The S&P500 declined only 0.2%, ending eight consecutive weekly gains. But the more dramatic moves were elsewhere. Big European equities rallies reversed abruptly. Germany’s DAX index traded up to an all-time high 13,526 in early Tuesday trading before reversing course and sinking 2.9% to end the week at 13,127. France’s CAC40 index opened Tuesday at the high since January 2008, only to reverse and close the week down 2.5%. Italy’s MIB Index traded as high as 23,133 Tuesday before sinking 2.5% to end the week at 22,561. Similarly, Spain’s IBEX index rose to 10,376 and then dropped 2.7% to close Friday’s session at 10,093.
Having risen better than 20% since early September, Japanese equities have been in speculative blow-off mode. After trading to a 26-year high of 23,382 inter-day on Thursday, Japan’s Nikkei 225 index sank as much as 859 points, or 3.6%, in afternoon trading. The dollar/yen rose to an eight-month high 114.73 Monday and then ended the week lower at 113.53. From Tokyo to New York, banks were hammered this week.
Perhaps the more important developments of the week unfolded in fixed-income. Despite the selloff in the region’s equities markets, European sovereign debt experienced no safe haven bid. German bund yields traded at 0.31% on Wednesday, before a backup in rates saw yields close the week at 0.41%. Italian bond yields traded as low as 1.69% on Wednesday before closing the week at 1.84%. Spain’s yields ended the week up 10 bps to 1.56%.
November 9 – Bloomberg (Molly Smith): “The run-up in junk bonds is showing signs of returning to earth. After a spate of bad news triggered sell-offs of a few big speculative-grade borrowers, the pain has spread and even led NRG Energy Inc. to pull a $870 million bond offering on Thursday. Exchange-traded funds that buy high-yield debt have plunged the most since August, with $563 million of retail outflows since the start of this week alone. Three of the biggest junk-rated borrowers, IHeartMedia Inc., CenturyLink Inc. and Community Health Systems Inc., posted disappointing earnings that sent their bonds plunging.”
November 10 – Wall Street Journal (Ben Eisen and Sam Goldfarb): “A red-hot bond market is turning more frosty toward junk-rated issuers. Investors demanded a 3.79 percentage point premium, or spread, over going rates to own junk bonds, the highest in nearly two months on Thursday… That’s up from 3.38 percentage point on Oct. 24, near its lowest since the financial crisis. The market gyrations suggest a shift away from particularly easy conditions that were on full display just a few months ago.”
November 9 – Bloomberg (Dani Burger): “As U.S. markets swim in sea of red, trading in the largest high-yield exchange-traded funds has skyrocketed to dizzying levels. The iShares iBoxx High Yield Corporate Bond ETF, Blackrock Inc.’s $18.7 billion fund, saw volume spike over five times higher than its average level… At more than 23.8 million shares, trading in the largest junk-bond fund has already surpassed its one-day average of 11 million for the past year -- outpacing volume notched in August amid saber-rattling between the U.S. and North Korea.”
NRG’s large refinancing was the first junk deal pulled since June. Friday then saw Canyon Consolidated Resources cancel its junk bond sale. Interestingly, Tesla’s $1.8 billion junk bond issue sold back in August now trades near 94, with yields up 50 bps in two weeks to 6.26%. Netflix’s 2018 bond saw yields jump 27 bps this week to 5.18%.
This week’s junk selloff was most pronounced in the telecom and healthcare sectors, buffeted by earnings disappointments and the failed Sprint/T-Mobile merger. Sprint CDS surged 120 bps this week to an 11-month high 342 bps. It’s worth noting that the telecommunications sector – making up about 20% of most junk indices – has suffered a flurry of earnings disappointments this quarter. CenturyLink (2039) bond yields surged 42 bps this week to 9.46%.
There were notable jumps in (high-yield) communication-related company CDS prices this week. CDS prices spiked 542 bps for Windstream, 223 bps for Frontier Communications, 175 bps for CenturyLink, 163 bps for Qwest, 88 bps for Level 3 Communications and 25 bps for Dish Corp. In the investment-grade communications arena, CBS, Viacom, Expedia and Bell South all saw CDS prices rise to near six-month highs.
Monitoring U.S. junk spreads by sector, Tech, Consumer Discretionary, Telecommunications and Healthcare all traded to three-month wides this week. One could argue that the strong performance of Energy over recent months has helped mask deteriorating performance in key high-yield sectors.
Especially late in Bubble periods, the marginal (“junk”) borrower plays an increasingly instrumental role in both Financial and Real Economy booms. Loose financial conditions and intense speculation ensure abundant cheap finance. And so long as cheap “money” remains readily available, it will be borrowed (irrespective of the trend in fundamental factors).
A tech-heavy Nasdaq surged to record highs during the first quarter of 2000, seemingly oblivious to the rout that was unfolding in telecom debt. In all the exuberance, it’s easy to forget that “tech” Bubbles are fueled by infrastructure spending by scores of negative cash flow enterprises dependent on junk bonds, leveraged lending, speculative sector flows and loose finance more generally. Especially after securities prices have succumbed to speculative blow-off dynamics, few are prepared for how rapidly liquidity abundance can disappear.
Over the past year, enormous worldwide issuance of high-yield debt has been integral to the global Bubble. From Bloomberg Intelligence: “Emerging market primary market activity remains red-hot, with benchmark-eligible hard-currency debt issuance surpassing $500 billion this year for the first time on record.” China is currently enveloped in a (higher-yielding) corporate debt issuance boom. Europe has been enjoying a spectacular boom, with junk yields sinking all the way to a ridiculous 2%.
At this point, junk bond weakness is relatively confined. And in the recent past we’ve witnessed pullbacks that refreshed. Speculators were emboldened, as financial conditions loosened only further. Yet could sector concerns prove a harbinger of asset class issues and a problematic Risk Off backdrop?
When markets turn highly speculative – and especially when in “melt-up mode” – underlying fundamentals are not all that relevant to securities prices. News and analysis will invariably focus on the positive, while surging markets create their own liquidity and self-reinforcing bullish psychology (“greed”). It’s also true that markets can enjoy speculative blow-offs even in the face of underlying fundamental deterioration. The years 1999 and 2007 are not yet ancient history.
I’m beginning to think it might not take all that much to wake folks up to risk. And by the looks of Japanese and European equities (along with junk ETFs) this week, there may be some big players with fingers hovering over sell buttons. The Fed will likely raise rates next month, and I’ve already read some analysis that chairman Powell may not be the dovish pushover he’s been portrayed. There was also news out this week shedding further light on the growing split at the ECB. Meanwhile, the esteemed head of the People's Bank of China was publicly warning of ‘hidden, complex, sudden, contagious and hazardous’ risks within the Chinese financial system.
General financial conditions seemed to tighten marginally this week. And, curiously, as global risk markets were indicating some vulnerability, sovereign yields did something anomalous: they rose. A jump in yields concurrent with widening Credit spreads puts pressure on leveraged trades. It’s worth noting as well that the yen, euro and swissy all posted modest gains this week, perhaps putting pressure on global leveraged “carry trades.”
Recent highflyer EM equities markets fell under some pressure. Stocks were down 2.4% in Brazil and 2.1% in Turkey. Stocks retreated about 1% in India and Mexico. Geopolitical issues hammered markets in the Middle East. In general, Latin American equities were under notable selling pressure. There was also upward pressure on local currency EM bond markets. Yields were up 65 bps in Lebanon, 55 bps in Argentina and 19 bps in Brazil. Many EM yields traded to six-month highs this week. Most dollar-denominated EM yields moved to three-month highs.
From Bloomberg: “Mysterious Gold Trades of 4 Million Ounces Spur Price Plunge.” I haven’t a clue who might want to dump gold. But it was a week that saw losses in stocks, Treasuries and corporate debt. I would venture that it was not a particularly good performance week for the so-called “risk parity” crowd. Few groups have benefitted more from the float-all-boats, massive monetary stimulus of the past (going on) nine years. There are scores of investment models that have worked brilliantly during the most prolonged of bull markets. A tightening of financial conditions would expose a lot of genius swimming naked.
