Weekly Commentary: Washington Finance and Bubble Illusion

June 18 – Financial Times (Mohamed El-Erian): “In hiking rates and, more notably, reaffirming its forward policy guidance and setting out plans for the phased contraction of its balance sheet, the Federal Reserve signalled last week that it has become less data dependent and more emboldened to normalise monetary policy. Yet, judging from asset prices, markets are failing to internalise sufficiently the shift in the policy regime. Should this discrepancy prevail in the months to come, the Fed could well be forced into the type of policy tightening process that could prove quite unpleasant for markets."

I’m not yet ready to move beyond the recent focus on global monetary policy. Belatedly, the Fed has become “more emboldened to normalise monetary policy.” Global policymakers may finally be turning more emboldened, though taking their precious time has nurtured alarming market complacency.

Over a period of years, securities markets became progressively more emboldened to the view that higher asset prices were the top priority of global central banks. For years I’ve argued that this is one policy slippery slope. For good reason, markets do not these days take seriously the threat of a tightening of financial conditions. The Fed and fellow central banks will surely seek to avoid what at this point would be a painful development for the global securities markets. When faced with a well-established Bubble, the notion of a painless tightening of financial conditions is a myth.

The current debate, focusing simplistically on interest rates and the level consumer price inflation, misses the overarching issue. U.S. and global central banking shifted to an untested and radical regime of directly inflating securities prices. No longer do central banks attempt to loosen or tighten bank lending through subtle changes in reserve holdings and interbank lending rates. Why not just purchase securities, supporting prices while injecting liquidity directly into the marketplace?

This momentous transformation of monetary management unfolded over a couple of decades – somehow seemingly unnoticed. Financial innovation played a key role. As more debt was securitized, the impact of marketplace liquidity upon system Credit dynamics became increasingly important. Much to its delight, the Fed recognized that small policy adjustments could exert big effects on risk-taking and leveraging – hence marketplace liquidity, pricing and overall system stimulus.

It was a case of booming Wall Street finance affording the Greenspan Fed the most powerfully alluring monetary policy transmission in history. At the same time, it was power our central bank was ill-equipped to administer. The Fed became increasingly supportive of the debt and equities markets – of Wall Street more generally - nurturing speculation, securities leveraging, derivatives and myriad deleterious financial and economic effects.

In terms of overall system stimulus, securities markets eventually came to dominate traditional bank lending. After disregarding repeated market warnings, the fragility of such a financial regime became obvious in 2008. Rather than using the crisis and its lessons to reposition to a more well-grounded monetary regime, the Fed and other central banks doubled down. Reflating securities markets became priority one, and central banks went so far as to be willing to inject newly created “money” directly into the markets to achieve their objective.

Central banks should not be in the business of favoring individual asset classes, sectors or groups in society. Never should a small group of unelected officials have such discretion to create Trillions of “money” and allocate wealth. After all, if “printing” Trillions to buy marketable debt was such a fine idea, why did central bankers wait until deep crisis to implement such a doctrine?

The new regime that developed specifically favored securities markets, Wall Street and the wealthy. It has fancied the financial speculator at the expense of the saver. The new regime favored financial engineering to productive investment – the white collar to the blue collar. There was no problem seen with deindustrialization and persistent huge Current Account Deficits. No issue whatsoever exchanging new financial claims for Chinese imports.

The new regime has spurred wealth redistribution that is at the root of a divided country, political dysfunction and escalating geopolitical risk. And there is little mystery surrounding weak economic underpinnings, dismal productivity trends and stagnant wages and living standards. Contemporary finance has proven itself especially deficient in allocating resources throughout the economy. Markets have been over-liquefied, too distorted, grossly speculative and too monstrous to be an effective mechanism for resource allocation.

All these consequences of precarious financial and policy regimes - and resulting Credit and assets Bubbles – apparently ensure that the Fed and global central bankers are trapped in policy doctrine beholden to the securities and derivatives markets.

This week I found myself again contemplating contemporary “money” and monetary theory. I pondered the attributes of “insatiable demand” and “preciousness” - and how governments throughout history abused the insatiable demand for money, eventually destroying its preciousness with dire consequences for financial systems, economies and societies.

Contemporary central bankers have become way too comfortable creating new “money” and using it to drive the markets. Over-liquefied markets, then, turned too comfortable financing (and leveraging) endless government borrowings. It has amounted to a historic inflation of “money” at the heart of the financial system. Especially since the crisis and Bernanke Reflation aftermath, Washington Finance has come to completely dominate the foundation of contemporary global finance.

