceptionally low inflation is receding from the global economic landscape. Several factors are behind the move, including a rebound in energy prices, falling unemployment which is reducing slack in some labor markets, and central banks’ low-interest-rate policies that spur lending and economic growth.”

January 29 – Financial Times (Jennifer Hughes): “President Donald Trump’s inauguration and the early lunar new year holiday triggered a borrowing frenzy in Asia this month, with regional companies and governments selling record amounts of bonds in the international markets. Asian borrowers from Japan’s megabanks and India’s Vedanta mining group… have sold $51bn of debt to international investors, according to Dealogic…”

January 30 – Bloomberg (Maria Tadeo): “Euro-area economic confidence hit a six-year high in January, adding to signs of stronger growth and inflation that are fueling a debate about European Central Bank stimulus. An index of executive and consumer sentiment rose to 107.9. from 107.8 in December… That’s the highest reading since March 2011…”

Brexit Watch:

February 1 – Bloomberg (Fergal O'Brien): “U.K. factories saw costs rise at a record pace at the start of 2017, pointing to increasing upward pressure on inflation that could weigh on the economy this year. A measure of input prices in IHS Markit’s monthly Purchasing Managers Index jumped to the highest since the series began in 1992…”

Europe Watch:

January 31 – Reuters (Jan Strupczewski and Francesco Guarascio): “Inflation in the euro zone has risen to just below the European Central Bank's target, economic growth is accelerating at greater speed than in the United States, and unemployment has hit a more than seven-year low. Myriad data releases showed… that the 19-member currency bloc's economy is on the mend - a confirmation of recovery that will intensify political pressure on the European Central Bank to haul back its generous stimulus program… Inflation accelerated to 1.8% year-on-year in January…, up from 1.1% in December, leaving it just shy of the ECB's medium-term target of below but close to 2%. It was the highest rate since February 2013 and came after data in the past two days that showed prices rising in Germany, France and Spain, three of the bloc's four biggest economies.”

January 30 – Bloomberg (Carolynn Look): “German critics of the European Central Bank’s 2.28 trillion-euro ($2.4 TN) bond-buying program got a little bit more ammunition on Monday. Inflation in the euro area’s biggest economy was 1.9% in January, the highest rate since July 2013... Perhaps more importantly, it’s now roughly at the level that the ECB targets for the currency bloc as a whole, a signal for many Germans that the central bank for 19 nations needs to rein in stimulus.”

January 30 – Bloomberg (David Goodman and Anooja Debnath): “Europeans are more confident about their economy than they’ve been in nearly six years, but you wouldn’t know it by looking at the markets. Investors dumped bonds and stocks across the region on Monday, spurred by a confluence of risks that echoed the euro-zone debt crisis. French and Italian election campaigns stoked concerns over the rise of anti-euro political powers, while inflation in Germany signaled European Central Bank stimulus may not last much longer. Meantime, Greece, the catalyst for the original crisis, reached another crossroads with its creditors.”

January 30 – Bloomberg (Carolynn Look): “Germany is feeling cursed by its own economic strength. For eight years, the nation of 83 million people has been the euro area’s growth driver. Now it’s at the forefront of the currency bloc’s reflation -- early data on Monday showed annual price increases exceeding 2% in some states -- and dissatisfaction with the European Central Bank has morphed into frustration. Critics and media are slamming the institution’s monetary stance… as mainstream parties struggle to contain a surge in populism ahead of national elections. Finance Minister Wolfgang Schaeuble has warned that higher inflation could cause ‘political problems,’ and German monetary officials are urging their peers to start devising an exit strategy from unconventional stimulus.”

February 1 – Wall Street Journal (Tasos Vossos and Nektaria Stamouli): “Investors are dumping Greek bonds, fearing that Athens will be unable to pay debt that comes due this summer. The selloff comes as the Greek government is again at a standstill in negotiations with its creditors in the eurozone and at the International Monetary Fund. Athens needs to break the deadlock and secure more aid before about €6 billion ($6.5bn) in debt has to be repaid in July. Complicating matters is a scheduled IMF board meeting next week and a lack of clarity over what position the U.S.—which has the largest vote at the fund—will take under the Trump administration.”