So how might we get from the recent “Risk On” to a problematic “Risk Off”?
Imagine a flurry of outflows from junk ETFs spurring illiquidity in the underlying securities holdings. This begins to spook some players leveraged in investment-grade corporate Credit. The more sophisticated players begin to take some risk off the table, as financial conditions tighten. Fears of outflows from the - now massive - passive investment-grade funds complex spur incipient risk aversion in equities. De-risking/de-leveraging dynamics begin to take hold – at home and abroad (spike in the yen pressuring global “carry”?). And with everyone now Crowded so nice and tight into the big tech names, an abrupt reversal of the leadership technology stocks would further rattle the leveraged lending market that has been operating in overdrive. Fears of a bursting “tech” Bubble overwhelm greed. Sinking tech would take down the indices, unleashing a bit of harsh reality upon the tsunami of “money” that has disregarded risk to participate in the passive index mania. The short volatility Crowd gets crushed.
For the Week:
The S&P500 dipped 0.2% (up 15.3% y-t-d), and the Dow declined 0.5% (up 18.5%). The Utilities gained 0.4% (up 13.9%). The Banks sank 4.4% (up 6.3%), while the Broker/Dealers added 0.3% (up 19.3%). The Transports dropped 2.6% (up 5.1%). The S&P 400 Midcaps declined 0.6% (up 9.9%), and the small cap Russell 2000 fell 1.3% (up 8.7%). The Nasdaq100 added 0.2% (up 29.7%). The Semiconductors increased 0.2% (up 43.8%). The Biotechs fell 2.8% (up 32.9%). With bullion up $6, the HUI gold index gained 0.5% (up 2.6%).
Three-month Treasury bill rates ended the week at 120 bps. Two-year government yields increased four bps to 1.66% (up 47bps y-t-d). Five-year T-note yields rose six bps to 2.05% (up 12bps). Ten-year Treasury yields gained seven bps to 2.40% (down 5bps). Long bond yields jumped nine bps to 2.88% (down 19bps).
Greek 10-year yields gained three bps to 5.12% (down 190bps y-t-d). Ten-year Portuguese yields slipped a basis point to 2.06% (down 169bps). Italian 10-year yields rose five bps to 1.85% (up 3bps). Spain's 10-year yields jumped 10 bps to 1.58% (up 20bps). German bund yields gained five bps to 0.41% (up 21bps). French yields increased three bps to 0.78% (up 10bps). The French to German 10-year bond spread narrowed two to 37 bps. U.K. 10-year gilt yields rose eight bps to 1.34% (up 11bps). U.K.'s FTSE equities dropped 1.7% (up 4.1%).
Japan's Nikkei 225 equities index added 0.6% to a 26-year high (up 18.7% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.04% (unchanged). France's CAC40 dropped 2.5% (up 10.7%). The German DAX equities index sank 2.6% (up 14.3%). Spain's IBEX 35 equities index fell 2.6% (up 7.9%). Italy's FTSE MIB index lost 2.0% (up 17.3%). EM markets were mostly lower. Brazil's Bovespa index dropped 2.4% (up 19.8%), and Mexico's Bolsa declined 1.0% (up 5.2%). India’s Sensex equities index fell 1.1% (up 25.1%). China’s Shanghai Exchange rose 1.8% (up 10.6%). Turkey's Borsa Istanbul National 100 index dropped 2.1% (up 39.4%). Russia's MICEX equities index surged 4.2% (down 2.8%).
Junk bond mutual funds saw outflows of $622 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates fell four bps to 3.90% (up 33bps y-o-y). Fifteen-year rates declined three bps to 3.24% (up 35bps). Five-year hybrid ARM rates slipped a basis point to 3.22% (up 34bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down eight bps to 4.10% (up 37bps).
Federal Reserve Credit last week declined $2.6bn to $4.418 TN. Over the past year, Fed Credit increased $3.5bn. Fed Credit inflated $1.599 TN, or 57%, over the past 261 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $7.6bn last week to $3.373 TN. "Custody holdings" were up $262bn y-o-y, or 8.4%.
M2 (narrow) "money" supply last week was little changed at $13.746 TN. "Narrow money" expanded $652bn, or 5.0%, over the past year. For the week, Currency increased $0.9bn. Total Checkable Deposits fell $43.7bn, while Savings Deposits jumped $40.1bn. Small Time Deposits were little changed. Retail Money Funds gained $1.4bn.
Total money market fund assets gained $10.6bn to $2.740 TN. Money Funds rose $57bn y-o-y, or 2.1%.
Total Commercial Paper added $3.9bn to $1.051 TN. CP gained $144bn y-o-y, or 15.8%.
Currency Watch:
The U.S. dollar index declined 0.6% 94.391 (down 7.8% y-t-d). For the week on the upside, the Swedish krona increased 1.0%, the Brazilian real 0.9%, the British pound 0.9%, the Canadian dollar 0.7%, the Mexican peso 0.5%, the Norwegian krone 0.5%, the euro 0.5%, the Japanese yen 0.5%, the Swiss franc 0.5%, the New Zealand dollar 0.4%, the Singapore dollar 0.4%, and the Australian dollar 0.1%. For the week on the downside, the South African rand declined 1.1% and the South Korean won dipped 0.3%. The Chinese renminbi was little changed versus the dollar this week (up 4.58% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index jumped 1.9% (up 7.6% y-t-d). Spot Gold added 0.5% to $1,275 (up 10.7%). Silver added 0.2% to $16.871 (up 5.6%). Crude gained another $1.10 to $56.74 (up 5%). Gasoline rose 1.1% (up 9%), while Natural Gas slipped 0.6% (down 14%). Copper fell 1.3% (up 23%). Wheat gained 1.4% (up 5.8%). Corn fell 1.4% (down 2%).
Trump Administration Watch:
November 6 – Wall Street Journal (Richard Rubin and Siobhan Hughes): “A House committee began considering a bill Monday that would reduce taxes by $1.4 trillion over 10 years, but disagreements over key pieces of the measure could force the GOP to make changes and slow down plans to pass it by year’s end. House Republicans are at odds over plans to eliminate deductions for state and local taxes. Senate Republicans disagree on child tax credits and whether to accept significantly bigger budget deficits. Narrow margins in both chambers leave the party little room to maneuver.”
November 7 – CNBC (Jacob Pramuk): “The House Republican tax plan may have a deficit problem. The GOP bill including some changes would increase federal budget deficits by $1.7 trillion over 10 years, according to Joint Committee on Taxation estimates shared by the nonpartisan Congressional Budget Office. That includes money for additional debt service payments due to the bill. Under the plan, U.S. debt would rise to 97.1% of gross domestic product in 2027, up from 91.2% under current CBO projections.”
November 7 – Bloomberg (Lynnley Browning): “Multinational companies including Apple Inc., Pfizer Inc. and others would face a new tax on payments they make to offshore affiliates under the House Republicans’ tax bill -- a surprise provision that has stunned tax experts. The new 20% tax is ‘the atomic bomb in the draft’ legislation, said Ray Beeman, co-leader of Ernst & Young’s Washington Council advisory services group. ‘We’re trying to get our arms around the implications.’ So far, many big U.S. companies have kept quiet on the proposal. But already, House Ways and Means Chairman Kevin Brady has tweaked the provision to lessen its impact, part of a package of changes the tax-writing panel adopted Monday night.”
November 8 – Financial Times (Demetri Sevastopulo and Tom Mitchell): “Donald Trump blamed his predecessors for the US’s widening trade deficit with China, praising Xi Jinping and telling an audience in Beijing he did not ‘blame’ Chinese leaders for ‘taking advantage’ of Washington. In a striking change of tone from the US president…, Mr Trump appeared at pains to rekindle the bonhomie that characterised the leaders’ first meeting at his Florida compound in April, a tenor that quickly deteriorated over North Korea. Although Mr Trump has been welcomed with a state dinner and extensive pomp, Mr Trump’s personal warmth towards Mr Xi was not reciprocated, with the Chinese leader using far more restrained language in his own comments.”
