Credit Bubble Bulletin : August 2017

“A resilient financial system is critical to a dynamic global economy -- the subject of this conference. A well-functioning financial system facilitates productive investment and new business formation and helps new and existing businesses weather the ups and downs of the business cycle.” Janet Yellen, “Financial Stability a Decade after the Onset of the Crisis,” August 25, 2017

I would add that a well-functioning financial system is critical to long-term social, political and geopolitical stability. Importantly, well-functioning finance would have mechanisms that promote adjustment and self-correction. This is fundamental to market-based systems. I would argue that this is also a basic premise of sound money and finance. Sound finance would neither suppress market volatility nor work to repeal business cycles - but would instead have inherent characteristics that counteract protracted market and economic excess.

For starters, I question whether a so-called “resilient financial system” is necessarily a sound one. As we have witnessed, obtrusive government measures can dictate “resilience” – in terms of extended sanguine backdrops free from volatility, risk aversion and crisis. Yet this type of resilience fosters excesses that can inevitably end with a financial and economic crash.

Ten years ago most would have argued forcefully that the system at the time was resilient. Chair Yellen argues in her Jackson Hole paper that myriad regulatory changes have created a much more resilient financial system and economy. Her long speech highlights a laundry list of measures put in place since the crisis. Much to my liking, 22 footnotes include references to even Minsky, Kindleberger and Charles Mackay.

There was also footnote #2: “A contemporaneous perspective on subprime mortgage market developments at this time is provided in Ben S. Bernanke (2007), "The Subprime Mortgage Market," speech delivered… May 17 (2007).”

Looking back, chairman Bernanke presented a knowledgeable understanding of the subprime industry in 2007. His deeply flawed understanding of the macro backdrop was captured in a single sentence: “In general, mortgage credit quality has been very solid in recent years.”

Total mortgage Credit had doubled in less than seven years. Indicators of excess were everywhere. Inflation psychology had taken deep root throughout the nation’s housing markets, with California housing prices spiraling ever higher. The inflationary backdrop ensured a proliferation of new mortgage products that kept the game going with low monthly payments for prime and subprime borrower alike.

As someone who chronicled the mortgage finance Bubble in its entirety on a weekly basis, it was all too conspicuous. This was the most important market for finance (mortgages) and the real economy (housing and home-related) – that was dominated by the thinly capitalized GSE with their implied federal backing. It was a sophisticated financial scheme. Measures going back to the Greenspan era (bolstered by “helicopter Ben” musings) convinced the markets that the Fed would respond aggressively to avert market crisis. Surely, Washington would never allow a housing bust. It would simply be too devastating. In an irony of recent Bubbles, the greater they inflate the more convinced markets become that officials will not permit a bust.

What might explain Bernanke’s indifference to unprecedented mortgage and housing risks? Well, his policy doctrine was at the heart of the problem: Dr. Bernanke had been a leading proponent for using mortgage finance to reflate the system after the bursting of the “tech” Bubble.

Yellen: “Repeating a familiar pattern, the ‘madness of crowds’ had contributed to a bubble, in which investors and households expected rapid appreciation in house prices. The long period of economic stability beginning in the 1980s had led to complacency about potential risks, and the buildup of risk was not widely recognized. …A self-reinforcing loop developed, …as investors sought ways to gain exposure to the rising prices of assets linked to housing and the financial sector. As a result, securitization and the development of complex derivatives products distributed risk across institutions in ways that were opaque and ultimately destabilizing. In response, policymakers around the world have put in place measures to limit a future buildup of similar vulnerabilities.”

As I’ve written in the past, I understand why officials did what they did back in the autumn of 2008. Clearly, they were not about to sit back and watch the system collapse. They would also not settle for mere stabilization. Their epic mistake was to push forward with aggressive reflationary policies – a global monetary inflation regime to which they remain entrapped nine years later. While post-“tech” Bubble reflation focused on mortgage Credit and housing, post-mortgage finance Bubble reflationary measures went much farther: reflate risk assets (equities, corporate debt and housing), collapse market yields and force savers out of the safety of deposits and money funds. It was the same flawed doctrine that had nurtured the “worst crisis since the Great Depression” – but on a much grander scale.

If there was the “madness of crowds” then, how about these days with Trillions flowing into passive ETFs, record corporate debt issuance, record securities and home prices, a proliferation of cryptocurrencies and a bubbling derivatives marketplace. So long as the Fed targets higher asset prices while repeatedly providing liquidity backstops, a culture of speculation becomes only more deeply entrenched.

Yellen’s speech makes repeated mention of “too big to fail” – and how policy measures have dealt with this leading element of the previous crisis. In reality, central bankers have ensured that “too big to fail” moral hazard has mushroomed from an issue with respect to large financial institutions to a critical facet afflicting global securities and derivatives market pricing.

Yellen’s speech, “Financial Stability a Decade after the Onset of the Crisis,” somehow doesn’t address the historic experiment with quantitative easing (QE). There’s no mention of the Fed (and global central banks) repeatedly responding to incipient market instability (with QE, an extension of monetary stimulus, or a postponement of “normalization”). The powerful doctrine of the Fed “pushing back against a tightening of financial conditions” is omitted from the discussion. The Fed chair largely avoids monetary policy altogether.

Bernanke had his “mortgage credit quality has been very solid…” For Yellen, it’s “evidence shows that reforms since the crisis have made the financial system substantially safer.” If the Yellen Fed believed as much, I doubt rates would be at 1.25% and their balance sheet would remain ballooned at $4.4 TN.

Yellen: “Investors have recognized the progress achieved toward ending too-big-to-fail… Credit default swaps for the large banks also suggest that market participants assign a low probability to the distress of a large U.S. banking firm.”

I would caution against calling out low bank CDS prices as evidence of progress toward ending too-big-to-fail. CDS is atypically low across the spectrum of corporate borrowers. Indeed, sovereign CDS pricing is unusually inexpensive around the globe despite a huge run up in debt loads (Italy 148bps!). And then there’s the historically low VIX that astute analysts argue has been disregarding risk. Low risk premiums across various asset classes - at home and abroad - are consistent with market perceptions that central bankers are committed to liquidity backstopping necessary to safeguard against another crisis. “Too big to fail” has never had such momentous market impacts.

Yellen: “Our more resilient financial system is better prepared to absorb, rather than amplify, adverse shocks, as has been illustrated during periods of market turbulence in recent years. Enhanced resilience supports the ability of banks and other financial institutions to lend, thereby supporting economic growth through good times and bad.”

Resilience over recent years has clearly been associated with concerted open-ended QE from all the world’s leading central banks. It would also appear that chair Yellen overly emphasizes traditional banking when referencing the “financial system.” “Banks are safer. The risk of runs owing to maturity transformation is reduced.”

It’s worth recalling that traditional bank runs were not much of an issue during the previous crisis. Traditional old Market Panic was. As they will do, long periods of market greed erupted into fear and panic. The acute issue was “repo” financing of large institutions financing MBS holdings – along with what a Wall Street liquidity crisis meant for the pricing of mortgage-related finance and the functioning of derivatives more generally. Investor panic was sparked by the loss of faith in the safety and liquidity of repo “money.” Yet the overriding issue remained the mispricing of Trillions of MBS and mortgage-related securities and derivatives. I’ve always argued that a repricing of mortgage debt – and risk more generally – was inevitable, and that major financial and economic repercussions were unavoidable. Bubbles are not forever.

There is no doubt in my mind that today’s issue of securities mispricing dwarfs the mortgage finance Bubble period. I also believe latent derivatives market-related instability (i.e. market “insurance”) also likely exceeds pre-2008 crisis levels. Less clear is where an acute liquidity episode could initially manifest. Lehman and the cadre of leveraged speculators borrowing in the short-term repo market to finance long duration mortgage securities was rather egregious.

Financial crisis typically erupts in the “money” markets. This is where risk is perceived to be minimal, yet it is at the same time the domain of aggressive risk intermediation that works to distort overall market dynamics. Throughout the mortgage finance Bubble period, “Wall Street Alchemy” transformed progressively riskier mortgages into endless perceived safe and liquid “money”-like instruments – “The Moneyness of Credit,” with the “repo” market at the epicenter of perilous risk distortions.

I have argued that unparalleled Fed and global central bank inflationary measures molded the “Moneyness of Risk Assets”. In particular, central bank backing ensured that inflating markets in equities and corporate Credit came to be perceived as low-risk stores of value. And with the proliferation of (perceived liquid) fund choices available in the marketplace (ETFs in particular), central banks coupled with Wall Street Alchemy achieved the incredible: the transformation of high-risk securities - with ever-rising prices - into perceived “money”-like instruments.

Returning to the above opening paragraph extracted from Yellen’s speech, I believe it is important to contemplate whether market resilience has been due to sound financial system structure or instead because of central bank-induced market distortions and liquidity backstops. If the latter, it is critical to appreciate that this extended period of “resiliency” has ensured cumulative financial distortions and Bubble Economy Maladjustment – on an unparalleled global scale. With tens of Trillions of mispriced securities globally, a painful bout of repricing is unavoidable.

We’ll see how resilient “the financial system” proves to be come the unmasking of risk market liquidity and safety misperceptions. It’s a curious discussion of “Financial Stability a Decade after the Onset of the Crisis,” that glosses over near zero rates, unending QE, Trillions of global debt securities trading with negative yields and the extraordinary expansion of the ETF complex. It recalls Alan Greenspan’s speeches - the reasoned analysis along with the intrigue of what went unsaid. For me, it’s disingenuous and lacks credibility.

For the Week:

The S&P500 increased 0.7% (up 9.1% y-t-d), and the Dow rose 0.6% (up 10.4%). The Utilities gained 1.1% (up 12%). The Banks advanced 1.0% (up 2.3%), and the Broker/Dealers rallied 1.1% (up 10.5%). The Transports increased 0.4% (up 1.0%). The S&P 400 Midcaps gained 1.0% (up 2.9%), and the small cap Russell 2000 recovered 1.4% (up 1.4%). The Nasdaq100 added 0.5% (up 19.7%), and the Morgan Stanley High Tech index rose 1.2% (up 25.5%). The Semiconductors gained 0.8% (up 19.2%). The Biotechs surged 2.6% (up 26.3%). With bullion up $7, the HUI gold index jumped 2.4% (up 10.3%).

