I’ve always felt the rating agencies got somewhat of a bum rap after the mortgage finance Bubble collapse. Sure, their ratings methodologies were flawed. In hindsight, Trillions of so-called “AAA” MBS were anything but pristine Credits. And, again looking back, it does appear a case of incompetence - if not worse. Yet reality at the time was one of home prices that had been inflating for years with a corresponding long spell of low delinquencies and minimal loan losses, along with GDP and incomes seemingly on a steady upward trajectory. The GSEs had come to dominate mortgage finance, while the Fed had market yields well under control. Washington surely wouldn’t allow a housing crisis, which ensured that markets were absolutely enamored with anything mortgage related. So the mortgage market enjoyed bountiful liquidity conditions, and it was just difficult for anyone – including the ratings firms – to see what might upset the apple cart.
The ratings agencies were basically oblivious to the key issue of deepening structural maladjustment throughout the mortgage finance Bubble period. They were inattentive to what a major de-leveraging episode could unleash. But so were the Federal Reserve, Wall Street and the world. Analysis and models did not incorporate latent (financial and economic) fragilities that had compounded from years of rapid credit growth and asset inflation. These days there’s a similar inability to comprehend the myriad global risks associated with the runaway Chinese Bubble.
The Moody’s downgrade spurred a bevy of articles this week examining China’s debt issues (i.e. “Total outstanding credit climbed to about 260% of GDP by the end of 2016, up from 160% in 2008”; “$9 trillion local bond market”; “debt has been increasing lately by an amount equal to about 15% of the country’s output each year”). Interestingly, I saw no mention that Chinese debt growth this year will likely approach $3.5 TN. Not only will this exceed U.S. 2017 debt growth, it will significantly surpass even peak annual U.S. debt expansion from the mortgage finance Bubble period.
May 23 – New York Times (Keith Bradsher): “China has gone on a spending spree, borrowing money to build cities, create manufacturing giants and nurture financial markets — money that has helped drive the economic powerhouse in recent years. But the debt-fueled binge now threatens to sap the energy of the world’s second-largest economy. With its economy maturing, China has to pile on ever more debt to keep its growth going, at a pace that could prove unsustainable. And the money is increasingly flowing through opaque channels that operate outside the regulated banking system, leaving China vulnerable to blowups. A major credit agency sounded the alarm on Wednesday, saying the steady buildup of debt would erode China’s financial strength in the years ahead… China’s debt has been increasing lately by an amount equal to about 15% of the country’s output each year, to keep the economy growing from 6.5% to 7%.”
The world has never witnessed such a Credit expansion. Moody’s noted the Chinese economy’s ongoing dependency on stimulus measures. I would argue that the key issue has evolved into China’s systemic addiction to ever-increasing expansions of “money” and Credit. The almost singular focus on debt to GDP ratios understates Chinese fragilities. In short, they succumbed to the debt trap: massive ongoing expansion of Credit - or bust. How sound is this Credit? How stable is the Chinese financial sector? And, perhaps most pressing, how vulnerable is their currency?
May 24 – New York Times (Keith Bradsher): “Moody’s… downgraded its rating of China’s sovereign debt one notch on Wednesday, citing concerns over growing debt in the country, which has the world’s second-largest economy. In recent years, as China’s stunning economic performance of past decades has become difficult to sustain, the country has used debt to fuel growth… When it comes to pumping money into a financial system, China has made the Federal Reserve in the United States and the European Central Bank look almost lackadaisical. It has expanded its broadly measured money supply by more than the rest of the world combined since the global financial crisis. Now it has 70% more money sloshing around its economy than the United States does, even though the American economy is bigger… China has accumulated its towering debt remarkably quickly. Goldman Sachs looked last year at how fast debt had accumulated relative to the size of the economy in 55 countries since 1960. It found that by the end of 2015, China was already in the top 2% of all credit expansions — and its debt shot up even higher last year. All of the other large expansions occurred in very small economies, some of which essentially lost control of their finances.”
Moody’s report focused on the risk of further leveraging. This is clearly an issue. Corporate debt is at very high levels ($18 TN, or 170% of GDP) and corporations (many with earnings and cash-flow issues) continue to pile on additional borrowings. Much of this debt is “non-productive,” as companies borrow to meet rising debt service and to plug expanding cash-flow deficits. Even more alarming, the bloated financial sector continues to balloon, issuing risky loans while creating new deposit “money”. From the NYT (Keith Bradsher) article above, China “has 70% more money sloshing around its economy than the United States.” Even more than “leverage,” China’s Wild West Risk-Intermediation Mayhem has created momentous systemic risk. Much of the risky “Terminal Phase” debt growth – financing inflated apartment values, uneconomic enterprises, economic maladjustment and chicanery – is being transformed into perceived safe and liquid “money” and money-like financial instruments.
The bulls were quick to downplay the importance of Moody’s action, stating both that China has minimal dependence on external financing and that the country still enjoys $3.0 TN of international reserve assets. I would view the issue differently. Yes, China has an extraordinarily large international reserve cushion, though holdings have declined $1.0 TN from June 2014. Most importantly, this large hoard has allowed authorities to prolong the Bubble and delay the type of harsh measures required to rein in Credit, speculation and now deeply imbedded boom-time psychology. Chinese savers are accumulating wealth they'd never dreamed of, backed by an economy with serious deficiencies and a financial sector of dubious standing.
Moody’s and others – certainly including Wall Street generally - handle China with kid gloves. Chinese authorities have backed away from needed reforms. The late-2015/early-2016 scare forced Beijing to effectively impose capital controls. Rather than promoting open and effective market-based mechanisms, the game has turned to only more zealous interventions: stabilize financial markets and promote rapid Credit growth necessary to sustain 6-7% GDP expansion, while cajoling and controlling to limit the capacity of all this Chinese “money” to flow out of the country.
Chinese authorities have also been pressing Chinese corporations and financial institutions to borrow in overseas markets. This kills two birds... China can offload some high-risk, late-cycle Credit to international investors, while also attracting needed financial inflows. The problem is that foreign investors fear capital control measures and don’t trust the renminbi. So much of this borrowing is done in dollar-denominated debt. And this large issuance of dollar-denominated debt only exacerbates systemic vulnerability to an abrupt renminbi devaluation.
May 24 – Reuters (Adam Jourdan and Samuel Shen): “The decision by Moody's… to downgrade China's credit rating is ‘illogical’ and overstates the levels of government debt, a commerce ministry researcher said in an editorial in the official People's Daily newspaper… Mei Xinyu, a researcher at China's Ministry of Commerce, wrote in a front page editorial of the paper's overseas edition the downgrade… overstated China's reliance on stimulus and the country's debt levels. Moody's downgraded China's credit ratings… for the first time in nearly 30 years, saying it expects the financial strength of the economy will erode in coming years as growth slows and debt continues to rise. China's Finance Ministry said… the downgrade overestimated the risks to the economy and was based on ‘inappropriate methodology’. China's state planner said debt risks were generally controllable.”
I’ve closely monitored China for years now. I recall reading some years back how Chinese officials had studied and learned from the Japanese Bubble experience. I’ve been waiting patiently for China to wrestle control of a precarious Credit Bubble. They have instead repeatedly taken tepid steps to curb various sectoral excesses – real estate, local government debt, stock market, corporate debt and, of late, shadow banking and insurance. Attempts to tamp down excess in one spot have only ensured it pops out elsewhere. The gravest policy misstep has been their failure to take a more systemic approach to Credit growth and asset inflation.
Basically, whenever tightening policies began to bite, Beijing would in short-order reverse course and stimulate. After a while, Chinese tightening measures lacked credibility. Moreover, the greater the inflation of Credit, financial institutions and perceived wealth, the more confident the Chinese population (including investors in real estate and financial assets, bankers, and corporate CEOs) became that Beijing would never tolerate a bust. Beijing these days essentially backs local government debt, the big state banks, corporate debt and apartment prices, not to mention $22 TN of “money” (M2) and trillions more of money-like “wealth management products” and such. The scope of Beijing’s contingent liabilities is unparalleled.