Looking back to 1990, there were about $2.5 TN of Treasury Securities, $1.5 TN of Agency Securities and $340bn of Federal Reserve Credit. The three main sources of Washington Finance combined to $4.25 TN, or 71% of GDP. The explosive growth of the GSEs helped push Washington Finance to $8.34 TN (Treasury $3.36 TN, Agency $4.35 TN, and Fed $635bn) by the end of 2000, or 81% of GDP. Nearing the end of the mortgage finance Bubble in 2007, Washington Finance had inflated to $14.4 TN (Treasury $6.05 TN, Agency $7.40 TN, and Fed $950bn), or 99% of GDP.

In terms of Washington Finance, it is simply astonishing to contemplate what has unfolded since the crisis. Outstanding Treasury securities have reached $16.0 TN, with the Fed’s balance sheet ending 2016 at $4.43 TN. After all the fraud, insolvency and receivership, one might have assumed a downsized Agency sector. Not to be. Once Washington Finance takes hold, there’s apparently no letting loose. After a notably strong year of GSE growth, outstanding Agency Securities ended 2016 at a record $8.52 TN. Total Washington Finance ended the year at an incredible $28.93 TN, or 156% of GDP.

This almost $29.0 TN of “money-like” Credit provides a deceptively (Bubble Illusion) solid foundation to U.S. and global finance. Here at home, this unprecedented inflation of Washington “money” has significantly bolstered asset prices, spending, corporate profits and government revenues. Globally, the flow of Washington “money” abroad (Current Account Deficits and financial flows) inflated international reserve holdings, integral to what became booming post-crisis EM financial systems. I would furthermore argue that the unprecedented inflation of Washington “money” was instrumental in bolstering Chinese Bubble inflation to epic proportions. Chinese financial and economic Bubbles then became elemental to powering Bubbles around the globe. And particularly over the past two years, unprecedented U.S.-inspired inflation of government “money” in Europe and Japan (and elsewhere) provided the liquidity to propel a financial Bubble in the face of an increasingly troubling fundamental backdrop.

This has now been going on so long that is seems business as usual. Central banking and contemporary monetary doctrine are held in high esteem. Yet the history of great monetary inflations shows that, once going, they’re virtually impossible to control. And that’s where we are today. Understandably, after accommodating Bubbles to this point, markets assume that policymakers (i.e. Washington, Beijing, Frankfurt, Tokyo, etc.) will not dare risk popping them. At the same time, central bankers must by now appreciate that ultra-loose policies are a clear and present danger to financial stability. Beijing at least recognizes the risk of letting their (out of control) Bubble run.

Surely officials in Washington, Beijing, Europe, Tokyo and elsewhere would prefer to begin normalizing policy at this point. But this now goes so far beyond interest rates. We’re talking tens of Trillions of specious “money” and money-like securities and even much larger quantities of equities and corporate Credit whose values have been inflated by the massive expansion of government finance. To be sure, the current backdrop so dwarfs market misperceptions, distortions and mispricing from the mortgage finance Bubble period.

Policymakers everywhere prefer a go slow approach to “tightening,” determined not to upset the securities markets. Beijing this week provided aggressive liquidity injections, taking some pressure off Chinese bond yields, interbank lending rates and stock prices. Market wishful thinking has it that both Chinese officials and the Federal Reserve have largely completed “tightening” measures. Both systems, however, have powerful Bubble Dynamics feeding off the perception of safe government “money” and ongoing government support for securities and asset prices. Policy “normalization” would require that governments retreat from backstopping the markets and dictating system finance more generally.

At this late-stage of the Bubble, markets have no fear that policymakers are willing to risk bursting Bubbles. A cautious go slow approach to tightening and normalization may seem perfectly logical to central bankers, but it’s tantamount to not going at all. Inflation psychology has become deeply engrained throughout global financial markets – and it will be broken only through significant disappointment and anguish.


For the Week:

The S&P500 added 0.2% (up 8.9% y-t-d), while the Dow was unchanged (up 8.3%). The Utilities dropped 1.8% (up 9.0%). The Banks fell 2.3% (down 0.3%), and the Broker/Dealers lost 1.6% (up 7.1%). The Transports slipped 0.3% (up 3.8%). The S&P 400 Midcaps declined 0.5% (up 5.0%), while the small cap Russell 2000 gained 0.6% (up 4.2%). The Nasdaq100 rallied 2.1% (up 19.3%), and the Morgan Stanley High Tech index jumped 3.0% (up 24%). The Semiconductors rose 2.0% (up 20.1%). The Biotechs surged 8.8% (up 30.6%). With bullion gaining $3, the HUI gold index recovered 4.4% (up 6.6%).

