Saturday, February 23, 2019

Weekly Commentary: Dudley on Debt and MMT

December’s market instability and resulting Fed capitulation to the marketplace continue to reverberate. At this point, markets basically assume the Fed is well into the process of terminating policy normalization. Only a couple of months since completing its almost $3.0 TN stimulus program, markets now expect the ECB to move forward with some type of additional stimulus measures (likely akin to its long-term refinancing operations/LTRO). There’s even talk that the Bank of Japan could, once again, ramp up its interminable “money printing” operations (BOJ balance sheet $5.0 TN… and counting). Manic global markets have briskly moved way beyond a simple Fed “pause.”

There was the Thursday Reuters article (Howard Schneider and Jonathan Spicer): “A Fed Pivot, Born of Volatility, Missteps, and New Economic Reality: The Federal Reserve’s promise in January to be ‘patient’ about further interest rate hikes, putting a three-year-old process of policy tightening on hold, calmed markets after weeks of turmoil that wiped out trillions of dollars of household wealth. But interviews with more than half a dozen policymakers and others close to the process suggest it also marked a more fundamental shift that could define Chairman Jerome Powell’s tenure as the point where the Fed first fully embraced a world of stubbornly weak inflation, perennially slower growth and permanently lower interest rates.”

And then Friday from the Financial Times (Sam Fleming): “Slow-inflation Conundrum Prompts Rethink at the Federal Reserve: Ten years into the recovery and with unemployment near half-century lows, the Federal Reserve’s traditional models suggest inflation should be surging. Instead, officials are grappling with unexpectedly tepid price growth, prompting some to rethink their strategy for steering the US economy. John Williams, the New York Fed president, said on Friday that persistently soft inflation readings over recent years could damage the Fed’s ability to convince the general public it will hit its 2% goal. Central banks in other major economies are likely to face similar problems, he warned… Persistent shortfalls relative to the Fed’s 2% target have already helped prompt officials to shelve plans for further rate rises. But they are also thinking more broadly about the US central bank’s inflation mandate… Officials are debating new approaches which could sometimes lead them to deliberately aim for above-target inflation. Richard Clarida, the Fed’s vice-chairman, said on Friday the central bank will be open-minded about these new ideas…”

Markets are raging and crazy talk is proliferating – and it’s already time to commence another momentous election cycle. Bill Dudley must have felt compelled to opine:

“People from across the political spectrum are challenging a bit of long-held conventional wisdom: that if the U.S. government runs big, sustained budget deficits, its mounting debts will eventually cause grievous harm to the economy. They have a point — but it is important not to push that point too far. The arguments come in different forms. Some mainstream economists — such as Olivier Blanchard, former chief economist at the International Monetary Fund –- note that sovereign debt is more manageable in a world where economic growth exceeds governments’ very low borrowing costs. On the more extreme end, proponents of Modern Monetary Theory argue that because the U.S. borrows in its own currency, it can always just print more dollars to cover its obligations.” Bill Dudley, former President of the New York Federal Reserve Bank, Bloomberg Opinion, February 19, 2019

Mr. Dudley surely appreciates the precarious state of things. “Deficits don’t matter.” Rebuild infrastructure; universal healthcare; universal basic income; reverse climate change; free college tuition; strong military; and low taxes. Where’s all the money to come from? Borrow a ton of it for sure. And, depending on your political affiliation, soak the rich.

Dudley: “Turning first to Blanchard, I agree that deficit spending looks less problematic than in the past. The government’s debt burden, measured as a percentage of gross domestic product, remains stable as long as debt and GDP grow at the same rate. This is easier to do now because the long-run nominal growth rate (around 3.5-4.0%) is well above the U.S. government’s borrowing cost (around 2.5%). So the government has some leeway: The debt can grow at nearly 4% per year, or 1.0% to 1.5% net of interest expense, without increasing the debt-to-GDP ratio. The low level of interest rates might help explain why markets have proven more tolerant of large, persistent budget deficits around the world, with Japan the most notable example.”

Could it be that markets are “more tolerant of large, persistent deficits around the world” specifically because of historic and far-reaching changes in central bank doctrine and policies? A decade ago, no one contemplated central banks purchasing more than $16 TN of government debt securities. Only a nutcase would have pondered ten years of near zero – or even negative – interest rates (and $10 TN of negative-yielding bonds). “Whatever it takes” central banking? Crazy talk.

These days, markets believe that central banks will be willing and able to purchase unlimited quantities of government bonds to ensure that yields remain low and markets highly liquid. No crisis necessary. Indeed, markets have been convinced without a doubt that central bankers will do whatever it takes to ensure no crises, bear markets or recessions.