The Moody’s executive stated that “It is likely to be a very medium-term and gradual erosion of credit metrics.” The Credit “metric” that matters most is my hypothetical chart of systemic risk that turned parabolic with the rapid acceleration of Credit of rapidly deteriorating quality. This “Terminal Phase” Dynamic unfolds during a period of momentous structural maladjustment, with government policies invariably exacerbating already deep structural impairment. It’s worth recalling that the Japanese enjoyed incredible economic growth and restructuring for more than three decades before blowing up their Credit system during the final four years of the boom. The Chinese situation is much more precarious.
I found myself this week thinking back to Dallas Fed President Robert McTeer’s 2001 comment, “Let's all hold hands and buy an SUV.” It was at the time a rather ridiculous central banker prescription for recovery from recession. Things, however, turned only more outrageous the following year, with the arrival of the Bernanke Doctrine at the Federal Reserve (and central banking more generally). Since then policy floodgates have been thrown wide open. What passes these days for reasonable policy would have been unimaginable fifteen years ago.
Chinese authorities apparently believe they can grow out of debt and structural issues. No matter what, they can always stimulate. And no need to dig holes and then refill them. Just tear down old apartments and structures and fabricate glossy tall new ones. Throw “money” at any problem, always plenty freely available. And there’s always endless new enterprises and technologies to support. Lend money around the world so buyers can afford to buy Chinese products. The quantity of debt doesn’t really matter all that much; just keep growing.
May 21 – Bloomberg (Alfred Liu, Moxy Ying, and Enda Curran): “In 1997, the Asian financial crisis touched off a six-year property bust in Hong Kong that shaved more than two-thirds off prices and saddled the city with a stagnant economy and deflation. As Hong Kong gets ready to celebrate the 20th anniversary of its handover to China, which happened just as Asia’s crisis began to unfold, that pain seems all but forgotten. Prices are at all-time highs. Mortgage borrowing is booming. Developers are bidding up the cost of land to records. People young and old are lining up to buy newly built apartments. In short, the kind of fervor that preceded the last bust is back. That’s got experts fretting about the potential fallout should the city of about 7.4 million people experience another crash. By several measures, Hong Kong looks more vulnerable this time around.”
The global government finance Bubble has “gone to unimaginable extremes - and then doubled.” And there are various elements of previous Bubbles that have coalesced into something that somehow masks inherent fragilities and the risk of devastating collapse. I think back to the commercial real estate Bubbles, junk bonds and LBOs from the late-eighties. Bond market leverage (“government carry trade”) and derivatives (mortgage IOs and POs) from the early-nineties. There was Mexico, SE Asia and EM from the mid-nineties. Russia and LTCM fiascos later in the decade. The “tech” and corporate debt Bubbles, followed by the great mortgage finance Bubble. Individually, we’ve seen these kinds of things before, and we know they end badly. But as one gigantic, comprehensive, almost all-inclusive Bubble garnering the attention and support from policymakers around the world, it’s different enough this time that risks are dismissed or downplayed. Greed trumps fear.
I look around the world and see an unprecedented Bubble in Chinese Credit and investment. EM more generally has borrowed enormous amounts of debt, much of it in dollars and foreign currencies. European securities markets have inflated into historic Bubbles. Bond markets around the global are mispriced like never before. Almost everything providing a yield – from commercial real estate to corporate debt to dividend stocks – trades today at inflated values. Especially considering the Trillions that have been issued – and Trillions more in the offing – Treasury prices are detached from market pricing mechanisms.
The Trillions of central bank “money” that has spurred a historic Bubble in “risk free” securities has worked similar magic on risk assets, notably corporate Credit, equities and EM debt. The reckless abandon that took derivatives markets by storm during the mortgage finance Bubble period has gone to even greater extremes, this time on a global basis. Everywhere, it seems market perceptions are more detached than ever from reality. I continue to see confirmation that China is a major global Bubble weak link.
May 26 – Bloomberg (Chris Anstey and Enda Curran): “Chalk up another win for the visible hand in China’s markets over the principle of the private sector determining prices. A move by authorities to smooth out daily changes in the yuan’s fixing versus the dollar, taken on its own, suggests a shift away from any eventual float of the currency. The news comes in a week when officials were suspected of having intervened in the stock market to limit damage to sentiment after Moody’s… downgraded China’s sovereign credit rating. Both developments underscore the importance the Communist Party leadership places on specific outcomes, rather than the embrace of free markets that Western nations once pressed on China. President Xi Jinping has every interest in avoiding turmoil in the currency and equity markets this year as he oversees a critical reshuffle of top officials. While relatively minor, the change ‘is surely a negative step for financial openness,’ said George Magnus, an associate at Oxford University’s China Centre and former adviser at UBS Group AG. It’s ‘another step by Xi Jinping and the leadership to exert control where the deference to market forces was making at least limited headway.’”
May 25 – Wall Street Journal (Lingling Wei and Saumya Vaishampayan): “China’s central bank is effectively anchoring the yuan to the dollar, a policy twist that has helped stabilize the currency in a year of political transition and market jitters about China’s economic management. The yuan weakened more than 6% against the dollar in 2016; this year, it is up roughly 1%, and the expectation that the currency will fluctuate—a gauge known as implied volatility—is around its lowest in nearly two years.”
After a brief bout of selling in Chinese and Asian equities, there was little market reaction to the Moody’s downgrade. Perhaps telling, Chinese authorities revalued the renminbi higher both Thursday and Friday, with the Chinese currency gaining a notable 0.43% for the week. With my belief that China’s currency may prove their system’s weak link, I find it intriguing that officials would be compelled to move immediately to manipulate its value higher. I believe Beijing prefers a weaker currency to support its massive export sector and to stoke moderately higher inflation. And while their currency policy may be somewhat posturing to the new U.S. administration, I suspect they are more fearful of an unwind of foreign-financed leveraged “carry trades” that have accumulated in higher-yielding Chinese Credit. In the past I’ve referred to the Chinese renminbi as a “currency peg on steroids.” There’s never been an EM currency with the potential for such massive outflows from domestic savers and international speculators alike.
May 26 – Bloomberg: “For ever yuan that the People’s Bank of China injects into the nation’s financial system, it’s up to the banks to decide how far they stretch it in the form of loans to the economy. Right now, they’re working overtime. China’s money multiplier -- the ratio between the broadest measure of money in use, M2, and base money created by the central bank -- has climbed to the highest on records that date to 1997, data compiled by Bloomberg show. Each yuan of base money is being turned into more than 5 in the real economy. The turbocharged multiplier is helping compensate for the drainage of cash caused by Chinese savers and companies venturing abroad. It’s also helping economic growth…”
For the Week:
The S&P500 jumped 1.4% (up 7.9% y-t-d), and the Dow rose 1.3% (up 6.7%). The Utilities surged 2.4% (up 8.6%). The Banks gained 0.9% (down 1.0%), and the Broker/Dealers rose 1.5% (up 4.0%). The Transports surged 3.3% (up 1.5%). The S&P 400 Midcaps added 0.9% (up 4.0%), and the small cap Russell 2000 gained 1.1% (up 1.9%). The Nasdaq100 advanced 2.4% (up 19.0%), and the Morgan Stanley High Tech index jumped 2.2% (up 21.4%). The Semiconductors rose 2.3% (up 19.7%). The Biotechs declined 1.1% (up 16.0%). Though bullion gained $11, the HUI gold index fell 1.2% (up 6.8%).
Three-month Treasury bill rates ended the week at 91 bps. Two-year government yields added two bps to 1.30% (up 11bps y-t-d). Five-year T-note yields rose one basis point to 1.79% (down 14bps). Ten-year Treasury yields added one basis point to 2.25% (down 20bps). Long bond yields increased two bps to 2.91% (down 15bps).