Three-month Treasury bill rates ended the week at 99 bps. Two-year government yields gained three bps to 1.33% (up 14bps y-t-d). Five-year T-note yields were unchanged at 1.76% (down 17bps). Ten-year Treasury yields declined three bps to 2.17% (down 28bps). Long bond yields fell three bps to 2.75% (down 32bps).

Greek 10-year yields fell nine bps to 5.49% (down 153bps y-t-d). Ten-year Portuguese yields jumped 10 bps to 2.87% (down 88bps). Italian 10-year yields rose seven bps to 2.10% (up 29bps). Spain's 10-year yields increased five bps to 1.61% (up 23bps). German bund yields slipped three bps to 0.38% (up 18bps). French yields declined two bps to 0.70% (up 1bp). The French to German 10-year bond spread widened one to 32 bps. U.K. 10-year gilt yields fell four bps to 1.05% (down 18bps). U.K.'s FTSE equities index rose 1.1% (up 3.6%).

Japan's Nikkei 225 equities index was little changed (up 1.8% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.02% (down 2bps). France's CAC40 slipped 0.2% (up 5.0%). The German DAX equities index was unchanged (up 6.0%). Spain's IBEX 35 equities index declined 0.4% (up 10.6%). Italy's FTSE MIB index dipped 0.3% (up 13.1%). EM equities were higher. Brazil's Bovespa index surged 3.4% (up 18%), and Mexico's Bolsa added 0.6% (up 12.6%). South Korea's Kospi gained 0.9% (up 17.4%). India’s Sensex equities index added 0.2% (up 18.7%). China’s Shanghai Exchange jumped 1.9% (up 7.3%). Turkey's Borsa Istanbul National 100 index rose 2.4% (up 40.5%). Russia's MICEX equities index rose 2.5% (down 11.4%).

Junk bond mutual funds saw outflows of $1.01 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped three bps to 3.86% (up 43bps y-o-y). Fifteen-year rates were unchanged at 3.16% (up 42bps). The five-year hybrid ARM rate added a basis point to 3.17% (up 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to 4.03% (up 46bps).

Federal Reserve Credit last week declined $5.4bn to $4.426 TN. Over the past year, Fed Credit declined $13.0bn. Fed Credit inflated $1.614 TN, or 58%, over the past 250 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $9.0bn last week to $3.342 TN. "Custody holdings" were up $135bn y-o-y, or 4.2%.

M2 (narrow) "money" supply last week expanded $11.5bn to a record $13.629 TN. "Narrow money" expanded $691bn, or 5.3%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits jumped $62bn, while Savings Deposits fell $59.2bn. Small Time Deposits gained $3.7bn. Retail Money Funds added $2.7bn.

Total money market fund assets jumped $29.65bn to a 2017 high $2.736 TN. Money Funds added $1.1bn y-o-y.

Total Commercial Paper rose $9.0bn to $996.5bn. CP declined $7.4bn y-o-y, or 0.7%.

Currency Watch:

The U.S. dollar index declined 0.7% to 92.74 (down 9.4% y-t-d). For the week on the upside, the Norwegian krone increased 2.0%, the Swedish krona 1.9%, the euro 1.4%, the South Korean won 1.2%, the Canadian dollar 0.8%, the Swiss franc 0.8%, the Mexican peso 0.5%, the Singapore dollar 0.5% and the British pound 0.1%. On the downside, the New Zealand dollar declined 1.0%, the Brazilian real 0.4% and the Japanese yen 0.2%. The Chinese renminbi gained 0.36% versus the dollar this week (up 4.49% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.4% (down 4.9% y-t-d). Spot Gold added 0.6% to $1,291 (up 12.1%). Silver rose 0.8% to $17.132 (up 7.2%). Crude fell 64 cents to $47.87 (down 11.1%). Gasoline jumped 2.6% (unchanged), while Natural Gas was little changed (down 23%). Copper surged 3.2% (up 22%). Wheat dropped 1.6% (up 7%). Corn sank 3.3% (unchanged).

Trump Administration Watch:

August 25 – Financial Times (Demetri Sevastopulo, Shawn Donnan and Gillian Tett): “Donald Trump will launch a major push on tax reform next week with a speech in Missouri, as the president shifts focus to fiscal policy in an effort to secure a badly needed first big legislative victory by the end of the year. Gary Cohn, head of the White House national economic council, told the Financial Times that the speech… would be the first in a series of addresses designed to convince the US public about the need to revamp a tax system that has remained largely unchanged for three decades. ‘Starting next week, the president’s agenda and calendar is going to revolve around tax reform,’ Mr Cohn said… ‘He will start being on the road making major addresses justifying the reasoning for tax reform and why we need it in the US.’”

August 23 – Reuters (Steve Holland and Dave Graham): “President Donald Trump delivered an angry and forceful defense of his response to the violence in Charlottesville, Virginia, declaring at a campaign-style rally of supporters in Phoenix that the news media had distorted his position. Addressing thousands of supporters… at the Phoenix Convention Center, Trump accused major media organizations of being ‘dishonest” and of failing ‘to report that I spoke out forcefully against hatred, bigotry.’ Trump spent more than 20 minutes of a 75-minute speech delivering a selective account of his handling of the violence in Charlottesville, where he overlooked his initial statement blaming ‘many sides,’ as well his subsequent remarks that there were good people marching alongside the white supremacists.”

August 23 – Wall Street Journal (Kristina Peterson and Siobhan Hughes): “President Donald Trump’s threat to shut down the government if Congress doesn’t approve funding for a wall along the Mexico border raised alarm among some GOP lawmakers, injecting new volatility into an already uncertain political climate this fall. Lawmakers returning to Washington in early September have a dozen days with both the House and Senate in session before the government’s current funding expires on Oct. 1. Lawmakers from both parties had expected Congress to pass a stopgap two- or three-month spending bill, but Mr. Trump’s remarks raised fresh questions about the path forward. The GOP president said… that he was prepared to dig in over his request for $1.6 billion toward the border wall, one of his signature campaign promises.”

August 23 – Reuters: “Credit ratings agency Fitch Ratings… said a failure by U.S. officials to raise the federal debt ceiling in a timely manner would prompt it to review the U.S. sovereign rating, ‘with potentially negative implications.’ Fitch, which currently assigns the United States its highest rating — ‘AAA’ — said in a statement that the prioritization of debt service payments over other government obligations, should the debt ceiling not be raised, ‘may not be compatible with 'AAA' status.’ Without the ability to sell more debt, the government is expected to run out of cash, possibly in early October, and faces the risk of not paying the interest and principal on its debt on time.”

August 20 – Financial Times (Shawn Donnan): “The Trump administration has decided to push hard for tax reform and dial down a controversial national security investigation into steel imports in a bid to swing Republican support behind the president after the turmoil of recent weeks, according to senior officials. They said that former marine general John Kelly, the new chief of staff, was leading efforts to restore order to the White House and reassure Republican leaders alarmed by Donald Trump’s equivocal reaction to white nationalist-fueled violence in Virginia last week and the subsequent open criticism from business leaders.”

August 23 – Reuters (Steve Holland and Dave Graham): “U.S. President Donald Trump warned… he might terminate the NAFTA trade treaty with Mexico and Canada after three-way talks failed to bridge deep differences. The United States, Canada and Mexico wrapped up their first round of talks on Sunday to revamp the trade pact with little sign of a breakthrough coming. Trump reopened negotiations of the 1994 treaty out of concern U.S. economic interests were suffering. ‘Personally, I don't think we can make a deal. I think we’ll probably end up terminating NAFTA at some point,’ Trump said… Suggesting a termination might help jumpstart the negotiations, Trump said: ‘I personally don’t think you can make a deal without a termination.’”

August 22 – Bloomberg (Sahil Kapur): “A growing number of key congressional Republicans are considering a controversial maneuver that would allow for about $450 billion of tax cuts without offsets, according to four congressional aides… Under the proposal, the GOP would not account for things like expiring tax breaks when gauging the budgetary impact of tax legislation -- giving tax writers more room for cuts. Senate budget and tax panels are discussing the move to a ‘current policy’ baseline -- instead of the standard ‘current law’ baseline… The chief House tax writer, Kevin Brady, also signaled openness to the approach last month, saying it would lead to deeper tax cuts. The switch would risk a backlash from Democrats and deficit hawks.”

August 22 – CNBC (Christine Wang): “President Donald Trump and Senate Majority Leader Mitch McConnell haven't spoken to each other in weeks, The New York Times reported… The newspaper said that one phone call between the president and the Kentucky Republican devolved into a ‘profane shouting match.’ Relations between the two men have been conspicuously tense. Trump has repeatedly slammed McConnell on Twitter, blaming him for the failure of the GOP's attempts to repeal and replace the Affordable Care Act.”

August 19 – Wall Street Journal (Michael C. Bender and Peter Nicholas): “President Donald Trump ousted chief strategist Steve Bannon on Friday, as newly minted Chief of Staff John Kelly sought to bring order to an administration riven by infighting and power struggles, and increasingly at odds with congressional leaders. Mr. Bannon’s departure marked the fourth senior official in five weeks—and sixth in seven months—to leave the Trump administration… A former investment banker and media executive, Mr. Bannon was most closely aligned with the president’s ‘America First’ agenda, which he described as economic nationalism.”

China Bubble Watch:

August 23 – Bloomberg: “China keeps tightening the screws in its campaign to reduce the mountain of debt. The latest curbs landed late Wednesday, with the banking watchdog targeting wealth-management products that have more than tripled in the past four years amid low deposit rates and curbs on financing to overheated industries. Lenders will need to record all WMP sales starting Oct. 20, after some ‘misled’ consumers or sold them without regulators’ permission. While the consensus is that China still has a long way to go when it comes to actual deleveraging, it seems to have at least reined in the credit-growth beast, with WMPs plateauing since the crackdown was intensified in April.”

August 19 – Reuters (Ma Rong and John Ruwitch): “China will strengthen oversight of arbitrage that takes advantage of uncoordinated regulations and increase penalties to try to prevent structural risks from getting out of control, a senior central banker said. Yin Yong, deputy governor of the People's Bank of China, told a conference… six forms of arbitrage were problematic. He said they involved differing maturities, credit conditions, investment liquidity, exchange rates, capital and information. ‘These six forms of malicious regulatory arbitrage, which circumvent the regulatory system and its arrangements, and take advantage of the incompleteness of regulation, could result in risks to the entire financial system getting out of control,’ he said. Chinese financial regulators have adopted a slew of ‘de-risking’ measures this year in the face of ballooning debt and have ramped up efforts to unearth hidden problems that could become systemic threats.”

