Saturday, October 28, 2017

Weekly Commentary: Must Stop Digging

Amazon, Google, Microsoft, Intel and Draghi all handily beat expectations. Booming technology earnings confirm the degree to which Bubble Dynamics have become entrenched within the real economy. Draghi confirms that central bankers remain petrified by the thought of piercing Bubbles.

There is a prevailing view that Bubbles reflect asset price gains beyond what is justified by fundamental factors. I counter with the argument that the inflation of underlying fundamentals – revenues, earnings, cash-flow, margins, etc. – is a paramount facet of Bubble Dynamics (How abruptly did the trajectory of earnings reverse course in 2001 and 2009?).

With extremely low rates, loose corporate Credit Availability, large deficit spending, inflating asset prices and a glut of “money” sloshing about, there is bountiful fodder for spending and corporate profits. And with technology one of the more beguiling avenues to employ the cash-flow bonanza – and tech start-ups, the cloud, AI, Internet of Things, robotics, cybersecurity, etc. white-hot right now – the Gargantuan Technology Oligopoly today luxuriates at the Bubble Core.

By this time, expanding global technology capacity is a straightforward endeavor, while the industry for now enjoys booming demand and outsized margins. This confluence of extraordinary attributes provides “tech” the latitude to operate as a powerful black hole absorbing global purchasing power (throughout economies as well as financial markets). As such, it has been a case of the greater the scope of the Bubble, the more supply of “tech” available to weigh on overall goods and services pricing pressures. Central bankers continue to misconstrue this dynamic, instead perceiving irrepressible disinflationary forces that they are compelled to counter (with year after year after year of flagrant monetary stimulus).

The Nasdaq Composite’s 24.5% y-t-d gain has provided a fantastic windfall to fortunate investors as well as tens of thousands of extremely fortunate employees. This financial godsend will exacerbate wealth disparities along with housing inflation in select localities. Yet there will be little boost to reported wages (capital gains instead) and negligible impact on the overall CPI index. Is CPI these days even a relevant gauge of inflationary pressures or monetary instability?

As for Mario Draghi’s practice of beating market expectations, he is the present-day Alan Greenspan – the savvy operator that over the years has grown too comfortable wielding power over global markets (not to mention over central bankers at home and abroad). Headline from the Financial Times: “Draghi Pulls Off Dovish Trick with His QE ‘Downsize’ - ECB President Determined Not to Repeat Mistake of Premature Tightening.”

The ECB – right along with central bankers around the globe – has replayed the fateful mistake of delaying for (way) too long the removal of monetary stimulus. Draghi refused to set a date to end the ECB’s “money” printing operations, ensuring at least several hundred billion of additional stimulus in 2018. And with the commitment to hold rates at the current negative level until well past the end of QE, a most inert “normalization” process will not even commence until well into 2019. Apparently, short rates likely won’t make it much past 1% for several years. Draghi’s central bank will continue to purchase large quantities of corporate debt next year. Moreover, with open-ended QE and assurances that operations could at any point be expanded, spoiled markets take great comfort that their beloved liquidity backstop is as unyielding as ever.

October 26 – Bloomberg (Alessandro Speciale and Mark Deen): “The European Central Bank should have decided on an end date for its asset-purchase program rather than retaining the option to extend it after September 2018, Bundesbank President Jens Weidmann said. ‘From my point of view, a clear end of net purchases would have been appropriate,’ Weidmann said in a speech… ‘The development of domestic price pressures shown in projections is in line with a trajectory that will take us toward our definition of price stability.’ Weidmann’s critique comes one day after the Governing Council extended quantitative easing until September at a monthly pace of 30 billion euros ($35bn), leaving the door open for further buying after that if needed. The Bundesbank president was among a handful of policy makers who didn’t support the decision, according to Germany’s Boersen-Zeitung.”

German stocks gained 1.7% this week, while French equities jumped 2.3%. German (38bps) and French (79bps) yields declined seven basis points to seven-week lows. Portuguese bond yields dropped 11 bps to a 30-month low 2.19%. Dropping nine bps, Italian 10-year yields traded back below 2%. And in a sign of these strange times, even Catalonia chaos couldn’t keep Spanish yields from declining eight bps to 1.58% (83bps below Treasuries!). Yet Draghi has company when it comes to assuring markets that central bank liquidity backstops are here to stay.

