Weekly Commentary: Cracks

After posting an intra-week high of 25,800 on Tuesday, the DJIA then dropped 1,583 points (6.1%) at the week’s Friday morning low (24,217) - before closing the session at 24,538 (down 3.0% for the week). The VIX traded as low as 15.29 Tuesday. It then closed Wednesday at 19.85, jumped as high as 25.30 on Thursday and then rose to 26.22 in wild Friday trading, before reversing sharply to close the week out at 19.59.

Friday’s session was another wild one. The Nasdaq Composite rallied 2.6% off early-session lows to finish the day up 1.1%. The small caps were as volatile, with an almost 1% decline turning into a 1.7% gain. The Banks had a 2.8% intraday swing and the Broker/Dealers 2.4%. The Biotechs had a 3.7% swing, ending the session up 3.2%. The Semiconductors swung 3.3%, gaining 1.8% on the day.

Friday morning trading was of the ominous ilk. Stocks, Treasuries, commodities and dollar/yen were all sinking in tandem. The VIX was surging. Japan’s Nikkei dropped 2.5% in Friday trading, with Germany’s DAX down 2.3% and France’s CAC losing 2.4%. The emerging markets (EEM) were down as much as 1.7%. For the week, the DAX sank 4.6% and the Nikkei fell 3.2%. Curiously, bank stocks outside of the U.S. came under notable pressure. European banks (STOXX) dropped 3.5%, Hong Kong’s Hang Seng Financial Index 4.5% and Japan’s TOPIX Bank index 3.4%.

There are cracks - cracks in the U.S. and cracks spread globally. This week’s market gyrations suggest these interconnected fissures will not prove transitory. VIX traders on edge. Risk parity and the CTA community on edge. ETF complex? Everything’s turned correlated. Hedges have become expensive, and the Treasury hedge isn’t working. The yen has taken on a life of its own. Central bankers playing coy. How long can all of this hold together?

This was never going to end well. It’s just that raging bull markets are willing to disregard so much. Fully inebriated by the bottomless libation of easy money, markets in speculative blow-off mode gleefully ignore about everything. President Trump had stated he wanted tariffs. Fed Chairman Powell was clearly no clone of Drs. Yellen and Bernanke. The Bank of Japan couldn’t stick with experimental monetary inflation forever. U.S. tax cuts won’t transform either a flawed financial structure or maladjusted economy.

Speculative blow-offs and “Terminal Phase Excess” are fundamental to Bubble analysis. It’s important to appreciate these culminations of excess are manifestations of Monetary Disorder. Invariably, prolonged bouts of asset inflation and Bubble Dynamics were fueled by some underlying monetary disturbance. Monetary policies remained excessively loose, with rates held too low for too long, often out of fear of lurking fragilities. Over time, markets will disregard underlying vulnerabilities – or even be willing to conceive of them bullishly. After all, structural deficiencies ensure uninterrupted easy “money” and ever higher asset prices. Speculative leverage accumulates at compounding rates.

As the cycle extends and timid central banks dilly-dally, the gap widens dramatically between bullish perceptions and mounting systemic deficiencies – between inflating expectations and deteriorating fundamental prospects. This chasm, however, is well-masked by the remarkable inflation of perceived financial wealth, along with, let us not forget, the associated boosts in “money,” Credit and market liquidity.

What’s more, loose financial conditions and rapidly inflating asset markets stimulate economic activity, reinforcing misperceptions as to the underlying soundness of the boom. This Wealth Illusion becomes powerfully self-reinforcing throughout both the Financial and Real Economy Spheres. It is one of the great wonders of economic history – how everyone turns so blindly optimistic right before the bottom falls out.

Tremendous structural damage can be wrought during the “Terminal Phase.” Financial flows go haywire, the reign of speculation dominates, markets turn whimsical, resources are terribly misallocated and systemic risk expands exponentially. Meanwhile, over-liquefied markets see sentiment turn wildly bullish. Misperceptions are rife, as rapidly mounting risks go completely unrecognized. When the spell is inevitably broken and markets reverse sharply lower, suddenly comes the recognition that things are not as previously perceived. So much changes so abruptly, as greed swings to fear.

Over the years, CBB analysis has focused on three epic and interrelated experiments: 1) Unfettered market-based finance. 2) A de-industrialized financial/services/consumption-based U.S. economic structure. 3) Activist central bank monetary inflation and market manipulation.

These runaway experiments have combined to inundate the world with “money” (dollar balances), inflating historic asset Bubbles at home and abroad. Unhinged U.S. finance cultivated unhinged finance globally. A Friday headline from ZeroHedge: “Pat Buchanan Blasts ‘The Fatal Delusions of Western Man - We fed the Tiger, and Created a Monster...’” China is unequalled in terms of feeding off unfettered dollar-based finance while championing economic power, national wealth, military might and global ambitions. And not until Bubbles burst will we have a clearer understanding as to how much wealth has been redistributed and how much has been pilfered and destroyed – and to what regrettably great consequence.

Myriad global Bubbles have been fundamental to unprecedented wealth redistribution, inequalities and economic stagnation - potent fuel for populism and anti-globalization movements (Italian election Sunday). The backdrop has nurtured the rise of the strongman politician, dictator and despot. In a deeply divided world, seemingly the only common understanding is that central bankers and policymakers won’t tolerate market dislocation, recession or crisis.