January 30 – Reuters (Francesco Guarascio): “Greece will only receive more loans from the euro zone if the International Monetary Fund joins its latest aid program, the head of the bloc's bailout fund said… Greece needs a new tranche of financial aid under its 86 billion euro bailout by the third quarter of the year or it faces the risk of defaulting on its debts. Under the current program, Greece's third since 2010, loans have been disbursed by euro zone creditors without the formal participation of the IMF, although that has always been a requirement. But with elections coming in the Netherlands and Germany -- two of the most adamant supporters of the IMF role in the bailout, the creditors want to apply the agreed conditions for new loans to Athens more strictly.”

February 2 – Financial Times (Mehreen Khan): “More signs of rumblings in the eurozone bond markets. With investors starting to demand the highest premium in three years to hold French over German government bonds, the yield gap between Italy and Spain is also at its highest level since the depths of the eurozone’s debt crisis. Diverging political and economic fortunes in the eurozone’s southern economies have sent Italy’s 10-year yield spread with Spain to over 60 bps – the widest since 2012… The peripheral bond market moves are the latest sign that investors are beginning to differentiate between the riskiness of debt of the eurozone’s biggest governments in a key year of elections in the single currency area.”

January 31 – Financial Times (Mehreen Khan): “France’s far-right presidential candidate Marine le Pen will look to take the country out of the single currency area in six months, setting out a radical economic vision for the eurozone’s second largest economy should she be elected in May. Jean Messiha, an adviser to Ms Le Pen, has fleshed out the eurosceptic party’s promises to pursue a ‘Frexit’, claiming the French state would redenominate its more than €2tn outstanding debt into a new franc and ‘guarantee’ companies will still have access to the debt markets to help smooth the transition out of the euro. Ms Le Pen has long promised to restore monetary sovereignty to France, railing against the EU’s debt rules and prohibitions on government spending.”

Fixed-Income Bubble Watch:

January 30 – Reuters (Dhara Ranasinghe): “Inflation has a habit of creeping up on you. Just ask historians. From rates below zero less than a year ago, inflation across the developed world has risen in recent months toward central bank targets, largely driven by a rising oil price. And if history is any guide, bond markets had better beware. Paul Schmelzing, a visiting scholar at the Bank of England from Harvard University, has studied 800 years of bond markets history and says the most relevant parallel with today's environment is with the late 1960s under U.S. President Richard Nixon. The United States was emerging from a prolonged period of low inflation, the jobs market was tightening and a new pro-business president had raised expectations of fiscal expansion. It was a bruising time for bond investors. U.S. bonds lost 36% in real price terms between 1965 and 1970, while annual consumer price inflation more than tripled in the period, to 5.9% from 1.6%.”

February 1 – Financial Times (Eric Platt): “Trading volumes of US corporate debt hit a record level on Tuesday. More than $38bn worth of investment grade, high yield and convertible bonds swapped hands on Tuesday, surpassing a high water market set last March… The surge in trading follows a near record month of borrowing by companies through US capital markets. Banks and companies that hold investment grade credit ratings sold $177.9bn of debt in the US in January, the second highest monthly tally on record and less than $3bn below a peak set in May 2016, according to Dealogic.”

U.S. Bubble Watch:

February 2 – Bloomberg (Sho Chandra): “Worker productivity in the U.S. cooled in the fourth quarter following the biggest jump in two years, resuming the weak efficiency gains that have plagued the expansion. The measure of employee output per hour increased at a 1.3% annualized rate, after a revised 3.5% rise in the prior three months… Expenses per worker rose at a 1.7% pace. The latest slowdown -- following a third-quarter gain that ended the longest streak of productivity declines since 1979 -- underscores the challenge of developing a sustained pickup.”