October 20 – Financial Times (Sam Fleming): “Janet Yellen… has warned that there is an ‘uncomfortably high’ risk that the central bank will have to deploy crisis-era stimulus tools again — even in the case of a less severe downturn than the Great Recession. Her comments come as President Donald Trump considers a sharp change of direction at the Fed which could see him install new leadership that is much more dubious about the Fed’s use of quantitative easing. Ms Yellen said in a speech that the US economy had made ‘great strides’ but that policymakers may be unable to lift short-term rates very far as the recovery proceeds. This could leave the Fed once again leaning on quantitative easing and forward guidance on the future rate outlook when the economy hits a downturn, she suggested… ‘Does this mean that it will take another Great Recession for our unconventional tools to be used again? Not necessarily. Recent studies suggest that the neutral level of the federal funds rate appears to be much lower than it was in previous decades,’ Ms Yellen said. ‘The bottom line is that we must recognise that our unconventional tools might have to be used again. If we are indeed living in a low-neutral-rate world, a significantly less severe economic downturn than the Great Recession might be sufficient to drive short-term interest rates back to their effective lower bound.’”

Apparently, there is an “uncomfortably high risk” that QE will be employed “in the case of a less severe downturn” because “policymakers may be unable to lift short-term rates very far as the recovery proceeds.” Does anyone believe that the Yellen Fed is less than comfortable with the prospect of restarting QE?

Q3 marked the second consecutive quarter of 3% U.S. growth; consumer confidence is the highest in years; stock markets are booming with record prices and “money” flooding into ETFs; debt issuance remains on record pace; leveraged lending and M&A are booming; a strong inflationary bias persists in housing; and the unemployment rate is down to 4.2%, lowest in 16 years. Why not begin a real normalization of monetary policy? Because some measures of core consumer price inflation remain slightly below 2.0%?

It has become increasingly apparent that central bankers recognize their predicament and have chosen not to risk piercing Bubbles. I suspect Draghi, Yellen and Kuroda (and others) fear the consequences of a destabilizing jump in global bond yields. I too fear the amount of leverage and range of distortions that have accumulated over the past nine years. The inescapable adjustment after such a prolonged boom will be quite difficult. Yet the analysis gets back to the “First Law of Holes:” Must Stop Digging. At this late (historic) Bubble stage, systemic risk is piling up exponentially.

October 24 – Financial Times (Robin Wigglesworth): “Inflows into exchange-traded bond funds have surged past last year’s record with several months to spare, as the seismic migration towards passive investing broadens out beyond the equity market. ETFs that track fixed-income benchmarks have attracted nearly $130bn so far this year, comfortably surpassing the record-breaking 2016, when almost $117bn gushed into bond ETFs… Bloomberg data puts this year’s inflows at more than $140bn. ‘It’s been a year of robust flows,’ said Steve Laipply, head of fixed income strategy at BlackRock’s iShares ETF business… ‘There has been accelerating institutional investor adoption of these products’… ETF providers such as Vanguard, State Street and BlackRock have rapidly grown their franchises, with BlackRock revealing in its latest quarterly earnings that it is currently taking in about $1.5bn a day.”

October 22 – Wall Street Journal (Christopher Whittall): “Investors hungry for returns are piling back into securities once tarnished by the financial crisis. Complex structured investments developed a bad reputation during the credit crunch. Ten years later, investors seeking yield are overcoming their skepticism and buying into securities that rely on financial engineering to juice returns. Volumes of CLOs, or collateralized loan obligations, hit a record $247 billion in the first nine months of the year… Fueled by a wave of refinancings and nearly $100 billion in new deals, that far outpaces their recent full-year high of $151 billion in 2014 and the precrisis peak of $136 billion in 2006. The CLO boom is the latest sign of the ferocious hunt for yield permeating markets. Stellar performance over the past year has made CLOs increasingly hard to ignore for investors like insurance companies and pension funds.”

October 20 – Financial Times (Gillian Tett): “A decade ago, whenever I chatted to anyone at Switzerland’s Bank for International Settlements, I felt like I was hobnobbing with dissidents. The reason? Back then, most western central bankers and finance ministers were convinced that the global economy was in good shape: inflation was low, growth was steady, corporate and consumer optimism was high. In fact, the data seemed so benign that economists had labelled the first decade of the 21st century the ‘great moderation’. Not the BIS. Starting in 2003, officials at… institution, which aims to ‘promote global monetary and financial stability through international co-operation’, started to warn that the world economy was plagued by excessive levels of debt. This made the system dangerously distorted; so went the off-the-record murmurs from men such as William White… and Claudio Borio... Most central bankers dismissed these warnings — some even tried to silence the BIS… Earlier this month I travelled to Washington for an International Monetary Fund and World Bank meeting. There was a cheery mood in the air, just as there was in 2006… But now, just as before, those BIS dissidents are muttering in the wings. At the IMF gala, Borio (still at the BIS) told me that the pesky matter of debt has not disappeared. On the contrary, since the 2008 credit crisis, it has risen sharply: the level of global debt to gross domestic product is now 40% — yes, 40% — higher than it was in 2008. The world has responded to a crisis caused by excess leverage by piling on more, not less, debt.”

