Weekly Commentary: Liquidity Supernova and the Big Ugly Flaw

April 21 – Reuters (Vikram Subhedar): “The $1 trillion of financial assets that central banks in Europe and Japan have bought so far this year is the best explanation for the gains seen in global stocks and bonds despite lingering political risks, Bank of America Merrill Lynch said on Friday. If the current pace of central bank buying, dubbed the ‘liquidity supernova’ by BAML, continues through the year, 2017 would record their largest financial asset purchases in a decade…”

From the report authored by BofA Merrill’s chief investment strategist Michael Hartnett: “The $1 trillion flow that conquers all… One flow that matters… $1 trillion of financial assets that central banks (European Central Banks & Bank of Japan) have bought year-to-date (= $3.6tn annualized = largest CB buying in past 10 years); ongoing Liquidity Supernova best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro."

A strong case can be made that Q1 2017 experienced the most egregious monetary stimulus yet. No financial or economic crisis – and none for years now. Consumer inflation trends have turned upward on a global basis. Stock prices worldwide have surged higher, with U.S. and other indices running to record highs. At the same time, global bond yields remained just off historic lows. Home prices in many key global markets have spiked upward. Meanwhile, central bank balance sheets expanded at a $3.6 TN annualized pace (from BofA) over the past four months.

With U.S. bond yields reversing lower of late, there’s been a fixation on weaker-than-expected Q1 U.S. GDP. Meanwhile, recent data have been stronger-than-expected in China, Europe and Japan. EM has been buoyed by strong financial inflows and a resulting loosening of financial conditions. Thus far, Fed baby-step normalization efforts have been overpowered by the “liquidity supernova”.

April 21 – Reuters (Balazs Koranyi): “Global growth and trade appear to be picking up strength but risks for the euro zone economy remain tilted to the downside, so 'very substantial' accommodation is still necessary, European Central Bank President Mario Draghi said on Friday. In a statement largely reflecting the bank's March policy statement, Draghi said that while the risk of deflation has largely disappeared, underlying inflation has shown no convincing upward trend.”

April 20 – Reuters (Leika Kihara): “Japan has benefitted from global tailwinds that boosted exports and factory output, [Bank of Japan Governor Haruhiko] Kuroda said, describing its economy as ‘expanding steadily as a trend’ - a more upbeat view than last month. But he offered a bleaker view on Japan's inflation, saying it lacked momentum with no clear sign yet it was shifting up. ‘That's why the BOJ will continue its ultra-easy monetary policy to achieve its 2% inflation target at the earliest date possible,’ he said.”

Bank of Japan Governor Haruhiko Kuroda, responding to a question from Bloomberg Television's Francine Lacqua: “The inflation rate continues to be quite sluggish. Although the real economy is improving – doing better than we anticipated just a few months ago. Like the IMF – the IMF itself also made up the [global growth] rate this time compared to the January figure. So, as far as the Japanese economy is concerned, yes the economy is doing better than we anticipated…, but the inflation front has not much improved, unfortunately.”

Mr. Kuroda is quick with a smile and carries an infectious laugh; seems like a nice guy. Seeing his big grin after stating “the inflation front has not much improved, unfortunately,” I couldn’t help but think he’s not at all unhappy with inflation stuck below target. And why not? The BOJ can proceed with its historic experiment in government debt monetization, in the process administering more liquidity upon a global system already inundated with central bank “money”. The Fateful Day of Reckoning and attendant very difficult decisions – for Japan and the rest of the world – can be relegated to some future date. Historians will surely appreciate what few are willing to admit today: it’s crazy that Haruhiko Kuroda has come to wield such incredible power over global finance and securities markets.

Japan and Europe confront deep structural issues. In particular, Japan faces an aging population and a conservative, high-savings society. It remains a powerful manufacturer and runs persistent Current Account surpluses. In the face of unprecedented debt monetization, the yen has proven impressively resilient. What’s more, the yen’s 7% y-t-d gain (vs. $) will not be supportive of the BOJ attaining its inflation target. As for the ECB’s Draghi, it’s even more difficult to argue that low inflation remains a scourge worthy of “whatever it takes.” Yet he’s obviously in no rush to rethink his aggressive printing operations – no hurry whatsoever to face his Day of Reckoning.

Here at home, inflationary biases throughout asset markets have over recent months turned increasingly robust. Stock prices surged to record highs, while home price inflation picked up steam as sales transactions escalated to the strongest pace since 2007. Debt issuance has been running at a record rate. In spite of it all, Fed chair Yellen has been quick to note that inflation remains “slightly” below the Fed’s 2% target. Rather quickly the markets question whether the Yellen Fed has the fortitude for a couple additional baby-step rate increases this year.

Can we all agree that this central bank fixation on a 2% consumer price inflation target is borderline ridiculous? Consumer price dynamics have changed momentously over the past 20 years. Most importantly, the technology revolution has basically created an unlimited supply of goods and services. From smart phones and tablets to digital downloads, companies can now easily expand output to meet heightened demand. There has been as well the equally momentous move to “globalization” – with seemingly limitless cheap labor coupled with unlimited cheap finance fundamentally boosting the supply of inexpensive goods and services globally.

Technological advancement has played a profound role in oil extraction, new energy technologies and energy conservation. There are as well advancements in pharmaceuticals and healthcare more generally. Even in basics like food, there is a proliferation of higher-priced organic and healthy-choice products. And somehow government economists are adept at constructing models and calculating hedonic adjustments to come to an accurate measure of true underlying CPI? And this single contrived data point has become key to policies that amount to a historic experiment in global activist monetary management? Wow.