November 6 – Financial Times (Demetri Sevastopulo and Robin Harding): “Donald Trump accused Japan of engaging in unfair trade practices on the first leg of his five-nation Asia tour, during which the American president will focus on improving the US trade balance and efforts to press North Korea to give up its nuclear weapons. Speaking in Tokyo on the second day of his visit to Japan, Mr Trump reprised some of the economic themes that dominated his presidential campaign by telling Japanese and US business executives that trade with Japan was ‘not free or reciprocal’. ‘We want fair and open trade. But right now, our trade with Japan is not fair and it’s not open,’ said Mr Trump. ‘The US has suffered massive trade deficits with Japan for many, many years. Many millions of cars are sold by Japan into the United States, whereas virtually no cars go from the US into Japan.”
November 7 – New York Times (Jane Perlez, Paul Mozur and Jonathan Ansfield): “When President Trump arrives in Beijing on Wednesday, he will most likely complain about traditional areas of dispute like steel and cars. But Washington officials and major global companies increasingly worry about a new generation of deals that could give China a firmer grip on the technology of tomorrow. Under an ambitious plan unveiled two years ago called Made in China 2025, Beijing has designs to dominate cutting-edge technologies like advanced microchips, artificial intelligence and electric cars, among many others, in a decade. And China is enlisting some of the world’s biggest technology players in its push. Sometimes it demands partnerships or intellectual property as the price of admission to the world’s second-largest economy. Sometimes it woos foreign giants with money and market access in ways that elude American and global trade rules.”
November 7 – Bloomberg (Michelle Jamrisko and Andrew Janes): “Trade tensions between the U.S. and China pose a greater worry to the global economy than a nuclear North Korea, said National Australia Bank Ltd. chief economist Alan Oster. The probability that the world’s two largest economies enter into a destructive trade war is around one-in-five, Oster said... It’s the biggest risk to global growth that’s otherwise chugging along at a decent rate and should rise to 3.6% in 2018 from 3.4% this year, he said. ‘It would kill Asia, and it would kill commodities,’ and have flow-through effects to the world, said Oster, a former senior adviser to Federal Treasury in Australia… ‘Overall, I think the world’s okay. Geopolitical risk is there a lot -- who knows about North Korea -- but I’m more worried about Trump and China.’”
Federal Reserve Watch:
November 8 – Bloomberg (Christopher Condon and Craig Torres): “Years before he was tapped to lead the Federal Reserve, Jerome Powell brought to the world’s most powerful central bank a lesson he learned in the business world: manage or be managed. On everything from the payments system to monetary policy, he noticed the Fed’s brainy staff of economists would hash out their differences among themselves and then present governors with a unified policy recommendation, expecting them mostly to follow their advice. That didn’t sit well with a lawyer who cut his teeth in private-equity investing. In that line of work, proposed deals must survive a gauntlet of scrutiny in front of top decision makers… So Powell the Fed governor pushed back. He insisted on some occasions that staff members debate policy ideas in front of him… He also pored over mountains of academic studies and asked questions. In his five-plus years at the Fed, he’s managed to gain the staff’s respect even as he challenged their ready-made recommendations.”
November 6 – CNBC (Jeff Cox): “The Federal Reserve will not only lose its three top-ranking officials in the months ahead but also the more than three decades of experience they brought to policymaking. In their place will be central bankers who could take quite a different approach to policy, a change the financial markets may not fully appreciate yet. New York Fed President William Dudley became the latest Fed official to say he'll be leaving soon… That comes just days after President Donald Trump said he will nominate Fed Governor Jerome Powell to take over the chairman's seat from Janet Yellen in February, and less than a month after the departure of Vice Chairman Stanley Fischer. That in effect takes out the ruling troika of monetary policy since early 2014, a group that holds some 35 years of monetary policy experience.”
U.S. Bubble Watch:
November 8 – Bloomberg: “Donald Trump touched down in China to news on one of his favorite topics: the trade deficit. But it mightn’t be the news he’s wanting. For the first 10 months of the year, China’s trade surplus with the U.S. was $223 billion… That pace should mean the full-year gap between China’s sales to the U.S. and its imports is about the same as in 2016, at around $250 billion… China’s trade data… showed: Exports increased 6.9% in dollar terms in October from a year earlier. Imports advanced 17.2% year-on-year. The total trade surplus was $38.2 billion.”
November 8 – CNBC (Diana Olick): “The steady rise in home prices is so far showing no boundaries, and that is turning up the heat on some already overheated housing markets. Home prices rose 7% nationally in September, compared with September 2016… according to CoreLogic, a real estate data firm. As a result, 48% of the nation's top 50 housing markets are now considered ‘overvalued,’ up from 46% in August. A market is considered overvalued when home prices are at least 10% higher than the long-term, sustainable level.”
November 8 – Wall Street Journal (Laura Kusisto): “California’s biggest housing markets figure to be among the losers if a Republican-sponsored tax overhaul becomes law, according to two analyses of local market data. The House bill would cap the size of mortgage loans for which taxpayers can deduct interest payments at $500,000. In most regions of the U.S., that represents a small fraction of properties. But in the priciest markets, concentrated in some of the nation’s largest coastal cities, the impact could be significant. In the San Jose, Calif., metropolitan area, 75% of new mortgage loans thus far in 2017 were for more than $500,000… The median home price there is more than $1 million, and even small starter homes can climb well above the proposed cap.”
November 7 – Wall Street Journal (Peter Grant and Laura Kusisto): “Rising homeownership is adding to the jitters in the residential rental market, which has slumped recently after a long stretch near the top of the commercial real-estate industry. For most of the current economic expansion, declining ownership rates have enabled landlords of apartments and single-family homes to raise rents far faster than the pace of inflation. Demand has been fueled by the millions of people who haven’t had the money, credit or desire to pursue the traditional American dream. But amid a hot housing market, the homeownership rate is now rising, in part because millennials are reaching the age when they’re forming families and settling down.”
November 8 – Wall Street Journal (Gordon Lubold): “U.S. wars in Afghanistan, Iraq, Syria and Pakistan have cost American taxpayers $5.6 trillion since they began in 2001, according to a new study, a figure more than three times that of the Pentagon’s own estimates. The Defense Department earlier this year estimated that the total cost of the conflicts since the 2001 attacks has amounted to about $1.5 trillion. The new study, by the Watson Institute of International and Public Affairs at Brown University, aims to reflect costs the Pentagon doesn’t include in its own calculations…”
November 6 – Bloomberg (Ben Steverman): “One of the hottest tickets in New York City this weekend was a discussion on whether to overthrow capitalism. The first run of tickets to ‘Capitalism: A Debate’ sold out in a day… The crowd waiting in a long line to get inside on Friday night was mostly young and mostly male. Asher Kaplan and Gabriel Gutierrez, both 24, hoped the event would be a real-life version of the humorous, anarchic political debates on social media. ‘So much of this stuff is a battle that’s waged online,’ said Gutierrez, who identifies, along with Kaplan, as a ‘leftist,’ if not quite a socialist. These days, among young people, socialism is ‘both a political identity and a culture,’ Kaplan said. And it looks increasingly attractive. Young Americans have soured on capitalism. In a Harvard University poll conducted last year, 51% of 18-to-29 year-olds in the U.S. said they opposed capitalism; only 42% expressed support… A poll released last month found American millennials closely split on the question of what type of society they would prefer to live in: 44% picked a socialist country, 42% a capitalist one.”
China Bubble Watch:
November 5 – Bloomberg: “China’s financial system is becoming significantly more vulnerable due to high leverage, according to central bank governor Zhou Xiaochuan, who has made a series of blunt warnings in recent weeks about debt levels… Latent risks are accumulating, including some that are ‘hidden, complex, sudden, contagious and hazardous,’ even as the overall health of the financial system remains good, Zhou wrote in a lengthy article published on the People’s Bank of China’s website… ‘High leverage is the ultimate origin of macro financial vulnerability,’ wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure. ‘In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.’”