March 2 – Bloomberg (Joe Deaux, Andrew Mayeda, Toluse Olorunnipa, and Jeff Black): “President Donald Trump pushed back against a wave of criticism against steel tariffs, telling the world that not only are trade wars good, they are easy to win. Trump is facing anger from manufacturers and trade partners in China and Europe after announcing tariffs of 25% on imported steel and 10% on aluminum for ‘a long period of time.’ The formal order is expected to be signed next week. ‘When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win,’ Trump said in an early morning tweet on Friday.”

March 2 – Axios (Mike Allen and Jonathan Swan): “President Trump has long mused about doing what he wants, when he wants, how he wants. He wanted tariffs on steel and aluminum — big ones — now. He wanted to negotiate with Congress — in public, on his court, surprise and shock, all for the cameras. He wanted to ditch any P.C. pretenses and consider Singapore-style death for all drug dealers. He wanted to play by his rules alone. Why it matters: His staff at times managed to talk him off the ledge. No more. Tired of the restraints, tired of his staff, Trump is reveling in ticking off just about every person who serves him.”

Trump’s Tariffs should come as little surprise. Perhaps markets are finally beginning to come to terms with the disequilibrium and turmoil of the Trump presidency. Rumors have it that Wall Street darling Gary Cohen, having lost on tariffs, could be on his way out. It’s alarming to see the spectacle of the President referring to the Attorney General as “DISGRACEFUL,” and Mr. Sessions pushing back with “I will continue to discharge my duties with integrity and honor…”

Top aid and close confidante Hope Hicks abruptly resigned this week, with National Security advisor H.R. McMaster’s job said to be in jeopardy. Trump family members are under intense scrutiny, while chief of staff John Kelly has been under attack. After assailing the NRA and contemplating gun control, what might our President do next? Turn on the stock market? But hasn’t he used surging equities to define the incredible merits of his leadership? Commentators Friday on Bloomberg TV used “unleashed” and “rogue.” Not so easy to disregard the Washington spectacle when the markets are unsettled.

Fed Chairman Powell’s testimony should have provided little surprise. He impressed as a traditional central banker. It’s been awhile, and it sure was refreshing. Powell highlighted recent economic momentum and, as a disciplined central banker should at this point, demonstrated a resolve to move toward normalizing monetary policy. Our top central banker wasn’t going to belabor the nuances of academic discussions on employment demographics or r-star. No talk of the economy’s higher “speed limit” or of a “global savings glut.”

The new Chairman is not in awe and, at least to commence his term, seems disinclined to pander to the markets. With greed waning, the change in tone was difficult for an uncomfortable Wall Street to ignore. Markets have grown too accustomed to central bank chiefs with an academic view of “efficient” markets – scholars wedded to doctrine that it’s the role of central banks to bolster and backstop securities markets. Powell knows better. As the old saying goes, “he knows where the bodies are buried.” Wall Street fancies the naïve. FT: “‘Powell Put’ Assumption Challenged as Fed Chief Shows Hand.”

I believe Powell recognizes the perils associated with backstopping a speculative marketplace. That doesn’t mean he won’t be compelled to do it. At some point, he’ll have little choice. But it likely means he will not act in haste. The Powell Fed will be much more cautious in delivering market assurances. He was skeptical of QE in the past, and I’ll assume he knows he was right. He will resort to additional QE slowly and cautiously. Importantly, I believe the new Chairman will want to pull the Fed back to traditional central banking. His preference would be to conclude the monetary experiment – end the follies of “whatever it takes.”

February 27 – Bloomberg (Jeanna Smialek): “Call them the star wars. Debate is heating up over whether the Federal Reserve’s neutral interest rate -- commonly called r-star -- is about to head higher, and America’s monetary policy outlook hinges on who has it right. In one corner, San Francisco Fed President John Williams and his co-authors think long-term factors are holding down the interest rate that neither stokes nor slows growth, so the Fed will have to stop lifting rates this cycle at a historically low endpoint. In the other, Goldman Sachs chief economist Jan Hatzius thinks the recent decline owes to cyclical factors and could reverse meaningfully, allowing the Fed to lift rates higher next year. The intellectual showdown is relevant as Jerome Powell heads to Capitol Hill Tuesday for his first testimony as Fed Chair, and as central bank-watchers look eagerly for hints about how the new chief expects r-star to evolve.”

An incredible amount of intellectual effort is expended on “r-star,” the Philipps Curve, NAIRU (non-accelerating inflation rate of unemployment), and the like. “R-star” – the neutral rate - is a myth. There is no single aggregate price level – there is no equilibrium interest rate. Importantly, the three epic experiments completely altered price dynamics throughout finance and real economies. Inflation is no longer too much money chasing too few goods. Too much “money” – in this age of momentous technological advancement, globalization and changes in the nature of economic output – no longer manifests primarily in problematic consumer price inflation.

There are instead powerful inflationary biases in securities and asset markets. Too much “money” - and activist central bank support – chasing limited quantities of securities (and upscale homes, commercial real estate, art, collectibles, etc.) The academics need to discard “r-star.” Determining monetary policy based on some convoluted notion of aggregate consumer price indices (or economic equilibrium) in the current backdrop will ensure destabilizing loose finance for securities and asset markets.

In Powell’s testimony, there was mention of the long-accepted view that central banks should not be in the business of Credit allocation. Yet contemporary central bankers have gone so far as to conspicuously favor the securities markets. This is fundamental as to why financial stability risks now reign supreme. Central bankers should take a broad view of monetary stability and begin extricating themselves from the business of incentivizing financial flows and speculation into the markets. I know others disagree, but I believe the majority of central bankers would prefer to return back to traditional monetary management. After almost a decade, they’ve grown weary - of the experiment; rationalizing the experiment; justifying the experiment.