Three-month Treasury bill rates ended the week at 94 bps. Two-year government yields rose 3 bps to 1.34% (up 15bps y-t-d). Five-year T-note yields increased a basis point to 1.76% (down 17bps). Ten-year Treasury yields slipped a basis point to 2.14% (down 30bps). Long bond yields fell six bps to 2.72% (down 35bps).

Greek 10-year yields dropped 24 bps to 5.37% (down 165bps y-t-d). Ten-year Portuguese yields were unchanged at 2.92% (down 82bps). Italian 10-year yields dropped seven bps to 1.92% (up 10bps). Spain's 10-year yields fell eight bps to 1.38% (unchanged). German bund yields slipped two bps to 0.26% (up 5bps). French yields declined three bps to 0.61% (down 7bps). The French to German 10-year bond spread narrowed one to 35 bps. U.K. 10-year gilt yields added a basis point to 1.03% (down 20bps). U.K.'s FTSE equities index slipped 0.5% (up 3.9%).

Japan's Nikkei 225 equities index gained 0.9% (up 5.3% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.06% (up 2bps). France's CAC40 was about unchanged (up 8.3%). The German DAX equities index slipped 0.2% (up 10.9%). Spain's IBEX 35 equities index fell 1.2% (up 13.7%). Italy's FTSE MIB index dipped 0.5% (up 8.3%). EM equities were mixed. Brazil's Bovespa index lost 0.9% (up 1.4%), and Mexico's Bolsa declined 0.5% (up 7.3%). South Korea's Kospi increased 0.7% (up 17.4%). India’s Sensex equities index added 0.3% (up 16.9%). China’s Shanghai Exchange rallied 1.1% (up 1.7%). Turkey's Borsa Istanbul National 100 index jumped 1.5% (up 27.5%). Russia's MICEX equities index recovered 2.4% (down 16.4%).

Junk bond mutual funds saw outflows of $198 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 3.90% (up 34bps y-o-y). Fifteen-year rates declined one basis point to 3.17% (up 34bps). The five-year hybrid ARM rate fell a basis point to 3.14% (up 40bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.0% (up 29bps).

Federal Reserve Credit last week expanded $2.4bn to $4.430 TN. Over the past year, Fed Credit declined $8.0bn. Fed Credit inflated $1.619 TN, or 58%, over the past 241 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $19.7bn last week to $3.290 TN. "Custody holdings" were up $51.5bn y-o-y, 1.6%.

M2 (narrow) "money" supply last week added $8.4bn to $13.516 TN. "Narrow money" expanded $708bn, or 5.5%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits fell $10.7bn, while Savings Deposits gained $12.1bn. Small Time Deposits rose $1.5bn. Retail Money Funds increased $1.6bn.

Total money market fund assets declined $16.2bn to $2.618 TN. Money Funds fell $85bn y-o-y (3.2%).

Total Commercial Paper jumped $10.3bn to $799bn. CP declined $60bn y-o-y, or 5.8%.

Currency Watch:

The U.S. dollar index was little changed at 97.26 (down 5.0% y-t-d). For the week on the upside, the New Zealand dollar increased 0.4%, the Swiss franc 0.4% and the Norwegian krone 0.1%. For the week on the downside, the Brazilian real declined 1.5%, the South African rand 0.9%, the Australian dollar 0.7%, the Mexican peso 0.5%, the British pound 0.5%, the South Korean won 0.4%, the Canadian dollar 0.4%, the Japanese yen 0.4%, the Singapore dollar 0.3%, and the Swedish krone 0.1%. The Chinese renminbi fell 0.38% versus the dollar this week (up 1.59% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.8% (down 11.2% y-t-d). Spot Gold increased 0.2% to $1,257 (up 9.1%). Silver added 0.3% to $16.707 (up 4.5%). Crude sank another $1.73 to $43.01 (down 20%). Gasoline declined 1.4% (down 14%), and Natural Gas sank 3.2% (down 22%). Copper rallied 2.3% (up 5%). Wheat fell 1.7% (up 16%). Corn sank 6.8% (up 4%).