I’m reminded of the mortgage finance Bubble period with chairman Greenspan supposedly fretting that booming housing markets were impervious to Fed “tightening” measures. I recall writing in the CBB at the time, “Greenspan could easily resolve this issue with two phone calls, and they’d both be local.” Fannie and Freddie were clearly at the heart of a historic Bubble in mortgage finance. Yet no one was willing to call the Fed out on the reckless GSEs and the powerful distortions emanating from the market embrace of the implied Washington backing of agency obligations.

These days, virtually no one is willing to call out global central bankers on their notion that there is basically no limit to measures to be employed to achieve 2% CPI bogeys. Zero rates, negative rates, Trillions of monetization, acquire equities and corporate debt, market yield manipulation, etc. Risk be damned. Everyone is content to disregard that central banks have inflated epic Bubbles almost everywhere across virtually all asset classes – and they’re trapped.

The entire contemporary notion of “inflation” is deeply flawed. Years ago, I adopted the “Austrian” view: start with the expansion of Credit – “Credit/monetary inflation” – and then diligently monitor for price effects and inflationary consequences associated with the resulting increase in purchasing power.

Inflation can arise in myriad forms: rising consumer and producer prices; higher asset values and market distortions; increasing corporate profits and investment; trade and Current Account deficits; etc. And, as the late Dr. Kurt Richebacher was so great at explaining, consumer prices were generally the least threatening inflationary manifestation. Central bankers could and would squeeze consumer inflation with tighter policy. Asset inflation, on the other hand, would be allowed (even nurtured) to develop into Bubbles that would inflate to the point of imparting deep structural (financial and economic) maladjustment. As we’ve witnessed for over twenty years now, there’s no constituency for thwarting rising asset prices.

After experiencing the mortgage finance Bubble fiasco, it’s difficult to comprehend that global central bankers have so aggressively embraced and promoted asset inflation. Central bankers have been hoping for modest self-reinforcing inflation in a general price level. General price inflation would, so the thinking goes, spur a commensurate increase in Credit that would support ongoing moderate increases in CPI.

Well, it may have worked that way in the past but no longer. Central banks have ensured that the powerful inflationary biases reside throughout the asset markets. These days, monetary inflation works predominately to stoke asset inflation and Bubbles, with major ramifications for ongoing inequitable wealth distribution and system fragility more generally. Deep structural impairment will be revealed when the Bubble falters, a dynamic that clearly reverberates these days throughout global bond markets.

April 20 – Reuters (David Morgan): “U.S. President Donald Trump's tax reform plan will rely largely on future revenue gains from faster economic growth to justify major tax cuts, top Trump advisers said… As Trump's first 100 days in office draw to a close, the disclosure is the latest sign that the White House could part ways with congressional Republicans who want to pay for tax cuts by taxing imports and eliminating a business tax deduction for debt interest payments. ‘Some of the lowering in (tax) rates is going to be offset by less deductions and simpler taxes,’ Treasury Secretary Mnuchin said…’But the majority of it will be made up by what we believe is fundamentally growth and dynamic scoring,’…”

During the late-nineties Bubble period, there was ruminating over fiscal surpluses that were expected to extinguish much of outstanding Treasury debt. It was all a Bubble mirage. Anyone contemplating a U.S. government $20 TN in the whole would have been viewed as a complete nut case. And here we are again in the heart of a historic Bubble, with Washington politicians talking about big tax cuts paid for with future revenues. The scope of prospective post-Bubble deficits is almost difficult to fathom.

Sunday’s first round French election will be captivating. A Marine Le Pen versus Jean-Luc Mélenchon second round would be a big issue for the markets. Markets Friday were somewhat concerned that Le Pen could receive a boost after this week’s terrorist shooting on Paris’ Champs- Élysées. For the most part, however, players were heartened by polls showing centrist Emmanuel Macron somewhat widening his narrow lead over Le Pen. Both François Fillon and Mélenchon remain within striking distance.

Crude was slammed almost 7%, as the GSCI commodities index sank 4.6% this week. And while OPEC remains an ongoing issue, China seemed to be at top of mind. It’s almost as if every headline related to tighter Chinese regulation – real estate finance, shadow-banking, wealth management products, insurance, corporate debt and repo leverage, Internet finance, the stock market – seems to help reawaken market fears of latent system fragilities. Timid policymaking has not only not worked, it’s has emboldened Bubble excess. Tough policies will be necessary but risk bursting the Bubble.

It’s evolved into a global issue: There’s no cure for major asset Bubbles other than unwinds. Once asset inflation becomes the prevailing inflationary manifestation it becomes impossible to inflate away the problem. Instead, central bank efforts to spur general inflation only exacerbate Bubbles and maladjustment. That’s The Big Ugly Flaw in this runaway global monetary experiment. Back when he served as president of the Dallas Fed, Richard Fisher espoused some cogent advice for global central bankers: The law of holes – when you find yourself in a hole, first you must stop digging. Well, the problem today is that instead of heeding Fisher’s “stop digging” they came together, called in the big backhoes and have been shoveling fanatically ever since.

Bloomberg's Francine Lacqua: “Do you worry - you’ve used a lot of tools – a lot of unconventional tools. Do you worry about your balance sheet – in terms of GDP it’s higher than that Fed’s.”

Bank of Japan Governor Haruhiko Kuroda: “Yes. We have acquired about 40% of JGBs outstanding. Which means about 80% of GDP equivalent of JGBs we have acquired. But this is a result of the quantitative and qualitative monetary easing, and we think that we can manage the enlarged balance sheet in a reasonable manner. Of course, once we exit from the QQE with yield curve control, we’ll have to consider how to deal with an enlarged balance sheet. But, like the Fed, I think we can manage the enlarged balance sheet in a reasonable way.”

Lacqua: “When is the ideal time to start talking about it [exiting QQE]?”

Kuroda: “It’s too early… Because our target rate is 2% - we’re still around zero percent inflation rate. So it’s a long way to go. So although we forecast that the inflation rate would gradually rise to our 2% and reaching the target sometime around fiscal 2018, it’s a long way to go. So, at this stage it’s premature to discuss in an exact way about an exit strategy.”