There are aspects of the current global Bubble that are reminiscent of pre-2008 crisis – though the amount of debt these days is larger, price distortions greater and misperceptions more perilous. Then: “Washington will not allow a housing bust.” Now: Global central bankers will not allow market dislocation. Unprecedented market distortions – including Trillions of mispriced “AAA” debt securities – back in 2008 look pee-wee when compared to today’s fiasco in perceived money-like instruments (fixed-income as well as equities)

At the same time, today’s “tech” party is more 1999 – just so much more expansive. Loose “money” coupled with government/central bank backstops have nurtured another epic sector mania – replete with more dangerous regional economic and housing Bubbles. Today’s EM backdrop has uncomfortable characteristics reminiscent of 1996, with the current “hot money” onslaught compounding already acute financial, economic, social and geopolitical fragilities from Asia to Eastern Europe to Latin America.

And there are elements of fixed-income excess that recall all the way back to 1993. The proliferation of leveraged derivatives strategies cultivates latent fragility. Meanwhile, the scope of flows into fixed-income ETFs at this late stage of the cycle is astonishing – yet, as they say, “par for the course.” It’s consistent with the flood of funds into passive U.S. equities indices and the emerging markets; the near-panic buying of European and U.S. corporate debt – the tsunami of “money” inundating virtually all risk assets via the ballooning ETF complex.

What most sets today’s Granddaddy of All Bubbles apart? Historic excess and distortion throughout the securities and derivatives markets – and asset markets more generally – on an unprecedented synchronized, systemic global scale. It’s become myriad powerful booms all packed into one killer Bubble unlike the world has ever experienced. History will not be kind to central banker fixation on arbitrary 2% annual CPI targets. Nasdaq inflated 2.2% in Friday’s session – the Nasdaq100 2.9%!


For the Week:

The S&P500 added 0.2% (up 15.3% y-t-d), and the Dow increased 0.5% (up 18.6%). The Utilities added 0.3% (up 13.2%). The Banks rose 1.0% (up 11.4%), and the Broker/Dealers increased 0.4% (up 20.4%). The Transports slipped 0.4% (up 9.8%). The S&P 400 Midcaps gained 0.3% (up 10.8%), while the small cap Russell 2000 was little changed (up 11.1%). The Nasdaq100 jumped 1.7% (up 27.8%). The Semiconductors surged 2.6% (up 39.4%). The Biotechs dropped 3.0% (up 33.9%). Bullion declined $7, while the HUI gold index was slammed 5.3% (up 2.6%).

Three-month Treasury bill rates ended the week at 107 bps. Two-year government yields added a basis point to 1.59% (up 40bps y-t-d). Five-year T-note yields added one basis point to 2.03% (up 10bps). Ten-year Treasury yields gained two bps to 2.41% (down 4bps). Long bond yields rose two bps to 2.92% (down 15bps).

Greek 10-year yields were little changed at 5.49% (down 153bps y-t-d). Ten-year Portuguese yields dropped 11 bps to 2.19% (down 155bps). Italian 10-year yields fell nine bps to 1.95% (up 14bps). Spain's 10-year yields declined nine bps to 1.59% (up 21bps). German bund yields fell seven bps to 0.38% (up 18bps). French yields declined seven bps to 0.79% (up 11bps). The French to German 10-year bond spread was little changed at 41 bps. U.K. 10-year gilt yields gained two bps to 1.35% (up 11bps). U.K.'s FTSE equities slipped 0.2% (up 5.1%).

Japan's Nikkei 225 equities index surged 2.6% to a 20-year high (up 15.1% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.07% (up 3bps). France's CAC40 jumped 2.3% (up 13%). The German DAX equities index rose 1.7% (up 15.1%). Spain's IBEX 35 equities index slipped 0.2% (up 9.0%). Italy's FTSE MIB index gained 1.4% (up 17.8%). EM equities were mixed. Brazil's Bovespa index declined 0.5% (up 26.1%), and Mexico's Bolsa fell 1.6% (up 7.8%). India’s Sensex equities index jumped 2.4% (up 24.5%). China’s Shanghai Exchange gained 1.1% (up 10.1%). Turkey's Borsa Istanbul National 100 index declined 0.6% (up 38.1%). Russia's MICEX equities index was little changed (down 7.3%).

Junk bond mutual funds saw inflows of $123 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose six bps to a 14-week high 3.94% (up 47bps y-o-y). Fifteen-year rates gained six bps to 3.25% (up 47bps). Five-year hybrid ARM rates added four bps to 3.21% (up 37bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up nine bps to a 15-week high 4.20% (up 53bps).

Federal Reserve Credit last week declined $5.0bn to $4.428 TN. Over the past year, Fed Credit slipped $2.4bn. Fed Credit inflated $1.608 TN, or 57%, over the past 259 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt slipped $0.3bn last week to $3.365 TN. "Custody holdings" were up $240bn y-o-y, or 7.7%.