March 2 – Bloomberg (Toru Fujioka): “The Bank of Japan will start thinking about how to exit its massive monetary stimulus program around the fiscal year starting in April 2019, Governor Haruhiko Kuroda said Friday, marking the first time he’s provided any clear guidance on timing for normalizing policy. The yen surged, gaining as much as 0.5% to 105.71 per dollar, while yields on Japanese sovereign debt climbed across the curve. The Nikkei 225 Index closed 2.5% lower and the Topix Index fell 1.8%.”


For the Week:

The S&P500 fell 2.0% (up 0.7% y-t-d), and the Dow dropped 3.0% (down 0.7%). The Utilities sank 2.9% (down 7.8%). The Banks declined 2.0% (up 4.9%), while the Broker/Dealers were little changed (up 6.5%). The Transports fell 2.3% (down 2.6%). The S&P 400 Midcaps declined 1.3% (down 1.3%), and the small cap Russell 2000 dipped 1.0% (down 0.2%). The Nasdaq100 fell 1.2% (up 6.5%). The Semiconductors added 0.9% (up 8.8%). The Biotechs slipped 0.8% (up 10.3%). With bullion down $6, the HUI gold index declined 2.1% (down 10.0%).

Three-month Treasury bill rates ended the week at 1.61%. Two-year government yields were unchanged at 2.24% (up 36bps y-t-d). Five-year T-note yields added a basis point to 2.63% (up 42bps). Ten-year Treasury yields were little changed at 2.87% (up 46bps). Long bond yields declined two bps to 3.14% (up 40bps).

Greek 10-year yields declined three bps to 4.33% (up 25bps y-t-d). Ten-year Portuguese yields fell five bps to 1.99% (up 4bps). Italian 10-year yields sank 10 bps to 1.97% (down 5bps). Spain's 10-year yields fell five bps to 1.55% (down 2bps). German bund yields were unchanged at 0.65% (up 22bps). French yields dipped a basis point to 0.92% (up 14bps). The French to German 10-year bond spread narrowed one to 27 bps. U.K. 10-year gilt yields dropped five bps to 1.47% (up 28bps). U.K.'s FTSE equities index dropped 2.4% (down 8.0%).

Japan's Nikkei 225 equities index sank 3.2% (down 7.0% y-t-d). Japanese 10-year "JGB" yields gained two bps to 0.07% (up 2bps). France's CAC40 dropped 3.4% (down 3.3%). The German DAX equities index sank 4.6% (down 7.8%). Spain's IBEX 35 equities index lost 3.0% (down 5.1%). Italy's FTSE MIB index dropped 3.4% (up 0.3%). EM markets were lower. Brazil's Bovespa index declined 1.8% (up 12.3%), and Mexico's Bolsa dropped 2.3% (down 3.7%). South Korea's Kospi index fell 2.0% (down 2.6%). India’s Sensex equities index slipped 0.3% (unchanged). China’s Shanghai Exchange declined 1.0% (down 1.6%). Turkey's Borsa Istanbul National 100 index dipped 0.6% (up 1.3%). Russia's MICEX equities index fell 2.1% (up 8.5%).

Junk bond mutual funds saw outflows of $703 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained three bps to 4.43%, the high since January 2014 (up 33bps y-o-y). Fifteen-year rates jumped five bps to 3.90% (up 58bps). Five-year hybrid ARM rates declined three bps to 3.62% (up 48bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down five bps to 4.61% (up 31bps).

Federal Reserve Credit last week declined $3.1bn to $4.366 TN. Over the past year, Fed Credit contracted $60.6bn, or 1.4%. Fed Credit inflated $1.555 TN, or 55%, over the past 278 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $5.9bn last week to $3.418 TN. "Custody holdings" were up $243bn y-o-y, or 7.6%.

M2 (narrow) "money" supply declined $5.1bn last week to $13.843 TN. "Narrow money" expanded $553bn, or 4.2%, over the past year. For the week, Currency dipped $1.2bn. Total Checkable Deposits fell $9.3bn, while savings Deposits were little changed. Small Time Deposits added $1.5bn. Retail Money Funds gained $3.2bn.

Total money market fund assets declined $2.0bn to $2.842 TN. Money Funds gained $164bn y-o-y, or 6.1%.

Total Commercial Paper slipped $2.7bn to $1.092 TN. CP gained $121bn y-o-y, or 12.4%.

Currency Watch:

The U.S. dollar index added 0.1% to 89.935 (down 2.4% y-o-y). For the week on the upside, the Japanese yen increased 1.1%, the Norwegian krone 0.8%, and the euro 0.2%. For the week on the downside, the South African rand declined 3.1%, the Canadian dollar 1.9%, the Mexican peso 1.4%, the British pound 1.2%, the Australian dollar 1.1%, the New Zealand dollar 0.9%, the Swedish krona 0.9%, the Brazilian real 0.5%, the Swiss franc 0.1%, the South Korean won 0.1% and the Singapore dollar 0.1%. The Chinese renminbi declined 0.13% versus the dollar this week (up 2.54% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.2% (down 0.2% y-t-d). Spot Gold slipped 0.5% to $1,323 (up 1.5%). Silver declined 0.5% to $16.466 (down 4.0%). Crude sank $2.30 to $61.25 (up 1%). Gasoline jumped 5.0% (up 6%), and Natural Gas gained 2.7% (down 9%). Copper sank 3.4% (down 5%). Wheat surged 7.7% (up 17%). Corn jumped 2.9% (up 9.8%).