August 23 – Reuters (Yawen Chen and Elias Glenn): “China will use all necessary means to defend the interests of the country and its companies against a U.S. trade investigation, a spokesman for the Ministry of Commerce said… The ministry… expressed ‘strong dissatisfaction’ with the U.S. launch of the probe into China's alleged theft of U.S. intellectual property, calling it ‘irresponsible’. The probe is the Trump administration's first direct measure against Chinese trade practices, which the White House and U.S. business groups say are bruising American industry.”

August 22 – Wall Street Journal (Yifan Xie and Biman Mukherji): “China metal prices tumbled Wednesday as sentiment was battered by fresh warnings that the recent steel rally was unsustainable, the latest move by regulators to tame volatility in the futures market. The main steel-rebar futures contract in Shanghai snapped a four-day rally to trade down 4.9% by midday Wednesday at 3,744 yuan ($562) a metric ton…, while hot-rolled coil futures tumbled 5.3% to 3,828 yuan a ton. On the Dalian Commodity Exchange, iron-ore futures fell 4.5% to 574.5 yuan a ton, after soaring more than 20% over the past four sessions.”

Central Bank Watch:

August 22 – BBC: “European Central Bank President Mario Draghi has said unconventional policies like quantitative easing (QE) have been a success both sides of the Atlantic. QE was introduced as an emergency measure during the financial crisis to pump money directly into the financial system and keep banks lending. A decade later, the stimulus policies are still in place, but he said they have ‘made the world more resilient’… Central bankers, including Mr Draghi, are meeting in Jackson Hole, Wyoming, later this week, where they are expected to discuss how to wind back QE without hurting the economy. On Monday, a former UK Treasury official likened the stimulus to ‘heroin’ because it has been so difficult to wean the UK, US and eurozone economies off it.”

Global Bubble Watch:

August 22 – Financial Times (Laurence Mutkin): “Since the financial crisis erupted in 2008, a significant source of demand in the world’s largest bond markets has been central banks. The quantitative easing policies that institutions, including the US Federal Reserve, European Central Bank and Bank of Japan, have adopted to resist deflationary pressures unleashed by the crisis have consisted mostly of buying government bonds. A decade on, the threat of deflation has faded (at least for now) and so the pace of bond buying by central banks, which has already moderated, is set to fall sharply next year if the ECB and the Fed announce the changes to their QE policies in coming months. Given the very low levels of yields, this poses a significant threat to the pricing of bonds — and possibly of other financial assets too. The ECB and the BoJ are continuing their QE programmes, printing money to buy more bonds every month, and the Fed and the Bank of England — although no longer increasing their balance sheets — are still reinvesting the proceeds of maturing bonds previously bought under their programmes.”

August 21 – Bloomberg (Jean-Michel Paul): “Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions. From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40%, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation.”

August 20 – Financial Times (John Authers and Claire Manibog): “The Great Financial Crisis did not turn into a second Great Depression, merely a Great Recession. Asset prices quickly recovered. But did the desperate measures taken then create new bubbles? Quantitative easing… left investors with cash that they had little choice but to put into risky assets. Critics complained that this was ‘printing money,’ and would lead to currency debasement. The havens were traditional stores of value that took on the acronym SWAG: silver, wine, art and gold. By 2012, SWAG assets had formed a bubble. But it deflated as inflation fears receded and confidence in governments returned. Bricks and mortar offered another haven — particularly for those nervous that their countries might not always tolerate their wealth.”

August 22 – Bloomberg (Sid Verma and Cecile Gutscher): “HSBC Holdings Plc, Citigroup Inc. and Morgan Stanley see mounting evidence that global markets are in the last stage of their rallies before a downturn in the business cycle. Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop. ‘Equities have become less correlated with FX, FX has become less correlated with rates, and everything has become less sensitive to oil,’ Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote… His bank’s model shows assets across the world are the least correlated in almost a decade…”

August 24 – Bloomberg (Robert Brand and Cormac Mullen): “Political instability, money problems and economic growth still top the list of threats to global markets. It’s just that the main players have swapped roles, according to Eurasia Group. ‘For much of the post-crisis period, U.S. money, Chinese growth, and European politics have mattered most’ to investors, …director of global strategy at Eurasia, Karthik Sankaran, wrote… ‘But developments over the past year suggest that markets should be paying attention to U.S. politics, European growth, and Chinese money.’”

Federal Reserve Watch:

August 24 – Bloomberg (Jeanna Smialek and Alessandro Speciale): “Federal Reserve Bank of Kansas City President Esther George said if U.S. economic data hold up, there will probably be an opportunity to raise interest rates again in 2017. ‘I’ll be looking at the data in the next few weeks as we get ready for the September meeting, and see whether that still makes sense,’ George said… ‘Based on what I see today, I think there’s still opportunity to do that,’ she told Bloomberg Television’s Mike McKee…”

U.S. Bubble Watch:

August 23 – Bloomberg (Suzanne Woolley): “In a perfect world, the largest expenses in retirement would be for fun things like travel and entertainment. In the real world, retiree health-care costs can take an unconscionably big bite out of savings. A 65-year-old couple retiring this year will need $275,000 to cover health-care costs throughout retirement, Fidelity Investments said in its annual cost estimate… That stunning number is about 6% higher than it was last year… You might think that number looks high. At 65, you’re eligible for Medicare, after all. But monthly Medicare premiums for Part B (which covers doctor’s visits, surgeries, and more) and Part D (drug coverage) make up 35% of Fidelity’s estimate. The other 65% is the cost-sharing, in and out of Medicare, in co-payments and deductibles, as well as out-of-pocket payments for prescription drugs.”

August 22 – Reuters (Herbert Lash): “The sale price of high-end condominiums in Manhattan's most expensive neighborhood averaged $14.1 million in the 12 months through June, with one unit going for $65.7 million… The unit, at 432 Park Avenue, billed as the tallest residential tower in the Americas, was one of three at the Midtown East building that were in the top-five most expensive condominium sales in Manhattan, an analysis by CityRealty said. The analysis examined sale prices and what was paid per square foot in an index the realty company has created to gauge investment performance for what it considers the top 100 condominium buildings in Manhattan. The average price per square foot rose 9% to $2,788 in the 12-month period ended June 30…”

Europe Watch:

August 23 – Reuters (Shrutee Sarkar): “Euro zone business growth maintained a solid clip in August, driven by the best manufacturing performance in 6-1/2 years despite a strong euro, easily offsetting a mild slowdown in services growth… Taken together with a mild pickup in price pressures, the data is likely to support expectations that the European Central Bank will proceed later this year with making plans to scale back its multi-billion euro monthly asset purchases.”

August 20 – Financial Times (Kate Allen and Claire Jones): “The European Central Bank may have little choice but to wind down its €2tn bond-buying programme next year — whether eurozone inflation picks up, or not. An improving eurozone economy already led the ECB to scale back its purchases by €20bn a month to €60bn in April, sharpening expectations that policymakers will set out a timeline for further tapering in the next couple of months… While traders will try to glean any indication of the ECB’s intentions, Mr Draghi faces a dilemma of his own: the central bank is running out of bonds to buy. Its own rules restrict it to only purchasing a third of each country’s debt in circulation, and the supply of German Bunds and Portuguese debt in particular is starting to run thin. ‘The 33% issuer limit in Bunds presets a course of [purchase programme] exit, no matter the inflation outlook,’ says Harvinder Sian, a Citigroup analyst.”

August 21 – Financial Times (Izabella Kaminska): “Talk of a domestic parallel currency being introduced in Italy is not new. But it has been reinvigorated this week because of an interview with Silvio Berlusconi (a longstanding proponent of the idea) in Italian publication Libero Quotidiano, where he argues the introduction of a national parallel currency will help Italy regain monetary sovereignty in a way that later supports domestic demand.”

Japan Watch:

August 20 – Reuters (Tetsushi Kajimoto and Izumi Kakagawa): “Confidence at Japanese manufacturers rose in August to its highest level in a decade led by producers of industrial materials, a Reuters poll showed, in a further sign of broadening economic recovery.”

EM Bubble Watch:

August 20 – Bloomberg Businessweek (Anurag Joshi and Anto Antony): “Defaults on bonds and syndicated loans of Indian companies are at a record of almost $2 billion so far this year, compared with $494 million for all of 2016… State Bank of India, the nation’s largest lender by assets, surprised investors this month when it reported bad loans had risen to 10% after the acquisition of smaller lenders. The government’s injection of funds in August into a state-owned bank at risk of missing a coupon payment is beneficial for bondholders but creates a moral hazard by taking pressure of lenders to manage their capital pro-actively, according to Fitch…”

Leveraged Speculation Watch:

August 23 – Financial Times (Joe Rennison): “Hedge funds are embracing an esoteric credit product widely blamed for exacerbating the financial crisis a decade ago, as low volatility and near record prices for corporate debt tempt them into riskier areas to seek higher returns. The market for ‘bespoke tranches’ — bundles of credit default swaps that are tied to the risk of corporate defaults — has more than doubled in the first seven months of 2017. Traders in this opaque, over-the-counter market estimate there has been issuance of $20bn to $30bn this year, compared to $15bn in the whole of 2016 and $10bn in 2015… The surge in activity reflects the effort by investors to generate a higher rate of return during a period of historically low volatility in credit markets, compounded by low fixed rate yields.”

Geopolitical Watch:

August 22 – Reuters (Christine Kim): “North Korean leader Kim Jong Un has ordered more solid-fuel rocket engines…, as he pursues nuclear and missile programs amid a standoff with Washington, but there were signs of tension easing. The report carried by the KCNA news agency lacked the traditionally robust threats against the United States after weeks of unbridled acrimony, and U.S. President Donald Trump expressed optimism about a possible improvement in relations. ‘I respect the fact that he is starting to respect us,’ Trump said of Kim at a raucous campaign rally in Phoenix, Arizona. ‘And maybe - probably not, but maybe - something positive can come about,’ he said.”