M2 (narrow) "money" supply last week declined $20.8bn to $13.727 TN. "Narrow money" expanded $666bn, or 5.1%, over the past year. For the week, Currency increased $2.4bn. Total Checkable Deposits fell $17.6bn, and Savings Deposits declined $5.6bn. Small Time Deposits were unchanged. Retail Money Funds were little changed.

Total money market fund assets added $3.6bn to $2.748 TN. Money Funds rose $97bn y-o-y, or 3.6%.

Total Commercial Paper gained $5.5bn to $1.067 TN. CP gained $164bn y-o-y, or 18.2%.

Currency Watch:

The U.S. dollar index gained 1.3% to 94.916 (down 7.3% y-t-d). For the week on the upside, the South Korean won increased 0.1%. For the week on the downside, the South African rand declined 3.3%, the Swedish krona 2.5%, the Norwegian krone 2.0%, the Australian dollar 1.8%, the euro 1.5%, the Canadian dollar 1.4%, the Swiss franc 1.4%, the Brazilian real 1.3%, the New Zealand dollar 1.2%, the Mexican peso 0.7%, the British pound 0.5%, the Singapore dollar 0.3% and the Japanese yen 0.1%. The Chinese renminbi decline 0.45% versus the dollar this week (up 4.43% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index jumped 2.4% (up 3.4% y-t-d). Spot Gold slipped 0.5% to $1,274 (up 10.6%). Silver lost 1.9% to $16.752 (up 4.8%). Crude rose $2.06 to $53.90 (unchanged). Gasoline surged 5.4% (up 6%), and Natural Gas rose 1.7% (down 21%). Copper dropped 2.0% (up 24%). Wheat increased 0.3% (up 5%). Corn gained 1.2% (down 1%).

Trump Administration Watch:

October 26 – Bloomberg (Maria Tadeo, Esteban Duarte, and Rodrigo Orihuela): “President Donald Trump stoked the sense of drama surrounding his choice for the next Fed chairman Friday as he tweeted out a video teasing an announcement he said would come next week. The president is leaning toward appointing Federal Reserve Governor Jerome Powell to be the next chairman of the Fed, according to three people familiar with the matter. ‘People are anxiously awaiting my decision as to who the next head of the Fed will be,’ Trump said in short Instagram video he sent to his 41 million Twitter followers. ‘It will be a person who hopefully will do a fantastic job. And I have somebody very specific in mind.’”

October 26 – CNBC (Jeff Cox): “The race to see who will lead the Federal Reserve in 2018 and beyond is becoming a process of elimination, with two and perhaps three candidates remaining. President Donald Trump apparently has solidified his thinking and is now choosing between Fed Governor Jerome ‘Jay’ Powell and Stanford economist John Taylor. However, several twists have been interjected into the equation. ‘Trump changes his mind about it everyday,’… The site speculated that current Chair Janet Yellen remains in the mix because Trump is worried that removing her might disrupt the hardy stock market rally that has taken place since his election.”

October 26 – Associated Press (Marcy Gordon): “President Donald Trump and Republicans were at odds on Wednesday over changing the 401(k) retirement program to help finance tax cuts, with the president insisting the middle-class favorite will remain untouched and lawmakers open to revisions. Rep. Kevin Brady, the chairman of the House’s tax-writing panel, wouldn’t rule out changes to the program used by 55 million U.S. workers who hold some $5 trillion in their 401(k) accounts, a system that has become a touchstone of retirement security for the middle class. Earlier this week, Trump promised the program would be left alone, and appeared to bolster that pledge Wednesday, saying he moved swiftly to end speculation that the tax-deferred program may be changed because it’s vital for working Americans. But he went on to muddy the waters…”

October 25 – Wall Street Journal (Michael C. Bender and Kristina Peterson): “The fault lines within the Republican Party cracked further on Tuesday as feuding between President Donald Trump and senators intensified within the U.S. Capitol, and anti-establishment activists claimed political momentum outside of it. Arizona Sen. Jeff Flake, in a speech where he announced he wouldn’t seek re-election, sharply criticized Mr. Trump, declaring himself unwilling to follow the lead of a president whose behavior in office is ‘not normal’ and ‘dangerous to a democracy.’”

Federal Reserve Watch:

October 24 – New York Times (Binyamin Appelbaum): “The two men that President Trump is considering as replacements for Chairwoman Janet L. Yellen of the Federal Reserve have sharply different views on monetary policy, offering a stark test of Mr. Trump’s economic priorities. The choice pits a status quo candidate, a current Fed governor, Jerome H. Powell, against a Stanford University economics professor, John B. Taylor, who is celebrated by many conservative Republicans for his insistence that the economy would produce stronger growth if the Fed would just get out of the way. Mr. Trump said last week that he also might nominate Ms. Yellen, whom he said he liked ‘a lot,’ to a second term. He said Monday that a decision is ‘very, very close.’ At a meeting with Senate Republicans on Tuesday, Mr. Trump conducted an informal poll, asking for a show of hands in support of Mr. Powell and Mr. Taylor.”