Market Dislocation Watch:

February 27 – Financial Times (Yian Mui): “Federal Reserve Chairman Jerome Powell played down concerns about recent market volatility, arguing Tuesday that the dramatic swings do not weigh heavily on his outlook for the economy and maintaining his expectation for further gradual increases in interest rates. In Capitol Hill testimony, Powell emphasized that the job market remains robust, consumer spending is solid and wage growth is accelerating. He also highlighted gains in U.S. exports and stimulative fiscal policy as new ‘tailwinds’ for the economy. ‘After easing substantially during 2017, financial conditions in the United States have reversed some of that easing,’ he said… ‘At this point, we do not see these developments as weighing heavily on the outlook for economic activity, the labor market and inflation. Indeed, the economic outlook remains strong.’”

February 27 – CNBC (Jeff Cox): “February's stock market correction probably would have been worse if companies had not stepped in to the fray. With both traders and retail investors selling at a frenzied level earlier this month, corporations swept in looking for bargains… As the month nears a close, companies have bought back $113.4 billion of their own shares, good for the highest total since April 2015, according to… TrimTabs. That's part of an overall strong trend for buybacks, which stand at $5.8 billion a day during the current earnings season, a record.”

February 26 – Financial Times (Robin Wigglesworth and Lindsay Fortado): “Computer-driven, trend-following hedge funds are heading for their worst month in nearly 17 years after getting whipsawed when the stock market’s steady soar abruptly reversed into one of the quickest corrections in history earlier in February. Hedge funds known as ‘commodity trading advisers’ or managed futures funds — which surf the momentum of markets — got sucked into big bets on stocks from last year’s rally, which culminated in the strongest monthly equity fund inflows since 1987 in January. But the rally unravelled in dramatic fashion in early February, slamming trend-followers. Société Générale’s CTA index is down 5.55% this month…, making it the worst period for these systematic hedge funds since November 2001.”

February 27 – Bloomberg (Sid Verma): “Risk appetite is back with a vengeance. As U.S. stocks rose to a nearly four-week high on Monday, inflows into the benchmark exchange-traded fund for technology shares jumped to the second-most on record… Money managers sank at least $2.7 billion into the PowerShares QQQ Trust Series 1 ETF, which follows the Nasdaq 100 Index, bringing assets under management to an all-time high of $65.7 billion.”

February 27 – Bloomberg (Luke Kawa): “Options tied to exchange-traded products that allow investors to place bets on U.S. equity volatility are getting crushed in early trading on Tuesday. Late on Monday evening, ProShares announced that it would be dialing down the leverage on the Short VIX Short-Term Futures exchange-traded fund (ticker SVXY) -- a product that offers exposure to market tranquility -- and the Ultra VIX Short-Term Futures ETF (ticker UVXY), whose owners were making a levered wager that equity volatility would increase. Reducing the leverage on these funds will dampen their price swings going forward. The shifts also make it much less likely that any out-of-the-money options tied to these products would ultimately pay off.”

Trump Administration Watch:

February 25 – Axios (Jonathan Swan): “Bloomberg scooped on Friday that Trump wants the Commerce Department to seek the harshest maximum tariffs on global steel imports: 24%. I’m told that’s accurate, but with one small tweak: Sources tell me the president has told confidants he actually wants a 25% global tariff on steel because it's a round number and sounds better. The big picture: Also, an official with knowledge of the trade discussions told me the White House is preparing to impose tariffs on a ‘shit ton’ — meaning, potentially hundreds — of Chinese products. They'll avoid going through the World Trade Organization — which Trump doesn't trust — and instead use Section 301 of the Trade Act of 1974 to unilaterally retaliate against China for stealing Americans’ intellectual property.”

March 1 – Bloomberg (Andrew Mayeda): “President Donald Trump is warning the U.S. will use ‘all available tools’ to prevent China’s state-driven economic model from undermining global competition, the latest warning to Beijing as America readies a host of trade actions. China hasn’t lived up to the promises of economic reforms it made when it joined the World Trade Organization in 2001, and actually appears to be moving further away from ‘market principles’ in recent years, according to the president’s annual report to Congress… China’s ‘statist’ policies are causing a ‘dramatic misallocation’ of global resources that is leaving all countries poorer than they should be, said the report.”

U.S. Bubble Watch:

February 27 – CNBC (Diana Olick): “Sky-high demand and record-low supply continued to push home prices higher in December, far faster than income growth. U.S. home prices increased 6.3% compared with December 2016, according to the… S&P CoreLogic Case-Shiller national home prices index. That is an increase from 6.1% annual growth in the previous month. The index measuring the nation's 20 largest metropolitan markets rose 6.3% year over year… ‘The rise in home prices should be causing the same nervous wonder aimed at the stock market after its recent bout of volatility,’ David M. Blitzer, managing director and chairman of the Index Committee at S&P Dow Jones Indices, said… ‘Across the 20 cities covered by S&P Corelogic Case Shiller Home Price Indices, the average increase from the financial crisis low is 62%; over the same period, inflation was 12.4%. Even considering the recovery from the financial crisis, we are experiencing a boom in home prices.’ The boom is strongest in Seattle, Las Vegas and San Francisco…”

March 1 – Bloomberg (Sho Chandra): “Americans’ wallets fattened in January on recent tax cuts, indicating increased spending power may boost the economy this quarter. Real disposable income, or earnings adjusted for taxes and inflation, advanced 0.6% from the prior month, the biggest gain since April 2015… Nominal consumer spending grew 0.2%, matching the median forecast… and following a 0.4% gain. The Federal Reserve’s preferred price gauge, excluding food and energy, had the biggest monthly increase in a year.”