Trump Administration Watch:

June 23 – New York Times (Jonathan Martin and Alexander Burns): “Senator Dean Heller of Nevada, perhaps the most vulnerable Republican facing re-election in 2018, said Friday that he would not support the Senate health care overhaul as written, dealing a serious blow to his party’s attempt to repeal the Affordable Care Act just days before a showdown vote. Using remarkably harsh language, Mr. Heller, who is seen as a pivotal swing vote, denounced the Senate-drafted bill in terms that Democrats swiftly seized on. He said the measure would deprive millions of health care and do nothing to lower insurance premiums. ‘I cannot support a piece of legislation that takes insurance away from tens of millions of Americans,’ he said at a news conference…”

China Bubble Watch:

June 20 – Reuters (Andrew Galbraith and Samuel Shen): “Generous money injections by China's central bank are helping to maintain some calm in the country's financial markets, but market rates are persistently high, reflecting worries that liquidity conditions remain unusually tight. Rates on 14-day repos climbed to 5.3% on Monday, their highest late April… Liquidity conditions are typically tight in China in June due to tax payments and as companies look to make their balance books look healthier at the end of the month and quarter… This year, a regulatory clampdown on riskier forms of financing, particularly between banks and non-financial institutions, has created additional strains on the system.”

June 20 – Reuters (Sue-Lin Wong and Shu Zhang): “The number of high net worth individuals (HNWIs) in China has risen nearly 9 times since a decade ago, a private survey released on Tuesday showed… Chinese with at least 10 million yuan ($1.47 million) of investable assets hit 1.6 million in 2016, up from 180,000 in 2006, according to the 2017 China Private Wealth Report by Bain Consulting and China Merchants Bank. The overall value of the private wealth market increased to 165 trillion yuan in 2016, growing at 21% annually in 2014-2016.”

June 19 – Bloomberg: “China’s home prices increased in fewer cities last month in the wake of cooling measures imposed by local authorities. New-home prices, excluding government-subsidized housing, gained from the previous month in 56 of 70 cities tracked by the government, compared with 58 in April… Prices fell in nine cities and were unchanged in five. In Beijing, the scene of the nation’s tightest property restrictions, prices of new homes were unchanged from the previous month, and prices of existing homes fell by 0.9%, the first decline since February 2015.”

June 19 – Bloomberg: “China’s workers may be starting to feel like they’re getting a raw deal. Amid soaring industrial profits, employees in the world’s second-largest economy saw slower wage growth last year -- and many are seeing the smallest raises since 1997. That’s another sign that the years of pay gains above ten percent and burgeoning spending power are coming to a close, as China confronts industrial overcapacity, mounting debt and waning competitiveness.”

June 21 – Bloomberg (Sam Mamudi and Ben Bartenstein): “Chinese stocks were little moved by their addition to MSCI Inc.’s benchmark indexes… While MSCI’s announcement was a landmark step in China’s integration with the global financial system, it will initially have a small effect on the amount of foreign money entering the nation’s $6.9 trillion stock market. Domestic shares will comprise just 0.7% of MSCI’s global emerging-markets gauge as inclusion begins in two steps: the first in May 2018 and the second in August of next year.”

June 19 – Bloomberg (Fion Li): “Hong Kong’s pegged exchange rate should stay as it has served the city well through financial crises for more than 30 years, the chief of its de facto central bank said. ‘Hong Kong is a small and open economy,’ Hong Kong Monetary Authority Chief Executive Norman Chan said… as the city approaches the 20th anniversary of Chinese rule. ‘Keeping a stable exchange rate between the Hong Kong dollar and the U.S. dollar is the most suitable arrangement. We have no need and no intention to change such an effective system.’”

Europe Watch:

June 19 – Bloomberg (Kevin Costelloe and Sonia Sirletti): “Italian finance officials and the European Commission are racing to find a solution for two troubled banks in the northern Veneto region that have weighed on the nation’s financial system. Finance Minister Pier Carlo Padoan said… the matter of Veneto Banca SpA and Banca Popolare di Vicenza SpA is being worked on ‘actively,’ without offering details. The European Commission is working ‘hand in hand’ with Italian authorities and Europe’s Single Supervisory Mechanism, and is making ‘good progress’ on reaching a solution within the bloc’s rules…”

Central Bank Watch:

June 20 – Bloomberg (Lucy Meakin and Fergal O'Brien): “Mark Carney ended more than a month of silence with a major speech that pushed back against rate hawks in the Bank of England and re-emphasized his concerns about the impact of Brexit on the economy. The U.K.’s exit from the European Union was a central theme of his address…, with the BOE governor highlighting the risks to consumer spending, business investment, the current-account deficit and financial services. He indicated he’s in no rush to raise interest rates, saying he wants to see how the economy responds to the ‘reality of Brexit negotiations.’”