August 22 – Reuters (David Brunnstrom and Doina Chiacu): “The United States… imposed new North Korea-related sanctions, targeting Chinese and Russian firms and individuals for supporting Pyongyang's weapons programs, but stopped short of an anticipated focus on Chinese banks. The U.S. Treasury designated six Chinese-owned entities, one Russian, one North Korean and two based in Singapore. They included a Namibia-based subsidiary of a Chinese company and a North Korean entity operating in Namibia. The sanctions also targeted six individuals - four Russians, one Chinese and one North Korean.”

August 21 – Reuters (Ben Blanchard and Doug Busvine): “China laid the blame at India's door… for an altercation along their border in the western Himalayas involving soldiers from both of the Asian giants. Both countries' troops have been embroiled in an eight-week-long standoff on the Doklam plateau in another part of the remote Himalayan region near their disputed frontier. Last week, a source in New Delhi, who had been briefed on the military situation on the border, said soldiers foiled a bid by a group of Chinese troops to enter Indian territory in Ladakh, near Pangong lake.”

August 23 – Reuters (Andrew Osborn): “Russian nuclear-capable strategic bombers have flown a rare mission around the Korean Peninsula at the same time as the United States and South Korea conduct joint military exercises that have infuriated Pyongyang. Russia, which has said it is strongly against any unilateral U.S. military action on the peninsula, said Tupolev-95MS bombers, code named ‘Bears’ by NATO, had flown over the Pacific Ocean, the Sea of Japan, the Yellow Sea and the East China Sea, prompting Japan and Seoul to scramble jets to escort them.”

August 22 – Reuters (Yeganeh Torbati): “The United States suggested… it could cut U.S. aid to Pakistan or downgrade Islamabad's status as a major non-NATO ally to pressure the South Asian nation to do more to help it with the war in Afghanistan. A day after President Donald Trump committed to an open-ended conflict in Afghanistan and singled out Pakistan for harboring Afghan Taliban insurgents and other militants, U.S. Secretary of State Rex Tillerson said Washington's relationship with Pakistan would depend on its help against terrorism… U.S. officials are frustrated by what they see as Pakistan's reluctance to act against groups such as the Afghan Taliban and the Haqqani network that they believe exploit safe haven on Pakistani soil to launch attacks on neighboring Afghanistan.”

Friday Evening Links

[Bloomberg] U.S. Stocks, Treasuries Rise After Yellen's Speech: Markets Wrap

[Bloomberg] Yellen Issues Broad Defense of Post-Crisis Financial Rules

[Bloomberg] Draghi Says Protectionism Is a Threat to Global Economic Growth

Thursday, August 24, 2017

Friday's News Links

[Bloomberg] Stocks Rise as Bonds Decline Before Bankers Speak: Markets Wrap

[Bloomberg] Rise in U.S. Business Equipment Orders Signals Steady Investment

[Bloomberg] Draghi Has Reason to Temper the Drama in Jackson Hole Sequel

[Bloomberg] Watch These Top Headliners at the Fed's Jackson Hole Conference

[CNBC] Fed Chair Yellen set to deliver what could be historic speech in Jackson Hole

[CNBC] Gary Cohn says Trump's Charlottesville reaction put 'enormous pressure' on him to resign

[Bloomberg] Citi Risk Aversion Signal Turns Bearish for First Time in a Year

[Bloomberg] U.S. Equity Funds Post Longest Run of Outflows Since 2004

[Bloomberg] China's Big Businesses Risk Trump's Punishment Over North Korea

[Bloomberg] Chinese Dealmaker Raises Billions From Shadow Banks

[Bloomberg] Japan Stuck in Inflation Doldrums With Core CPI at 0.5%

[FT] Trump to push for tax reform passage by year’s end, says Cohn

[FT] What happened to the ‘too big to fail’ banks?

[FT] Low rates benefited investors more than ordinary Americans

[CNBC] Hurricane Harvey strengthens, threatens US with most powerful storm in 12 years

Thursday Evening Links

[Reuters] Wall Street edges lower with Jackson Hole meeting in focus

[Bloomberg] How the Debt Ceiling Debate Could Affect America’s Credit Rating

[Bloomberg] Phillips Curve Doesn't Help Forecast Inflation, Fed Study Finds

[Reuters] U.S. existing home sales unexpectedly fall in July

[CNBC] Most Americans live paycheck to paycheck

[Bloomberg] China Liquidity Stress Signs Build as Fund Cost Jumps at Auction

[Bloomberg] China Says U.S. Probe 'Sabotages' Global Trade System

[WSJ] Markets Eye Debt Ceiling With Unease

Wednesday, August 23, 2017

Thursday's News Links

[Bloomberg] U.S. Stocks Fluctuate With Jackson Hole Looming: Markets Wrap

[CNBC] Fitch: US 'AAA' rating at risk if debt ceiling not raised

[Bloomberg] Below-Forecast U.S. Jobless Claims Signal Tight Labor Market

[Bloomberg] Fed's George Sees Another 2017 Rate Hike Despite Low Inflation

[Bloomberg] The U.S. Replaces Europe as the Market's Political Problem Child

[Bloomberg] Health-Care Costs Could Eat Up Your Retirement Savings

[Reuters] China says will use all necessary means to defend interests against U.S. trade probe

[Bloomberg] China Is Squeezing the Wealth Management Product Bubble

[Bloomberg] Crackdown Risk Has China's Hottest Stocks Looking Vulnerable

[WSJ] Bull Market in Uncertainty Propels Gold Rush

[WSJ] Trump’s Border-Wall Pledge Complicates GOP Efforts to Avoid Government Shutdown

[WSJ] Janet Yellen’s Future at the Fed Unresolved Heading Into Jackson Hole

[FT] Mario Draghi and Janet Yellen pose headline risks for traders

[NYT] Trump Takes Aim at the Press, With a Flamethrower

[Reuters] Russia sends nuclear-capable bombers on mission near South Korea, Japan

[Reuters] Defense Secretary Mattis promises support to Ukraine, but no arms

Wednesday Evening Links

[Bloomberg] Trump Shutdown Talk Weighs on Asia Stocks, Yields: Markets Wrap

[Bloomberg] Stocks Fall, Treasuries Advance on Policy Concerns: Markets Wrap

[Bloomberg] Trump Shutdown Threat Complicates Congress's Debt Ceiling Plans

[Reuters] Fellow Republicans rebuke Trump over government shutdown threat

[Reuters] Mexico, Canada dismiss Trump threats to scrap NAFTA trade pact

[Reuters] U.S. new home sales hit seven-month low as prices soar

[WSJ] Global Economies Grow in Sync

[FT] Investors pour back into crisis-era credit product

[FT] Yellen’s Fed legacy hangs over Jackson Hole meeting

Tuesday, August 22, 2017

Wednesday's News Links

[Bloomberg] Stocks, Dollar Slip as Trump Stokes Policy Concern: Markets Wrap

[CNBC] Trump: I'm building the wall even 'if we have to close down our government'

[Bloomberg] Economy Parties a Bit Like 1999 as Yellen Heads to Jackson Hole

[Reuters] Trump warns may terminate NAFTA treaty

[AP] Trump Revisits His Charlottesville Comments In a Angry Speech

[Bloomberg] Trump Hits Media, Angrily Defends Charlottesville Response

[Reuters] Euro zone August business growth keeps up solid pace

[CNBC] Trump and McConnell are reportedly not talking to each other

[BBC] ECB chief Draghi: QE has made economies more resilient

[Bloomberg View] Central Banks Need to End QE for the Sake of Markets

[Reuters] North Korea's Kim orders production of more rocket engines, warhead tips: KCNA

[WSJ] Trains in Vain: Epic CSX Traffic Jam Snarls Deliveries, From Coal to Fries

[WSJ] China Metals Prices Slide on Warning Over Unsustainable Rally

[FT] Credit crisis led to a bonfire of the acronyms

[FT] China reform plans could be stifled as economy cools

Tuesday Evening Links

[Reuters] Miners, tech lift stocks, crude rebounds on supply

[Bloomberg] GOP Eyes Budget Maneuver to Allow $450 Billion More in Tax Cuts

[Bloomberg] Wall Street Banks Warn Winter Is Coming as Business Cycle Peaks

[Reuters] U.S. targets Chinese, Russia entities for helping North Korea

Monday, August 21, 2017

Tuesday's News Links

[Bloomberg] Stocks Rebound in Thin Trading; Gold, Bonds Slide: Markets Wrap

[Politico] Trump’s team and lawmakers making strides on tax reform plan

[Reuters] Manhattan high-end condo prices rise with strong demand: report

[Bloomberg View] The Unintended Consequences of Quantitative Easing

[Reuters] Exclusive: China's 'big four' banks raise billions for Belt and Road deals - sources

[NYT] China, Like U.S., Struggles to Revive Industrial Heartland

[Bloomberg] A Second Korean War Could Quickly Spread Across All of Asia

[WSJ] North Korea Threatens ‘Absolute Force’ as U.S., South Hold Military Drills

[Reuters] Trump commits to more troops in Afghanistan, vows 'fight to win'

[WSJ] Complications Arise in the Housing Recovery

[FT] Globalisation in retreat: capital flows decline since crisis

[FT] Bonds won’t face QE cold turkey, but it will be painful

[FT] Dealing with the effects of one bubble creating more

[FT] Parallel currency talk gains ground in Italy

Monday Evening Links

[Bloomberg] U.S. Stocks Advance, Dollar Drops as Bonds Rise: Markets Wrap

[Bloomberg] McConnell and Mnuchin Predict Congress Will Raise the Debt Ceiling

[Bloomberg] Metals Frenzy Has China Bond Buyers Flocking to Smokestack Debt

Sunday, August 20, 2017

Saturday, August 19, 2017

Saturday's News Links

[Reuters] Summer rumblings could herald a stormy fall for U.S. stocks

[Reuters] Nervous Japanese hold drill in case North Korea fires missiles over them

[Bloomberg] Terror in Spain Shows Islamic State Is Down Not Out

[WSJ] Steve Bannon, Controversial Aide to Trump, Exits White House Staff

[FT] In charts: The rise and rise of China’s tech trinity

Friday, August 18, 2017

Weekly Commentary: Crisis of Confidence

Global markets are indicating heightened vulnerability. Thursday trading saw the S&P500 decline 1.54%, the second biggest decline of 2017. The session also saw the junk bond market under pressure. A notable $2.19bn of junk fund outflows this week spurred the headline, “Risk Exodus Gets Real With Biggest Fund Redemptions in 6 Months.” Currency markets are increasingly unstable. The euro traded to 1.1838 on Monday and fell to a trading low of 1.1662 on Thursday. The dollar/yen rose to 110.95 on Wednesday before reversing course to a near nine-month low of 108.60 during Friday trading. Gold traded to $1,300 in early Friday trading, the high going back to the election. Early-week market relief over the North Korean situation quickly shifted to unease over festering domestic issues.