February 28 – Bloomberg (Sarah McGregor): “Foreign holdings of U.S. securities rose to a record $18.4 trillion as of the end of June… An annual survey of foreign portfolio investments -- including U.S. stocks along with short-and long-term debt -- showed holdings rose by 8%, up from $17.1 trillion a year earlier… Japan was largest investing country with $2 trillion, followed by the Cayman Islands at $1.7 trillion and the U.K. and China at about $1.5 trillion each. Luxembourg rounded out the top five at $1.4 trillion. Foreign holdings of U.S. equities climbed to $7.2 trillion as of June 30, from $6.2 trillion a year earlier. Short-term debt holdings increased to $954 billion from $909 billion, while long-term debt holdings rose to $10.3 trillion from $10 trillion…”

March 1 – Wall Street Journal (Akane Otani, Richard Rubin and Theo Francis): “U.S. companies are buying back their shares at an aggressive pace, stirring debates in Washington and on Wall Street about how savings from corporate tax cuts are being used and who benefits most. Share buybacks announced by large U.S. companies have exceeded $200 billion in the past three months, more than double the prior year, according to a Wall Street Journal analysis of data for S&P 500 companies. Among the biggest: Cisco Systems Inc. at $25 billion, Wells Fargo & Co. at about $21 billion, PepsiCo Inc. at $15 billion, AbbVie Inc. and Amgen Inc. at $10 billion apiece, and Alphabet Inc. at $8.6 billion.”

February 25 – Reuters (Eric M. Johnson and Chris Prentice): “The drive for cost cuts and higher margins at U.S. trucking and railroad operators is pinching their biggest customers, forcing the likes of General Mills Inc and Hormel Foods Corp to spend more on deliveries and consider raising their own prices as a way to pass along the costs. Interviews with executives at 10 companies across the food, consumer goods and commodities sectors reveal that many are grappling with how to defend their profit margins as transportation costs climb at nearly double the inflation rate.”

February 26 – Bloomberg (Sho Chandra): “U.S. sales of new homes unexpectedly fell in January to the lowest level since August as borrowing costs rose and winter weather depressed demand… Single-family home sales dropped 7.8% m/m to 593k annualized pace (est. 647k) after 643k rate (revised from 625k)… The results, which are volatile on a month-to-month basis, showed a 14.2% slump in the South, the largest decrease since March 2015 and a sharp decline in the Northeast. The two areas experienced inclement weather.”

February 27 – Bloomberg (Shelly Hagan and Sho Chandra): “U.S. consumer confidence jumped to a 17-year high as optimism about employment prospects grew and Americans began seeing additional money in their paychecks from recently enacted tax cuts, data from the… Conference Board showed… Confidence index rose to 130.8 (est. 126.5), highest since Nov. 2000, from downwardly revised 124.3 in January. Present conditions measure climbed to 162.4, highest since 2001, from 154.7.”

February 28 – Bloomberg (Luke Kawa): “The high-flying technology sector hit a potentially ominous milestone on Tuesday: It now amounts to more than 25% of the S&P 500 Index. ‘It’s the first time the sector has made up at least a quarter of the S&P since a one-year period that ran from Thanksgiving 1999 through Thanksgiving 2000,’ according… Bespoke Investment Group. ‘Notably, the weighting only got above 25% for the final four months of the dot-com bubble when share prices were going insane.’”

February 25 – Wall Street Journal (Michael Wursthorn and Chelsey Dulaney): “Investors borrowing record sums to bet on stocks exacerbated this month’s selloff, after they were hit with calls to reduce those obligations and forced to sell shares to raise cash. If that debt, known as margin loans, continues to rise at the current pace, analysts warn that big selloffs and sudden bouts of volatility in the stock market could become more commonplace. Retail and institutional investors have borrowed a record $642.8 billion against their portfolios…, as they try to pocket bigger gains by ramping up their exposure to stocks.”

Federal Reserve Watch:

March 1 – Financial Times (Joe Rennison and Nicole Bullock): “The Powell Put has a nice ring to it. After years of being able to count on having the Federal Reserve in their corner, investors had assumed it would be more of the same from the new Fed chair. Yet as Jay Powell, who has been a Fed governor since 2012 and spent almost 20 years as a partner at private equity firm Carlyle, publicly outlined his views on policy for the first time since succeeding Janet Yellen that assumption was under threat. In a marked departure from the more academic tone of his immediate predecessors in the Fed chair, the 65-year old signalled to Congress a willingness to look beyond bursts of volatility in financial markets and would tighten policy against a backdrop of a strengthening economy that may in due course reveal signs of overheating.”

February 27 – Bloomberg (Craig Torres and Christopher Condon): “Jerome Powell opened the door to the Federal Reserve raising U.S. interest rates four times this year as he acknowledged stronger economic growth may prompt policy makers to rethink their plan for three hikes. ‘My personal outlook for the economy has strengthened since December,’ the Fed chairman said Tuesday in response to a question about what would cause the central bank to step up the pace of policy tightening. He then listed four events that are causing him to revise up his outlook.”