U.S. Bubble Watch:

October 25 – Bloomberg (Sho Chandra): “U.S. purchases of new homes unexpectedly surged in September to the highest level in a decade as activity accelerated in the South after hurricanes Harvey and Irma… Single-family home sales rose 18.9% m/m to 667k annualized pace (est. 554k), the strongest since October 2007. Purchases in U.S. South surged 25.8% m/m to 405k rate, fastest since July 2007… Supply of homes at current sales rate dropped to 5 months from 6 months; 279,000 new houses were on market at end of September.”

October 22 – Financial Times (Gregory Meyer and Joe Rennison): “Intense price swings in cryptocurrencies are luring the highest-volume traders on Wall Street as they search for relief from the low volatility blanketing finAncial markets. Proprietary trading firms, which bet their own capital in markets from stocks to futures, are wading into bitcoin, ethereum and other cryptocurrencies better known as a playground for small speculators and a haven for money-laundering. DRW of Chicago, one of the world’s largest proprietary trading companies, has led the charge.”

China Bubble Watch:

October 23 – Financial Times (Gideon Rachman): “The Communist party congress in Beijing is a milestone. As the Xi Jinping era enters its second term, China’s challenge to the west is becoming more overt. There is a growing official confidence in Beijing — verging on arrogance — that China is on the rise, while the west is in decline. The Chinese challenge to the west is taking place on three fronts: ideological, economic and geopolitical. In the realm of ideas, the Communist party leadership is increasingly strident in repudiating western liberalism. President Xi and his colleagues argue that one-party rule works well for China — and should extend long into the future. There is more discussion of the idea that a ‘China model’ can be pushed in the rest of the world — as an alternative to America’s promotion of democracy. Just as the financial crisis of 2008 damaged the credibility of western economic ideas in China, so the election of Donald Trump and the fracturing of the EU have made it easier for China’s leaders to scorn western political practices.”

October 24 – Bloomberg: “Whether or not Chinese President Xi Jinping signals a successor Wednesday, he’s amassed enough power to effectively rule for decades. The Communist Party approved a sweeping charter revision at the end of its twice-a-decade congress Tuesday that elevates Xi to a status alongside the nation’s most vaunted political figures. The document put Xi’s contributions on par with those of Mao Zedong and Deng Xiaoping and also declared him the party’s ‘core’ leader indefinitely.”

October 24 – Bloomberg (Ting Shi and Keith Zhai): “Chinese President Xi Jinping unveiled a new leadership line-up that didn’t include a clear potential heir, breaking with a quarter-century-old succession system and raising the chances that he might seek to stay in office beyond 2022.”

October 25 – Wall Street Journal (Jeremy Page and Chun Han Wong): “The future of 1.4 billion people, the world’s second-largest economy and an emerging military juggernaut now lies largely in the hands of just one man: China’s President Xi Jinping. In unveiling a new top leadership lineup without a potential successor to Mr. Xi…, the Communist Party edged closer to resurrecting one-man rule, four decades after the death of Chairman Mao. The parade of the seven-man Politburo Standing Committee onto a red-carpeted podium in Beijing’s Great Hall of the People was the climax of a twice-a-decade process that placed Mr. Xi on a par with Mao in the party constitution and positioned him as pre-eminent leader even beyond his second five-year term… Mr. Xi is calculating that strongman rule will make it easier to add China to the ranks of rich, global powers and to project Chinese power globally.”

October 24 – CNBC (Sri Jegarajah): “China is looking to make a major move against the dollar's global dominance, and it may come as early as this year. The new strategy is to enlist the energy markets' help: Beijing may introduce a new way to price oil in coming months — but unlike the contracts based on the U.S. dollar that currently dominate global markets, this benchmark would use China's own currency. If there's widespread adoption, as the Chinese hope, then that will mark a step toward challenging the greenback's status as the world's most powerful currency. China is the world's top oil importer, and so Beijing sees it as only logical that its own currency should price the global economy's most important commodity. But beyond that, moving away from the dollar is a strategic priority for countries like China and Russia. Both aim to ultimately reduce their dependency on the greenback, limiting their exposure to U.S. currency risk and the politics of American sanctions regimes.”

October 22 – Financial Times (Gabriel Wildau and Tom Mitchell): “When Zhou Xiaochuan last week used the phrase ‘Minsky moment’ to warn against complacency during the current period of unexpectedly strong Chinese growth, it was not the first time the central bank chief had highlighted risks from excessive debt and speculative investment. But Mr Zhou, governor of the People’s Bank of China, would surely have known that the colourful phrase — redolent of the 2008 financial crisis, which resurrected the reputation of the US economist Hyman Minsky — would grab headlines. Mr Zhou’s statements about Chinese economics and policy have become increasingly candid in recent weeks, and central bank watchers say it is no accident. At the same meeting where he warned of Minsky-ite risks, Mr Zhou, 69, confirmed that he would retire ‘soon’ after serving since 2002… As rumours swirl about his possible successor, observers say Mr Zhou’s increasing bluntness reflects a final appeal directed towards Communist party elites to continue financial reforms that he has advocated but that have suffered setbacks over the past year.”