August 16 – Wall Street Journal (Gabriel Wildau): “One of the most influential analysts of China’s financial system believes that bad debt is $6.8tn above official figures and warns that the government’s ability to enforce stability has allowed underlying problems to go unchecked. Charlene Chu built her reputation as China banking analyst at credit rating agency Fitch, where she was among the earliest to warn of risks from rising debt, especially in the country’s shadow banking system… In her latest report, Ms Chu estimates that bad debt in China’s financial system will reach as much as Rmb51tn ($7.6tn) by the end of this year, more than five times the value of bank loans officially classified as either non-performing or one notch above. That estimate implies a bad-debt ratio of 34%, well above the official 5.3% ratio for those two categories at the end of June… ‘What I’ve gotten a greater appreciation for is how everything is so orchestrated by the authorities,’ she said. ‘The upside is that it creates stability. The downside is that it can create a problem of proportions that people would think is never possible. We’re moving into that territory.’”

As is typical, China’s Credit expansion slowed during the month of July. Growth in Total Aggregate Social Finance declined to about $180bn. New loans increased $124bn, the slowest rise since last November - but still stronger-than-expected and much larger than July 2016. In a data point to follow closely, loans to households (mostly mortgages) slowed from June’s strong pace. Shadow banking contracted during June (first since October), although y-o-y growth remained a robust 16.5%. At 9.2%, y-o-y "money" supply growth was the slowest in decades.

It’s worth mentioning that Chinese data generally disappointed this week. Retail sales (up 10.4%) were down marginally from June and were below estimates (10.8%). Growth in Fixed Investment (8.3%) and Industrial Production (6.4%) were similarly down m-o-m and below forecasts.

August 13 – Bloomberg: “China’s home sales grew last month at the slowest pace in more than two years amid regulators’ moves to rein in soaring prices. The value of new homes sold rose 4.3% to 779 billion yuan ($117bn) in July from a year earlier… The increase is the smallest since March 2015, when the home market started to take off on policies to encourage demand from buyers.”

There is significant uncertainty associated with Chinese Credit and economic prospects. Through July, the growth in Total Aggregate Social Finance is tracking 20% above 2016’s record level. The first-half boom in Chinese Credit growth – especially household mortgage borrowings – goes a long way in explaining economic resiliency. There are certainly indications that Chinese officials are increasingly concerned with overall system Credit growth, but there is also the view that no tough measures will be adopted that would risk instability heading into this fall’s communist party gathering.

August 15 – Financial Times (Tom Mitchell): “China’s economy will grow faster than expected over the next three years because of the government’s reluctance to rein in ‘dangerous’ levels of debt, the International Monetary Fund warned… In an annual review of the world’s second-largest economy, IMF staff said China’s annual economic growth would average 6.4% in 2018-20, compared with a previous estimate of 6%. The IMF is also predicting that the Chinese economy will expand 6.7% this year, up from its earlier forecast of 6.2% growth. The Chinese government, which pledged to double the size of the economy between 2010 and 2020, has tolerated a rapid run-up in debt in order to meet its target. ‘The [Chinese] authorities will do what it takes to attain the 2020 GDP target,’ the IMF said. As a result, the IMF now expects China’s non-financial sector debt to exceed 290% of GDP by 2022, compared with 235% last year. The fund had previously estimated that debt levels would stabilise at 270% of GDP over the next five years.”

Looking out past the next few months, there’s significant uncertainty associated with Chinese policymaking, finance and economic performance. And before we segue to the mess in Washington, there are as well major near-term uncertainties with respect to global monetary management. There were indications this week that both the ECB and Federal Reserve lack the confidence and consensus necessary to communicate a plan for unwinding what have been years of unprecedented monetary stimulus. It’s not confidence inspiring.

August 17 – Wall Street Journal (Todd Buell): “The European Central Bank is wary of pulling the plug too soon on its large bond-buying program, and worried that any move in that direction will push the euro higher, the accounts of its latest meeting showed… The comments suggest that ECB President Mario Draghi will move with immense caution as he approaches two major public appearances in the coming weeks…”

August 17 – Bloomberg (Craig Torres): “Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong. Minutes from the July 25-26 Federal Open Market Committee meeting showed a revealing debate over why the economy isn’t producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth. The central bank has missed its 2% price goal for most of the past five years. Still, a majority of FOMC participants favor further rate increases. The July minutes showed an intensifying debate over whether that is the right policy response. ‘These minutes to me were troubling,’ said Ward McCarthy, chief financial economist at Jefferies… ‘They don’t have their confidence in their policy decisions; and they don’t have confidence that they can provide the right kind of guidance.’”

August 16 – Wall Street Journal (David Harrison): “New doubts over sagging inflation in the past few months are driving a split at the Federal Reserve about the timing of the next increase in interest rates. The internal debate raises the possibility that the Fed could deviate from its plans for a third rate increase this year. Soft inflation has bedeviled Fed officials, forcing them to pull back on plans to raise rates multiple times in 2015 and 2016. Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being.”

China is in an historic Bubble, and this has created extraordinary uncertainty for the future. Global central banks have been engaged in an unprecedented and prolonged monetary inflation, and this has created extraordinary uncertainty for the future. An important facet of the problem is that years of extreme monetary stimulus have ensured that way too much “money” has gravitated to highly speculative global securities and derivatives markets. This has profoundly distorted inflationary dynamics throughout the securities markets as well as in the global economy overall.

Central bankers are increasingly perplexed as to how to proceed with normalization. While markets remain convinced that monetary policies globally will stay loose indefinitely, I believe indecision at the major central banks creates uncertainties that will increasingly weigh on risk-taking (especially with leverage). Watch the currencies. With the backdrop set, let’s move on to Washington.

The Trump Administration now confronts a full-fledged Crisis of Confidence. Even Republican supporters are calling for radical change. And it would at this point appear that some degree of radical departure will be required for the President to muster enough support to move forward with his agenda. I assume the administration will adopt a razor-sharp focus on tax cuts and reform in an attempt to stabilize a sinking ship.

As for the stock market, this week saw the “Trump Rally” conveniently morph into the “Cohn Rally.” Rumors of a Gary Cohn departure were said to be behind market selling pressure. It would be shocking to see Cohn abandoned Washington. He may now be the second most powerful individual in the country, with the most powerful enveloped in mayhem.

Importantly, “Risk Off” is gathering some momentum. Over recent years we’ve witnessed the markets repeatedly disregard – or at least downplay – major political developments. For the most part, markets were this week resilient in the face of a distressing and rapidly deteriorating political landscape. So far, the monetary and economic backdrops have remained constructive.

This week saw a stronger-than-expected reading in the Empire Manufacturing Index. Monthly Retail Sales were stronger-than-expected, as was the National Home Builders Housing Market Index (although Starts and Permits lagged). The weekly Bloomberg Consumer Comfort index rose to the highest level since 2001. The Bloomberg National Economy Expectations index surged back to near multi-year highs.

It’s worth noting that 10-year Treasury yields declined less than four basis points during Thursday’s stock market swoon. For a week that saw U.S. risk markets under some pressure and the VIX spike for the second straight week, it was notable that Treasury yields rose slightly. This should raise concerns that Treasuries may no longer provide much of a hedge during the next bout of “Risk Off.” And if Treasury gains are limited in the event of “Risk Off,” what are the ramifications for an overheated corporate debt marketplace?

Unprecedented risk has accumulated across the markets over the past nine years. “Money” has flooded into passive strategies that are essentially a speculation that the bull market – in equities and corporate Credit – will run unabated. Myriad derivatives strategies have flourished, with the proliferation of many products that are essentially writing market insurance (“flood insurance during a drought”).

Markets have experience “flash crashes” in the recent past, so I assume there will be more. For good reason, market participants these days presume that central banks will use their balance sheets to ensure that markets remain abundantly liquid. At the same time, the reality is that global central bankers have limited policy tools available in the event of market instability. The downside of delaying policy normalization (for years) is that we’re in the late innings of a global Bubble yet rates remain at or near zero around the globe. Central banks have little room to cut interest-rates, while pressure builds to wind down extraordinary balance sheet operations.

I am somewhat reminded of when accounting fraud issues precluded Fannie and Freddie from providing the MBS marketplace a liquidity backstop. It was a pivotal development, though market players were content to ignore ramifications for several years. With booming markets anticipating liquidity abundance indefinitely, it wasn’t until the 2008 de-leveraging episode that the absence of the GSE backstop bid mattered.

I don’t want to get too far ahead of myself here, but it’s worth noting that bank CDS has begun to price in rising risk. For the most part, CDS price reversals are modest and come from multi-year lows. But bank CDS risk has been increasing now for going on a month. And on a global basis, it’s kind of the same old potential problem children that have experienced the biggest gains – Dexia, Deutsche Bank, Societe Generale, UBS, BNP Paribas and Credit Suisse. Some of the big European banks saw CDS rise to two month highs this week. U.S. banks are now also seeing a modest rise in CDS prices, in many cases ending the week at one-month highs. It’s worth noting as well that the broker/dealer equities index (XBD) declined more than 2% Thursday and was hit 1.4% for the week. Japan’s TOPIX Bank Index dropped 2.4% this week.

August 15 – Financial Times (Eric Platt): “Amazon sealed the year’s fourth-largest corporate bond sale on Tuesday as the technology and online retail group locked in $16bn to fund its takeover of premium grocer Whole Foods… The company, founded by Jeff Bezos, borrowed the $16bn across seven tranches, ranging from three- to 40-year maturities. Orders for the multibillion-dollar deal climbed to nearly $49bn as banks closed their books…”

I’ll also be closely monitoring indicators of corporate Credit risk. According to Dealogic, August’s $110 billion of U.S. corporate debt sales pushed y-t-d issuance to $1.2 TN. And while corporate debt prices for the most part held their own this week, spreads have widened meaningfully from July. Even the investment-grade market is indicating a changing backdrop.