February 25 – Bloomberg (Rich Miller and Shelly Hagan): “Federal Reserve Chairman Jerome Powell and his colleagues may be willing to accept inflation rising as high as 2.5% as they seek to extend the almost nine-year economic expansion. So say a number of veteran Fed watchers who argue that the central bank’s Federal Open Market Committee would tolerate a moderate rise in inflation above its 2% goal after years of falling below that objective… ‘I’ve had some hawks on the committee surprise me and say they wouldn’t be worried about a modest overshoot’ as long as it’s below 2.5%, former Fed governor Laurence Meyer said…”

February 26 – Financial Times (Sam Fleming): “The US may be on the cusp of a shift to higher sustained growth, pointing to a possible rise in the interest rate needed to maintain stable prices and full employment, a senior Federal Reserve policymaker said… Randal Quarles, the vice-chairman for financial supervision at the Fed’s board of governors, told a conference that growth may outpace central bankers’ forecasts as post-crisis drags abate… A jump in the growth rate to a durably faster pace could lead to a rise in the so-called natural rate of interest — the rate that keeps the economy on an even keel…. ‘There is a real possibility that some of the factors that have been holding back growth in recent years could shift, moving the economy on to a higher growth trajectory,’ Mr Quarles told the National Association for Business Economists…”

China Watch:

February 25 – Financial Times (Jamil Anderlini): “In the aftermath of Chairman Mao Zedong’s disastrous personality cult, Chinese paramount leader Deng Xiaoping recognised the dangers of totalitarian dictatorship. In the early 1980s Deng set about establishing a system that relied on competent governance, co-opting the elite and consensus rule at the top. China was still an autocracy but it incorporated and empowered enough interest groups to provide basic political stability and stellar economic growth, with just one big exception in 1989. That system, which has served China so well for decades, has now been swept away. On Sunday, the Communist party announced it would remove term limits on the presidency, allowing Xi Jinping to rule for life if he wants.”

February 26 – Financial Times (Lucy Hornby): “China’s Communist party has cleared the way for President Xi Jinping to rule for life, and in the process strengthened the state’s ‘command and control’ power over the world’s second-largest economy. Mr Xi’s unparalleled power theoretically allows him to push through painful reforms in the face of recalcitrant vested interests, particularly in state-dominated sectors... When Mr Xi took over the Communist party in 2012, bureaucrats hastened to reassure foreign businesses and diplomats that the president was merely consolidating power to enact economic reforms. So far economic liberalisation has been slow to materialise. ‘Xi believes that he is ideally suited to keep China politically and economically strong in coming decades and he is trying to make sure his power is equal to the task,’ says Andrew Collier, managing director at Orient Capital Research. Mr Xi’s advisers are aware the country faces the end of its demographic boom and a growing debt problem, he adds.”

February 28 – Financial Times (Hudson Lockett): “China’s official gauge of manufacturing activity suffered its largest fall since 2011 in February, an unexpectedly sharp slowdown that left it near the zero-growth level. The manufacturing purchasing managers’ index… dropped to 50.3, down a point from January and the largest fall in more than six years. The fall marked the gauge’s nearest brush with the 50-point mark that separates growth from contraction since August 2016.”

February 28 – Bloomberg: “China plans to expand its unprecedented crackdown on financial risk to money-market funds by capping how much investors can redeem in a day, people familiar with the matter said. The limit for same-day redemption will be set at 10,000 yuan ($1,580)… The same restriction will apply when investors use their assets in money-market funds directly for payment and consumption… Such a move would be the latest tightening by China’s policy makers, who are making stability job No. 1 as they work to balance continued expansion with defusing the country’s debt bomb.”

February 23 – Reuters (Josephine Mason and Pei Li): “China’s new home prices grew in January although major cities saw early signs of softening, as the government continued its efforts to rein in speculative demand to fend off bubble risk. The acceleration in prices across the nation suggests moves by provincial governments to support first-time buyers and upgraders by relaxing some purchase restrictions may be further fanning price gains in a market where fear of missing out is strong and mortgage fraud is rampant. Average new home prices in China’s 70 major cities rose 5% in January from a year earlier and 0.3% month on month…”

February 28 – Reuters (Michael Martina and Patricia Zengerle): “China expressed anger on Thursday after the U.S. Senate passed a bill promoting closer U.S. ties with Taiwan, but the step drew praise from the self-ruled island which pledged to deepen cooperation. The move adds to tensions between China and the United States, already at loggerheads over trade, with President Xi Jinping’s close economic advisor Liu He in Washington this week to try and avert a trade war.”

February 23 – Wall Street Journal (Nathaniel Taplin): “China’s Anbang Insurance went from zero to too-big-to-fail in the blink of an eye. It is a lesson in how quickly China’s financial problems grow—and how much is left to clean up. Beijing said Friday that the state is taking direct control of Anbang Insurance Group, the acquisitive purveyor of unusual investment products whose high-flying chairman Wu Xiaohui was detained last summer amid a broader crackdown on debt… The total cost of cleaning up the mess, including whatever losses sit on Anbang’s gargantuan balance sheet—put at close to 2 trillion yuan ($300bn) in April by financial magazine Caixin—is an unknown.”

March 1 – Bloomberg (Keith Zhai and Alfred Cang): “President Xi Jinping’s government has fired another warning shot at global dealmakers doing business with Chinese billionaires: Not even the most well-connected tycoons are safe. Ye Jianming, a globe-trotting Chinese tycoon who runs the conglomerate CEFC China Energy Co., has been investigated by authorities, according to people with knowledge… The news, first reported by local media outlet Caixin, comes shortly after Xi’s government seized Anbang Insurance Group Co., a global empire whose once-influential founder, Wu Xiaohui, is detained while facing fraud charges.”