Greek 10-year yields jumped 29 bps to 5.91% (down 111bps y-t-d). Ten-year Portuguese yields declined four bps to 3.14% (down 60bps). Italian 10-year yields fell four bps to 2.10% (up 29bps). Spain's 10-year yields declined four bps to 1.54% (up 16bps). German bund yields fell four bps to 0.33% (up 13bps). French yields dropped five bps to 0.76% (up 8bps). The French to German 10-year bond spread narrowed one to 43 bps. U.K. 10-year gilt yields dropped eight bps to 1.01% (down 22bps). U.K.'s FTSE equities index gained 1.0% (up 5.7%).
Japan's Nikkei 225 equities index added 0.5% (up 3.0% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.04% (unchanged). France's CAC40 increased 0.2% (up 9.8%). The German DAX equities index slipped 0.3% (up 9.8%). Spain's IBEX 35 equities index rose 0.6% (up 16.6%). Italy's FTSE MIB index fell 1.7% (up 10.3%). EM equities were mostly higher. Brazil's Bovespa index recovered 2.3% (up 6.4%). Mexico's Bolsa gained 1.2% (up 8.8%). South Korea's Kospi jumped 2.9% (up 16.2%). India’s Sensex equities index rose 1.8% (up 16.5%). China’s Shanghai Exchange increased 0.6% (up 0.2%). Turkey's Borsa Istanbul National 100 index surged 2.5% (up 24.8%). Russia's MICEX equities index fell 1.4% (down 13.4%).
Junk bond mutual funds saw outflows of $568 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates dropped seven bps to 3.95% (up 37bps y-o-y). Fifteen-year rates fell eight bps to 3.19% (up 36bps). The five-year hybrid ARM rate declined six bps to 3.07% (up 23bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.06% (up 31bps).
Federal Reserve Credit last week declined $4.5bn to $4.435 TN. Over the past year, Fed Credit gained $3.3bn (up 0.1%). Fed Credit inflated $1.624 TN, or 58%, over the past 237 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $10.0bn last week to $3.244 TN. "Custody holdings" were up $26.1bn y-o-y, or 0.8%.
M2 (narrow) "money" supply last week rose $25.2bn to a record $13.485 TN. "Narrow money" expanded $750bn, or 5.9%, over the past year. For the week, Currency increased $2.6bn. Total Checkable Deposits surged $50.7bn, while Savings Deposits fell $26.1bn. Small Time Deposits added $2bn. Retail Money Funds fell $4.0bn.
Total money market fund assets gained $3.7bn to $2.649 TN. Money Funds fell $85bn y-o-y (3.1%).
Total Commercial Paper increased $0.7bn to $987bn. CP declined $92bn y-o-y, or 8.5%.
Currency Watch:
The U.S. dollar index recovered 0.3% to 97.44 (down 4.8% y-t-d). For the week on the upside, the South African rand increased 2.7%, the New Zealand dollar 2.0%, the Mexican peso 1.1%, the South Korean won 0.6%, the Canadian dollar 0.5%, the Swedish krona 0.5%, and the Singapore dollar 0.3%. For the week on the downside, the British pound declined 1.8%, the euro 0.2%, the Brazilian real 0.2%, the Australian dollar 0.2%, the Swiss franc 0.1%, and the Japanese yen 0.1%. The Chinese renminbi gained 0.43% versus the dollar this week (up 1.31% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index increased 0.4% (down 3.3% y-t-d). Spot Gold added 0.9% to $1,267 (up 9.9%). Silver jumped 2.8% to $17.32 (up 8.4%). Crude fell 63 cents to $49.80 (down 8%). Gasoline slipped 0.5% (down 2%), while Natural Gas gained 1.8% (down 12%). Copper fell 0.9% (up 2%). Wheat increased 0.7% (up 7%). Corn added 0.5% (up 6%).
Trump Administration Watch:
May 25 – Bloomberg (Laura Litvan): “Senate Republicans are weighing a two-step process to replace Obamacare that would postpone a repeal until 2020, as they seek to draft a more modest version than a House plan that nonpartisan analysts said would undermine some insurance markets. Republicans -- in the early stages of private talks on the Senate plan -- say they may first take action to stabilize premium costs in Obamacare’s insurance-purchasing exchanges in 2018 and 2019. Major insurers have said they will leave the individual market in vast regions of states including North Dakota, Iowa and Missouri.”
May 26 – New York Times (Jennifer Steinhaurer and Robert Pear): “Shortly after President Trump took office, Senator Mitch McConnell of Kentucky, the majority leader, met privately with his colleagues to discuss the Republican agenda. Repealing the Affordable Care Act was at the top, he said. But replacing it would be really hard. Mr. McConnell was right. The many meetings Republicans held to discuss a Senate health care bill have exposed deep fissures within the party that are almost as large as the differences between Republicans and Democrats. Elements of a bill that passed the House this month have divided Republicans. Mr. McConnell faces an increasingly onerous math problem. He can afford to lose only two Republicans if he is to get a bill through the Senate, and that would require the help of Vice President Mike Pence, who would have to cast the tiebreaking vote. But at least three senators in the party are diametrically opposed to the views of at least another three, so the path to agreement is narrow.”
May 23 – Bloomberg (Erik Wasson, Steven T. Dennis, and John McCormick): “President Donald Trump made an impassioned plea for support from minority voters during his election campaign by asking them, ‘What do you have to lose?’ On Tuesday, they got an answer, as did many of the rural, poor and working-class voters who propelled him into office. In his fiscal 2018 budget proposal, Trump asked Congress for $3.6 trillion in spending cuts that would mean steep reductions in food stamps, Medicaid health insurance payments, disability benefits, low-income housing assistance and block grants that fund meals-on-wheels for the elderly. The plan found little favor in Congress, even among Republican lawmakers from districts and states that gave Trump wide margins in the November election, and it had Democrats talking about a deal on spending that would exclude the White House. The administration was undeterred.”
May 22 – Politico (Rachael Bade and Josh Dawsey): “Paul Ryan and the White House are barreling toward a tax reform show-down — a faceoff that’s becoming all but inevitable as the speaker continues selling a tax plan rejected by Trump officials. At issue is a controversial pillar of the House GOP tax plan that effectively hikes taxes on imports. Top administration officials from Treasury Secretary Steven Mnuchin to chief economic adviser Gary Cohn have warned the speaker that they’re not exactly fans of the so-called border adjustment tax — hoping Ryan would take a hint and change direction. But the Wisconsin Republican is refusing to back off, arguing in recent days that it’s ‘the smart way to go.’”
China Bubble Watch:
May 23 – Bloomberg: “Moody’s… cut its rating on China’s debt for the first time since 1989, challenging the view that the nation’s leadership will be able to rein in leverage while maintaining the pace of economic growth. Stocks and the yuan slipped in early trading after Moody’s reduced the rating to A1 from Aa3… Moody’s cited the likelihood of a ‘material rise’ in economy-wide debt and the burden that will place on the state’s finances, while also changing the outlook to stable from negative. It’s ‘absolutely groundless’ for Moody’s to argue that local government financing vehicles and state-owned enterprise debt will swell the government’s contingent liabilities, according to… the Ministry of Finance. The ratings company has underestimated the capability of the government to deepen reform and boost demand, the ministry said… Total outstanding credit climbed to about 260% of GDP by the end of 2016, up from 160% in 2008…”
May 22 – Wall Street Journal (Shen Hong): “China’s $1.7 trillion government-bond market is turning ever weirder. In a fresh sign of the nerves among investors caused by Beijing’s campaign this spring to make Chinese markets less risky, the yield on seven-year government bonds rose to 3.79% on Monday, above the yield on both five-year and 10-year bonds. The highly unusual move means that China’s government-bond yield curve now resembles a triangle, with the seven-year yield at its highest since October 2014… The shift comes less than two weeks after the government-bond yield curve became inverted for the first time on record…”
May 21 – Bloomberg (Alfred Liu, Moxy Ying, and Enda Curran): “In 1997, the Asian financial crisis touched off a six-year property bust in Hong Kong that shaved more than two-thirds off prices and saddled the city with a stagnant economy and deflation. As Hong Kong gets ready to celebrate the 20th anniversary of its handover to China, which happened just as Asia’s crisis began to unfold, that pain seems all but forgotten. Prices are at all-time highs. Mortgage borrowing is booming. Developers are bidding up the cost of land to records. People young and old are lining up to buy newly built apartments. In short, the kind of fervor that preceded the last bust is back. That’s got experts fretting about the potential fallout should the city of about 7.4 million people experience another crash. By several measures, Hong Kong looks more vulnerable this time around.”