November 5 – Bloomberg: “China’s financial system is becoming significantly more vulnerable due to high leverage, according to central bank governor Zhou Xiaochuan, who has made a series of blunt warnings in recent weeks about debt levels in the world’s second-largest economy. Latent risks are accumulating, including some that are ‘hidden, complex, sudden, contagious and hazardous,’ even as the overall health of the financial system remains good, Zhou wrote in a lengthy article published on the People’s Bank of China’s website… The nation should toughen regulation and let markets serve the real economy better, according to Zhou. The government should also open up markets by relaxing capital controls and reducing restrictions on non-Chinese financial institutions that want to operate on the mainland, he wrote.”
November 8 – Bloomberg: “China’s factory prices kept surging last month as authorities curb production in smokestack industries to combat pollution. The producer price index rose 6.9% in October from a year earlier, versus a projected 6.6% rise… and matching September’s pace. The consumer price index climbed 1.9%.”
November 8 – New York Times (Keith Bradsher): “China on Wednesday released fresh details about a new financial regulatory body intended to calm a financial system that in recent years has endured a stock market crash, a huge exodus of money outside the country and the rapid accumulation of debt. But the details may raise more questions than they answer, and could disappoint those looking for a strong hand to rein in the financial system underpinning the world’s second-largest economy. Official Chinese media reported… that a new Financial Stability and Development Committee had held its first meeting, nearly four months after President Xi Jinping ordered its creation. It said the meeting was led by Ma Kai, a 71-year-old vice premier. At the meeting, Mr. Ma stressed that China’s financial system should serve the real economy… namely, making money available to businesses that need it. He also stressed financial security, the report said.”
November 5 – Bloomberg: “China’s shadow banking sector, estimated by some analysts to be worth 122.8 trillion yuan ($18.5 trillion), stopped growing in the first half of the year as issuance of wealth management products declined, according to Moody’s… For the first time since 2012, China’s gross domestic product grew faster than shadow banking assets in the six-month period… Following last month’s Communist Party Congress, further regulation will continue to rein in shadow banking and address some of the key systemic imbalances, Moody’s said. While Moody’s assessment offers some evidence that China’s crackdown on shadow financing is starting to bite, authorities continue to sound the alarm on high debt levels.”
November 7 – Bloomberg: “Under pressure to trim borrowings, China’s companies have found a way to reduce their lofty debt burdens -- even if some of the risk remains. Sales of perpetual notes -- long-dated securities that can be listed as equity rather than debt on balance sheets given that in theory they could never mature -- have soared to a record this year as Beijing zeros in on leverage and the threat it poses to the financial system. The bonds are so popular that issuance by non-bank firms has jumped to the equivalent of 433 billion yuan ($65bn), more than seven times sales by companies in the U.S. ‘Chinese issuers love perpetual bonds because they are under great pressure to deleverage,’ said Wang Ying, a senior director at Fitch… ‘Sophisticated investors should do their homework and shouldn’t be misled by the numbers in accounting books.’”
November 5 – Financial Times (Charles Clover): “China has unveiled a ‘magical’ island-building ship on the eve of Donald Trump’s visit in a move likely to renew fears about its claims to territory in the South China Sea. At 140 metres the Tiankun is the biggest dredger in Asia, with cutters and pumps capable of smashing the equivalent of three Olympic pools of rock an hour from the sea floor and shooting it 15km away to create land. During the past five years, China has used similar vessels to create a string of strategic islands to support its claims to 85% of the sea.”
Central Banker Watch:
November 7 – Bloomberg (Alessandro Speciale and Piotr Skolimowski): “Three of the European Central Bank’s top policy makers pushed last month to alter a commitment to keep buying bonds until inflation improves, signaling challenges ahead for President Mario Draghi as the bank seeks to slow quantitative easing. Board member Benoit Coeure, Bundesbank President Jens Weidmann and Bank of France Governor Francois Villeroy de Galhau were the heavyweights who recommended tying the overall level of monetary stimulus -- rather than just asset purchases -- to the outlook for prices…”
Global Bubble Watch:
November 8 – Bloomberg (Luke Kawa): “The best way to crush the crowd in 2017? Buy the things everyone insisted would never keep going up. A portfolio stuffed with allegedly over-inflated assets would have returned more than 120% so far in 2017, trouncing the S&P 500 Index... The hypothetical ‘Bubblicious’ portfolio includes Chinese real estate and internet names, a pair of U.S. tech behemoths, a cryptocurrency fund, the ETF industry, bonds that mature decades from now, and a dash of short volatility bets just to make things more interesting. The out-performance is a testament to the momentum mania prevalent in today’s markets, a dynamic which has prompted the likes of Greenlight Capital’s David Einhorn, Goldman Sachs…, and Sanford C Bernstein… to mull whether value investing is in the midst of an existential crisis given ultra-low interest rates and abundant liquidity.”
November 6 – Bloomberg (Ian King): “Broadcom Ltd. offered about $105 billion for Qualcomm Inc., kicking off an ambitious attempt at the largest technology takeover ever in a deal that would rock the electronics industry. Broadcom made an offer of $70 a share in cash and stock for Qualcomm, the world’s largest maker of mobile phone chips. That’s a 28% premium over the stock’s closing price on Nov. 2… The proposed transaction is valued at approximately $130 billion on a pro forma basis, including $25 billion of net debt. Buying Qualcomm would make Broadcom the third-largest chipmaker, behind Intel Corp. and Samsung Electronics Co. The combined business would instantly become the default provider of a set of components needed to build each of the more than a billion smartphones sold every year. The deal would dwarf Dell Inc.’s $67 billion acquisition of EMC in 2015 -- then the biggest in the technology industry.”
Fixed Income Bubble Watch:
November 7 – Bloomberg (Cormac Mullen): “It’s one step forward, two steps back for bond volatility. Bank of America Merrill Lynch’s MOVE Index, a gauge of price swings in the U.S. Treasury market, fell to a record low on Monday, bucking last month’s uptrend. Renewed expectations that the Federal Reserve will stay the course on monetary policy in the midst of a leadership transition and the unveiling of the Republican tax plan have spurred an eight-day decline in the volatility of the world’s largest bond market.”
November 6 – Bloomberg (Lisa Lee and Adam Tempkin): “One of the last hurdles preventing riskier companies from slashing borrowing costs in an already red-hot leveraged loan market is crumbling. Managers of collateralized loan obligations, the biggest buyers of U.S. leveraged loans, have started to give in to an unprecedented surge of repricings of the debt they hold in their portfolios. More than $175 billion of CLOs have refinanced in the last 12 months, up from less than $10 billion in the prior one-year period… These refinancings could further strengthen the hands of borrowers, allowing them to demand even more rate cuts from their creditors who have little choice other than to say yes. Unlike junk bonds, loans are relatively easy to prepay, giving companies the option to refinance with a new group of investors. About $525 billion of loans have repriced during the last 12 months, compared to $130 billion in the prior one-year period…”
November 7 – Wall Street Journal (Paul J. Davies): “The hunt for yield is taking Wall Street and investors into exotic territory, and that means an appetite for credit assets that are private, not easily tradable and often complex. Putting together deals in what some dub ‘nonlinear finance’ is a growth business for investment banks’ big bond-trading arms and is helping clear unwanted assets off some balance sheets. However, such private deals, which aren’t publicly traded and don’t have public credit ratings, are a challenge for regulators keeping track of the growth of shadow banking and understanding whether such activity is driven by regulation or its avoidance. The business isn’t new, but it is heating up as banks hire specialists and commit balance-sheet capacity to feed investor demand.”
November 7 – Financial Times (Nicholas Megaw): “Record high prices combined with more risky corporate bond supply is creating ‘increasing uncertainty’ and raising the chances of a sharp turnround in the European high-yield credit market, Fitch… warned. Yields on the most popular benchmark for European junk bonds fell below 2% for the first time ever last week, but Fitch warned that recent market calm and the distorting impact of central bank monetary policy ‘obscure the true risk-return dynamics faced by investors’. The ratings agency said the proportion of newly-issued bonds with the lowest credit ratings – CCC+ or below – has risen to its highest level since 2013, when average yields were more than 5%.”