Central Bank Watch:

March 2 – Bloomberg (Lucy Meakin and Edward Robinson): “Mark Carney is calling for greater regulation to bring the era of cryptocurrency “anarchy” to an end. ‘The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system,’ the Bank of England governor said… Carney, who is also head of the Financial Stability Board, joins a growing chorus calling for greater oversight of the technology after the explosion of new cryptocurrencies created more than $438 billion in paper wealth since March 2, 2017…”

Global Bubble Watch:

February 28 – Financial Times (Eric Platt and Joe Rennison): “Some of the biggest international buyers of US corporate debt are showing signs of stepping back from this $8.8tn market, reflecting expectations of a bigger shift under way: the retreat of central banks from the era of easy money. In contrast to Europe and Japan, the fixed yields paid to holders of US corporate debt has long been much higher, an attractive proposition to global investors until late last year. International investors were net sellers of US corporate paper in December, only the second time this has occurred in the past three years as the rising cost of insulating their portfolios against swings in the dollar erodes the attraction of high US bond yields. ‘[Foreign] investors are seeing their net returns post-hedge eroded,’ says Steven Oh, global head of credit and fixed income at PineBridge Investments. ‘And because they are losing that yield differential, they are going to rethink not only their allocation to US credit but going forward [if] they actually withdraw.’”

February 28 – Wall Street Journal (Jon Sindreu): “The rise in Treasury yields should make U.S. debt more attractive to international investors still struggling with low returns at home—yet few are buying. The rising costs of currency hedges means it often isn’t worth it… Last year, buying Treasurys and swapping the proceeds back into euros provided European investors with a higher return than buying German sovereign bonds. Now, hedging costs have increased so much that this trade is no longer profitable. That could sap an important source of demand for U.S. Treasurys. It’s also making it more expensive for foreign investors to buy U.S. corporate debt.”

February 25 – Financial Times (Javier Espinoza): “Private equity groups are buying public companies at the fastest rate since before the financial crisis, with deals totalling $180bn last year, nearly twice the level of 2016, according to Bain & Co. The jump in dealmaking is the largest increase since 2007 and comes as the sector is under pressure to deploy record sums of cash… Bain… said in its global report that the number of ‘public-to-private’ deals, where a private equity group buys a listed company, hit 152 last year, up from 94 in 2016. The all-time high of 196 transactions was hit in 2007, while the record value for such deals was $423bn in 2006.”

March 1 – Bloomberg (Emily Cadman): “Australian home prices fell for a fifth consecutive month in February, in a further sign the property boom is over. Housing prices fell 0.1% nationally, led by a 0.6% decline in Sydney, according to CoreLogic… Prices in Sydney, the epicenter of the boom, are down 0.5% from a year earlier -- the first annual decline since 2012.”

February 28 – Wall Street Journal (Jean Eaglesham and Paul Vigna): “The Securities and Exchange Commission has issued dozens of subpoenas and information requests to technology companies and advisers involved in the red-hot market for cryptocurrencies, according to people familiar with the matter. The sweeping probe significantly ratchets up the regulatory pressure on the multibillion-dollar U.S. market for raising funds in cryptocurrencies. It follows a series of warning shots from the top U.S. securities regulator suggesting that many token sales, or initial coin offerings, may be violating securities laws.”

Fixed-Income Bubble Watch:'

February 27 – Wall Street Journal (Kosaku Narioka and Saumya Vaishampayan): “Japanese investors may be America’s bond bears. They are shifting toward selling U.S. Treasury bonds and other dollar-based debt after fears have picked up in recent weeks that the Trump administration’s budget and other policies add up to a weak dollar… Any questioning in Tokyo of the dollar or of the U.S. Treasury is significant because Japanese holders including the government own nearly $1.1 trillion in Treasury bonds, a close second to China. For years, the U.S. economy has relied on Japan and China to recycle their trade surpluses back into the U.S. by buying American debt. Japan’s suspicions were fanned by Treasury Secretary Steven Mnuchin’s remark in January that ‘a weaker dollar is good for trade.’”

February 27 – Bloomberg (Sid Verma and Luke Kawa): “Investors reaching for yield are now finding it’s less of a stretch. Global credit markets are on the cusp of a post-crisis regime shift as higher rates on short-dated U.S. Treasuries challenge the investment case for high-grade corporate bonds -- on both sides of the Atlantic. Consider this: The Vanguard short-term corporate bond exchange-traded fund, which holds U.S. investment grade debt with a maturity of less than five years, now has an indicated dividend yield only 0.54 percentage point above that of the three-month Treasury bill. That represents a tiny pickup compared with a whopping 2 percentage points in early 2017.”

February 28 – Financial Times (Eric Platt and Joe Rennison): “US short-dated bank bonds have been in the line of fire in recent weeks and this selling pressure reflects tax reform, analysts say, rather than a change in traders’ beliefs about the creditworthiness of financials. Companies with large amounts of offshore cash from their global operations placed the money in US government and corporate bonds. Now as the cash appears set to come home thanks to changes in US tax law, the first signs of liquidation are being seen. Many big multinationals invested primarily in corporate bonds and the likes of Apple, for example, were large buyers of short-term bank bonds… Highlighting a sell-off, risk premiums rose for senior unsecured bonds issued by Bank of America, Citigroup and JPMorgan…”

Europe Watch:

March 1 – Reuters (Markus Wacket): “Germany’s Social Democrat (SPD) environment minister said on Thursday she expects party members to support a new coalition government with Chancellor Angela Merkel’s conservatives by a margin of 60%. The SPD’s 464,000 members are voting in a postal ballot on whether to endorse their party leadership’s decision to renew for another four years the ‘grand coalition’ that took office in 2013. The result of the postal ballot is due on Sunday.”