The reality is that global central banks have fundamentally inflated the price of government debt, while systematically altering market risk perceptions. And, yes, it has made deficit spending appear much less problematic. As illustrated most starkly in Japan, on an ongoing basis governments issue enormous quantities of debt instruments without markets demanding one iota of risk premium. Heck, the bigger the deficit (and heightened systemic risk) the lower risk premiums. It’s all astonishing, entertaining - and has turned almost comical. But it has seriously become the greatest market distortion in history – today viewed as “business as usual.” And, importantly, with “risk free” sovereign debt the foundation of global finance, distortions in prices and risk perceptions encompass securities markets (and asset markets more generally) around the globe.

“The government’s debt burden, measured as a percentage of gross domestic product, remains stable as long as debt and GDP grow at the same rate.” Okay, except that for a decade now debt has been expanding more rapidly than GDP - for what is now among the longest expansions on record. And I strongly caution against extrapolating 3.5-4.0% economic growth into the future. A scenario of 5% to 7% debt growth, with zero to 2% real GDP expansion, is not only not unreasonable, it’s realistic. And let’s not disregard demographics and the projected surge in entitlement spending. Truth be told, we’re now a mere garden-variety bear market and recession away from Fiscal Armageddon. At some point, markets may even place a risk premium on Treasury debt. Interest payments on federal borrowings are projected at $364 billion in fiscal 2019. Factoring only a small increase in market yields, debt service is projected to more than double by 2018. In the event of a deep recession and another round of bailouts, annual deficits approaching $2.0 TN are not crazy talk.

Dudley: “How and when the government spends the money also matters. Infrastructure investment, for example, can actually pay for itself by boosting the economy’s productive capacity. This is particularly relevant in the U.S., where dilapidated roads, ports and other public works desperately need an upgrade. (Imagine the benefits of a second rail tunnel between New York City and New Jersey.) Deficit spending in recessions can also be self-funding, because it engages unused resources — for example, by employing people whose abilities and skills would otherwise be wasted.”

The past decade has seen an incredible expansion of federal debt. To come out of such a period with “dilapidated roads, ports and other public works” does not instill confidence that funds have been – or ever will be – spent wisely.

Dudley: “Yet Modern Monetary Theory goes one big step further. It suggests that a government like the U.S. needn’t worry about debt at all. As long as it borrows in its own currency, there is no risk of default or bankruptcy. It can spend as much as it wants on any projects, such as education and health care, and just create additional IOUs to cover the cost.”

Like Dudley, I have few kind words for Modern Monetary Theory (MMT). I basically liken it to crackpot theories that have haunted monetary stability throughout history. Every great monetary inflation is replete with deeply flawed notions, justifications and rationalizations. But that MMT seems even remotely reasonable these days is owed directly to “activist” central banking - and the perception that central bank rate manipulation and the unlimited purchase of securities ensure forever low market yields and endless demand for government obligations.

It’s now been almost a decade since I began warning of the incipient “global government finance Bubble.” In true Epic Bubble form, after a decade of unprecedented expansion of government and central bank Credit, there’s a deeply embedded market perception that basically no amount of supply will impact the price of so-called “risk free” debt. And it’s precisely this perilous delusion that ensures an eventual crisis of confidence.

Today’s crackpot theories hold that central banks can continue to suppress interest rates and stimulate financial markets so long as consumer price inflation remains muted. It’s the old “money” as a “medium of exchange” focus that has led to scores of fantastic booms followed certainly by devastating collapses. The infamous monetary theorist John Law and his experiment in paper money were celebrated in France – that is until the spectacular 1720 collapse of his scheme and the attendant Mississippi Bubble. It literally took generations for trust in banking to return. Contemporary central banking is both the architect and enabler of crackpot theories. The celebration, today seemingly everlasting, will prove tragically transitory.

“Money” as a “Store of Value.” It is delusional to believe that endless issuance of non-productive Credit will not at some point significantly impact the value of these instruments. And the more central bankers manipulate the debt markets, the greater the issuance. Arguably, one of the greatest costs associated with the ongoing experiment in “activist” monetary management is the bevy of market distortions that promote the rapid expansion of government and other non-productive debt.

Moreover, central banks injecting “money” directly into – and furthermore supporting – securities markets is an allocation of Credit predominantly benefitting the wealthy. Sure, there’s some “trickle down.” The unemployment rate is historically low and jobs are more plentiful. By now, however, it should be abundantly clear that employment gains do not abrogate a system that has evolved to distribute wealth so inequitably – or the perception that the system is rigged for the benefit of the wealthy.