Lacqua: “Governor, what have you learned in your time as head of the BOJ? I don’t know if it is easier or more difficult than you thought to manage this complicated economy.”

Kuroda: “It’s maybe of course challenging, depending on the economic and market conditions when the BOJ starts to exit from the current QQE and yield control. But I think it can be managed in a reasonable way. So I have no particular concern about the increased balance sheet or negative interest rates on the short end. No.”


For the Week:

The S&P500 gained 0.8% (up 4.9% y-t-d), and the Dow added 0.5% (up 4.0%). The Utilities were little changed (up 5.9%). The Banks rallied 1.8% (down 2.4%), and the Broker/Dealers recovered 3.0% (up 2.3%). The Transports rallied 2.9% (up 1.0%). The S&P 400 Midcaps gained 2.2% (up 3.4%), and the small cap Russell 2000 jumped 2.6% (up 1.7%). The Nasdaq100 advanced 1.7% (up 11.9%), and the Morgan Stanley High Tech index rose 1.6% (up 13.6%). The Semiconductors rallied 3.4% (up 9.5%). The Biotechs declined 1.3% (up 13.2%). Though bullion was little changed, the HUI gold index dropped 3.4% (up 12.8%).

Three-month Treasury bill rates ended the week at 76 bps. Two-year government yields declined two bps to 1.18% (down 1bp y-t-d). Five-year T-note yields were little changed at 1.77% (down 16bps). Ten-year Treasury yields added a basis point to 2.25% (down 20bps). Long bond yields increased one basis point to 2.90% (down 16bps).

Greek 10-year yields declined two bps to 6.55% (down 47bps y-t-d). Ten-year Portuguese yields fell 14 bps to 3.74% (unchanged). Italian 10-year yields dropped six bps to 2.26% (up 45bps). Spain's 10-year yields slipped a basis point to 1.70% (up 32bps). German bund yields jumped seven bps to 0.25% (up 5bps). French yields gained two bps to 0.94% (up 26bps). The French to German 10-year bond spread widened five to 69 bps. U.K. 10-year gilt yields dipped one basis point to 1.03% (down 20bps). U.K.'s FTSE equities index dropped 2.9% (down 0.4%).

Japan's Nikkei 225 equities index rallied 1.6% (down 2.6% y-t-d). Japanese 10-year "JGB" yields increased one basis point to 0.02% (down 2bps). The German DAX equities index slipped 0.5% (up 4.9%). Spain's IBEX 35 equities index increased 0.5% (up 11%). Italy's FTSE MIB index slipped 0.2% (up 2.6%). EM equities were mixed. Brazil's Bovespa index recovered 1.5% (up 5.9%). Mexico's Bolsa was unchanged (up 7.3%). South Korea's Kospi rallied 1.4% (up 6.8%). India’s Sensex equities index slipped 0.3% (up 10.3%). China’s Shanghai Exchange dropped 2.2% (up 2.2%). Turkey's Borsa Istanbul National 100 index rose 2.6% (up 18.3%). Russia's MICEX equities index gained 1.5% (down 12.9%).

Junk bond mutual funds saw outflows of $362 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates sank 11 bps to five-month low 3.97% (up 38bps y-o-y). Fifteen-year rates fell 11 bps to 3.23% (up 38bps). The five-year hybrid ARM rate declined eight bps to 3.10% (up 39bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down eight bps to 4.07% (up 40bps).

Federal Reserve Credit last week expanded $9.3bn to $4.444 TN. Over the past year, Fed Credit dipped $8.1bn (down 0.2%). Fed Credit inflated $1.624 TN, or 58%, over the past 231 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $6.4bn last week to $3.206 TN. "Custody holdings" were down $35.8bn y-o-y, or 1.1%.

M2 (narrow) "money" supply last week jumped $42.1bn to a record $13.405 TN. "Narrow money" expanded $797bn, or 6.3%, over the past year. For the week, Currency increased $3.3bn. Total Checkable Deposits sank $84.7bn, while Savings Deposits surged $126bn. Small Time Deposits rose $0.9bn. Retail Money Funds declined $3.2bn.

Total money market fund assets dropped $16.7bn to $2.627 TN. Money Funds fell $72bn y-o-y (2.7%).

Total Commercial Paper fell $10.0bn to $974.9bn. CP declined $136bn y-o-y, or 12.2%.

Currency Watch:

April 18 – Bloomberg (Steve Matthews and Matthew Boesler): “Goldman Sachs… has finally dumped the dollar. The U.S. investment bank closed one of its top trade recommendations for 2017 -- long-dollar positioning against the euro, the sterling, and the Chinese yuan -- citing a slowdown in the reflationary momentum in the U.S. economy. ‘In recent years we have generally maintained a bullish dollar view, and the greenback still has a number of things going for it, including a healthy domestic economy, an active central bank, and lower political uncertainty compared with the U.K. and euro area,’ Goldman economist Zach Pandl wrote… ‘However, a number of fundamentals have changed on the margin, such that the long-dollar story no longer warrants a place among our ‘Top Trades.’’”

The U.S. dollar index declined 0.5% to 99.98 (down 2.4% y-t-d). For the week on the upside, the South African rand increased 2.5%, the British pound 2.4%, the euro 1.0%, the Swiss franc 0.9%, the Swedish krona 0.5%, the South Korean won 0.5%, the New Zealand dollar 0.3% and the Singapore dollar 0.1%. For the week on the downside, the Mexican peso declined 1.5%, the Canadian dollar 1.3%, the Norwegian krone 1.0%, the Australian dollar 0.5% and the Japanese yen 0.4%. The Chinese renminbi was little changed versus the dollar this week (up 0.87% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index sank 4.6% (down 3.9% y-t-d). Spot Gold was little changed at $1,284 (up 11.4%). Silver fell 3.1% to $17.94 (up 12.2%). Crude sank $3.56 to $49.62 (down 8%). Gasoline fell 5.2% (down 2%), and Natural Gas dropped 3.9% (down 17%). Copper declined 0.8% (up 1.7%). Wheat was hit 4.9% (up 3%). Corn fell 3.8% (up 3%).