Europe Watch:
November 7 – Reuters (Thomas Escritt): “The German economy is at risk of overheating, according to a leaked advisory council report that follows pressure from the Bundesbank for a swifter end to the European Central Bank’s expansive monetary policy. In their annual report… the five ‘wise men’ who advise the German government on economic policy said the economy, which they expected to expand strongly this year and next, was moving gradually into a ‘boom phase’. ‘There are clear signs that economic capacity is over-utilised,’ read the report…”
November 8 – Bloomberg (Lorenzo Totaro): “Italy’s ratio of debt to economic output will rise slightly this year and won’t fall below 130% through 2019 as the pace of recovery slows, the European Commission said. The ratio will increase to 132.1% of gross domestic product from 132% in 2016, the Brussels-based EU executive arm said…”
Emerging Market Watch:
November 6 – Bloomberg (Daniel Cancel): “Venezuelan debt is teetering toward default with average prices near 30 cents on the dollar. As investors ponder an invite from the government to come to Caracas next week to discuss a restructuring…, they now demand a record 40.8 percentage points of extra yield over U.S. Treasury bills to hold the country’s bonds. No one really expects those yields to pay out as Venezuela seeks debt relief, but they do give an idea as to just how distressed the securities have become.”
Leveraged Speculation Watch:
November 7 – Bloomberg (Cecile Gutscher): “Hedge funds are headed for their best year since 2013 thanks to a gravity-defying stock market. Improving performance may go some way to assuaging criticism for fees that are hard to justify with mediocre returns, even though on average the funds underperformed equity benchmarks including the S&P 500 Index, which is up 15.7% year-to-date. 2017’s winning strategies were deployed by equity funds skewed toward health care and technology, according to… Hedge Fund Research Inc. through September. Over the same period, the S&P 500 Tech Index returned 26%...”
Geopolitical Watch:
November 7 – BBC (Suzy Waite and Nishant Kumar): “Saudi Arabia's Crown Prince Mohammed bin Salman has accused Iran of an act of ‘direct military aggression’ by supplying missiles to rebels in Yemen. This ‘may be considered an act of war’, state media quoted the prince as telling UK Foreign Secretary Boris Johnson…”
November 7 – Reuters (Tom Perry and Laila Bassam): “Saudi Arabia has opened a new front in its regional proxy war with Iran, threatening Tehran’s powerful ally Hezbollah and its home country Lebanon to try to regain the upper hand. With Iranian power winning out in Iraq and Syria, and Riyadh bogged down in a war with Iran-allied groups in Yemen, the new Saudi approach could bring lasting political and economic turmoil to a country where Tehran had appeared ascendant. The resignation on Saturday of the Saudi-allied Lebanese prime minister Saad al-Hariri, announced from Riyadh and blamed on Iran and Hezbollah, is seen by many as the first step in an unprecedented Saudi intervention in Lebanese politics.”
November 7 – Bloomberg (Suzy Waite and Nishant Kumar): “Cheap money may have buoyed emerging-market macro hedge funds toward their ninth straight annual advance, but that doesn’t mean investors are expecting an exodus as the world’s central bankers start turning off the taps. Demand for these funds remains so brisk, in fact, that some are turning new money away.”
November 7 – Financial Times (Erika Solomon): “A string of escalatory moves in the Gulf in recent days suggests the long-brewing cold war between Saudi Arabia and its regional arch-rival Iran could soon grow hot. It began with the surprise resignation of the Lebanese prime minister, Saad al-Hariri, announced on Saturday from Saudi Arabia. Riyadh is believed to have pressed him to step down in frustration that Mr Hariri, a long-time Saudi ally, had in effect given cover to the Lebanese Shia force Hizbollah, Iran’s top regional proxy, by sharing control of government with them. Hours later, in Yemen, a ballistic missile was fired by Iran-backed Houthi rebels towards Riyadh airport. Saudi Arabia accused Iran… of an ‘act of war’ over the incident; the same day King Salman of Saudi Arabia summoned Mahmoud Abbas, president of the Palestinian Territories, to a meeting. It raised suspicions that Mr Abbas too was coming under pressure from Riyadh after reaching a power-sharing deal with Hamas, the Iran-backed militant group.”
November 6 – AFP (Alison Tahmizian Meuse and Mohamed Hasni): “Saudi Arabia and Iran traded fierce accusations over Yemen…, with Riyadh saying a rebel missile attack ‘may amount to an act of war’ and Tehran accusing its rival of war crimes. Tensions have been rising between Sunni-ruled Saudi Arabia and predominantly Shiite Iran, which are opposed in disputes and conflicts across the Middle East from Yemen and Syria to Qatar and Lebanon. On Monday, a Saudi-led military coalition battling Tehran-backed rebels in Yemen said it reserved the ‘right to respond’ to the missile attack on Riyadh at the weekend, calling it a ‘blatant military aggression by the Iranian regime which may amount to an act of war’. Saudi Foreign Minister Adel al-Jubeir also warned Tehran. ‘Iranian interventions in the region are detrimental to the security of neighbouring countries and affect international peace and security. We will not allow any infringement on our national security,’ Jubeir tweeted.”
Greek 10-year yields gained three bps to 5.12% (down 190bps y-t-d). Ten-year Portuguese yields slipped a basis point to 2.06% (down 169bps). Italian 10-year yields rose five bps to 1.85% (up 3bps). Spain's 10-year yields jumped 10 bps to 1.58% (up 20bps). German bund yields gained five bps to 0.41% (up 21bps). French yields increased three bps to 0.78% (up 10bps). The French to German 10-year bond spread narrowed two to 37 bps. U.K. 10-year gilt yields rose eight bps to 1.34% (up 11bps). U.K.'s FTSE equities dropped 1.7% (up 4.1%).
Japan's Nikkei 225 equities index added 0.6% to a 26-year high (up 18.7% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.04% (unchanged). France's CAC40 dropped 2.5% (up 10.7%). The German DAX equities index sank 2.6% (up 14.3%). Spain's IBEX 35 equities index fell 2.6% (up 7.9%). Italy's FTSE MIB index lost 2.0% (up 17.3%). EM markets were mostly lower. Brazil's Bovespa index dropped 2.4% (up 19.8%), and Mexico's Bolsa declined 1.0% (up 5.2%). India’s Sensex equities index fell 1.1% (up 25.1%). China’s Shanghai Exchange rose 1.8% (up 10.6%). Turkey's Borsa Istanbul National 100 index dropped 2.1% (up 39.4%). Russia's MICEX equities index surged 4.2% (down 2.8%).
Junk bond mutual funds saw outflows of $622 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates fell four bps to 3.90% (up 33bps y-o-y). Fifteen-year rates declined three bps to 3.24% (up 35bps). Five-year hybrid ARM rates slipped a basis point to 3.22% (up 34bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down eight bps to 4.10% (up 37bps).
Federal Reserve Credit last week declined $2.6bn to $4.418 TN. Over the past year, Fed Credit increased $3.5bn. Fed Credit inflated $1.599 TN, or 57%, over the past 261 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $7.6bn last week to $3.373 TN. "Custody holdings" were up $262bn y-o-y, or 8.4%.
M2 (narrow) "money" supply last week was little changed at $13.746 TN. "Narrow money" expanded $652bn, or 5.0%, over the past year. For the week, Currency increased $0.9bn. Total Checkable Deposits fell $43.7bn, while Savings Deposits jumped $40.1bn. Small Time Deposits were little changed. Retail Money Funds gained $1.4bn.
Total money market fund assets gained $10.6bn to $2.740 TN. Money Funds rose $57bn y-o-y, or 2.1%.
Total Commercial Paper added $3.9bn to $1.051 TN. CP gained $144bn y-o-y, or 15.8%.
Currency Watch:
The U.S. dollar index declined 0.6% 94.391 (down 7.8% y-t-d). For the week on the upside, the Swedish krona increased 1.0%, the Brazilian real 0.9%, the British pound 0.9%, the Canadian dollar 0.7%, the Mexican peso 0.5%, the Norwegian krone 0.5%, the euro 0.5%, the Japanese yen 0.5%, the Swiss franc 0.5%, the New Zealand dollar 0.4%, the Singapore dollar 0.4%, and the Australian dollar 0.1%. For the week on the downside, the South African rand declined 1.1% and the South Korean won dipped 0.3%. The Chinese renminbi was little changed versus the dollar this week (up 4.58% y-t-d).