March 1 – Financial Times: “It is a mark of the impatience of Italian voters that Silvio Berlusconi is poised to stage a political resurrection in Italy’s March 4 elections. The disgraced tycoon and former prime minister is barred from holding office as a result of a conviction for tax fraud, at least until 2019. Whatever the fate of the alliance between his Forza Italia party, the resurgent populist nationalist Northern League, and smaller far-right Brothers of Italy in a centre right coalition, he remains the potential kingmaker. Strikingly, given the extreme views of his fellow travellers, Mr Berlusconi’s own past outbursts and indiscretions seem relatively moderate. Sunday’s polls are the most significant in this year’s European calendar, testing the resilience of the populist nationalist vote, and long-term future of the centre-left. They have a bearing on the future of the eurozone, on the precarious fortunes of its third-largest economy and on Europe’s response to migration.”

February 28 – BBC: “An EU proposal for the Northern Ireland border threatens the ‘constitutional integrity’ of the United Kingdom, Theresa May has said. The EU's draft legal agreement proposes a ‘common regulatory area’ after Brexit on the island of Ireland - in effect keeping Northern Ireland in a customs union - if no other solution is found. Mrs May said ‘no UK prime minister could ever agree’ to this. The EU says the ‘backstop’ option is not intended to "provoke" the UK.”

Japan Watch:

February 28 – Reuters (Stanley White): “Bank of Japan Governor Haruhiko Kuroda said… that once the central bank starts to normalize monetary policy the process would be ‘very gradual,’ and that the BOJ would pay attention to any risks to the economy. Speaking in the lower house of parliament, Kuroda said the BOJ would not continue with its aggressive monetary easing when inflation reached its price target and the economy was growing stably.”

EM Bubble Watch:

February 27 – Bloomberg (Selcuk Gokoluk): “Developing-nation borrowers are raising more money in local markets than ever before… Local-currency bond sales in emerging markets this year exceeded $1 trillion, almost triple the amount raised in the same period last year and dwarfing the $160 billion in hard-currency issues… Domestic sales have increased almost five-fold in the past five years.”

Leveraged Speculator Watch:

March 1 – Bloomberg (John Ainger): “Hedge-fund veteran Paul Tudor Jones has joined the growing chorus of big hitters in the fixed-income world warning that bonds are well and truly in a bear market. He sees 10-year U.S. Treasury yields rising to 3.75% by year-end as a ‘conservative’ target given that supply outweighs demand, economic momentum is outpacing the monetary policy response, and that bond valuations are ‘glaring.’ That puts him in the company of Bill Gross and Ray Dalio who say the days of a bond bull market are over.”

February 28 – Bloomberg (Scott Deveau): “One of the longest and most colorful battles in Wall Street history is over, and Bill Ackman lost. Ackman has almost entirely exited his position in Herbalife Ltd., ending a short-selling campaign that lasted more than five years… The move follows a steady rise in the shares of a company that he repeatedly called an illegal pyramid scheme and vowed to destroy.”

Geopolitical Watch:

February 28 – Wall Street Journal (Sune Engel Rasmussen): “The demise of Islamic State is intensifying a scramble among foreign powers in Syria, raising the risk that diverging strategic and commercial interests could lead to a wider regional war. In the past month, a U.S. airstrike in the eastern part of the country killed an unknown number of Russian military contractors; Israel hit Iranian military installations deep inside Syria; while Turkey waged a campaign against Kurdish militias in the north. The volatile situation is a result of how the fight against Islamic State was conducted, with players seizing territory, arming proxies and aggravating long-existing ethnic and political divisions. The result: a series of flashpoints where clashes could erupt among major powers and spill over Syria’s borders. ‘No one wants that war, but everyone is ready for it and expects it,’ said Emile Hokayem, a Syria expert at the International Institute for Strategic Studies in London.”

February 27 – Financial Times (Ben Bland): “While Beijing was outlining the path for Xi Jinping to rule as China’s president for life, Tsai Ing-wen, his democratically elected counterpart in Taiwan, was speaking about the importance of universal human rights at a Holocaust memorial ceremony in Taipei. But Mr Xi’s concentration of power — unparalleled since the era of Mao Zedong — represents a growing threat to Taiwan’s efforts to maintain de facto independence, in the face of Beijing’s insistence that the island is part of its territory, and to the embattled democracy movement in neighbouring, semi-autonomous Hong Kong. ‘Xi Jinping has largely been the author of fairly hard-line policies toward [Hong Kong and Taiwan],’ said William Stanton, a former US diplomat… ‘The problem with all dictators is that no one can put a brake on anything they want to do.’”

March 1 – Bloomberg (Ben Blanchard and Yimou Lee): “China warned Taiwan on Friday it would only get burnt if it sought to rely on foreigners, adding to warnings from state media the country could go to war over Taiwan if the United States passes into law a bill promoting closer U.S. ties.”

Friday Afternoon Links

[Bloomberg] Stocks Fluctuate, Bonds Fall as Tariffs Set Tone: Markets Wrap

[Bloomberg] U.S. Car Loan Rates Rise to Highest in Eight Years

[Reuters] NAFTA talks soured, hamstrung by Trump steel trade war threats

[Bloomberg] The Yen Emerges as the Currency-Market Winner From Trade Tensions

[Bloomberg] Hedge Funds Feel Episodic Volatility: ‘You’re Going to Get Hurt’

[Reuters] Italy's 5-Star rallies voters as center-right frets