Trump Administration Watch:

April 16 – Wall Street Journal (John D. McKinnon): “A senior Trump administration official warned Sunday that North Korea’s provocative behavior ‘can’t continue,’ and said the U.S. is working with partners including China to develop a range of possible responses to future ‘destabilizing behavior.’ ‘It’s really the consensus with the president, our key allies in the regions—Japan and South Korea in particular, but also the Chinese leadership—that this problem is coming to a head,’ White House national security adviser Lt. Gen. H.R. McMaster said… ‘And so it’s time for us to undertake all actions we can, short of a military option, to try to resolve this peacefully.’”

April 20 – Reuters (Ju-min Park): “North Korean state media warned the United States of a ‘super-mighty preemptive strike’ after U.S. Secretary of State Rex Tillerson said the United States was looking at ways to bring pressure to bear on North Korea over its nuclear programme… The Rodong Sinmun, the official newspaper of the North's ruling Workers' Party, did not mince its words. ‘In the case of our super-mighty preemptive strike being launched, it will completely and immediately wipe out not only U.S. imperialists' invasion forces in South Korea and its surrounding areas but the U.S. mainland and reduce them to ashes,’ it said.”

April 19 – Politico (Josh Dawsey and Jake Sherman): “The White House, under internal pressure to show legislative achievements ahead of the 100-day mark, is gearing up for a government shutdown fight to secure money for a border wall, more immigration enforcement officers and a bigger military, according to White House and congressional sources… It is a risky gambit. With almost uniform Democratic opposition to nearly all of the Trump administration's spending proposals, the fight could lead to a government shutdown next Friday — the day government spending expires… Officials could also strike a one-week compromise, giving them more time for a broader agreement.”

April 19 – Bloomberg (Billy House and Anna Edgerton): “There may be only one way for Speaker Paul Ryan to avoid a government shutdown: Ask his Democratic counterpart, Nancy Pelosi, for help. The problem is, the two don’t have much history of deal-making together. They don’t even know each other that well. But after spending weeks trying -- so far unsuccessfully -- to ram through legislation to undo Democrats’ signature health-care law, Ryan will almost certainly need Pelosi’s support to keep the government open after April 28, when current funding expires. Ryan and Pelosi have dined together only once… The distance between the pair, who are separated in age by three decades, also reflects how little time House Republicans have spent negotiating with Democrats in recent years.”

April 20 – Wall Street Journal (Peter Nicholas, Kate Davidson and Nick Timiraos): “White House officials said Thursday they are developing a sweeping plan to overhaul both corporate and individual taxes, dismissing concerns that a more modest proposal might be more viable in today’s political climate. Speaking at a conference of international financial firms, Treasury Secretary Steven Mnuchin said the administration would release its tax overhaul ‘very soon.’ The remarks ended weeks of mixed signals from the White House about the breadth of President Donald Trump’s plan, and came as some of his former campaign advisers cautioned against an aggressive approach”.

April 17 – Reuters (Laharee Chatterjee): “U.S. Treasury Secretary Steven Mnuchin said the Trump administration’s timetable for tax reform is set to falter following setbacks in negotiations with Congress over healthcare, the Financial Times reported… Mnuchin told the Financial Times… that the target to get tax reforms through Congress and on President Donald Trump's desk before August was ‘highly aggressive to not realistic at this point’. ‘It is fair to say it is probably delayed a bit because of the healthcare,’ Mnuchin told the newspaper.”

April 19 – Reuters (David Milliken): “U.S. President Donald Trump is ‘absolutely not’ trying to talk down the strength of the dollar, Treasury Secretary Steven Mnuchin was quoted as saying in the Financial Times… Trump said last week in an interview with the Wall Street Journal that the dollar was ‘getting too strong’, and backed away from labelling China a currency manipulator. Mnuchin had played down that comment on the dollar… In a more detailed version published on Wednesday, he directly rejected the idea that Trump was trying to talk down the dollar, saying ‘Absolutely not, absolutely not.’”

April 17 – Reuters (James Oliphant and Svea Herbst-Bayliss): “In a White House marked by infighting, top economic aide Gary Cohn, a Democrat and former Goldman Sachs banker, is muscling aside some of President Donald Trump's hard-right advisers to push more moderate, business-friendly economic policies. Cohn, 56, did not work on Republican Trump's campaign and only got to know him after the November election, but he has emerged as one of the administration's most powerful players in an ascent that rankles conservatives…”

April 20 – Reuters (Pete Schroeder): “The head of the U.S. House of Representatives' banking panel has unveiled the Republicans' most ambitious plan so far to loosen financial regulations, a 600-page bill to replace the Dodd-Frank financial reform law. Representative Jeb Hensarling, who chairs the House Financial Services Committee, also set an April 26 hearing to discuss replacing the 2010 law. ‘Republicans are eager to work with the president to end and replace the Dodd-Frank mistake with the Financial CHOICE Act because it holds Wall Street and Washington accountable, ends taxpayer-funded bank bailouts, and unleashes America’s economic potential,’ the Texas Republican said…”

April 18 – New York Times (Vindu Goel): “President Trump signed an executive order… that directs federal agencies to review employment immigration laws to promote ‘Hire American’ policies. The order makes no immediate changes to work visa programs but tells the Departments of Labor, Justice, Homeland Security and State to study existing laws and procedures and recommend changes. In the case of one program, H-1B temporary visas, the order directs the agencies to suggest changes to help ensure that the visas are awarded to the most skilled, best-paid immigrant workers.”