I feel compelled to offer brief comments on the sad state of our great nation. Sure, the stock market is close all-time highs and unemployment is at multi-year lows. Business and consumer confidence are strong, which is understandable considering the prolonged Bubble period. That there are such widespread feelings of acrimony and animosity - and that our country can be so bitterly divided - in the midst of today’s economic/market backdrop must be alarming to anyone paying attention. I hate to think of the environment after the Bubble bursts – the type of hostility and insecurity that would seem to ensure an epic bear market.

It’s almost unbelievable that the November election offered a choice between about the two most divisive figures in American politics. It’s as if there are two completely divergent and irreconcilable views of how the world works, how the economy should operate and the role of the federal government. Somehow we’ve gotten to the point where there cannot even be a civil discussion – let alone a meeting of the minds - on the most basic issues.

As has become a popular (Daniel Moynihan) quote to recite, “Everyone is entitled to their own opinions, but they are not entitled to their own facts.” These days, facts are in dispute and they’re often disputed hatefully. Okay, let’s assume the Administration does see some legislative success. What happens after the mid-terms?

It’s too easy to blame the political class. Yet politicians do what politicians do. There should be little doubt that the boom and bust dynamics experienced over recent decades have taken a toll on our nation’s social and economic fabric. And while many want to blame “globalization,” I believe much that we label “globalization” would be more accurately understood as fallout from years of unfettered global finance. Could NAFTA have been so destabilizing to U.S. manufacturing without endless cheap finance flooding into Mexico (and EM more generally). How dominant would China be today without essentially limitless amounts of virtually free “money” to finance over-investment the likes of which the world has never experienced?

I strongly believe that unfettered finance has been instrumental in the long period of U.S. deindustrialization – the transformation from a manufacturing powerhouse into an experiment in a consumption and services-based economic structure. Bubbling securities markets and booming Wall Street finance were integral to this fateful structural shift.

Millions of skilled jobs have been lost, replaced by millions of service sector positions where workers can toil for years and still possess skills of only marginal value. It’s now been decades of malinvestment and structural impairment. There has been profound overinvest in almost all things consumption related, which impinges both economic productivity and wage growth. Unimaginable monetary stimulus has spurred asset inflation and spending, but we’re now left with a historic Bubble and only deeper structural maladjustment.

Understandably, much of the population feels they’ve been shortchanged or even cheated. The ongoing inequitable redistribution of wealth becomes only more conspicuous as those fortunate enough to participate in the Bubble accumulate incredible wealth. There’s a general sense that the system is unfair and untrustworthy. Too many citizens no longer trust Washington and Wall Street, and they’re as well losing trust in our institutions more generally. There’s tremendous deep-seated anger for large groups of citizens that feel cheated and marginalized. Two-decades of spectacular boom and bust dynamics have left a tremendous amount of damage.

It’s all been so frustratingly predictable. Certainly not for the first time in history, the scourge of unsound money and inflationism has been so subtle that it goes virtually undetected. Instead of being appreciated as the root cause of economic, social, political and geopolitical trouble, monetary inflation is viewed as integral to the solution. Just a little more – just one more round of monetary inflation will do the trick and we’ll get back to normal. Right… It ensures hopeless addiction – with tremendous collateral damage. It was a troubling week where the absurdity of it all seemed on full display.

For the Week:

The S&P500 slipped 0.6% (up 8.3% y-t-d), and the Dow declined 0.8% (up 9.7%). The Utilities gained 1.2% (up 10.9%). The Banks dipped 0.6% (up 1.6%), and the Broker/Dealers fell 1.4% (up 9.3%). The Transports lost 1.1% (up 0.6%). The S&P 400 Midcaps dropped 1.1% (up 1.9%), and the small cap Russell 2000 fell 1.2% (unchanged). The Nasdaq100 declined 0.7% (up 19.1%), while the Morgan Stanley High Tech index added 0.6% (up 24%). The Semiconductors increased 0.5% (up 18.2%). The Biotechs dropped 1.2% (up 23.2%). With bullion down $5, the HUI gold index declined 0.7% (up 7.8%).

Three-month Treasury bill rates ended the week at 99 bps. Two-year government yields added a basis point to 1.31% (up 12bps y-t-d). Five-year T-note yields gained two bps to 1.76% (down 17bps). Ten-year Treasury yields increased one basis point to 2.19% (down 25bps). Long bond yields slipped a basis point to 2.78% (down 29bps).

Greek 10-year yields rose seven bps to 5.76% (down 145bps y-t-d). Ten-year Portuguese yields fell eight bps to 2.77% (down 97bps). Italian 10-year yields were unchanged at 2.03% (up 22bps). Spain's 10-year yields jumped 10 bps to 1.56% (up 18bps). German bund yields gained three bps to 0.41% (up 21bps). French yields rose three bps to 0.71% (up 3bps). The French to German 10-year bond spread was little changed at 30 bps. U.K. 10-year gilt yields increased three bps to 1.09% (down 15bps). U.K.'s FTSE equities index added 0.2% (up 2.5%).

Japan's Nikkei 225 equities index fell 1.3% (up 1.9% y-t-d). Japanese 10-year "JGB" yields declined three bps to 0.03% (down 1bp). France's CAC40 advanced 1.1% (up 5.2%). The German DAX equities index gained 1.3% (up 6.0%). Spain's IBEX 35 equities index increased 1.0% (up 11.1%). Italy's FTSE MIB index jumped 2.2% (up 13.4%). EM equities were mostly higher. Brazil's Bovespa index jumped 2.2% (up 14.1%), and Mexico's Bolsa increased 0.8% (up 11.9%). South Korea's Kospi rallied 1.7% (up 16.4%). India’s Sensex equities index rose 1.1% (up 18.4%). China’s Shanghai Exchange jumped 1.9% (up 5.3%). Turkey's Borsa Istanbul National 100 index added 0.2% (up 37.2%). Russia's MICEX equities index declined 0.7% (down 13.5%).

Junk bond mutual funds saw outflows of $2.188 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 3.89% (up 46bps y-o-y). Fifteen-year rates dipped two bps to 3.16% (up 42bps). The five-year hybrid ARM rate rose two bps to 3.16% (up 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 4.07% (up 46bps).

Federal Reserve Credit last week added $1.4bn to $4.430 TN. Over the past year, Fed Credit declined $8.4bn. Fed Credit inflated $1.619 TN, or 58%, over the past 249 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $3.5bn last week to $3.333 TN. "Custody holdings" were up $129bn y-o-y, or 4.0%.

M2 (narrow) "money" supply last week expanded $7.3bn to $13.619 TN. "Narrow money" expanded $694bn, or 5.4%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits dropped $46.6bn, while Savings Deposits jumped $49.6bn. Small Time Deposits added $1.2bn. Retail Money Funds rose $1.3bn.

Total money market fund assets gained $12.6bn to $2.706 TN. Money Funds fell $23bn y-o-y (0.1%).

Total Commercial Paper rose $7.3bn to $988bn. CP declined $25bn y-o-y, or 2.4%.

Currency Watch:

The U.S. dollar index gained 0.4% to 93.43 (down 8.8% y-t-d). For the week on the upside, the South African rand increased 2.4%, the Brazilian real 1.5%, the Canadian dollar 0.7%, the Mexican peso 0.7%, the Australian dollar 0.4%, the Norwegian krone 0.3%, and the South Korean won 0.3%. On the downside, the British pound declined 1.1%, the euro 0.5%, the Swiss franc 0.3% and the Singapore dollar 0.1%. The Chinese renminbi declined 0.1% versus the dollar this week (up 4.12% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 0.6% (down 4.5% y-t-d). Spot Gold dipped 0.4% to $1,284 (up 11.4%). Silver slipped 0.4% to $17.00 (up 6.4%). Crude declined 31 cents to $48.51 (down 10%). Gasoline recovered 0.7% (down 3%), while Natural Gas dropped 3.0% (down 23%). Copper rose 1.7% (up 18%). Wheat sank 5.2% (up 9%). Corn dropped 2.4% (up 4%).

Trump Administration Watch:

August 16 – Wall Street Journal (Peter Nicholas, Siobhan Hughes and Michael C. Bender): “President Donald Trump’s comments faulting both sides in Saturday’s deadly white nationalist protest in Virginia rattled his staff and risk setting back his policy agenda in Congress, lawmakers and administration aides said. Mr. Trump’s top economic adviser, Gary Cohn, was upset by the remarks and the trajectory of a news conference Tuesday that was supposed to showcase the White House’s infrastructure plans, aides said. Instead, the event was dominated by Mr. Trump’s fiery commentary about the violence in Charlottesville that left one person dead.”

August 15 – Wall Street Journal (Andrew Browne): “By ordering his first trade action against Beijing, while amping up pressure on Chinese leaders to rein in Pyongyang’s nuclear menace, U.S. President Donald Trump is bringing to a head two of the most intractable problems that bedevil U.S.-China relations. There are hints that Mr. Trump’s hard-nosed strategy could be having an impact—at least in the near-term. After repeated North Korean threats to launch missiles toward the U.S. Pacific territory of Guam, Pyongyang suddenly backed away from that threat Tuesday. And China has signed on to U.N. sanctions that will slash North Korea’s already meager foreign revenues by another $1 billion. But Mr. Trump’s strategy comes with risks; each issue—trade and North Korea—is volatile enough to upend the relationship. Mismanaged, one could ignite a trade war, the other trigger scenarios that could lead to military conflict.”

August 14 – CNBC (Jacob Pramuk): “President Donald Trump on Monday signed a memorandum that could lead to a trade investigation of alleged Chinese theft of intellectual property. The measure directs U.S. Trade Representative Robert Lighthizer to look into options to protect U.S. intellectual property. It does not take any specific action against China at this point. ‘We will safeguard the copyrights, patents, trademarks, trade secrets and other intellectual property that is so vital to our security and to our prosperity,’ Trump said. He added, ‘This is just the beginning.’”

August 14 – Reuters (Michael Martina): “China will take action to defend its interests if the United States damages trade ties, the Ministry of Commerce said…, after U.S. President Donald Trump authorized an inquiry into China's alleged theft of intellectual property. Trump's move, the first direct trade measure by his administration against China, comes at a time of heightened tension over North Korea's nuclear ambitions, though it is unlikely to prompt near-term change in commercial ties. U.S. Trade Representative Robert Lighthizer will have a year to look into whether to launch a formal investigation of China's policies on intellectual property, which the White House and U.S. industry groups say are harming U.S. businesses and jobs.”