October 22 – Bloomberg: “China home prices rose in the fewest cities since January 2016, adding to signs of a property slowdown as curbs on buyers bite. New-home prices, excluding government-subsidized housing, in September rose in 44 of 70 cities tracked by the government, compared with 46 in August… Prices fell in 18 cities from the previous month and were unchanged in eight… President Xi Jinping renewed a yearlong call that homes are built ‘to be inhabited’ and not for speculation in his speech at the twice-a-decade Party Congress, inking the language in one of the nation’s top policy frameworks.”

October 26 – Bloomberg (Katia Porzecanski): “Hedge fund manager Kyle Bass, who has been betting against the yuan and warning of a collapse in China’s banking system, said the nation will one day come to regret handing Xi Jinping more power than any leader in decades. ‘Today Xi is celebrated in media reports, but when future historians look back, he will be blamed for recklessly building the Chinese economy on a foundation of sand,’ Bass… said… ‘Xi desperately seeks credibility, but true developed economies do not impose severe capital controls or move short-term rates hundreds of basis points overnight in attempts to manipulate their own currency.’ …‘Recklessly growing a banking system in pursuit of global economic growth and respect will cause severe financial instability in the years to come… The dangerous $40 trillion credit experiment with Chinese characteristics will run its course.’”

Central Banker Watch:

October 25 – Financial Times (Claire Jones): “When Mario Draghi evaluated the market reaction to the European Central Bank’s policy announcement on Thursday — its most important of the year — he allowed himself a wry smile. The ECB had just said that its bond buying spree in 2018 was likely to be less than half the size of that spent on quantitative easing this year. And yet the euro had fallen, stock markets were up. That investors bought the line that this was no ‘taper’ but merely a ‘downsize’ of eurozone QE says much about how far the region’s recovery has come over the past 12 months. The ECB’s communication was also ‘pretty effective’, Mr Draghi crowed, in the sense that most analysts had correctly predicted the ECB would promise to buy €30bn in bonds a month from January until September. But it was not just that. In the detail and in his post-meeting remarks, the ECB was more dovish than its watchers had forecast. The message to investors was clear. Under Mr Draghi’s watch, the bank would not make the same mistake it did in 2008 — and again in 2011 — when it raised interest rates, only to find itself having to reverse course, after the collapse of Lehman Brothers in the first instance and then during the region’s sovereign debt crisis. The central bank still reserved the right to boost QE…”

October 24 – Financial Times (Claire Jones): “The European Central Bank is gearing up for its most important meeting of the year, as senior officials gather to decide the fate of the €2.1tn asset purchase scheme that many credit with breathing life into the eurozone recovery. At issue is whether the ECB will declare this week that the economy has recovered sufficiently for quantitative easing to end next year… On one side of Thursday’s debate is Mario Draghi, the ECB’s president, who would like to preserve room for manoeuvre. On the other are more hawkish policymakers, notably from Germany, who have long been uncomfortable with the bank’s ultraloose monetary policy and are keen for the ECB finally to bring the curtain down on QE. The hawks accept that the ECB’s governing council cannot completely rule out buying more bonds. ‘We know that you cannot lock the door,’ said one person familiar with its deliberations. ‘But there are many on the council who want the message to be communicated that the door is nowhere near as open as it once was.’”

October 24 – Wall Street Journal (Christopher Whittall): “In the spring of 2016, traders at Germany’s central bank sat down with investment bank advisers in Frankfurt to discuss a once unthinkable project: how to build a multibillion-euro corporate-debt fund. Fast forward 18 months and the European Central Bank has changed the face of the euro corporate-debt market, having bought almost €120 billion ($141bn) of these securities. Financing costs for companies have fallen to the point where junk-rated firms can borrow at similar yields to U.S. government debt, prompting concerns it is fueling a bubble… ‘When the ECB steps back, it increases vulnerability in the market,’ said Hans Lorenzen, head of European credit strategy at Citigroup…”

October 24 – Financial Times (Dan McCrum): “Canada today, Europe tomorrow, then Japan, the US and England in quick succession. An eight-day parade of central bank meetings will signal the direction for monetary policy. Rather than a return to normal, another lap near zero seems a more likely outcome. The Bank of Canada, after increasing interest rates twice in quick succession, to 1%, has shifted tone. Governor Stephen Poloz recently said ‘we will continue to feel our way cautiously as we get closer to home’. Market expectations have slipped, with prices implying a less than 50/50 chance of another rise this year. Mario Draghi’s European Central Bank has reached the point when announcing a reduction in the €60bn of bonds purchased each month is inevitable. Yet the noise has been about calibration, leading to some new market jargon. Instead of a US-style ‘taper’, expect a European ‘scaling’ of purchases. Leaving its options open, while announcing say nine months of buying at a reduced level, would suggest normality remains a distant prospect.”