China Bubble Watch:

April 17 – Bloomberg: “The value of China’s home sales remained buoyant in March, though volume figures indicated that curbs in a number of cities may be slowing the recent buying frenzy. New home sales by value rose 18% to 1 trillion yuan ($145bn) last month from a year earlier… The increase compares with a 23% surge in the first two months of the year.”

April 17 – Bloomberg: “China home prices rose in the most cities since October, suggesting buyers are trying to get in ahead of any further restrictions on property purchases. New-home prices, excluding government-subsidized housing, gained last month in 62 of the 70 cities tracked by the government, compared with 56 in February… Prices fell in eight cities… Chinese authorities have pledged to enforce strict curbs in most first- and second-tier cities to prevent a housing bubble, while seeking to clear a glut of unsold homes in smaller urban centers.”

April 17 – Reuters (Kevin Yao and Yawen Chen): “Real estate investment in China remained robust in the first quarter from a year earlier…, as the pace of new construction quickened, despite intensified government cooling measures. Growth in property investment, which includes residential, commercial and office spaces, accelerated to 9.1% from 8.9% in the first two months of 2017… In March alone, property investment growth rose to 9.4%...”

April 17 – Bloomberg: “China’s economy accelerated for a second-straight quarter as investment picked up, retail sales rebounded and factory output strengthened amid robust credit growth and further strength in property markets. Gross domestic product increased 6.9% in the first quarter from a year earlier… It was the first back-to-back acceleration in seven years… Fixed-asset investment excluding rural areas expanded 9.2% for the first three months, accelerating from 8.1% growth last year. Retail sales increased 10.9% from a year earlier in March…”

April 18 – Financial Times (Gabriel Wildau): “China's new chief banking regulator has started with a bang, issuing a flurry of new policy directives during his first month aimed at the industry's knottiest problems, in line with the government’s focus this year on managing financial risk. The China Banking Regulatory Commission has issued seven policy documents in the past 12 days, in what state news agency Xinhua is calling a ‘regulatory windstorm’… ‘Without a doubt, 2017 will be a big year for financial regulation. Regulation of the entire banking industry will become stricter and enforcement will become more rigorous,’ Sun Binbin, chief fixed-income analyst at TF Securities in Shanghai, wrote…’What we’ve seen so far is just framework. The detailed rules are yet to come.’”

April 20 – Wall Street Journal (James T. Areddy): “The Chinese government is trying to ensure financial-system stability in a pivotal political year by focusing on the officials who do the regulating. China has removed three of its four top financial-industry regulators over the past year or so as it also tightens the reins on banks, brokerages and insurers. The latest to fall was liberalizing insurance regulator Xiang Junbo, who jazzed up a stodgy business but caused ripples beyond his agency’s purview. After encouraging liberalization for banks, brokers and insurers in hopes of fueling a slowing economy, Beijing is becoming increasingly anxious about possible financial shock. The new message for its regulators: back to basics.”

April 20 – Bloomberg: “China’s regulators will consider potential market impacts when they introduce additional regulations on the shadow banking sector, according to a top central bank researcher. Any new rules on wealth management products and other asset management offerings will be rolled out gradually, Ma Jun, chief economist of the research bureau of the People’s Bank of China, said… The rebounding economy has created room for expedited structural reforms, Ma said. To curb risks in shadow banking… regulators are working to draft sweeping new rules…”

April 17 – Bloomberg: “China’s market for wealth management products is due for some pain as officials tighten regulations on the sector amid their campaign to curb financial risk, says the head of the nation’s third-largest mutual fund manager. Some holders of the products -- popular among individual investors for their high yields -- hold the ‘very dangerous assumption’ that the government will step in to support WMPs if they get in to trouble, said Tang Xiaodong, chief executive officer of China Asset Management Co…‘The WMPs have been developing a little too fast, too soon,’ Tang said… ‘That’s why the tightening of those regulations is a step in the right direction.’”

April 17 – Wall Street Journal (Shen Hong): “China’s riskiest corporate bonds are looking disproportionately expensive, a worrying sign that investors may have underestimated their risk as a tighter monetary policy and painful industrial restructuring weaken companies’ ability to repay debt. The unexpected popularity of bonds with low credit ratings in recent months, despite expectations of rising debt defaults and Beijing’s pledge to reduce leverage in financial markets, is the latest example of the constant anomalies in the world’s third-largest but still underdeveloped $9 trillion bond market.”

April 17 – Bloomberg: “China’s dollar bond market has a diversity problem. As borrowers raised a record $51.7 billion in dollar-denominated debt this year, Chinese banks bought about half of the notes, according to UBS… U.S.-based money managers only got access to 7% of the deals, down from 46% in 2014… The domination of China-based investors is fueling angst about the potential fallout if they all get cold feet at once, especially with $195 billion of dollar notes maturing over the next three years. Risk of a regulatory crackdown on wealth management products and a strengthening yuan are near the top of the worry list…”

April 20 – Reuters (Kevin Yao): “Capital outflows from China eased sharply in the first quarter and cross border flows were more balanced, the foreign exchange regulator said…, in the latest official comments indicating policymakers are growing less worried about the yuan currency. Reduced pressure from outflows has helped steady the yuan this year and brought China's foreign currency reserves back over the closely watched $3 trillion mark.”

April 18 – Reuters: “China's non-financial outbound direct investment (ODI) slumped 30.1% in March from a year earlier as authorities kept a tight grip on capital outflows… Non-financial ODI totalled $7.11 billion last month... For the first three months of this year, non-financial ODI tumbled 48.8% to $20.54 billion from the same period last year.”