June 21 – Bloomberg (Jill Ward): “Bank of England chief economist Andy Haldane is leaning toward joining the hawks on the Monetary Policy Committee, saying that the risks of leaving policy tightening too late are rising and that he considered a vote for a rate increase as early as June. ‘The risks of tightening ‘too early’ have shrunk as growth and, to lesser extent, inflation have shown greater resilience than expected,’ Haldane said in a speech… ‘Provided the data are still on track, I do think that beginning the process of withdrawing some of the incremental stimulus provided last August would be prudent moving into the second half of the year.’ The comments from Haldane, usually on the more dovish end of the panel, add to signs that policy makers are becoming increasingly restless as inflation breaches their 2% target.”

June 21 – Bloomberg (Paul Gordon): “The European Central Bank cited the government of U.S. President Donald Trump as a key reason why the risks to the global economy remain tilted to the downside. The… ECB said in an article from its Economic Bulletin… that while some concerns over the prospects for world growth have diminished, such as China’s short-term outlook and the resilience of emerging-market economies, others have appeared. ‘Since the U.S. election, pressures for more inward-looking policies have risen… In particular, there is significant policy uncertainty surrounding the intentions of the new U.S. administration regarding fiscal and, especially, trade policies, the latter entailing potentially significant negative effects on the global economy.’”

Brexit Watch:

June 23 – UK Guardian (Dan Roberts): “One year on from Britain’s vote to leave the EU, the anniversary of the referendum was overshadowed by fresh outbreaks of doubt. In Brussels, Theresa May’s farewell offer on EU citizenship was met with a shrug from commission president Jean-Claude Juncker and a chorus of voices urging Britain to stay. In Westminster, her own chancellor, Philip Hammond, is one of many dusting down alternative models of Brexit to soften its impact on a faltering economy. British officials in Whitehall have meanwhile had to temper their negotiating strategy after May’s mandate to walk away with no deal was undermined by a humiliating general election result. But what are the chances of Brexit 2.0 emerging from a second year of Britain’s post-referendum soul-searching? Has an election in which both main parties still supported departure simply flushed out the last few remoaners in denial? Or was this the week the wheels started to fall off May’s all-or-nothing exit vehicle?”

Global Bubble Watch:

June 19 – Wall Street Journal (Steven Russolillo): “The calm that has descended on U.S. financial markets is stretching around the world. Based on one commonly used measure, Asian equities are near their least volatile this century... In the U.S., Wall Street’s ‘fear gauge’ is near all-time lows, and in Europe, volatility has also largely subsided. ‘This is a global dynamic,’ said Michael Parker, head of strategy, Asia-Pacific at Bernstein Research in Hong Kong. ‘You see low volatility everywhere.’”

June 16 – CNBC (Jeff Cox): “The staggering level of government debt carrying negative yields, after falling from its peak a year ago, is back on the rise. A slew of factors converged in May to send the global total to $9.5 trillion of sovereign debt — a situation where governments effectively are getting paid to borrow money, according to Fitch Ratings. The total represented a 10.5 percent increase from April. Prominent investors have warned of the dangers of so much negative-yielding debt. Janus Henderson's Bill Gross has called it a ‘supernova’ that will ‘explode,’ while Deutsche Bank CEO John Cryan has cautioned about "fatal consequences" of central banks being enticed by slashing rates to that extent.”

June 19 – Bloomberg (Emily Cadman): “Moody’s… cut the long-term credit rating of Australia’s four biggest banks, saying surging home prices, rising household debt and sluggish wage growth pose a threat to the lenders. Australia & New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Ltd. and Westpac Banking Corp. were all downgraded to Aa3 from Aa2, Moody’s said… The ratings outlook for all four lenders is stable, Moody’s said. ‘Risks associated with the housing market have risen sharply in recent years… While a sharp housing downturn isn’t its core scenario, ‘the tail risk represented by increased household sector indebtedness becomes a material consideration in the context of the very high ratings assigned to Australian banks…’”

June 17 – CNBC (Robert Frank): “The world's millionaires, who represent the top 1% of the population, now own a record 45% of the global wealth and their share is growing… There are now 17.9 million households in the world, up 8% from 16.6 million last year, according to… The Boston Consulting Group. The U.S. has the most millionaires, with over 7 million millionaire households, with China ranking second with 2.1 million.”

June 20 – Financial Times (Vanessa Houlder): “Offshore companies in the British Virgin Islands have assets of more than $1.5tn, more than twice the sum estimated in 2010. Two-thirds of the offshore companies registered in the BVI are used for ‘corporate structuring’, and more than 140 listed businesses in London, New York and Hong Kong have a unit in the BVI… These units can be used for tax planning, but can also be useful as a tax-neutral hub for investors from different locations. Companies are also attracted by the BVI’s legal system, which mirrors British law.”