October 23 – Wall Street Journal (David Harrison and Harriet Torry): “Leaders of the world’s largest central banks indicated that weak inflation in advanced economies could prolong the postcrisis era of easy money policies. Despite a broad-based improvement in the global economy, wages and consumer prices remain stubbornly low, making central bankers wary of removing their stimulus measures too quickly, they told a Group of 30 banking conference… Their concerns contrasted with the generally upbeat tone that prevailed during last week’s fall meetings of the International Monetary Fund and World Bank, and they suggest that there is still work to do to get the world’s economy on track nearly a decade after the onset of the global financial crisis.”

Global Bubble Watch:

October 24 – Financial Times (Michael Mackenzie): “The endless debate over valuation metrics that have accompanied the storming bull run in stocks misses a much bigger point about investing in 2017. Thanks to the outsized role of central banks, it is the credit markets that run the show. If you want clues on when the bull run in equities is entering the red zone, keep your eyes on the corporate debt market. Before central banks’ quantitative easing policies engineered the current cycle of financial suppression, credit markets had already established their bona fides as an early warning system for investors. When equities peaked in October 2007, the credit market had already begun turning lower. A decade on, the risk premium, or additional yield, offered by corporate bonds over that of a US government bond is at its narrowest since 2007… The big lesson digested by investors since the financial crisis is that you need to own yield, and the money gushing into bond funds remains immense. About $241bn flowed into US high grade bond funds and exchange traded funds in the first nine months of the year, according to Bank of America Merrill Lynch estimates. That’s a whopping 34% higher than 2012’s full-year record of $180bn, the bank says. This high tide of money means companies can keep selling debt — running at a record $1.4tn pace this year in the US — at very low interest rates. The resulting higher leverage in the system helps explain why the equity market keeps updating the record books with alacrity.”

October 24 – CNBC (Fred Imbert): “As stocks have climbed to record levels this year, investors are neglecting one very important aspect of financial markets, according to analysts at Bank of America Merrill Lynch. That aspect is the existence of risk, said Nikolay Angeloff, equity-linked analyst… ‘The market seems to currently imply there is no way a shock can happen,’ he said. ‘We have now recorded 334 days without a 5% or more pullback, the fourth longest period since 1928,’ Angeloff said. ‘If it continues at this pace, it will be the least volatile October in history and third least volatile month ever.’”

Europe Watch:

October 26 – Bloomberg (Maria Tadeo, Esteban Duarte, and Rodrigo Orihuela): “Catalonia is headed for a dramatic confrontation with Spain after the insurgent region’s parliament voted to declare independence and the government in Madrid gained the power to oust its separatist leadership. The resolution approved by lawmakers in Barcelona said the establishment of Europe’s newest sovereign country had been set in motion. The portion of the text submitted to a vote included measures to ask all nations and institutions to recognize the Catalan Republic.”

October 24 – Wall Street Journal (Jeannette Neumann and Giovanni Legorano): “Spanish Prime Minister Mariano Rajoy asked lawmakers to grant him unprecedented power to remove the leaders of Catalonia and temporarily control the region from Madrid, a forceful move aimed at bringing the separatist movement to heel. Mr. Rajoy on Saturday said Spain’s central government ministries would administer the region’s agencies until new elections are called, a shake-up meant to quell Catalan leaders’ insurrection.”

October 24 – Reuters (Renee Maltezou): “Outgoing German Finance Minister Wolfgang Schaeuble urged debt-wracked Greece to stop blaming others for its financial woes and stick to a reform agenda instead of relying on debt relief. Schaeuble, a leading advocate of Greece’s tough austerity programs and one of Germany’s most powerful politicians, was elected speaker of its lower house of parliament… ‘When you ask others for loans, you cannot insult them for granting the loans. It doesn’t make sense. Greece’s problems are Greece’s problems,’ the conservative Christian Democrat said in an interview aired in Greece…”

Brexit Watch:

October 22 – Reuters (Alastair Macdonald): “Theresa May looked ‘despondent’, with deep rings under her eyes, EU chief executive Jean-Claude Juncker told aides after dining with the British prime minister last week… The report by a Frankfurter Allgemeine Zeitung correspondent whose leaked account of a Juncker-May dinner in April caused upset in London, said Juncker thought her ‘marked’ by battles over Brexit with her own Conservative ministers as she asked for EU help to create more room for maneuver at home.”