Europe Watch:

April 19 – Wall Street Journal (Mike Bird and Christopher Whittall): “With the start of the French election just days away, investors are contemplating their nightmare scenario: a choice between far-left and far-right candidates. In recent days, a surge in opinion polls has placed Jean-Luc Mélenchon, a left-wing firebrand who promises higher wages and fewer working hours, as a potential candidate to move past this Sunday’s first round of voting. That could set up a second-round vote in May 7 with Marine Le Pen, an economic nationalist who wants to pull France out of the euro. Most analysts still expect a mainstream candidate to make it through to the second round and eventually clinch the presidency. But Mr. Mélenchon’s sudden rise has spooked investors just five days before voting kicks off.”

April 17 – Financial Times (Michael Stothard): “As he roared to the crowd, Jean-Luc Mélenchon showed how he has shaken up France’s presidential race as it heads in to the last few days of campaigning before Sunday’s first-round vote. While his rivals were hosting traditional rallies in arenas across the country, the far-left firebrand turned innovative campaigner was addressing a bankside crowd from a boat puttering down a Parisian canal. His supporters cheered wildly as the 65-year-old fan of former Venezuelan leader Hugo Chávez railed against international finance, free trade and the EU while rooting for ‘the people against the oligarchy’. Bankers, Mr Mélenchon said, are ‘parasites’ on society who ‘produce nothing’. Free trade ‘destroys everything’ and leads to the ‘total perversity’ of social dumping. Uber… is a ‘swindle’ that offers work without social protection.”

April 17 – Reuters (Michel Rose): “Presidential candidate Emmanuel Macron urged French voters… to turn the page on the last 20 years and bring a new generation to power, as he stepped up attacks against resurgent far-left and conservative rivals six days before voting day. Macron, a 39-year-old pro-EU centrist who would become the youngest French leader since Napoleon if elected, said recent leaders had betrayed the post-war generation which had rebuilt the country, leaving France unreformed and sclerotic. ‘What has been proposed to the French in the last 20 years is not liberation or reconstruction, but a slow, unavowed acceptation of unemployment, state impotence and social breakdown,’ he told a cheering crowd…”

April 18 – Reuters: “The International Monetary Fund will not take part in a bailout program for Greece if it deems the country's debt is unsustainable, the international lender's chief Christine Lagarde said… Greece needs to implement reforms agreed by euro zone finance ministers earlier this month to secure a new loan under its 86 billion-euro ($91.58 billion) bailout program, the third since 2010. The loan is needed to pay debt due in July, but talks continue and the IMF has not yet decided whether to join the bailout. The fund's participation is seen as a condition for Germany to unblock new funds to Greece.”

April 20 – Reuters (Jonathan Cable): “The euro zone economy bounded into the second quarter with strong broad-based growth, according to a survey showing businesses increased activity at the fastest rate for six years as new orders stayed robust… IHS Markit's Flash Composite Purchasing Managers' Index, seen as a good guide to growth, climbed to 56.7 from March's 56.4, its highest since April 2011.”

April 20 – Bloomberg (Fergal O'Brien): “The European Commission’s consumer-confidence index for the euro area jumped the most in five months in April. The advance put the index at its highest since March 2015, matching the strongest reading since before the financial crisis. The latest figures were far better than economists had anticipated…”

ECB Watch:

April 20 – Bloomberg (Carolynn Look, Jana Randow, and Matthew Boesler): “European Central Bank officials signaled that they’re getting close to the point when they’ll start preparing for the end of an era of unprecedented stimulus. In the last round of speeches before a week-long quiet period ahead of the next policy meeting, Executive Board members Benoit Coeure and Peter Praet agreed that the euro-area recovery has become broad-based… The 25-member Governing Council will debate the precise formulation of its stance on the economy when it decides on interest rates and stimulus settings on April 27. But with a potentially explosive election in France coming this weekend, that may still prove too soon for any change in its currently ultra-cautious tone.”

April 19 – Reuters (Andrea Shalal): “The German government believes an interest rate increase by the European Central Bank (ECB) would help to reduce Germany's often-criticized export surplus, the Funke Mediengruppe newspaper chain reported… The newspaper cited an eight-page paper prepared by the German finance and economics ministries which Finance Minister Wolfgang Schaeuble plans to present at the spring meeting of the International Monetary Fund later this week. Schaeuble is a longtime critic of the ECB's current ultra-low interest rate policy.”

Brexit Watch:

April 19 – Reuters (Elizabeth Piper, Kylie MacLellan and William James): “British Prime Minister Theresa May called… for an early election on June 8, saying she needed to strengthen her hand in divorce talks with the European Union by bolstering support for her Brexit plan. …May said she had been reluctant to ask parliament to back her move to bring forward the poll from 2020. But, after thinking ‘long and hard’ during a walking holiday, she decided it was necessary to try to stop the opposition ‘jeopardizing’ her work on Brexit. Some were surprised by May's move… but opinion polls give her a strong lead and the British economy has so far defied predictions of a slowdown.”

Global Bubble Watch:

April 18 – Bloomberg (Enda Curran, Liz McCormick, and Eric Lam): “After heading into the uncharted territory of quantitative easing, the world’s central banks are starting to plan their course through the uncharted waters of quantitative tightening. How the Federal Reserve, European Central Bank and -- eventually -- the Bank of Japan handle the transition could make the difference between a global rerun of the 2013 ‘taper tantrum,’ or the near undetectable market response to China’s run-down of U.S. Treasuries in recent years. Combined, the balance sheets of the three now total about $13 trillion… Former Fed Chair Ben S. Bernanke… has argued for a pre-set strategy to shrink the balance sheet… ‘You know what they say about mountaineering right? The descent is always more dangerous than the ascent,’ said Stephen Jen, …chief executive of hedge fund Eurizon SLJ Capital Ltd. ‘Shrinking the balance sheet will be the descent.’”