The global government finance Bubble has “gone to unimaginable extremes - and then doubled.” And there are various elements of previous Bubbles that have coalesced into something that somehow masks inherent fragilities and the risk of devastating collapse. I think back to the commercial real estate Bubbles, junk bonds and LBOs from the late-eighties. Bond market leverage (“government carry trade”) and derivatives (mortgage IOs and POs) from the early-nineties. There was Mexico, SE Asia and EM from the mid-nineties. Russia and LTCM fiascos later in the decade. The “tech” and corporate debt Bubbles, followed by the great mortgage finance Bubble. Individually, we’ve seen these kinds of things before, and we know they end badly. But as one gigantic, comprehensive, almost all-inclusive Bubble garnering the attention and support from policymakers around the world, it’s different enough this time that risks are dismissed or downplayed. Greed trumps fear.
I look around the world and see an unprecedented Bubble in Chinese Credit and investment. EM more generally has borrowed enormous amounts of debt, much of it in dollars and foreign currencies. European securities markets have inflated into historic Bubbles. Bond markets around the global are mispriced like never before. Almost everything providing a yield – from commercial real estate to corporate debt to dividend stocks – trades today at inflated values. Especially considering the Trillions that have been issued – and Trillions more in the offing – Treasury prices are detached from market pricing mechanisms.
The Trillions of central bank “money” that has spurred a historic Bubble in “risk free” securities has worked similar magic on risk assets, notably corporate Credit, equities and EM debt. The reckless abandon that took derivatives markets by storm during the mortgage finance Bubble period has gone to even greater extremes, this time on a global basis. Everywhere, it seems market perceptions are more detached than ever from reality. I continue to see confirmation that China is a major global Bubble weak link.
May 26 – Bloomberg (Chris Anstey and Enda Curran): “Chalk up another win for the visible hand in China’s markets over the principle of the private sector determining prices. A move by authorities to smooth out daily changes in the yuan’s fixing versus the dollar, taken on its own, suggests a shift away from any eventual float of the currency. The news comes in a week when officials were suspected of having intervened in the stock market to limit damage to sentiment after Moody’s… downgraded China’s sovereign credit rating. Both developments underscore the importance the Communist Party leadership places on specific outcomes, rather than the embrace of free markets that Western nations once pressed on China. President Xi Jinping has every interest in avoiding turmoil in the currency and equity markets this year as he oversees a critical reshuffle of top officials. While relatively minor, the change ‘is surely a negative step for financial openness,’ said George Magnus, an associate at Oxford University’s China Centre and former adviser at UBS Group AG. It’s ‘another step by Xi Jinping and the leadership to exert control where the deference to market forces was making at least limited headway.’”
May 25 – Wall Street Journal (Lingling Wei and Saumya Vaishampayan): “China’s central bank is effectively anchoring the yuan to the dollar, a policy twist that has helped stabilize the currency in a year of political transition and market jitters about China’s economic management. The yuan weakened more than 6% against the dollar in 2016; this year, it is up roughly 1%, and the expectation that the currency will fluctuate—a gauge known as implied volatility—is around its lowest in nearly two years.”
After a brief bout of selling in Chinese and Asian equities, there was little market reaction to the Moody’s downgrade. Perhaps telling, Chinese authorities revalued the renminbi higher both Thursday and Friday, with the Chinese currency gaining a notable 0.43% for the week. With my belief that China’s currency may prove their system’s weak link, I find it intriguing that officials would be compelled to move immediately to manipulate its value higher. I believe Beijing prefers a weaker currency to support its massive export sector and to stoke moderately higher inflation. And while their currency policy may be somewhat posturing to the new U.S. administration, I suspect they are more fearful of an unwind of foreign-financed leveraged “carry trades” that have accumulated in higher-yielding Chinese Credit. In the past I’ve referred to the Chinese renminbi as a “currency peg on steroids.” There’s never been an EM currency with the potential for such massive outflows from domestic savers and international speculators alike.
May 26 – Bloomberg: “For ever yuan that the People’s Bank of China injects into the nation’s financial system, it’s up to the banks to decide how far they stretch it in the form of loans to the economy. Right now, they’re working overtime. China’s money multiplier -- the ratio between the broadest measure of money in use, M2, and base money created by the central bank -- has climbed to the highest on records that date to 1997, data compiled by Bloomberg show. Each yuan of base money is being turned into more than 5 in the real economy. The turbocharged multiplier is helping compensate for the drainage of cash caused by Chinese savers and companies venturing abroad. It’s also helping economic growth…”
For the Week:
The S&P500 jumped 1.4% (up 7.9% y-t-d), and the Dow rose 1.3% (up 6.7%). The Utilities surged 2.4% (up 8.6%). The Banks gained 0.9% (down 1.0%), and the Broker/Dealers rose 1.5% (up 4.0%). The Transports surged 3.3% (up 1.5%). The S&P 400 Midcaps added 0.9% (up 4.0%), and the small cap Russell 2000 gained 1.1% (up 1.9%). The Nasdaq100 advanced 2.4% (up 19.0%), and the Morgan Stanley High Tech index jumped 2.2% (up 21.4%). The Semiconductors rose 2.3% (up 19.7%). The Biotechs declined 1.1% (up 16.0%). Though bullion gained $11, the HUI gold index fell 1.2% (up 6.8%).
Three-month Treasury bill rates ended the week at 91 bps. Two-year government yields added two bps to 1.30% (up 11bps y-t-d). Five-year T-note yields rose one basis point to 1.79% (down 14bps). Ten-year Treasury yields added one basis point to 2.25% (down 20bps). Long bond yields increased two bps to 2.91% (down 15bps).
Greek 10-year yields jumped 29 bps to 5.91% (down 111bps y-t-d). Ten-year Portuguese yields declined four bps to 3.14% (down 60bps). Italian 10-year yields fell four bps to 2.10% (up 29bps). Spain's 10-year yields declined four bps to 1.54% (up 16bps). German bund yields fell four bps to 0.33% (up 13bps). French yields dropped five bps to 0.76% (up 8bps). The French to German 10-year bond spread narrowed one to 43 bps. U.K. 10-year gilt yields dropped eight bps to 1.01% (down 22bps). U.K.'s FTSE equities index gained 1.0% (up 5.7%).
Japan's Nikkei 225 equities index added 0.5% (up 3.0% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.04% (unchanged). France's CAC40 increased 0.2% (up 9.8%). The German DAX equities index slipped 0.3% (up 9.8%). Spain's IBEX 35 equities index rose 0.6% (up 16.6%). Italy's FTSE MIB index fell 1.7% (up 10.3%). EM equities were mostly higher. Brazil's Bovespa index recovered 2.3% (up 6.4%). Mexico's Bolsa gained 1.2% (up 8.8%). South Korea's Kospi jumped 2.9% (up 16.2%). India’s Sensex equities index rose 1.8% (up 16.5%). China’s Shanghai Exchange increased 0.6% (up 0.2%). Turkey's Borsa Istanbul National 100 index surged 2.5% (up 24.8%). Russia's MICEX equities index fell 1.4% (down 13.4%).
Junk bond mutual funds saw outflows of $568 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates dropped seven bps to 3.95% (up 37bps y-o-y). Fifteen-year rates fell eight bps to 3.19% (up 36bps). The five-year hybrid ARM rate declined six bps to 3.07% (up 23bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.06% (up 31bps).