Commodities Watch:
The Goldman Sachs Commodities Index jumped 1.9% (up 7.6% y-t-d). Spot Gold added 0.5% to $1,275 (up 10.7%). Silver added 0.2% to $16.871 (up 5.6%). Crude gained another $1.10 to $56.74 (up 5%). Gasoline rose 1.1% (up 9%), while Natural Gas slipped 0.6% (down 14%). Copper fell 1.3% (up 23%). Wheat gained 1.4% (up 5.8%). Corn fell 1.4% (down 2%).
Trump Administration Watch:
November 6 – Wall Street Journal (Richard Rubin and Siobhan Hughes): “A House committee began considering a bill Monday that would reduce taxes by $1.4 trillion over 10 years, but disagreements over key pieces of the measure could force the GOP to make changes and slow down plans to pass it by year’s end. House Republicans are at odds over plans to eliminate deductions for state and local taxes. Senate Republicans disagree on child tax credits and whether to accept significantly bigger budget deficits. Narrow margins in both chambers leave the party little room to maneuver.”
November 7 – CNBC (Jacob Pramuk): “The House Republican tax plan may have a deficit problem. The GOP bill including some changes would increase federal budget deficits by $1.7 trillion over 10 years, according to Joint Committee on Taxation estimates shared by the nonpartisan Congressional Budget Office. That includes money for additional debt service payments due to the bill. Under the plan, U.S. debt would rise to 97.1% of gross domestic product in 2027, up from 91.2% under current CBO projections.”
November 7 – Bloomberg (Lynnley Browning): “Multinational companies including Apple Inc., Pfizer Inc. and others would face a new tax on payments they make to offshore affiliates under the House Republicans’ tax bill -- a surprise provision that has stunned tax experts. The new 20% tax is ‘the atomic bomb in the draft’ legislation, said Ray Beeman, co-leader of Ernst & Young’s Washington Council advisory services group. ‘We’re trying to get our arms around the implications.’ So far, many big U.S. companies have kept quiet on the proposal. But already, House Ways and Means Chairman Kevin Brady has tweaked the provision to lessen its impact, part of a package of changes the tax-writing panel adopted Monday night.”
November 8 – Financial Times (Demetri Sevastopulo and Tom Mitchell): “Donald Trump blamed his predecessors for the US’s widening trade deficit with China, praising Xi Jinping and telling an audience in Beijing he did not ‘blame’ Chinese leaders for ‘taking advantage’ of Washington. In a striking change of tone from the US president…, Mr Trump appeared at pains to rekindle the bonhomie that characterised the leaders’ first meeting at his Florida compound in April, a tenor that quickly deteriorated over North Korea. Although Mr Trump has been welcomed with a state dinner and extensive pomp, Mr Trump’s personal warmth towards Mr Xi was not reciprocated, with the Chinese leader using far more restrained language in his own comments.”
November 6 – Financial Times (Demetri Sevastopulo and Robin Harding): “Donald Trump accused Japan of engaging in unfair trade practices on the first leg of his five-nation Asia tour, during which the American president will focus on improving the US trade balance and efforts to press North Korea to give up its nuclear weapons. Speaking in Tokyo on the second day of his visit to Japan, Mr Trump reprised some of the economic themes that dominated his presidential campaign by telling Japanese and US business executives that trade with Japan was ‘not free or reciprocal’. ‘We want fair and open trade. But right now, our trade with Japan is not fair and it’s not open,’ said Mr Trump. ‘The US has suffered massive trade deficits with Japan for many, many years. Many millions of cars are sold by Japan into the United States, whereas virtually no cars go from the US into Japan.”
November 7 – New York Times (Jane Perlez, Paul Mozur and Jonathan Ansfield): “When President Trump arrives in Beijing on Wednesday, he will most likely complain about traditional areas of dispute like steel and cars. But Washington officials and major global companies increasingly worry about a new generation of deals that could give China a firmer grip on the technology of tomorrow. Under an ambitious plan unveiled two years ago called Made in China 2025, Beijing has designs to dominate cutting-edge technologies like advanced microchips, artificial intelligence and electric cars, among many others, in a decade. And China is enlisting some of the world’s biggest technology players in its push. Sometimes it demands partnerships or intellectual property as the price of admission to the world’s second-largest economy. Sometimes it woos foreign giants with money and market access in ways that elude American and global trade rules.”
November 7 – Bloomberg (Michelle Jamrisko and Andrew Janes): “Trade tensions between the U.S. and China pose a greater worry to the global economy than a nuclear North Korea, said National Australia Bank Ltd. chief economist Alan Oster. The probability that the world’s two largest economies enter into a destructive trade war is around one-in-five, Oster said... It’s the biggest risk to global growth that’s otherwise chugging along at a decent rate and should rise to 3.6% in 2018 from 3.4% this year, he said. ‘It would kill Asia, and it would kill commodities,’ and have flow-through effects to the world, said Oster, a former senior adviser to Federal Treasury in Australia… ‘Overall, I think the world’s okay. Geopolitical risk is there a lot -- who knows about North Korea -- but I’m more worried about Trump and China.’”
Federal Reserve Watch:
November 8 – Bloomberg (Christopher Condon and Craig Torres): “Years before he was tapped to lead the Federal Reserve, Jerome Powell brought to the world’s most powerful central bank a lesson he learned in the business world: manage or be managed. On everything from the payments system to monetary policy, he noticed the Fed’s brainy staff of economists would hash out their differences among themselves and then present governors with a unified policy recommendation, expecting them mostly to follow their advice. That didn’t sit well with a lawyer who cut his teeth in private-equity investing. In that line of work, proposed deals must survive a gauntlet of scrutiny in front of top decision makers… So Powell the Fed governor pushed back. He insisted on some occasions that staff members debate policy ideas in front of him… He also pored over mountains of academic studies and asked questions. In his five-plus years at the Fed, he’s managed to gain the staff’s respect even as he challenged their ready-made recommendations.”
November 6 – CNBC (Jeff Cox): “The Federal Reserve will not only lose its three top-ranking officials in the months ahead but also the more than three decades of experience they brought to policymaking. In their place will be central bankers who could take quite a different approach to policy, a change the financial markets may not fully appreciate yet. New York Fed President William Dudley became the latest Fed official to say he'll be leaving soon… That comes just days after President Donald Trump said he will nominate Fed Governor Jerome Powell to take over the chairman's seat from Janet Yellen in February, and less than a month after the departure of Vice Chairman Stanley Fischer. That in effect takes out the ruling troika of monetary policy since early 2014, a group that holds some 35 years of monetary policy experience.”
U.S. Bubble Watch:
November 8 – Bloomberg: “Donald Trump touched down in China to news on one of his favorite topics: the trade deficit. But it mightn’t be the news he’s wanting. For the first 10 months of the year, China’s trade surplus with the U.S. was $223 billion… That pace should mean the full-year gap between China’s sales to the U.S. and its imports is about the same as in 2016, at around $250 billion… China’s trade data… showed: Exports increased 6.9% in dollar terms in October from a year earlier. Imports advanced 17.2% year-on-year. The total trade surplus was $38.2 billion.”
November 8 – CNBC (Diana Olick): “The steady rise in home prices is so far showing no boundaries, and that is turning up the heat on some already overheated housing markets. Home prices rose 7% nationally in September, compared with September 2016… according to CoreLogic, a real estate data firm. As a result, 48% of the nation's top 50 housing markets are now considered ‘overvalued,’ up from 46% in August. A market is considered overvalued when home prices are at least 10% higher than the long-term, sustainable level.”
November 8 – Wall Street Journal (Laura Kusisto): “California’s biggest housing markets figure to be among the losers if a Republican-sponsored tax overhaul becomes law, according to two analyses of local market data. The House bill would cap the size of mortgage loans for which taxpayers can deduct interest payments at $500,000. In most regions of the U.S., that represents a small fraction of properties. But in the priciest markets, concentrated in some of the nation’s largest coastal cities, the impact could be significant. In the San Jose, Calif., metropolitan area, 75% of new mortgage loans thus far in 2017 were for more than $500,000… The median home price there is more than $1 million, and even small starter homes can climb well above the proposed cap.”