Japan Watch:

October 22 – Bloomberg (Isabel Reynolds): “Prime Minister Shinzo Abe’s gamble on an early election may have just won him a chance to lead Japan through 2021. Abe… saw his ruling coalition retain its two-thirds majority in the 465-member lower house in an election on Sunday. That boosts his chances at winning another term next year as head of his Liberal Democratic Party… The landslide win -- helped along by a disparate and weak opposition -- paves the way for more ultra-easy monetary policy that has boosted stocks to the highest level in two decades and helped Asia’s second-biggest economy expand for six straight quarters. Yet pressure is also growing for Abe to tackle Japan’s swollen debt, increase stagnant wages and overhaul the labor market to replenish a rapidly aging workforce.”

Emerging Market Watch:

October 24 – Bloomberg (Ben Bartenstein): “John-Paul Smith won’t give up on his bearish bet against developing nations. The founder of research firm Ecstrat Ltd., renowned for his early warning of Russia’s equity-market plunge in 1998 while at Morgan Stanley, is finding plenty of places to direct his pessimism. Among his latest concerns: authoritarian regimes in China and Russia as well as governments in Thailand, Turkey and the Philippines shifting in that direction. Smith’s caution runs counter to recent history, in which the world’s autocratic nations have rewarded bond traders with larger returns than democratic countries. While that may be true in the early stages of a regime, he says an authoritarian rule eventually hurts productivity with the value of debt and equity assets taking a hit. ‘I’m struggling to identify any attractive bets for emerging markets under authoritarian regimes,’ Smith said… ‘The notion that both sovereign and corporate governance throughout the world will gradually converge towards some supposed liberal norm is now well and truly dead.’”

October 26 – Bloomberg (Colleen Goko, Neo Khanyile, and Thembisile Dzonzi): “The rand and South African bonds extended declines as foreign investors dumped the country’s notes in the wake of government forecasts for higher public debt and wider budget deficits in the next three years. Stocks rose to a record as gains for rand hedges offset drops for banks and retailers. The nation’s currency extended its longest losing streak in a month, while the yield on benchmark 10-year notes rose to the highest in 16 months.”

Leveraged Speculation Watch:

October 23 – Financial Times (Robin Wigglesworth): “Two Sigma has vaulted over the $50bn assets under management mark to put it on a par with Renaissance Technologies as the biggest global quantitative hedge fund, as investors continue to pile into computer-powered investment strategies. The… hedge fund set up in 2001 by computer scientist David Siegel and mathematician John Overdeck has been growing rapidly in recent years. Two Sigma managed about $6bn in 2011, but jumped past the $50bn mark earlier this month… That puts it roughly level with Renaissance Technologies… and more than DE Shaw’s $45bn… Investor demand for algorithmic investing has exploded in recent years, even as the rest of the hedge fund industry has struggled with poor performance and outflows. Morgan Stanley recently estimated that various quant strategies, ranging from cheap next-generation exchange traded funds to pricey sophisticated hedge fund vehicles, have grown at 15% annually over the past six years, and now control about $1.5tn.”

Geopolitical Watch:

October 25 – Reuters (David Alexander, David Brunnstrom and Idrees Ali): “The recent warning from North Korea’s foreign minister of a possible atmospheric nuclear test over the Pacific Ocean should be taken literally, a senior North Korean official told CNN… ‘The foreign minister is very well aware of the intentions of our supreme leader, so I think you should take his words literally,’ Ri Yong Pil, a senior diplomat in North Korea’s Foreign Ministry, told CNN.”

October 21 – Reuters (Jim Finkle): “The U.S government issued a rare public warning that sophisticated hackers are targeting energy and industrial firms, the latest sign that cyber attacks present an increasing threat to the power industry and other public infrastructure. The Department of Homeland Security and Federal Bureau of Investigation warned in a report… that the nuclear, energy, aviation, water and critical manufacturing industries have been targeted along with government entities in attacks dating back to at least May.”

October 21 – Reuters (Dirimcan Barut and Tulay Karadeniz): “Turkish President Tayyip Erdogan showed no retreat from a diplomatic row with the United States…, castigating Washington for what he said an ‘undemocratic’ indictment against his security detail. His comments may further dash hopes of a quick resolution to an on-going diplomatic crisis between the NATO allies. Both Ankara and Washington have cut back issuing visas to each other’s citizens as ties have worsened.”

October 24 – Reuters (Maher Chmaytelli): “Iraqi Prime Minister Haider al-Abadi defended the role of an Iranian-backed paramilitary force at a meeting with U.S. Secretary of State Rex Tillerson… Tillerson arrived… hours after the Iraqi government rejected his call to send home the Popular Mobilisation, an Iran-backed force that helped defeat Islamic State and capture the Kurdish-held city of Kirkuk. In his opening remarks at the meeting with Tillerson, Abadi said Popular Mobilisation ‘is part of the Iraqi institutions,’ rejecting accusations that it is acting as an Iranian proxy.”