Fixed Income Bubble Watch:

June 19 – Wall Street Journal (Julie Wernau and Taos Turner): “Argentina sold a 100-year bond on Monday, the latest sign of investor hunger for yield as the country joined a small group to sell so-called century bonds. The Argentine government raised $2.75 billion through the debt issue with a yield of 7.9%... Proceeds from the private-placement offering will go toward financing its budget and refinancing existing debt. The yield was lower than the initial price talk of 8.25%, an indication that many investors around the world jumped at the chance to own debt with yields exceeding those of even many emerging-market issuers.”

Federal Reserve Watch:

June 20 – Reuters (Ann Saphir and Lindsay Dunsmuir): “The outlook for inflation and the future of financial stability are emerging as dueling concerns at the heart of a debate at the U.S. central bank over how fast to proceed on future interest-rate hikes. That is a change from years past, where high unemployment was at the top of the Federal Reserve's worry list for the U.S. economy. But with the U.S. unemployment rate now at 4.3%, most Fed officials are now convinced that nearly all Americans who want jobs can and do get them. That is a main reason the Fed last week raised its target range for short-term interest rates for the second time this year… Fed Chair Janet Yellen expressed confidence inflation would eventually perk up, but some policymakers cast doubt.”

June 19 – Reuters (Jonathan Spicer): “U.S. inflation is a bit low but should rebound alongside wages as the labor market continues to improve, an influential Federal Reserve official said…, reinforcing the message that a recent patch of weak data is unlikely to derail plans to keep raising interest rates. The comments by New York Fed President William Dudley… were among the first after the U.S. central bank hiked rates last week in the face of a series of soft inflation readings… ‘We are pretty close to full employment… Inflation is a little lower than what we would like, but we think that if the labor market continues to tighten, wages will gradually pick up and with that, inflation will gradually get back to 2%.’”

June 20 – Reuters (Lindsay Dunsmuir): “Boston Fed President Eric Rosengren said… that the era of low interest rates in the United States and elsewhere poses financial stability risks and that central bankers must factor such concerns into their decision-making. ‘Monetary policy is less capable of offsetting negative shocks when rates are already low,’ Rosengren said in a speech at a conference on macroprudential policy in Amsterdam jointly organized by the Dutch and Swedish central banks. In particular, he said… ‘Reach-for-yield behavior can make financial intermediaries and the economy more risky,’ Rosengren said.”

U.S. Bubble Watch:

June 20 – Reuters: “The U.S. current account deficit widened slightly in the first quarter, as the country imported more crude oil, car parts and supplies for its factories. …The current account deficit, which measures the flow of goods, services and investments into and out of the country, expanded by 2.4% to $116.8 billion… The first-quarter current account deficit represented 2.5% of gross domestic product…”

June 17 – Associated Press (Sara Burnett): “The Illinois official responsible for paying the state's bills is warning that new court orders mean her office must pay out more each month than Illinois receives in revenue. Comptroller Susana Mendoza must prioritize what gets paid as Illinois nears its third year without a state budget. A mix of state law, court orders and pressure from credit rating agencies requires some items be paid first. Those include debt and pension payments, state worker paychecks and some school funding. Mendoza says a recent court order regarding money owed for Medicaid bills means mandated payments will eat up 100% of Illinois' monthly revenue.”

June 20 – Bloomberg (Kristy Westgard): “Even a stock market soaring to record highs won’t rescue America’s struggling state and local pension plans. A ‘best case’ scenario of a cumulative 25% investment return during the 2017-2019 period will not offer a respite for chronically underfunded U.S. public pension plans, according to a Moody’s... The growing gap between how much state and local governments are projected to pay employees and how much funds they actually have set aside has risen to over $4 trillion nationwide. New Jersey sports the widest funding gap, followed closely by Kentucky and Illinois. The optimistic ‘best case’ of cumulative 25% investment return would reduce net pension liabilities by just 1% through 2019 year-end because of past bad investment returns and weak contributions. Meanwhile, the ‘base case’ scenario of 19% returns would see net pension liabilities rise by 15%.”

June 21 – CNBC (Diana Olick): “After surging to the highest level since the presidential election, demand for home loans remained steadily elevated last week… Mortgage applications to purchase a home, which are less sensitive to weekly rate moves, fell 1% for the week, seasonally adjusted, but are 9% higher than the same week one year ago.”