November 7 – Wall Street Journal (Peter Grant and Laura Kusisto): “Rising homeownership is adding to the jitters in the residential rental market, which has slumped recently after a long stretch near the top of the commercial real-estate industry. For most of the current economic expansion, declining ownership rates have enabled landlords of apartments and single-family homes to raise rents far faster than the pace of inflation. Demand has been fueled by the millions of people who haven’t had the money, credit or desire to pursue the traditional American dream. But amid a hot housing market, the homeownership rate is now rising, in part because millennials are reaching the age when they’re forming families and settling down.”
November 8 – Wall Street Journal (Gordon Lubold): “U.S. wars in Afghanistan, Iraq, Syria and Pakistan have cost American taxpayers $5.6 trillion since they began in 2001, according to a new study, a figure more than three times that of the Pentagon’s own estimates. The Defense Department earlier this year estimated that the total cost of the conflicts since the 2001 attacks has amounted to about $1.5 trillion. The new study, by the Watson Institute of International and Public Affairs at Brown University, aims to reflect costs the Pentagon doesn’t include in its own calculations…”
November 6 – Bloomberg (Ben Steverman): “One of the hottest tickets in New York City this weekend was a discussion on whether to overthrow capitalism. The first run of tickets to ‘Capitalism: A Debate’ sold out in a day… The crowd waiting in a long line to get inside on Friday night was mostly young and mostly male. Asher Kaplan and Gabriel Gutierrez, both 24, hoped the event would be a real-life version of the humorous, anarchic political debates on social media. ‘So much of this stuff is a battle that’s waged online,’ said Gutierrez, who identifies, along with Kaplan, as a ‘leftist,’ if not quite a socialist. These days, among young people, socialism is ‘both a political identity and a culture,’ Kaplan said. And it looks increasingly attractive. Young Americans have soured on capitalism. In a Harvard University poll conducted last year, 51% of 18-to-29 year-olds in the U.S. said they opposed capitalism; only 42% expressed support… A poll released last month found American millennials closely split on the question of what type of society they would prefer to live in: 44% picked a socialist country, 42% a capitalist one.”
China Bubble Watch:
November 5 – Bloomberg: “China’s financial system is becoming significantly more vulnerable due to high leverage, according to central bank governor Zhou Xiaochuan, who has made a series of blunt warnings in recent weeks about debt levels… Latent risks are accumulating, including some that are ‘hidden, complex, sudden, contagious and hazardous,’ even as the overall health of the financial system remains good, Zhou wrote in a lengthy article published on the People’s Bank of China’s website… ‘High leverage is the ultimate origin of macro financial vulnerability,’ wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure. ‘In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.’”
November 5 – Bloomberg: “China’s financial system is becoming significantly more vulnerable due to high leverage, according to central bank governor Zhou Xiaochuan, who has made a series of blunt warnings in recent weeks about debt levels in the world’s second-largest economy. Latent risks are accumulating, including some that are ‘hidden, complex, sudden, contagious and hazardous,’ even as the overall health of the financial system remains good, Zhou wrote in a lengthy article published on the People’s Bank of China’s website… The nation should toughen regulation and let markets serve the real economy better, according to Zhou. The government should also open up markets by relaxing capital controls and reducing restrictions on non-Chinese financial institutions that want to operate on the mainland, he wrote.”
November 8 – Bloomberg: “China’s factory prices kept surging last month as authorities curb production in smokestack industries to combat pollution. The producer price index rose 6.9% in October from a year earlier, versus a projected 6.6% rise… and matching September’s pace. The consumer price index climbed 1.9%.”
November 8 – New York Times (Keith Bradsher): “China on Wednesday released fresh details about a new financial regulatory body intended to calm a financial system that in recent years has endured a stock market crash, a huge exodus of money outside the country and the rapid accumulation of debt. But the details may raise more questions than they answer, and could disappoint those looking for a strong hand to rein in the financial system underpinning the world’s second-largest economy. Official Chinese media reported… that a new Financial Stability and Development Committee had held its first meeting, nearly four months after President Xi Jinping ordered its creation. It said the meeting was led by Ma Kai, a 71-year-old vice premier. At the meeting, Mr. Ma stressed that China’s financial system should serve the real economy… namely, making money available to businesses that need it. He also stressed financial security, the report said.”
November 5 – Bloomberg: “China’s shadow banking sector, estimated by some analysts to be worth 122.8 trillion yuan ($18.5 trillion), stopped growing in the first half of the year as issuance of wealth management products declined, according to Moody’s… For the first time since 2012, China’s gross domestic product grew faster than shadow banking assets in the six-month period… Following last month’s Communist Party Congress, further regulation will continue to rein in shadow banking and address some of the key systemic imbalances, Moody’s said. While Moody’s assessment offers some evidence that China’s crackdown on shadow financing is starting to bite, authorities continue to sound the alarm on high debt levels.”
November 7 – Bloomberg: “Under pressure to trim borrowings, China’s companies have found a way to reduce their lofty debt burdens -- even if some of the risk remains. Sales of perpetual notes -- long-dated securities that can be listed as equity rather than debt on balance sheets given that in theory they could never mature -- have soared to a record this year as Beijing zeros in on leverage and the threat it poses to the financial system. The bonds are so popular that issuance by non-bank firms has jumped to the equivalent of 433 billion yuan ($65bn), more than seven times sales by companies in the U.S. ‘Chinese issuers love perpetual bonds because they are under great pressure to deleverage,’ said Wang Ying, a senior director at Fitch… ‘Sophisticated investors should do their homework and shouldn’t be misled by the numbers in accounting books.’”
November 5 – Financial Times (Charles Clover): “China has unveiled a ‘magical’ island-building ship on the eve of Donald Trump’s visit in a move likely to renew fears about its claims to territory in the South China Sea. At 140 metres the Tiankun is the biggest dredger in Asia, with cutters and pumps capable of smashing the equivalent of three Olympic pools of rock an hour from the sea floor and shooting it 15km away to create land. During the past five years, China has used similar vessels to create a string of strategic islands to support its claims to 85% of the sea.”
Central Banker Watch:
November 7 – Bloomberg (Alessandro Speciale and Piotr Skolimowski): “Three of the European Central Bank’s top policy makers pushed last month to alter a commitment to keep buying bonds until inflation improves, signaling challenges ahead for President Mario Draghi as the bank seeks to slow quantitative easing. Board member Benoit Coeure, Bundesbank President Jens Weidmann and Bank of France Governor Francois Villeroy de Galhau were the heavyweights who recommended tying the overall level of monetary stimulus -- rather than just asset purchases -- to the outlook for prices…”
Global Bubble Watch:
November 8 – Bloomberg (Luke Kawa): “The best way to crush the crowd in 2017? Buy the things everyone insisted would never keep going up. A portfolio stuffed with allegedly over-inflated assets would have returned more than 120% so far in 2017, trouncing the S&P 500 Index... The hypothetical ‘Bubblicious’ portfolio includes Chinese real estate and internet names, a pair of U.S. tech behemoths, a cryptocurrency fund, the ETF industry, bonds that mature decades from now, and a dash of short volatility bets just to make things more interesting. The out-performance is a testament to the momentum mania prevalent in today’s markets, a dynamic which has prompted the likes of Greenlight Capital’s David Einhorn, Goldman Sachs…, and Sanford C Bernstein… to mull whether value investing is in the midst of an existential crisis given ultra-low interest rates and abundant liquidity.”