April 19 – Reuters (Jamie McGeever): “Stocks, bond yields and the dollar are all falling, yield curves are flattening and sterling is marching higher. The ‘reflation’ trades of 2016 that were supposed to mark a turning point in global markets are fading. Fast. The question for investors is whether this is the play book for the rest of the year, or whether the trends of 2016 will resume in the second half of the year. What is clear is that much of the conviction with which investors went into 2017 has been lost… Trump's surprise election victory was supposed to unleash a wave of tax cuts, banking deregulation and fiscal largesse that would lift U.S. -- and global -- growth. Meanwhile, sterling's 20% plunge after the Brexit vote was supposed to pave the way for a surge in UK equities and inflation.”

April 16 – Financial Times (Chris Flood): “Exchange traded funds attracted record inflows in the first three months of 2017 as investors continue to move out from traditional actively managed funds in protest against inconsistent performance and high fees. Investors worldwide ploughed $197.3bn into ETFs between January and March, a quarterly record… This follows 2016, when ETFs, which are famed for being low cost, gathered the highest ever annual amount of $390.4bn in new cash. Robert Buckland, a strategist at Citigroup, said the surge in ETF growth was a ‘seismic shift’, driven by a ‘profound re-assessment’ among investors about the fees they were prepared to pay asset managers to put money to work in the stock market.”

April 17 – New York Times (Landon Thomas Jr.): “The Vanguard trading floor is the epicenter of one of the great financial revolutions of modern times, yet it is a surprisingly relaxed place. A few men and women gaze at Bloomberg terminals. There is a muted television or two and a view of verdant suburban Philadelphia. No one is barking orders to buy or sell stock. For a $4.2 trillion mutual fund giant that is still growing rapidly, it occupies a small fraction of the space of a typical Wall Street trading hub. You can barely hear the quiet hum of money being invested — money in scarcely imaginable quantities, pouring into low-cost index mutual funds and exchange-traded funds (E.T.F.s) that track financial markets. In the last three calendar years, investors sank $823 billion into Vanguard funds… The scale of that inflow becomes clear when it is compared with the rest of the mutual fund industry — more than 4,000 firms in total. All of them combined took in just a net $97 billion during that period…”

April 19 – Financial Times (Ben McLannahan and Eric Platt): “Was Goldman Sachs — of all banks — wrongfooted by the Trump trade? Since the election of Donald Trump in November, the Wall Street bank has seen several senior executives decamp to Washington: none of them more influential than Gary Cohn, the bank’s former president now serving as Mr Trump’s top economic adviser. Despite that apparent edge, the bank was the only one of the US’s top six banks to report disappointing earnings for the first quarter. While rivals were boosted by brighter performances from bond-trading units, Goldman’s revenues from debt trading were basically flat. Analysts and traders say the bank may well have made a big bet that went wrong during the first quarter: the assumption that Mr Trump’s talk of boosting growth would push up interest rates, and thus push down the price of trillions of dollars of corporate bonds.”

April 18 – Bloomberg (Kim Chipman and Maciej Onoszko): “Canadian officials across all three levels of government vowed to be vigilant in monitoring the Toronto region’s rapidly accelerating housing market, including possibly taking formal steps aimed at curbing speculative activity. Federal Finance Minister Bill Morneau, Ontario Finance Minister Charles Sousa and Toronto Mayor John Tory met Tuesday to discuss the thorny question of how to cool the city’s residential real estate market… Possible steps include taxing homes left empty for speculative purposes, Tory said… Home prices in the Toronto area climbed 6.2% in March, the biggest one-month gain on record…, and are up almost 30% over the past 12 months.”

April 17 – Bloomberg: “Australia’s central bank will focus on the performance of the nation’s labor and housing markets in coming months… In minutes of this month’s policy meeting released Tuesday, the Reserve Bank of Australia noted labor market conditions were ‘somewhat weaker than had been expected’… ‘The board judged that developments in the labor and housing markets warranted careful monitoring over coming months,’ the RBA said…”

April 19 – Bloomberg (Dani Burger): “Exchange-traded funds are making stock markets dumber -- and more expensive. That’s the finding of researchers at Stanford University, Emory University and the Interdisciplinary Center of Herzliya in Israel. They’ve uncovered evidence that higher ownership of individual stocks by ETFs widens the bid-ask spreads in those shares, making them more expensive to trade and therefore less attractive. This phenomenon eventually turns stocks into drones that move in lockstep with their industry…The study is the latest to point out signs of diminished efficiency in markets increasingly overrun by the funds.”

Fixed Income Bubble Watch:

April 20 – Financial Times (Eric Platt and Joe Rennison): “Within the US fixed income market, investors are sending a clear message about the prospect of higher interest rates. In recent weeks, investors have pushed back against a string of leveraged loan transactions, with a handful of deals pulled as money flows into the sector have shrunk. The stumbles underline a diminished appetite for richly valued, floating rate loans, seen as providing investors with some protection from a rising interest rate environment.”

April 19 – Financial Times (Shawn Donnan and Gemma Tetlow): “A debt binge has left a quarter of US corporate assets vulnerable to a sudden increase in interest rates, the International Monetary Fund has warned. The ability of companies to cover interest payments is at its weakest since the 2008 financial crisis, according to one measure. The IMF’s twice-yearly Global Financial Stability Report released on Wednesday highlights what economists at the fund see as one of the main risks facing President Donald Trump and his plans to boost US growth via a combination of tax cuts and infrastructure spending.”

April 17 – Reuters (Ernest Scheyder): “Investors who took a hit last year when dozens of U.S. shale producers filed for bankruptcy are already making big new bets on the industry's resurgence. In the first quarter, private equity funds raised $19.8 billion for energy ventures - nearly three times the total in the same period last year… The quickening pace of investments from private equity, along with hedge funds and investment banks, comes even as the recovery in oil prices from an 8-year low has stalled at just over $50 per barrel amid a stubborn global supply glut.”