Federal Reserve Credit last week declined $4.5bn to $4.435 TN. Over the past year, Fed Credit gained $3.3bn (up 0.1%). Fed Credit inflated $1.624 TN, or 58%, over the past 237 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $10.0bn last week to $3.244 TN. "Custody holdings" were up $26.1bn y-o-y, or 0.8%.
M2 (narrow) "money" supply last week rose $25.2bn to a record $13.485 TN. "Narrow money" expanded $750bn, or 5.9%, over the past year. For the week, Currency increased $2.6bn. Total Checkable Deposits surged $50.7bn, while Savings Deposits fell $26.1bn. Small Time Deposits added $2bn. Retail Money Funds fell $4.0bn.
Total money market fund assets gained $3.7bn to $2.649 TN. Money Funds fell $85bn y-o-y (3.1%).
Total Commercial Paper increased $0.7bn to $987bn. CP declined $92bn y-o-y, or 8.5%.
Currency Watch:
The U.S. dollar index recovered 0.3% to 97.44 (down 4.8% y-t-d). For the week on the upside, the South African rand increased 2.7%, the New Zealand dollar 2.0%, the Mexican peso 1.1%, the South Korean won 0.6%, the Canadian dollar 0.5%, the Swedish krona 0.5%, and the Singapore dollar 0.3%. For the week on the downside, the British pound declined 1.8%, the euro 0.2%, the Brazilian real 0.2%, the Australian dollar 0.2%, the Swiss franc 0.1%, and the Japanese yen 0.1%. The Chinese renminbi gained 0.43% versus the dollar this week (up 1.31% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index increased 0.4% (down 3.3% y-t-d). Spot Gold added 0.9% to $1,267 (up 9.9%). Silver jumped 2.8% to $17.32 (up 8.4%). Crude fell 63 cents to $49.80 (down 8%). Gasoline slipped 0.5% (down 2%), while Natural Gas gained 1.8% (down 12%). Copper fell 0.9% (up 2%). Wheat increased 0.7% (up 7%). Corn added 0.5% (up 6%).
Trump Administration Watch:
May 25 – Bloomberg (Laura Litvan): “Senate Republicans are weighing a two-step process to replace Obamacare that would postpone a repeal until 2020, as they seek to draft a more modest version than a House plan that nonpartisan analysts said would undermine some insurance markets. Republicans -- in the early stages of private talks on the Senate plan -- say they may first take action to stabilize premium costs in Obamacare’s insurance-purchasing exchanges in 2018 and 2019. Major insurers have said they will leave the individual market in vast regions of states including North Dakota, Iowa and Missouri.”
May 26 – New York Times (Jennifer Steinhaurer and Robert Pear): “Shortly after President Trump took office, Senator Mitch McConnell of Kentucky, the majority leader, met privately with his colleagues to discuss the Republican agenda. Repealing the Affordable Care Act was at the top, he said. But replacing it would be really hard. Mr. McConnell was right. The many meetings Republicans held to discuss a Senate health care bill have exposed deep fissures within the party that are almost as large as the differences between Republicans and Democrats. Elements of a bill that passed the House this month have divided Republicans. Mr. McConnell faces an increasingly onerous math problem. He can afford to lose only two Republicans if he is to get a bill through the Senate, and that would require the help of Vice President Mike Pence, who would have to cast the tiebreaking vote. But at least three senators in the party are diametrically opposed to the views of at least another three, so the path to agreement is narrow.”
May 23 – Bloomberg (Erik Wasson, Steven T. Dennis, and John McCormick): “President Donald Trump made an impassioned plea for support from minority voters during his election campaign by asking them, ‘What do you have to lose?’ On Tuesday, they got an answer, as did many of the rural, poor and working-class voters who propelled him into office. In his fiscal 2018 budget proposal, Trump asked Congress for $3.6 trillion in spending cuts that would mean steep reductions in food stamps, Medicaid health insurance payments, disability benefits, low-income housing assistance and block grants that fund meals-on-wheels for the elderly. The plan found little favor in Congress, even among Republican lawmakers from districts and states that gave Trump wide margins in the November election, and it had Democrats talking about a deal on spending that would exclude the White House. The administration was undeterred.”
May 22 – Politico (Rachael Bade and Josh Dawsey): “Paul Ryan and the White House are barreling toward a tax reform show-down — a faceoff that’s becoming all but inevitable as the speaker continues selling a tax plan rejected by Trump officials. At issue is a controversial pillar of the House GOP tax plan that effectively hikes taxes on imports. Top administration officials from Treasury Secretary Steven Mnuchin to chief economic adviser Gary Cohn have warned the speaker that they’re not exactly fans of the so-called border adjustment tax — hoping Ryan would take a hint and change direction. But the Wisconsin Republican is refusing to back off, arguing in recent days that it’s ‘the smart way to go.’”
China Bubble Watch:
May 23 – Bloomberg: “Moody’s… cut its rating on China’s debt for the first time since 1989, challenging the view that the nation’s leadership will be able to rein in leverage while maintaining the pace of economic growth. Stocks and the yuan slipped in early trading after Moody’s reduced the rating to A1 from Aa3… Moody’s cited the likelihood of a ‘material rise’ in economy-wide debt and the burden that will place on the state’s finances, while also changing the outlook to stable from negative. It’s ‘absolutely groundless’ for Moody’s to argue that local government financing vehicles and state-owned enterprise debt will swell the government’s contingent liabilities, according to… the Ministry of Finance. The ratings company has underestimated the capability of the government to deepen reform and boost demand, the ministry said… Total outstanding credit climbed to about 260% of GDP by the end of 2016, up from 160% in 2008…”
May 22 – Wall Street Journal (Shen Hong): “China’s $1.7 trillion government-bond market is turning ever weirder. In a fresh sign of the nerves among investors caused by Beijing’s campaign this spring to make Chinese markets less risky, the yield on seven-year government bonds rose to 3.79% on Monday, above the yield on both five-year and 10-year bonds. The highly unusual move means that China’s government-bond yield curve now resembles a triangle, with the seven-year yield at its highest since October 2014… The shift comes less than two weeks after the government-bond yield curve became inverted for the first time on record…”
May 24 – Bloomberg: “China’s first credit rating downgrade by Moody’s… since 1989 couldn’t have come at a worse time for the nation’s companies, which have never been more reliant on the overseas bond market for funding. While Chinese companies’ foreign-currency debt is only a fraction of the $9 trillion local bond market, China Inc. is on pace for record dollar bond sales this year after the authorities’ crackdown on financial leverage drove up borrowing costs at home. Overseas borrowing has also been part of the government’s strategy to encourage capital inflows in a bid to ease the depreciation pressure on the yuan.”
May 24 – Bloomberg: “Hong Kong saw its debt rating cut by Moody’s… hours after China’s downgrade, highlighting potential risks from a tightening economic integration. The former British colony has seen not only its property and stock markets increasingly entwined with the world’s second-largest economy, but its government as well. Moody’s cut the rating on local- and foreign-currency issuances to Aa2 from Aa1… That’s the territory’s first cut in ranking by Moody’s since the throes of the Asian financial crisis in 1998… ‘Credit trends in China will continue to have a significant impact on Hong Kong’s credit profile due to close and tightening economic, financial and political linkages with the mainland,’ Moody’s said… Closer financial ties ‘risk introducing more direct contagion channels between China’s and Hong Kong’s financial markets.’”
Europe Watch:
May 23 – Bloomberg (Alessandro Speciale and Piotr Skolimowski): “Mario Draghi’s right-hand man and left-hand man may have some differences to sort out. Peter Praet and Benoit Coeure, arguably the two most influential members of the European Central Bank after the president, have struck contrasting tones about how to communicate the institution’s intentions. Both are wary of how markets will react to the ECB’s first step toward unwinding stimulus, but while Praet advocates caution and maintaining the easing bias enshrined in current guidance, Coeure has warned that moving too slowly could eventually lead to a bigger shock.”