November 6 – Bloomberg (Ian King): “Broadcom Ltd. offered about $105 billion for Qualcomm Inc., kicking off an ambitious attempt at the largest technology takeover ever in a deal that would rock the electronics industry. Broadcom made an offer of $70 a share in cash and stock for Qualcomm, the world’s largest maker of mobile phone chips. That’s a 28% premium over the stock’s closing price on Nov. 2… The proposed transaction is valued at approximately $130 billion on a pro forma basis, including $25 billion of net debt. Buying Qualcomm would make Broadcom the third-largest chipmaker, behind Intel Corp. and Samsung Electronics Co. The combined business would instantly become the default provider of a set of components needed to build each of the more than a billion smartphones sold every year. The deal would dwarf Dell Inc.’s $67 billion acquisition of EMC in 2015 -- then the biggest in the technology industry.”
Fixed Income Bubble Watch:
November 7 – Bloomberg (Cormac Mullen): “It’s one step forward, two steps back for bond volatility. Bank of America Merrill Lynch’s MOVE Index, a gauge of price swings in the U.S. Treasury market, fell to a record low on Monday, bucking last month’s uptrend. Renewed expectations that the Federal Reserve will stay the course on monetary policy in the midst of a leadership transition and the unveiling of the Republican tax plan have spurred an eight-day decline in the volatility of the world’s largest bond market.”
November 6 – Bloomberg (Lisa Lee and Adam Tempkin): “One of the last hurdles preventing riskier companies from slashing borrowing costs in an already red-hot leveraged loan market is crumbling. Managers of collateralized loan obligations, the biggest buyers of U.S. leveraged loans, have started to give in to an unprecedented surge of repricings of the debt they hold in their portfolios. More than $175 billion of CLOs have refinanced in the last 12 months, up from less than $10 billion in the prior one-year period… These refinancings could further strengthen the hands of borrowers, allowing them to demand even more rate cuts from their creditors who have little choice other than to say yes. Unlike junk bonds, loans are relatively easy to prepay, giving companies the option to refinance with a new group of investors. About $525 billion of loans have repriced during the last 12 months, compared to $130 billion in the prior one-year period…”
November 7 – Wall Street Journal (Paul J. Davies): “The hunt for yield is taking Wall Street and investors into exotic territory, and that means an appetite for credit assets that are private, not easily tradable and often complex. Putting together deals in what some dub ‘nonlinear finance’ is a growth business for investment banks’ big bond-trading arms and is helping clear unwanted assets off some balance sheets. However, such private deals, which aren’t publicly traded and don’t have public credit ratings, are a challenge for regulators keeping track of the growth of shadow banking and understanding whether such activity is driven by regulation or its avoidance. The business isn’t new, but it is heating up as banks hire specialists and commit balance-sheet capacity to feed investor demand.”
November 7 – Financial Times (Nicholas Megaw): “Record high prices combined with more risky corporate bond supply is creating ‘increasing uncertainty’ and raising the chances of a sharp turnround in the European high-yield credit market, Fitch… warned. Yields on the most popular benchmark for European junk bonds fell below 2% for the first time ever last week, but Fitch warned that recent market calm and the distorting impact of central bank monetary policy ‘obscure the true risk-return dynamics faced by investors’. The ratings agency said the proportion of newly-issued bonds with the lowest credit ratings – CCC+ or below – has risen to its highest level since 2013, when average yields were more than 5%.”
Europe Watch:
November 7 – Reuters (Thomas Escritt): “The German economy is at risk of overheating, according to a leaked advisory council report that follows pressure from the Bundesbank for a swifter end to the European Central Bank’s expansive monetary policy. In their annual report… the five ‘wise men’ who advise the German government on economic policy said the economy, which they expected to expand strongly this year and next, was moving gradually into a ‘boom phase’. ‘There are clear signs that economic capacity is over-utilised,’ read the report…”
November 8 – Bloomberg (Lorenzo Totaro): “Italy’s ratio of debt to economic output will rise slightly this year and won’t fall below 130% through 2019 as the pace of recovery slows, the European Commission said. The ratio will increase to 132.1% of gross domestic product from 132% in 2016, the Brussels-based EU executive arm said…”
Emerging Market Watch:
November 6 – Bloomberg (Daniel Cancel): “Venezuelan debt is teetering toward default with average prices near 30 cents on the dollar. As investors ponder an invite from the government to come to Caracas next week to discuss a restructuring…, they now demand a record 40.8 percentage points of extra yield over U.S. Treasury bills to hold the country’s bonds. No one really expects those yields to pay out as Venezuela seeks debt relief, but they do give an idea as to just how distressed the securities have become.”
Leveraged Speculation Watch:
November 7 – Bloomberg (Cecile Gutscher): “Hedge funds are headed for their best year since 2013 thanks to a gravity-defying stock market. Improving performance may go some way to assuaging criticism for fees that are hard to justify with mediocre returns, even though on average the funds underperformed equity benchmarks including the S&P 500 Index, which is up 15.7% year-to-date. 2017’s winning strategies were deployed by equity funds skewed toward health care and technology, according to… Hedge Fund Research Inc. through September. Over the same period, the S&P 500 Tech Index returned 26%...”
Geopolitical Watch:
November 7 – BBC (Suzy Waite and Nishant Kumar): “Saudi Arabia's Crown Prince Mohammed bin Salman has accused Iran of an act of ‘direct military aggression’ by supplying missiles to rebels in Yemen. This ‘may be considered an act of war’, state media quoted the prince as telling UK Foreign Secretary Boris Johnson…”
November 7 – Reuters (Tom Perry and Laila Bassam): “Saudi Arabia has opened a new front in its regional proxy war with Iran, threatening Tehran’s powerful ally Hezbollah and its home country Lebanon to try to regain the upper hand. With Iranian power winning out in Iraq and Syria, and Riyadh bogged down in a war with Iran-allied groups in Yemen, the new Saudi approach could bring lasting political and economic turmoil to a country where Tehran had appeared ascendant. The resignation on Saturday of the Saudi-allied Lebanese prime minister Saad al-Hariri, announced from Riyadh and blamed on Iran and Hezbollah, is seen by many as the first step in an unprecedented Saudi intervention in Lebanese politics.”
November 7 – Bloomberg (Suzy Waite and Nishant Kumar): “Cheap money may have buoyed emerging-market macro hedge funds toward their ninth straight annual advance, but that doesn’t mean investors are expecting an exodus as the world’s central bankers start turning off the taps. Demand for these funds remains so brisk, in fact, that some are turning new money away.”
November 7 – Financial Times (Erika Solomon): “A string of escalatory moves in the Gulf in recent days suggests the long-brewing cold war between Saudi Arabia and its regional arch-rival Iran could soon grow hot. It began with the surprise resignation of the Lebanese prime minister, Saad al-Hariri, announced on Saturday from Saudi Arabia. Riyadh is believed to have pressed him to step down in frustration that Mr Hariri, a long-time Saudi ally, had in effect given cover to the Lebanese Shia force Hizbollah, Iran’s top regional proxy, by sharing control of government with them. Hours later, in Yemen, a ballistic missile was fired by Iran-backed Houthi rebels towards Riyadh airport. Saudi Arabia accused Iran… of an ‘act of war’ over the incident; the same day King Salman of Saudi Arabia summoned Mahmoud Abbas, president of the Palestinian Territories, to a meeting. It raised suspicions that Mr Abbas too was coming under pressure from Riyadh after reaching a power-sharing deal with Hamas, the Iran-backed militant group.”
November 6 – AFP (Alison Tahmizian Meuse and Mohamed Hasni): “Saudi Arabia and Iran traded fierce accusations over Yemen…, with Riyadh saying a rebel missile attack ‘may amount to an act of war’ and Tehran accusing its rival of war crimes. Tensions have been rising between Sunni-ruled Saudi Arabia and predominantly Shiite Iran, which are opposed in disputes and conflicts across the Middle East from Yemen and Syria to Qatar and Lebanon. On Monday, a Saudi-led military coalition battling Tehran-backed rebels in Yemen said it reserved the ‘right to respond’ to the missile attack on Riyadh at the weekend, calling it a ‘blatant military aggression by the Iranian regime which may amount to an act of war’. Saudi Foreign Minister Adel al-Jubeir also warned Tehran. ‘Iranian interventions in the region are detrimental to the security of neighbouring countries and affect international peace and security. We will not allow any infringement on our national security,’ Jubeir tweeted.”