Federal Reserve Watch:

April 19 – Bloomberg (Wes Goodman): “Traders are pulling back from bets the Federal Reserve will raise interest rates in June as inflation expectations crumble. The odds of a hike have fallen back to about 44% from more than 60% earlier this month… Yields on federal funds futures contracts for June and July are retreating as investors scale back forecasts for a move. Two-year Treasuries, among the most sensitive to Fed policy expectations, are poised for their first two-month rally in a year. Investors are questioning the strength of the U.S. economy and the Fed’s plan to raise rates three times in 2017… They’re also voicing disappointment that President Donald Trump’s proposed tax cuts and infrastructure spending plans have yet to materialize.”

April 20 – Bloomberg (Craig Torres, Rich Miller, and Matthew Boesler): “Don’t bet on the Federal Reserve blinking again. U.S. central bankers appear to be on course to raise interest rates twice more this year and remain confident in their forecast for growth of around 2% despite a series of weak first-quarter reports. That’s a shift from past performance, when they backed away from projected rate increases in the face of unexpected headwinds. Now, the bar for delay is higher.”

April 16 – Wall Street Journal (Nick Timiraos): “The Federal Reserve is moving quickly to fill in the details of how it will wind down its securities holdings in the years ahead, a process that could start this year and become the next big challenge for investors grown accustomed to easy money from the world’s most important central bank. The Fed wants to move toward a smaller portfolio for several reasons. The economy is on stronger footing, leaving less need for support from a large bond portfolio. The large holdings have become a political liability, unpopular in Congress. Moreover, getting started now could relieve pressure on possible new leadership in 2018, when Fed Chairwoman Janet Yellen’s term ends. Finally, officials want room to ramp it back up in a crisis if needed. The Fed moved closer to agreement on the outlines of a plan at their March 14-15 meeting…”

April 18 – Bloomberg (Steve Matthews and Matthew Boesler): “Federal Reserve Bank of Kansas City President Esther George urged the Federal Open Market Committee to start shrinking its $4.5 trillion balance sheet this year, making reductions automatic and not subject to a quick reversal. ‘Balance sheet adjustments will need to be gradual and smooth, which is an approach that carries the least risk in terms of a strategy to normalize its size,’ George said… ‘Importantly, once the process begins, it should continue without reconsideration at each subsequent FOMC meeting. In other words, the process should be on autopilot and not necessarily vary with moderate movements in the economic data.””

U.S. Bubble Watch:

April 20 – Bloomberg (Katherine Burton and Katia Porzecanski): “Yellen and investors: Be very afraid. The legendary macro trader says that years of low interest rates have bloated stock valuations to a level not seen since 2000, right before the Nasdaq tumbled 75% over two-plus years. That measure -- the value of the stock market relative to the size of the economy -- should be ‘terrifying’ to a central banker, Jones said earlier this month at a closed-door Goldman Sachs Asset Management conference… Jones is voicing what many hedge fund and other money managers are privately warning investors…”

Japan Watch:

April 20 – Bloomberg (James Mayger and Francine Lacqua): “The Bank of Japan will continue with very accommodative monetary policy and maintain the current pace of asset purchases for some time, Governor Haruhiko Kuroda said… While Japan’s economy is doing better than thought a few months ago, the inflation rate is still quite sluggish, Kuroda said… Speaking a week before the BOJ’s next policy meeting, when the board will also update its estimates for growth and consumer prices, he said the exchange rate could affect inflation in the short term and that if the yen appreciates, there is a chance of a delay in hitting his 2% price goal.”

April 19 – Bloomberg (Connor Cislo and Maiko Takahashi): “Japanese exports grew at the fastest rate in more than two years in March, supporting a moderate economic recovery in the face of weak domestic demand. Exports rose 12% from a year earlier (median estimate +6.2%)… Imports jumped 15.8% (median estimate 10%), the biggest gain in more than three years.”

EM Watch:

April 17 – Reuters (Tuvan Gumrukcu and Humeyra Pamuk): “President Tayyip Erdogan declared victory in a referendum on Sunday to grant him sweeping powers in the biggest overhaul of modern Turkish politics, but opponents said the vote was marred by irregularities and they would challenge its result. Turkey's mainly Kurdish southeast and its three main cities, including the capital Ankara and the largest city Istanbul, looked set to vote ‘No’ after a bitter and divisive campaign.”

Geopolitical Watch:

April 18 – BBC: “North Korea will continue to test missiles, a senior official has told the BBC in Pyongyang, despite international condemnation and growing military tensions with the US. ‘We'll be conducting more missile tests on a weekly, monthly and yearly basis,’ Vice-Foreign Minister Han Song-ryol told the BBC's John Sudworth. He said that an ‘all-out war’ would result if the US took military action.”

Friday Evening Links

[Bloomberg] U.S. Stocks End Two-Week Losing Streak as Industrials Rally

[Reuters] "Liquidity supernova" keeping markets afloat, Europe in demand - BAML

[Bloomberg] Trump Plan Said Unlikely to Back Ryan's Border-Adjusted Tax

[Bloomberg] Sales of Existing U.S. Homes Rise to Fastest Pace in a Decade

[Reuters] Fitch cuts Italy's debt rating; cites weak growth, political risk

[Bloomberg] Fannie-Freddie Overhaul Is 'Very Important' Goal, Mnuchin Says

[Bloomberg] Quants Fire Back at Paul Tudor Jones After His Attack on Risk Parity

[Reuters] Security dominates French election after shooting

[WSJ] Brick-and-Mortar Stores Are Shuttering at a Record Pace

[WSJ] Too Many Questions on Too Big to Fail

[NYT] I.M.F. Torn Over Whether or Not to Bail Out Greece Again

[NYT] Regulators Worry Banks Are Too Big to Fail. The Markets Don’t.