June 19 – New York Times (David Streitfeld): “Joke all you want about drone-delivered kale and arugula. Amazon's $13.4 billion bet to take on the $800 billion grocery business in the United States by acquiring Whole Foods fits perfectly into the retailer's business model. Unlike almost any other chief executive, Amazon's founder, Jeff Bezos, has built his company by embracing risk, ignoring obvious moves and imagining what customers want next… Key to that strategy is his approach to failure. While other companies dread making colossal mistakes, Mr. Bezos seems just not to care. Losing millions of dollars for some reason doesn't sting. Only success counts. That breeds a fiercely experimental culture that is disrupting entertainment, technology and, especially, retail.”

June 16 – New York Times (Rachel Abrams and Julie Creswell): “Shares of Walmart, Target, Kroger and Costco, the largest grocery retailers, all tumbled on Friday. And no wonder. Grocery stores have spent the last several years fighting against online and overseas entrants. But now, with its $13.4 billion purchase of Whole Foods, Amazon has effectively started a supermarket war. Armed with giant warehouses, shopper data, the latest technology and nearly endless funds — and now with Whole Foods’ hundreds of physical stores — Amazon is poised to reshape an $800 billion grocery market that is already undergoing many changes.”

Japan Watch:

June 19 – Bloomberg (Isabel Reynolds): “Japanese Prime Minister Shinzo Abe struck an apologetic tone at a news conference Monday as he expressed his regret that a cronyism scandal had eaten into parliamentary debate on policy and triggered public mistrust in his government. Abe said that the opposition’s focus on the question of his possible intervention in the government’s approval of a school run by one of his close associates took up too much time in the current parliament session. The premier said he would fulfill his responsibility to explain the issue.”

June 19 – Reuters (Tetsushi Kajimoto and Izumi Nakagawa): “Confidence among Japanese manufacturers bounced in June to match a decade-high level recorded in April and is expected to rise for several months, a Reuters survey found, providing more evidence of economic recovery. Service-sector mood rose to a two-year high…”

EM Watch:

June 17 – Reuters (Bruno Federowski): “Brazilian President Michel Temer led a corruption scheme in which lawmakers squeezed high-profile executives for bribes, billionaire Joesley Batista told magazine Época… In his first interview since striking a leniency agreement with Brazilian prosecutors, Batista told Época that Temer asked for money several times since 2010. Batista told the magazine that Temer led a group of senior politicians regularly demanding kickbacks in exchange for political favors.”

June 21 – Reuters (Lisandra Paraguassu and Brad Brooks): “Brazil's federal police… delivered to a top court justice the bulk of their investigation into allegations that President Michel Temer took bribes in exchange for political favors doled out to the world's largest meatpacker, JBS SA. The document, made public by the top court, is a significant step in the investigation, which is widely expected to lead to Brazil's top federal prosecutor lodging corruption charges against Temer by the end of next week… It also adds to doubts that Temer will be able to push through badly needed economic reforms through congress, needed to spark Brazil's economy just as it emerges from its worst recession on record.”

Leveraged Speculator Watch:

June 20 – Bloomberg (Dani Burger): “Believe the hype. Quants have never been more popular. After doubling over the past decade, assets run by so-called systematic funds have hit a record $500 billion this year, according to… Barclays Plc. In some ways, their meteoric rise is due to the same technological advances that are disrupting most industries. Faster computers and better data has enabled asset managers to automate skills that once were limited to market legends… The most popular type of quant hedge fund strategy, managed futures funds, aim to capture broad market trends across asset classes and trade futures to do so. They oversee nearly $200 billion…”

Geopolitical Watch:

June 18 – Financial Times (Wolfgang Münchau): “Matteo Renzi, David Cameron, Theresa May — all were fooled by the polls. The problem was not that the polls were wrong. Some were quite good, and most were right at the time when the leaders took the politically fateful decisions. The former Italian and UK prime ministers clearly had the support of a majority of their electorates when they called referendums and were sure they could win. The Conservative party was indeed well ahead of Labour in April this year when the prime minister called her snap election. The speed with which the electorate changed its mind was more fateful than the polls themselves. The French electorate has been more extreme than any other. It managed to eradicate virtually the entire political establishment in a short sequence of elections… The French are in a process of exhausting all their alternatives. It is painful to think what they might do if they ever become disillusioned with Emmanuel Macron.”