February 2 – Reuters (Lucia Mutikani): “U.S. factory activity accelerated to more than a two-year high in January amid sustained gains in new orders and raw material costs… Other data on Wednesday showed private employers boosted hiring last month.”

January 31 – Reuters (Chuck Mikolajczak): “U.S. single-family home price increases accelerated at a faster pace than expected in November and rising mortgage rates coupled with potential economic growth could push them higher… The S&P CoreLogic Case-Shiller composite index of 20 metropolitan areas rose 5.3% in November on a year-over-year basis, up from a 5.1% climb in October.”

February 1 – Bloomberg (Jamie Butters and David Welch): “Toyota… led major carmakers reporting lower U.S. sales in January, even as an industry trying for another record year piled on discounts to keep showrooms busy. Deliveries fell about 11% for both Toyota and Fiat Chrysler Automobiles NV. Sales also dropped for General Motors Co. and Ford Motor Co., pacing a 1.8% decrease for the industry in January…”

February 1 – Wall Street Journal (Laura Kusisto): “Young Americans are losing confidence in their prospects for buying a home, suggesting that even with prices at all-time highs the dream of homeownership is losing its grip on some. The share of renters and people living with family members who believe now is a good time to buy declined to 55% in the fourth quarter of 2016 from 58% in the third quarter and 63% at the beginning of last year… Lawrence Yun, chief economist at the National Association of Realtors, blamed lack of affordability, a shortage of inventory, student debt and a perception that credit remains tight for potential buyers’ lack of confidence… Of the roughly 40% of people surveyed who don’t own a home and have student debt, more than half said they weren’t comfortable taking on a mortgage.”

January 31 – Financial Times (Alistair Gray): “An influential bankers lobby is pushing the Trump administration to tackle one of the thorniest unsolved problems from the financial crisis by overhauling the two giant businesses that back most US mortgages. Fannie Mae and Freddie Mac would be turned into privately owned utilities with returns to shareholders determined by regulators under proposals put forward by the Mortgage Bankers Association. The two groups would enjoy government support under the MBA’s plans — but so would rivals and new entrants, a structure proponents say would encourage competition.”

January 30 – Bloomberg (Michael McDonald): “U.S. college endowments suffered their biggest loss since the financial crisis, dragged down by global stocks, hedge funds and natural resources, according to an industry survey… The 1.9% average loss reported by the National Association of College and University Business Officers and money manager Commonfund…, for the year ended June 30, compared with a nearly 4% gain… in the S&P 500 Index. In the prior 12-month period, schools saw a 2.4% return on average.”

Federal Reserve Watch:

February 1 – New York Times (Binyamin Appelbaum): “The Federal Reserve is waiting for more information about the Trump administration’s economic plans, just like everyone else. After its first policy making meeting of the year, the Fed said on Wednesday that its economic outlook remained essentially unchanged since its previous meeting in December. The nation’s slow-and-steady economic expansion has continued, with little sign in the latest data that it is flagging or accelerating. And as expected, the Federal Open Market Committee… left the Fed’s benchmark interest rate unchanged. The question is what comes next.”

February 2 – Bloomberg (Steve Matthews): “A decade after the U.S. housing market collapsed, Federal Reserve officials are watching rising apartment towers as the next potential asset-price bubble, which could add to the debate about the pace of interest-rate hikes this year. Fed Chair Janet Yellen cited commercial real estate prices as ‘high’ in a speech at Stanford University on Jan. 19. That message has been echoed by Governor Jerome Powell, who warned ‘low rates may lead to a reach for yield,’ as well as Boston Fed President Eric Rosengren, who cited luxury housing in his city. While single-family housing prices have had a gradual recovery from the mortgage bust, commercial real estate is showing signs of being overheated in markets such as New York, San Francisco and Boston. Fed officials have mostly said they plan to address potential asset price bubbles with financial supervision, rather than by raising interest rates at a faster pace…”