May 22 – Bloomberg (Viktoria Dendrinou, Corina Ruhe, and Joao Lima): “Euro-area finance ministers gathering in Brussels… failed to break an impasse on debt relief for Greece, delaying the completion of the country’s bailout review and the disbursement of fresh loans needed to repay obligations in July. After nearly eight hours of talks and multiple draft compromises, Athens and its creditors couldn’t reach an accord that would ease Greece’s debt and that would convince the International Monetary Fund to agree to help finance the country’s bailout. ‘The Eurogroup held an in-depth discussion on the sustainability of Greece’s public debt but did not reach an overall agreement,’ said Jeroen Dijsselbloem, the Dutch finance minister who presides over meetings with his euro-area counterparts. Work will continue in the coming weeks…”
May 24 – Bloomberg (Jana Randow, Alessandro Speciale, and Piotr Skolimowski): “Mario Draghi is leading a push to stamp out any speculation that the European Central Bank might raise interest rates before it ends quantitative easing. …The ECB president reaffirmed the ‘logic’ of the current sequencing, arguing that the unwarranted side effects of negative rates are likely to be less of a problem than those potentially produced by asset purchases. Along with his deputy Vitor Constancio and Executive Board member Peter Praet, he urged investors waiting for a signal on the path of policy normalization to be patient, signaling that June might not be the time for big decisions.”
May 23 – Bloomberg (Piotr Skolimowski and Alessandro Speciale): “The German economy is firing on all cylinders, and a surge in sentiment suggests it has staying power. Business confidence rose to the highest since 1991 this month, while manufacturers saw the fastest growth in six years amid a surge in orders. Consumer spending, investment and exports all contributed to growth in the first quarter, helping the economy to expand 0.6%, its strongest performance in a year.”
Brexit Watch:
May 22 – Bloomberg (Joe Mayes): “European Union ministers finalized their Brexit negotiating position a day after the U.K. threatened to quit talks on its departure unless the bloc drops its demands for a divorce payment as high as 100 billion euros ($112bn). Governments of the 27 remaining nations approved their mandate for the EU’s chief negotiator Michel Barnier at a two-hour meeting in Brussels. The size of Britain’s exit bill, and which types of negotiations can begin before it is determined, has been a source of debate for weeks and will prove an early test of the ability of both sides to find common ground. Even a 1 billion pound settlement would be ‘a lot of money,’ Brexit Secretary David Davis said…”
Global Bubble Watch:
May 23 – Bloomberg (Lisa Pham): “Just as China embarks on a massive Silk Road development funding initiative, a survey of business practices suggests corruption in Asia is only getting worse, adding potential potholes to new deals. Despite anti-graft initiatives under way from China to India, the survey by EY -- formerly known as Ernst & Young -- found that ‘ethical standards are not improving.’ Some 63% of respondents said that bribery or corrupt practices ‘happen widely’ in their country, up from 60% in 2015. And 35% cited bribery as ‘common practice’ to win contracts in their industry or sector, up from 31% in the 2015 survey.”
May 22 – Reuters (A. Ananthalakshmi and Mai Nguyen): “Japan and other members of the Trans-Pacific Partnership agreed… to pursue their trade deal without the United States as the Trump administration's ‘America First’ policy created tension at a meeting of Asia-Pacific countries. Turmoil over global trade negotiations was laid bare at a meeting of the Asia-Pacific Economic Cooperation (APEC) forum, which failed to agree on its usual joint statement after U.S. opposition to wording on fighting protectionism. The meeting in Hanoi, Vietnam, was the biggest trade gathering since U.S. President Donald Trump upended the old order, arguing that multilateral free-trade agreements were costing American jobs and that he wanted to cut new deals.”
Fixed Income Bubble Watch:
May 23 – Financial Times (Eric Platt): “A month after the International Monetary Fund sounded the alarm over a debt binge by US companies, investors are expressing confidence in the sector and have been eager buyers of tens of billions of new bond offerings… Monica Erickson, a portfolio manager with asset manager DoubleLine Capital, says for many investors ‘leverage is less of a concern with earnings growth’. Outstanding US corporate debt has swelled more than 275% over the past two decades to $8.5tn, with credit ratings broadly deteriorating over that period. In 1996, roughly two-thirds of groups rated by S&P Global held an investment-grade rating. That has fallen to less than 45% today…”
Federal Reserve Watch:
May 25 – Bloomberg (Jeanna Smialek and Christopher Condon): “Most Federal Reserve officials judged ‘it would soon be appropriate’ to tighten monetary policy again and backed a plan that would gradually shrink their $4.5 trillion balance sheet. ‘Most participants judged that if economic information came in about in line with their expectations it would soon be appropriate for the committee to take another step in removing some policy accommodation,’ according to minutes from the Federal Open Market Committee’s May 2-3 gathering… The statement points toward a hike as soon as the Fed’s meeting in mid-June, though FOMC voters added the caveat that ‘it would be prudent’ to wait for evidence that a recent slowdown in economic activity had been transitory.”
May 21 – Wall Street Journal (Katy Burne): “Federal Reserve officials grappling with the legacy of expansive stimulus would find it difficult to return to the central bank’s precrisis role on the sidelines of financial markets, analysts and central-bank watchers say. A long list of programs adopted to help foster economic growth, along with changes in money markets and bank regulation, have vastly expanded the Fed’s balance sheet and its involvement in markets. The Fed’s assets now total $4.5 trillion, up from less than $1 trillion a decade ago. Since 2013 the central bank has become one of the largest traders with U.S. taxable money-market funds… Many analysts and investors worry that significantly rolling back the Fed’s expansion… risks disrupting markets and the economy at a time when growth remains tepid. It would also reduce the connections the institution has built with a diverse set of Wall Street firms, beyond the group of banks it dealt with before the crisis. The Fed has become ‘like an octopus,’ said Jeffrey Cleveland, chief economist at Payden & Rygel… ‘Once you get the power and you are influencing all these markets, do you really want to retreat from all that?’”
U.S. Bubble Watch:
May 24 – Bloomberg: “Hong Kong saw its debt rating cut by Moody’s… hours after China’s downgrade, highlighting potential risks from a tightening economic integration. The former British colony has seen not only its property and stock markets increasingly entwined with the world’s second-largest economy, but its government as well. Moody’s cut the rating on local- and foreign-currency issuances to Aa2 from Aa1… That’s the territory’s first cut in ranking by Moody’s since the throes of the Asian financial crisis in 1998… ‘Credit trends in China will continue to have a significant impact on Hong Kong’s credit profile due to close and tightening economic, financial and political linkages with the mainland,’ Moody’s said… Closer financial ties ‘risk introducing more direct contagion channels between China’s and Hong Kong’s financial markets.’”
Europe Watch:
May 23 – Bloomberg (Alessandro Speciale and Piotr Skolimowski): “Mario Draghi’s right-hand man and left-hand man may have some differences to sort out. Peter Praet and Benoit Coeure, arguably the two most influential members of the European Central Bank after the president, have struck contrasting tones about how to communicate the institution’s intentions. Both are wary of how markets will react to the ECB’s first step toward unwinding stimulus, but while Praet advocates caution and maintaining the easing bias enshrined in current guidance, Coeure has warned that moving too slowly could eventually lead to a bigger shock.”
May 22 – Bloomberg (Viktoria Dendrinou, Corina Ruhe, and Joao Lima): “Euro-area finance ministers gathering in Brussels… failed to break an impasse on debt relief for Greece, delaying the completion of the country’s bailout review and the disbursement of fresh loans needed to repay obligations in July. After nearly eight hours of talks and multiple draft compromises, Athens and its creditors couldn’t reach an accord that would ease Greece’s debt and that would convince the International Monetary Fund to agree to help finance the country’s bailout. ‘The Eurogroup held an in-depth discussion on the sustainability of Greece’s public debt but did not reach an overall agreement,’ said Jeroen Dijsselbloem, the Dutch finance minister who presides over meetings with his euro-area counterparts. Work will continue in the coming weeks…”
May 24 – Bloomberg (Jana Randow, Alessandro Speciale, and Piotr Skolimowski): “Mario Draghi is leading a push to stamp out any speculation that the European Central Bank might raise interest rates before it ends quantitative easing. …The ECB president reaffirmed the ‘logic’ of the current sequencing, arguing that the unwarranted side effects of negative rates are likely to be less of a problem than those potentially produced by asset purchases. Along with his deputy Vitor Constancio and Executive Board member Peter Praet, he urged investors waiting for a signal on the path of policy normalization to be patient, signaling that June might not be the time for big decisions.”