June 19 – Wall Street Journal (Dion Nissenbaum and Thomas Grove): “Tensions between Washington and Moscow escalated… when Russia threatened to track American warplanes in Syria after a U.S. pilot shot down a Syrian jet for the first time in the country’s six-year war. The U.S. military responded to Moscow’s warnings by shifting the flight routes of some pilots carrying out missions in Syria, U.S. officials said, an effort to minimize risks to American pilots as the White House and the Pentagon both appealed for calm. Sunday’s U.S. downing of the Syrian regime warplane came as American forces are increasingly at risk of direct confrontation with Syrian President Bashar al-Assad and his allies from Russia and Iran.”

June 16 – Wall Street Journal (Nathan Hodge and Julian E. Barnes): “A quarter-century after the Cold War ended, U.S. and Russian tank formations are once again squaring off. This spring, the North Atlantic Treaty Organization moved armored forces to the Russian border, where they are conducting daily drills from Poland to Estonia. Less than 100 miles away, Moscow’s forces are preparing for large-scale maneuvers in the autumn, a demonstration of the country’s revitalized might... Facing off behind these front lines and shaping each side’s grand strategy are two of this generation’s most influential officers in Washington and Moscow: U.S. Army Lt. Gen. H.R. McMaster and Russian Gen. Valery Gerasimov.”

June 19 – Reuters (Stephen Kalin and William Maclean): “Two years after launching headfirst into a conflict in Yemen that has no end in sight, Saudi Arabia and the United Arab Emirates have astonished the world again, this time with a severe boycott of neighboring Qatar. Like the Yemen war, which has killed more than 10,000 people, the rift with Qatar is most closely associated with a new generation of leaders in the energy-rich Gulf who are more hawkish than conservative predecessors… While the dispute could end up costing Qatar dearly, it also has implications for the Saudis and Emiratis whose activism, critics say, is fuelling uncertainty in an already unstable neighborhood and could even push the region towards all-out conflict with arch-enemy Iran.”

June 19 – Bloomberg (Golnar Motevalli and Ladane Nasseri): “Iran said it fired missiles at Islamic State targets in Syria in retaliation for the jihadists’ deadly attacks in Tehran last week, a rare strike signaling Iran’s willingness to escalate its use of military power in the region’s conflicts. Six surface-to-surface missiles were launched on Sunday from western bases in Iran at command centers, logistic sites and suicide car bomb factories in Syria’s eastern Deir Ezzor area... The missile operation ‘is just a very small part of the capability of Iran’s punitive force against the terrorists and its enemies,’ the Islamic Students’ News Agency quoted Guards spokesman Brigadier General Ramezan Sharif…”

June 20 – Financial Times (Rebecca Collard, Erika Solomon, Najmeh Bozorgmehr and Katrina Manson): “The military activity last month around al-Tanf, a Syrian town on the Iraqi border, was an early sign that as rival forces scrambled to capture Isis territory in eastern Syria, the region risked becoming the flashpoint for international confrontation. As Syrian regime forces advanced towards a base used by US soldiers to train rebels to fight Isis, US-led coalition jets dropped leaflets carrying a stark warning. ‘Any movements toward al-Tanf will be considered an aggression that our forces [will] defend against . . . you have entered a safe zone, leave the area now.’ The fears of a confrontation materialised on Sunday when the US shot down a Syrian warplane that the Pentagon said was bombing areas near a Syrian Kurdish militia it backs in Raqqa province. The same day, Iran fired ballistic missiles into Syria for the first time to target Isis but also to put on a show of force intended to send a message to the US and Saudi Arabia, its regional rival.”

June 21 – Bloomberg (Zaid Sabah, Alaa Shahine, Vivian Nereim, and Tarek El-Tablawy): “The abrupt shake-up that made Saudi Prince Mohammed bin Salman heir to his father’s throne gives the 31-year-old extraordinary powers to push through his vision to wean the economy off oil and exert his influence in regional conflicts. Prince Mohammed replaced his elder cousin as crown prince, removing any doubt of how succession plans will unfold following the reign of King Salman, now 81. Even before the promotion, the new crown prince was dictating defense and oil policy, including overseeing plans to privatize state oil giant Aramco. The move suggests a harder foreign policy line for the key U.S. ally in a region fraught with instability.”

Friday Evening Links

[Bloomberg] U.S. Stocks Gain as Oil Stabilizes, Dollar Falls: Markets Wrap

[Reuters] Policy ponder: central banks head for the Portuguese hills

[Reuters] Fed's Mester unmoved by weak U.S. inflation

[Bloomberg] Fed's Mester Argues for Rate Hikes as Bullard Counsels Patience

[Bloomberg] A Second, Even Bigger Foreclosure Reaches NYC Billionaires' Row

[Reuters] Trump, Putin and Erdogan behave like autocratic rulers: Germany's Schulz