August 15 – Reuters (Balazs Koranyi): “The United States… laid down a tough line for modernizing the North American Free Trade Agreement, demanding major changes to the pact that would reduce U.S. trade deficits with Mexico and Canada and increase U.S. content for autos. Speaking at the start of the talks in Washington, U.S. President Donald Trump's top trade adviser, Robert Lighthizer, said Trump was not interested in ‘a mere tweaking’ of the 23-year-old pact, which he blames for hundreds of thousands of job losses to Mexico. ‘We feel that NAFTA has fundamentally failed many, many Americans and needs major improvement,’ Lighthizer, the U.S. Trade Representative, said in an opening statement.”

August 14 – Reuters: “Industry groups and other sectors of society are gearing up to fight proposed changes to the personal income tax. Proposed changes to the personal tax code have already stirred opposition from real estate agents, home builders, mortgage lenders and charities. U.S. Congress members are focused during their August recess on finding ways to lower the corporate tax rate.”

China Bubble Watch:

August 14 – Wall Street Journal (Anjani Trivedi): “All roads in Beijing’s deleveraging efforts lead to its banks. China’s central bank—increasingly becoming the one all-powerful financial regulator—said it would begin reclassifying the fastest-growing source of banks’ wholesale funding from the first quarter of next year. So-called negotiable certificates of deposits (NCDs), a type of money-market instrument that came into existence just three years ago, have grown almost 60% in the past year to 8.4 trillion yuan ($1.26 trillion) in July. The new rule is supposed curb Chinese banks’ ability to expand their balance sheets rapidly using these short-term financing tools. Funding has become a difficult task for China’s banks. The traditional deposit base has been fleeing to higher-yielding investment products while capital markets have made raising debt punitive. So NCDs have been all the rage. Of the 1.6 trillion yuan issued in July, small and midsize banks issued the bulk of the volume and half of all NCDs are issued by a dozen such banks.”

August 15 – Bloomberg: “China’s giant shadow banking industry shrank for the first time in nine months during July -- evidence Beijing’s campaign to quash risks to the financial system may be starting to bear fruit. At the same time, however, traditional forms of lending are seeing a renaissance. Net corporate bond issuance has been jumping as non-financial corporations opt for cheaper sources of finance than borrowing in the shadow banking sector, where costs have surged amid the government crackdown. As China stares down a twice-a-decade leadership re-shuffle later this year, President Xi Jinping has made financial-sector stability a top priority.”

August 14 – Bloomberg: “China’s economy showed further signs of entering a second-half slowdown, as curbs on property, excess borrowing and industrial overcapacity began to bite. Industrial output rose 6.4% from a year earlier in July, versus a median projection of 7.1% and June’s 7.6%. Retail sales expanded 10.4% from a year earlier, compared with a projection of 10.8% and 11% in June. Fixed-asset investment in urban areas rose 8.3% from a year earlier in the first seven months, versus a forecast 8.6% rise.”

August 14 – Bloomberg: “Nearly two months after reports about Chinese regulators’ scrutiny of the country’s top dealmakers, the concerns have left a mark in the local bond market, where one of those companies is facing yields double the national average. Yields on onshore securities without put or call options of Dalian Wanda Commercial Properties Co., which has an AAA rating onshore, are above 9%... That compares with the average 4.55% yield on top-rated notes due in three years from all corporate borrowers in the country. It’s also higher than the 5.8% average yield on three-year notes with AA- ratings, considered junk in China.”

August 16 – Bloomberg: “Yu’E Bao, the world’s biggest money-market fund, still has potential to grow more even after it expanded at the fastest half-year pace in three years in the first six months of 2017, according to Fitch… The Chinese fund is sold on the mobile-payment platform Alipay, offered by Alibaba Group Holding Ltd.’s financial affiliate, which is controlled by Jack Ma. The billionaire founder of Alibaba has promoted Alipay for everything from grocery shopping to settling restaurant bills. That’s spurred growth of Yu’E Bao, which gives users a way to stash away savings with no minimum investment or time frame. Yu’E Bao has 1.4 trillion yuan ($210bn) of assets under management… It has beaten the average returns for money-market funds in the nation for much of this year, further boosting its allure, according to Fitch analyst Huang Li.”

Central Bank Watch:

August 16 – Reuters (Balazs Koranyi): “European Central Bank President Mario Draghi will not deliver a new policy message at the U.S. Federal Reserve's Jackson Hole conference, two sources familiar with the situation said, tempering expectations for the bank to start charting the course out of stimulus. An ECB spokesman said that Draghi will focus on the theme of the symposium, fostering a dynamic global economy, in his Aug. 25 remarks, while the sources added that he was keen to hold off on the policy discussion until the autumn… Expectations for the speech had been building in recent weeks with investors pointing to next Friday's event as the likely kick off in the ECB's debate how to recalibrate monetary policy given solid growth, rapidly falling unemployment but persistently weak underlying inflation.”

August 15 – Financial Times (Claire Jones): “The European Central Bank faces a legal challenge over its €2tn quantitative easing programme after Germany’s highest court said the measures may violate EU law. The country’s constitutional court said on Tuesday that it would refer a case launched against QE to the European Court of Justice. It said there were indications that decisions about the programme overstepped the ECB’s mandate and contravened a ban on purchasing bonds directly from governments, known as monetary financing. ‘In the view of the [court] significant reasons indicate that the ECB decisions governing the asset purchase programme violate the prohibition of monetary financing and exceed the monetary policy mandate of the European Central Bank,’ the court said… ‘It is doubtful whether the [purchase of government bonds under QE] is compatible with the prohibition of monetary financing.’”

Global Bubble Watch:

August 15 – Financial Times (Kate Allen and Keith Fray): “Leading central banks now own a fifth of their governments’ total debt, a sign of the scale of the challenge they will face in unwinding unprecedented stimulus measures deployed over the past decade. Since the financial crisis emerged, the world’s biggest central banks have carried out large-scale purchases of bonds and other securities in a bid to boost the global economy by driving down borrowing costs for households and businesses. In total, the six central banks that have embarked on quantitative easing over the past decade — the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England, along with the Swiss and Swedish central banks — now hold more than $15tn of assets, …more than four times the pre-crisis level. Of this, more than $9tn is government bonds — one dollar in every five of the $46tn total outstanding debt owed by their governments.”

August 14 – Financial Times (Leo Lewis): “There was a time when a US president threatening ‘fire and fury’ and footage of children practising nuclear drills might have hit the Nikkei 225 harder than a 2% dip. But that was before the Bank of Japan’s addiction to exchange traded funds (ETFs). There is no enigma here. Last week, when Japanese investors might reasonably have taken fright, the BoJ unleashed a test launch of its own — a record-breaking grab of more than $2bn of Japanese equity ETFs in 52 hours. That adds to a BoJ share portfolio whose book value passed $127bn at the end of June…”

August 13 – Bloomberg: “China’s surging commodity prices are sending a warning signal on inflation. That should be negative for bonds, but the debt market seems unruffled. As futures on steel reinforcement bars surged to their highest level since 2013 in Shanghai last week, joining copper and aluminum at multi-year highs, bonds barely registered. A Bank of America index of the Chinese debt market was little changed, continuing a trend that’s left it steady in the quarter, even as commodity prices look to be stirring.”

August 15 – Bloomberg (Greg Quinn and Erik Hertzberg): “Canada’s benchmark home price fell by the most in nearly a decade last month as Toronto led a fourth straight decline in sales. The nationwide benchmark home price declined 1.5% to C$607,100 ($476,000) from June… In Toronto, the country’s largest city, the price fell 4.7% on the month.”

August 14 – Bloomberg (Michael Heath): “Australia’s central bank renewed its focus on mounting household debt, even as the outlook for the nation’s economy improved, according to the minutes of this month’s policy decision… The main change is one of emphasis after the Reserve Bank of Australia removed the labor market and added household balance sheets -- where debt is currently at a record 190% of income -- to its key areas of concern alongside the residential property market.”

Fixed Income Bubble Watch:

August 15 – Wall Street Journal (Sam Goldfarb): “Amazon.com Inc. sold $16 billion of bonds… to help fund its purchase of Whole Foods Market Inc., meeting strong demand from investors as it made a rare trip to the debt market. Amazon sold a $3.5 billion 10-year bond at a 0.9-percentage-point yield-premium to Treasurys, below the 1.1-percentage-point guidance set by underwriters earlier in the day... The e-commerce giant benefited from similarly favorable price adjustments across six other maturities, ranging from three-years to 40-years, the person said. In its entirety, the sale added up to the fourth-largest U.S. corporate bond deal of the year…”

August 17 – Bloomberg (Natasha Doff): “Investors overseeing about $1.1 trillion have been cutting exposure to the world’s riskiest corporate debt as rates grind too low to compensate for potential risks. Even after a selloff last week amid rising tensions between the U.S. and North Korea, a Bloomberg Barclays index of global junk bonds still yields 5.3%, 100 bps below the average for the past five years. High-yield corporate debt has been one of the biggest beneficiaries of central stimulus… The danger now is that higher Federal Reserve interest rates and the European Central Bank tapering will reverse the trend.”

August 14 – Bloomberg (Nabila Ahmed, Sally Bakewell, Molly Smith, and Claire Boston): “Have we finally reached peak credit markets? It’s a question that big names like BlackRock, DoubleLine and Pimco have been asking during this seemingly endless summer of debt. Signs of froth are everywhere. U.S. high-grade companies, which have already sold almost $1 trillion of bonds this year, are on track to break old issuance records. By some measures, corporate America is deeper in debt than ever before. Junk bonds, yielding on average just 5.8%, have fallen close to post-crisis lows. And on Friday, investors lined up in droves to provide $1.8 billion in financing to Elon Musk’s unprofitable electric carmaker, Tesla Inc. -- and at interest rates that few could have envisioned a couple of years ago.”