May 23 – Bloomberg (Piotr Skolimowski and Alessandro Speciale): “The German economy is firing on all cylinders, and a surge in sentiment suggests it has staying power. Business confidence rose to the highest since 1991 this month, while manufacturers saw the fastest growth in six years amid a surge in orders. Consumer spending, investment and exports all contributed to growth in the first quarter, helping the economy to expand 0.6%, its strongest performance in a year.”
Brexit Watch:
May 22 – Bloomberg (Joe Mayes): “European Union ministers finalized their Brexit negotiating position a day after the U.K. threatened to quit talks on its departure unless the bloc drops its demands for a divorce payment as high as 100 billion euros ($112bn). Governments of the 27 remaining nations approved their mandate for the EU’s chief negotiator Michel Barnier at a two-hour meeting in Brussels. The size of Britain’s exit bill, and which types of negotiations can begin before it is determined, has been a source of debate for weeks and will prove an early test of the ability of both sides to find common ground. Even a 1 billion pound settlement would be ‘a lot of money,’ Brexit Secretary David Davis said…”
Global Bubble Watch:
May 23 – Bloomberg (Lisa Pham): “Just as China embarks on a massive Silk Road development funding initiative, a survey of business practices suggests corruption in Asia is only getting worse, adding potential potholes to new deals. Despite anti-graft initiatives under way from China to India, the survey by EY -- formerly known as Ernst & Young -- found that ‘ethical standards are not improving.’ Some 63% of respondents said that bribery or corrupt practices ‘happen widely’ in their country, up from 60% in 2015. And 35% cited bribery as ‘common practice’ to win contracts in their industry or sector, up from 31% in the 2015 survey.”
May 22 – Reuters (A. Ananthalakshmi and Mai Nguyen): “Japan and other members of the Trans-Pacific Partnership agreed… to pursue their trade deal without the United States as the Trump administration's ‘America First’ policy created tension at a meeting of Asia-Pacific countries. Turmoil over global trade negotiations was laid bare at a meeting of the Asia-Pacific Economic Cooperation (APEC) forum, which failed to agree on its usual joint statement after U.S. opposition to wording on fighting protectionism. The meeting in Hanoi, Vietnam, was the biggest trade gathering since U.S. President Donald Trump upended the old order, arguing that multilateral free-trade agreements were costing American jobs and that he wanted to cut new deals.”
Fixed Income Bubble Watch:
May 23 – Financial Times (Eric Platt): “A month after the International Monetary Fund sounded the alarm over a debt binge by US companies, investors are expressing confidence in the sector and have been eager buyers of tens of billions of new bond offerings… Monica Erickson, a portfolio manager with asset manager DoubleLine Capital, says for many investors ‘leverage is less of a concern with earnings growth’. Outstanding US corporate debt has swelled more than 275% over the past two decades to $8.5tn, with credit ratings broadly deteriorating over that period. In 1996, roughly two-thirds of groups rated by S&P Global held an investment-grade rating. That has fallen to less than 45% today…”
Federal Reserve Watch:
May 25 – Bloomberg (Jeanna Smialek and Christopher Condon): “Most Federal Reserve officials judged ‘it would soon be appropriate’ to tighten monetary policy again and backed a plan that would gradually shrink their $4.5 trillion balance sheet. ‘Most participants judged that if economic information came in about in line with their expectations it would soon be appropriate for the committee to take another step in removing some policy accommodation,’ according to minutes from the Federal Open Market Committee’s May 2-3 gathering… The statement points toward a hike as soon as the Fed’s meeting in mid-June, though FOMC voters added the caveat that ‘it would be prudent’ to wait for evidence that a recent slowdown in economic activity had been transitory.”
May 21 – Wall Street Journal (Katy Burne): “Federal Reserve officials grappling with the legacy of expansive stimulus would find it difficult to return to the central bank’s precrisis role on the sidelines of financial markets, analysts and central-bank watchers say. A long list of programs adopted to help foster economic growth, along with changes in money markets and bank regulation, have vastly expanded the Fed’s balance sheet and its involvement in markets. The Fed’s assets now total $4.5 trillion, up from less than $1 trillion a decade ago. Since 2013 the central bank has become one of the largest traders with U.S. taxable money-market funds… Many analysts and investors worry that significantly rolling back the Fed’s expansion… risks disrupting markets and the economy at a time when growth remains tepid. It would also reduce the connections the institution has built with a diverse set of Wall Street firms, beyond the group of banks it dealt with before the crisis. The Fed has become ‘like an octopus,’ said Jeffrey Cleveland, chief economist at Payden & Rygel… ‘Once you get the power and you are influencing all these markets, do you really want to retreat from all that?’”
U.S. Bubble Watch:
May 24 – Bloomberg (Prashant Gopal): “Home prices in the U.S. increased 6% in the first quarter from a year earlier as competition heated up for a scarcity of listings. Prices rose 1.4% on a seasonally adjusted basis from the previous three months… In March, prices climbed 0.6% from February, matching the average estimate… Job growth is firing up demand for real estate, pushing buyers into bidding wars for the tight supply of homes on the market. There were 1.83 million previously owned homes available for sale at the end of March, down 6.6% from a year earlier…”
Japan Watch:
May 23 – Reuters (Stanley White): “Former Federal Reserve Chairman Ben Bernanke said… the Bank of Japan may need to coordinate a new fiscal spending plan with the government, allowing for inflation to accelerate above its 2% target without worsening the debt burden. Making a temporary commitment to allow inflation to overshoot would help keep the ratio of debt to gross domestic product stable, and is different from directly underwriting fiscal spending, Bernanke said. Bernanke also said the BOJ's current policy framework may be reaching its limits because short- and long-term interest rates are near zero, but the need for more easing cannot be ruled out. ‘The direct approach...would be for the BOJ to commit to a temporary overshoot of its inflation target sufficient to avoid any increase in the debt-to-GDP ratio,’ Bernanke said. ‘This commitment amounts to a monetary financing of the fiscal program without relying on exotic concepts like helicopter drops.’”
May 23 – Reuters (Stanley White): “Bank of Japan Governor Haruhiko Kuroda said… that uncertainty about the natural rate of interest - the level of interest rates that neither stimulates nor constrains growth - is making it difficult for central bankers to steer policy. Kuroda, who spoke at a seminar hosted by the BOJ, said the natural rate of interest has been falling globally, which has led central banks to adopt unconventional economic policies.”
EM Watch:
May 22 – Reuters (Silvio Cascione and Anthony Boadle): “Brazilian President Michel Temer, facing growing calls for his resignation over a corruption scandal, said he would not step down even if he was formally indicted by the Supreme Court. ‘I will not resign. Oust me if you want, but if I stepped down, I would be admitting guilt,’ Temer told Folha de S.Paulo, Brazil's biggest newspaper… Brazilians who have become inured to a massive, three-year corruption investigation were shocked last week by the disclosure of a recording that appeared to show Temer condoning the payment of hush money to a jailed lawmaker.”
May 25 – Reuters (Alonso Soto and Anthony Boadle): “Protesters demanding the resignation of Brazilian President Michel Temer staged running battles with police and set fire to a ministry building in Brasilia on Wednesday, prompting the scandal-hit leader to order the army onto the streets. Police unleashed volleys of tear gas, stun grenades and rubber bullets to halt tens of thousands of protesters as they marched towards Congress to call for Temer's ouster and an end to his austerity program.”