January 29 – Wall Street Journal (Michael S. Derby): “While Federal Reserve officials ponder when to raise short-term interest rates again, they are beginning to wrestle with another big policy decision—whether this is the year to start shrinking their immense portfolio of mortgage and Treasury securities. The Fed has boosted its portfolio of long-term bonds and other assets to $4.45 trillion from less than $1 trillion in 2007… Officials believe the large portfolio has helped to spur economic growth by holding down long-term interest rates. With the economy closer to healed from the financial crisis and recession, the central bank has already begun raising short-term rates. Fed Chairwoman Janet Yellen has said the Fed would reduce the bondholdings once interest rate increases were ‘well under way.’ Many officials hope to get the portfolio back to some state of precrisis normalcy.”

February 1 – Reuters (Ann Saphir and Richard Leong): “Federal Reserve policymakers are putting markets on notice that the central bank's $4.5 trillion balance sheet is back on the agenda in an apparent effort to give investors time to prepare for changes rather than to signal any action is imminent. Policymakers want to minimize any volatility that slimming the Fed's massive balance sheet might cause, and have said they will only do so after interest rate increases are ‘well underway.’”

Japan Watch:

January 31 – Bloomberg (Toru Fujioka and Enda Curran): “Optimistic economic forecasts and monetary policy settings that haven’t changed since September lend an aura of calm and control to the Bank of Japan. The problem is, much of what’s been going right lately -- and a lot of what could go wrong this year -- are beyond its control. This was clear Tuesday when the central bank raised its projections for growth and maintained bullish price estimates, while warning that the risks to this picture are skewed to the downside… The BOJ said it would continue to buy bonds and other securities at the same pace it did last year, and left its key short-term and long-term policy rates unchanged…”

EM Watch:

January 31 – Bloomberg (David Biller): “Brazil’s unemployment rate unexpectedly rose to the highest on record at the end of 2016… The jobless rate was 12% in the fourth quarter, up from 11.9% in the three months ending in November…”

Geopolitical Watch:

February 2 – Reuters (Parisa Hafezi): “A top adviser to Supreme Leader Ayatollah Ali Khamenei said… Iran will not yield to ‘useless’ U.S. threats from ‘an inexperienced person’ over its ballistic missile program. U.S. President Donald Trump's national security adviser, Michael Flynn, said on Wednesday the United States was putting Iran on notice over its ‘destabilizing activity’ after it test-fired a ballistic missile. Trump echoed that language on Thursday, saying in a tweet ‘Iran has been formally put on notice’ after his administration said it was reviewing how to respond to the launch that Iran said was solely for defensive purposes.’”

February 2 – Reuters (Steve Holland and Matt Spetalnick): “The White House put Iran ‘on notice’ on Wednesday for test-firing a ballistic missile and said it was reviewing how to respond, taking an aggressive posture toward Tehran that could raise tensions in the region. While the exact implications of the U.S. threat were unclear, the new administration signaled that President Donald Trump intended to do more, possibly including imposing new sanctions, to curb what he sees as defiance of a nuclear deal negotiated in 2015 by then-President Barack Obama. The tough talk commits the administration to back up its rhetoric with action…”

January 31 – Reuters (Pavel Polityuk, Natalia Zinets, Katya Golubkova, Vladimir Soldatkin and Peter Hobson): “Ukraine and Russia blamed each other on Tuesday for a surge in fighting in eastern Ukraine in recent days that has led to the highest casualty toll in weeks and cut off power and water to thousands of civilians on the front line. The Ukrainian military and Russian-backed separatists accuse each other of launching offensives in the government-held industrial town of Avdiyivka and firing heavy artillery in defiance of the two-year-old Minsk ceasefire deal. Eight Ukrainian troops have been killed and 26 wounded since fighting intensified on Sunday…”