Federal Reserve Watch:

August 16 – Wall Street Journal (David Harrison): “New doubts over sagging inflation in the past few months are driving a split at the Federal Reserve about the timing of the next increase in interest rates. The internal debate raises the possibility that the Fed could deviate from its plans for a third rate increase this year. Soft inflation has bedeviled Fed officials, forcing them to pull back on plans to raise rates multiple times in 2015 and 2016. Minutes from the July 25-26 meeting released Wednesday reveal growing concern among some officials that recent soft inflation numbers could be a sign that something has fundamentally changed in the economy, leading them to suggest holding off on raising rates again for the time being.”

August 14 – Bloomberg (Jeanna Smialek): “Federal Reserve Bank of New York President William Dudley said it isn’t unreasonable to expect the central bank to announce plans in September to start trimming its balance sheet and said he supports another interest-rate increase this year if the economy evolves as he expects. ‘I would expect -- I would be in favor of doing another rate hike later this year’ if the economy holds up, Dudley said…”

August 14 – Wall Street Journal (Ben Eisen): “The market is once again second-guessing whether the Federal Reserve can lift rates again this year. The yield on the two-year Treasury note… fell to 1.29% from its early-July level of 1.41%, the highest since 2008. In the fed funds futures market, where traders wager on the path of the Fed’s policy rate, there was a 36% chance of at least one more rate increase by the end of the year, down from 54% a month ago…”

August 16 – Financial Times (Sam Fleming): “One of the Federal Reserve’s top policymakers has attacked attempts to reverse the post-crisis drive for tougher regulation, calling efforts to loosen constraints on banks ‘dangerous and extremely short-sighted’. Stanley Fischer, the vice-chairman of the Fed’s board of governors, said… there are troubling signs of a drive to return to the status quo that preceded it. While he endorsed efforts to ease up on small banks, he said political pressure in Washington to curtail regulatory burdens on large institutions was very hazardous. Republican politicians have been urging a loosening of some capital and liquidity requirements on financial institutions, arguing that they are hampering firms’ ability to lend… ‘I am worried that the US political system may be taking us in a direction that is very dangerous… It took almost 80 years after 1930 to have another financial crisis that could have been of that magnitude. And now after 10 years everybody wants to go back to a status quo before the great financial crisis. And I find that really, extremely dangerous and extremely short-sighted. One can understand the political dynamics of this thing, but one cannot understand why grown intelligent people reach the conclusion that [you should] get rid of all the things you have put in place in the last 10 years.’”

U.S. Bubble Watch:

August 13 – Financial Times (Chris Flood): “Record-breaking inflows into exchange traded funds this year are fuelling fears that the tide of money surging into passive investment is helping to inflate a bubble in the US stock market… Investors have ploughed $391bn into ETFs in the first seven months of 2017, already surpassing last year’s record annual inflow of $390bn, according to ETFGI… The ETF industry has attracted almost $2.8tn in new business since the start of 2008, coinciding with one of the longest bull runs in US stock market history. The US benchmark S&P 500 index hit an all-time high on August 8, up 267% since its post financial-crisis low in March 2009… ‘When the management of assets is on autopilot, as it is with ETFs, then investment trends can go to great excess,’ said Howard Marks, co-founder of Oaktree Capital.’”

August 15 – Reuters (Jonathan Spicer): “Americans' debt level notched another record high in the second quarter, after having earlier in the year surpassed its pre-crisis peak, on the back of modest rises in mortgage, auto and credit card debt, where delinquencies jumped. Total U.S. household debt was $12.84 trillion in the three months to June, up $552 billion from a year ago… The proportion of overall debt that was delinquent, at 4.8%, was on par with the previous quarter. However a red flag was raised over the transitions of credit card balances into delinquency, which the New York Fed said ‘ticked up notably.’”

August 15 – Bloomberg (Adam Tempkin): “Amid all the reflection on the 10-year anniversary of the start of the subprime loan crisis, here’s a throwback that investors could probably do without. There’s a section of the auto-loan market -- known in industry parlance as deep subprime -- where delinquency rates have ticked up to levels last seen in 2007, according to… Equifax. ‘Performance of recent deep subprime vintages is awful,’ Equifax said… ‘We’re seeing an increase in delinquencies across all credit scores, but in the highest credit quality, it’s just a basis point or two,’ Chief Economist Amy Crews Cutts said… ‘In deep subprime, the rise is more substantial. What stood out to me was the issuers. Those that have been doing this for a decade or more were showing the ‘better’ performance, while those that were relative newcomers were in the ‘worse’ category.’”

August 16 – Bloomberg (Michelle Jamrisko): “U.S. housing starts stumbled in July on an abrupt slowdown in apartment construction and a modest decline in single-family homebuilding that shows the industry will do little to spur the economy… Residential starts decreased 4.8% to a 1.16 mln annualized rate (est. 1.22 mln). Multifamily home starts slumped 15.3%, one-family down 0.5%. Permits, a proxy for future construction, fell 4.1% to 1.22 mln rate.”

August 15 – Bloomberg (Michelle Jamrisko): “Sentiment among American homebuilders unexpectedly increased to a three-month high as builders saw greater prospects for industry demand despite elevated material costs and shortages of labor and lots, according to… the National Association of Home Builders/Wells Fargo. Builders’ Housing Market Index increased to 68 (est. 64) from 64 in July. Measure of six-month sales outlook rose to 78 from 73. Index of current sales climbed to 74 after 70.”

August 15 – CNBC (Diana Olick): “The cost of housing is rising at a fast clip, and nowhere is it more apparent than in the market for newly built homes. Sales there are rising, but only on the higher end, and that is leaving the majority of entry-level buyers out of luck… While homebuilders claim they are trying to target the high demand from entry-level buyers, the numbers simply don't show that. More affordable homes, those priced under $200,000, made up 44% of the market in 2010. Today, they are just 16% of new, for-sale construction… During the same period, the share of newly built homes priced between $200,000 and $400,000 has grown to 55% from 43%. Going even further up the price scale, the share of new homes priced above $400,000 has more than doubled to 29% of the market from 13%.”

August 14 – Bloomberg (Luke Kawa): “U.S. stocks have been able to hit fresh highs this year despite a dearth of demand from a key source of buying. Share repurchases by American companies this year are down 20% from this time a year ago, according to Societe Generale global head of quantitative strategy Andrew Lapthorne. Ultra-low borrowing costs had encouraged large firms to issue debt to buy back their own stock, thereby providing a tailwind to earnings-per-share growth. ‘Perhaps over-leveraged U.S. companies have finally reached a limit on being able to borrow simply to support their own shares,’ writes Lapthorne. Repurchase programs account for the lion’s share of net inflows into U.S. equities during this bull market.”

Europe Watch:

August 14 – Reuters (Gernot Heller): “German Finance Minister Wolfgang Schaeuble said… that the European Central Bank's ultra-loose monetary policy would come to an end in the foreseeable future, but interest rates would remain low. Regarding the end of the period of low interest rates, Schaeuble said: ‘There are signs that it is gradually getting better.’ Speaking at an campaign rally ahead of a Sept. 24 election, the veteran conservative said: ‘No one seriously disputes that interest rates are rather too low for the strength of the German economy and the exchange rate of the euro, which is rising now.’ Schaeuble said most people expected the ECB to take a further step at a September meeting towards gradually quitting its very expansive monetary policy.”

Japan Watch:

August 13 – Bloomberg (Keiko Ujikane): “Japan’s economy grew for a sixth straight quarter, extending the longest expansion in more than a decade, as a strong pick-up in demand at home compensated for softer exports. Gross domestic product increased by an annualized 4.0% in the three months ended June 30 (estimate +2.5%), compared with a revised 1.5% in the previous quarter.”

August 16 – Wall Street Journal (Peter Landers): “Amid a welter of conflicting views over North Korea, there is one reliable standby. Japan’s prime minister has agreed with President Donald Trump, every time. Shinzo Abe is the type of leader to repeat talking points in measured words, while Mr. Trump is known for issuing aggressive statements unpredictably. On substance, however, they are in the same place… ‘I think highly of President Trump’s commitment toward the security of allies,’ Mr. Abe said Tuesday after a 30-minute phone call with the president, the ninth time the two leaders have spoken by telephone since Mr. Trump’s inauguration. The two have also met three times this year in person…”

EM Bubble Watch:

August 16 – Financial Times (Adam Samson): “Investors in exchange-traded funds have garnered increasing sway over emerging-market stocks and bonds, Citigroup said…, underscoring the swelling importance to global markets of passive instruments. ETFs that track EM assets now have almost $250bn dollars under management, with $196bn in equities and $48bn in fixed income... That represents close to a fifth of total emerging-market mutual fund AUM. Just two years ago, the figure was just above 12%. The figures highlight how the boom in passive investing is not limited just to developed markets that have more liquid assets. In fact, the sixth-biggest ETF by assets tracks emerging markets stocks… ‘ETF flows themselves increasingly representative of asset class sentiment as a whole,’ notes Citi’s Luis Costa.”

Geopolitical Watch:

August 16 – CNBC (Justina Crabtree): “While the world has focused on North Korea, the globe's two biggest emerging economies are squaring off over their shared border. China and India's borderlands, though geographically desolate and inhospitable, have been a hot spot for increasing military tension in recent months. The two giants are wrestling more broadly for hegemony in Asia, and given that both are equipped with nuclear weapons, the situation could escalate. ‘Both sides stand to lose tremendously, economically speaking, should this boil over into an actual war,’ wrote Asia analysts Shailesh Kumar and Kelsey Broderick at consulting firm Eurasia Group.”

August 15 – Reuters: “Indian and Chinese soldiers were involved in an altercation in the western Himalayas on Tuesday, Indian sources said, further raising tensions between the two countries, which are already locked in a two-month standoff in another part of the disputed border. A source in New Delhi, who had been briefed on the military situation on the border, said soldiers foiled a bid by a group of Chinese troops to enter Indian territory in Ladakh, near the Pangong lake.”

August 15 – Reuters: “Iran could abandon its nuclear agreement with world powers ‘within hours’ if the United States imposes any more new sanctions, Iranian President Hassan Rouhani said… If America wants to go back to the experience (of imposing sanctions), Iran would certainly return in a short time - not a week or a month but within hours - to conditions more advanced than before the start of negotiations,’ Rouhani told a session of parliament… Iran says new U.S. sanctions breach the agreement it reached in 2015 with the United States, Russia, China and three European powers in which it agreed to curb its nuclear work in return for the lifting of most sanctions.”

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