May 25 – Bloomberg (Tim Padgett): “In U.S. history, entire cities and states have been branded corrupt: Think Richard J. Daley’s Chicago or Huey Long’s Louisiana. But amid even the worst federal scandals, Watergate included, the country has never been nationally profiled as crooked—a venal society from coast to coast, from dogcatcher to commander-in-chief. Brazil feels that way right now, largely the result of a bribery scandal of Amazonian proportions known in Portuguese as Lava Jato, or Operation Car Wash, believed to be the largest corruption case in modern history… And it could force the resignation of Brazilian President Michel Temer, who’s been fingered repeatedly in recent weeks for allegedly orchestrating and receiving millions of dollars in bribes.”
May 23 – Wall Street Journal (Carolyn Cui): “S&P Global Ratings delivered more bad news to Brazil, warning… that it may cut the country’s sovereign debt rating because of its troubled political situation. S&P said questions surrounding the president’s political future could stall efforts to enact fiscal and economic reforms. Reports surfaced last week that President Michel Temer is embroiled in corruption allegations. He has denied the allegations. The credit rating firm placed Brazil’s long-term foreign and local currency sovereign credit ratings on its negative credit-watch list, which indicates that Brazil could be downgraded in the next three months.”
May 22 – Bloomberg (Ahmed Feteha and Tarek El-Tablawy): “Egyptian stocks fell the most in the world on Monday after the central bank unexpectedly raised interest rates to contain surging prices… The Monetary Policy Committee raised the benchmark overnight deposit rate by 200 bps, or two percentage points, to 16.75%...”
May 23 – Financial Times (Jeevan Vasagar and Alice Woodhouse): “Shares in Noble Group endured a turbulent day, as the crisis-hit Asian commodities trader tried to reassure about its future by saying it was still in talks with potential major investors. The Singapore-listed company’s stock fell as much as 27% on Wednesday, before closing down 8% at S$0.385. Noble, which has been searching for a new investor for more than a year, said in a statement: ‘The company has previously announced it is in talks with various potential strategic parties, and has informed the market that no assurance can be given that any discussion will result in a transaction. Such discussions are ongoing.’”
Geopolitical Watch:
May 23 – Reuters (Stanley White): “Former Federal Reserve Chairman Ben Bernanke said… the Bank of Japan may need to coordinate a new fiscal spending plan with the government, allowing for inflation to accelerate above its 2% target without worsening the debt burden. Making a temporary commitment to allow inflation to overshoot would help keep the ratio of debt to gross domestic product stable, and is different from directly underwriting fiscal spending, Bernanke said. Bernanke also said the BOJ's current policy framework may be reaching its limits because short- and long-term interest rates are near zero, but the need for more easing cannot be ruled out. ‘The direct approach...would be for the BOJ to commit to a temporary overshoot of its inflation target sufficient to avoid any increase in the debt-to-GDP ratio,’ Bernanke said. ‘This commitment amounts to a monetary financing of the fiscal program without relying on exotic concepts like helicopter drops.’”
May 23 – Reuters (Stanley White): “Bank of Japan Governor Haruhiko Kuroda said… that uncertainty about the natural rate of interest - the level of interest rates that neither stimulates nor constrains growth - is making it difficult for central bankers to steer policy. Kuroda, who spoke at a seminar hosted by the BOJ, said the natural rate of interest has been falling globally, which has led central banks to adopt unconventional economic policies.”
EM Watch:
May 22 – Reuters (Silvio Cascione and Anthony Boadle): “Brazilian President Michel Temer, facing growing calls for his resignation over a corruption scandal, said he would not step down even if he was formally indicted by the Supreme Court. ‘I will not resign. Oust me if you want, but if I stepped down, I would be admitting guilt,’ Temer told Folha de S.Paulo, Brazil's biggest newspaper… Brazilians who have become inured to a massive, three-year corruption investigation were shocked last week by the disclosure of a recording that appeared to show Temer condoning the payment of hush money to a jailed lawmaker.”
May 25 – Reuters (Alonso Soto and Anthony Boadle): “Protesters demanding the resignation of Brazilian President Michel Temer staged running battles with police and set fire to a ministry building in Brasilia on Wednesday, prompting the scandal-hit leader to order the army onto the streets. Police unleashed volleys of tear gas, stun grenades and rubber bullets to halt tens of thousands of protesters as they marched towards Congress to call for Temer's ouster and an end to his austerity program.”
May 25 – Bloomberg (Tim Padgett): “In U.S. history, entire cities and states have been branded corrupt: Think Richard J. Daley’s Chicago or Huey Long’s Louisiana. But amid even the worst federal scandals, Watergate included, the country has never been nationally profiled as crooked—a venal society from coast to coast, from dogcatcher to commander-in-chief. Brazil feels that way right now, largely the result of a bribery scandal of Amazonian proportions known in Portuguese as Lava Jato, or Operation Car Wash, believed to be the largest corruption case in modern history… And it could force the resignation of Brazilian President Michel Temer, who’s been fingered repeatedly in recent weeks for allegedly orchestrating and receiving millions of dollars in bribes.”
May 23 – Wall Street Journal (Carolyn Cui): “S&P Global Ratings delivered more bad news to Brazil, warning… that it may cut the country’s sovereign debt rating because of its troubled political situation. S&P said questions surrounding the president’s political future could stall efforts to enact fiscal and economic reforms. Reports surfaced last week that President Michel Temer is embroiled in corruption allegations. He has denied the allegations. The credit rating firm placed Brazil’s long-term foreign and local currency sovereign credit ratings on its negative credit-watch list, which indicates that Brazil could be downgraded in the next three months.”
May 22 – Bloomberg (Ahmed Feteha and Tarek El-Tablawy): “Egyptian stocks fell the most in the world on Monday after the central bank unexpectedly raised interest rates to contain surging prices… The Monetary Policy Committee raised the benchmark overnight deposit rate by 200 bps, or two percentage points, to 16.75%...”
May 23 – Financial Times (Jeevan Vasagar and Alice Woodhouse): “Shares in Noble Group endured a turbulent day, as the crisis-hit Asian commodities trader tried to reassure about its future by saying it was still in talks with potential major investors. The Singapore-listed company’s stock fell as much as 27% on Wednesday, before closing down 8% at S$0.385. Noble, which has been searching for a new investor for more than a year, said in a statement: ‘The company has previously announced it is in talks with various potential strategic parties, and has informed the market that no assurance can be given that any discussion will result in a transaction. Such discussions are ongoing.’”
Geopolitical Watch:
May 23 – Reuters (Phil Stewart and Idrees Ali): “North Korea, if left unchecked, is on an ‘inevitable’ path to obtaining a nuclear-armed missile capable of striking the United States, Defense Intelligence Agency Director Lieutenant General Vincent Stewart told a Senate hearing… The remarks are the latest indication of mounting U.S. concern about Pyongyang's advancing missile and nuclear weapons programs, which the North says are needed for self-defense.”
May 25 – Bloomberg: “China’s government warned a U.S. warship to leave waters around a reef it claims in the South China Sea, saying the vessel was trespassing on its territory and undermining security in the region. The U.S. warship entered waters adjacent to the Spratly islands, an area where China has ‘indisputable sovereignty,’ defense ministry spokesman Ren Guoqiang said… China ‘identified, tracked, verified and warned off the ship.’ The so-called freedom of navigation operation in the South China Sea was the first under President Donald Trump.”
May 25 – Bloomberg: “China’s government warned a U.S. warship to leave waters around a reef it claims in the South China Sea, saying the vessel was trespassing on its territory and undermining security in the region. The U.S. warship entered waters adjacent to the Spratly islands, an area where China has ‘indisputable sovereignty,’ defense ministry spokesman Ren Guoqiang said… China ‘identified, tracked, verified and warned off the ship.’ The so-called freedom of navigation operation in the South China Sea was the first under President Donald Trump.”