Even with gainful employment, many see the system as hopelessly unfair. The Fed can now feign trepidation for CPI missing its 2% inflation objective. Yet tens of millions struggle making ends meet against constantly inflating costs (including housing, healthcare and tuition). We’re now clearly on a trajectory for risking a crisis of confidence in financial assets and our institutions more generally.

Dudley: “Alas, there is no free lunch. For one, the economy might not have enough resources — in the form of workers and industrial capacity — to meet the combined demand from the government and the private sector. The result would be inflation, as too much money chased too few goods and services.”

That it has the appearance of a “free lunch” is at the heart of the quandary. And it’s not that “the result would be inflation.” Indeed, the result is and has been inflation, just not the typical variety. The prevailing source of monetary inflation is central banks injecting new “money” into the securities markets, while essentially promising liquid and levitated markets. The upshot is too much “money” chasing financial market returns. Monetary Disorder. Booms and Busts. Unmanageable Speculation. Intractable Resources Misallocation. Economic Maladjustment and Global Imbalances

The dilemma today - as it’s been with great inflationary episodes throughout history – is that inflation becomes deeply ingrained and halting it too painful. Policymakers refuse to accept mistakes and change directions. Instead, there is denial and the irresistibility of rationalization and justification. Throughout the devastating Weimar hyperinflation, Germany’s central bank refused to accept that they were the party of primary responsibility – but instead rationalized the bank was being forced to respond to outside forces. Today’s great global inflation is characterized by contrasting dynamics, but some of the devastating consequences of failing to recognize the essence of the problem are all too similar. Markets. Social. Political. Economic. Geopolitical.


For the Week:

The S&P500 rose 0.6% (up 11.4% y-t-d), and the Dow added 0.6% (up 11.6%). The Utilities jumped 2.8% (up 8.3%). The Banks increased 0.6% (up 16.6%), and the Broker/Dealers rose 1.4% (up 13.7%). The Transports added 0.2% (up 15.5%). The S&P 400 Midcaps gained 1.0% (up 16.3%), and the small cap Russell 2000 jumped 1.3% (up 17.9%). The Nasdaq100 increased 0.5% (up 12.0%). The Semiconductors advanced 1.0% (up 18.1%). The Biotechs declined 1.4% (up 16.8%). With bullion adding $7, the HUI gold index surged 3.9% (up 8.6%).

Three-month Treasury bill rates ended the week at 2.40%. Two-year government yields declined two bps to 2.50% (up 1bp y-t-d). Five-year T-note yields slipped two bps to 2.47% (down 4bps). Ten-year Treasury yields dipped a basis point to 2.65% (down 3bps). Long bond yields increased two bps to 3.01% (unchanged). Benchmark Fannie Mae MBS yields fell four bps to 3.40% (down 9bps).

Greek 10-year yields slipped a basis point to 3.80% (down 55bps y-t-d). Ten-year Portuguese yields fell eight bps to 1.49% (down 23bps). Italian 10-year yields gained five bps to 2.85% (up 11bps). Spain's 10-year yields dropped six bps to 1.18% (down 24bps). German bund yields were little changed at 0.10% (down 14bps). French yields declined two bps to 0.52% (down 19bps). The French to German 10-year bond spread narrowed two to 42 bps. U.K. 10-year gilt yields were unchanged at 1.16% (down 12bps). U.K.'s FTSE equities index declined 0.8% (up 6.7% y-t-d).

Japan's Nikkei 225 equities index jumped 2.5% (up 7.0% y-t-d). Japanese 10-year "JGB" yields declined two bps to negative 0.04% (down 4bps y-t-d). France's CAC40 gained 1.2% (up 10.3%). The German DAX equities index rose 1.4% (up 8.5%). Spain's IBEX 35 equities index increased 0.9% (up 7.8%). Italy's FTSE MIB index added 0.2% (up 10.6%). EM equities were higher. Brazil's Bovespa index added 0.4% (up 11.4%), and Mexico's Bolsa jumped 1.7% (up 5.0%). South Korea's Kospi index gained 1.6% (up 9.3%). India's Sensex equities index added 0.2% (down 0.5%). China's Shanghai Exchange surged 4.5% (up 12.4%). Turkey's Borsa Istanbul National 100 index increased 0.5% (up 13.1%). Russia's MICEX equities index was little changed (up 5.5%).

Investment-grade bond funds saw inflows of $1.953 billion, and junk bond funds posted inflows of $284 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined two bps to a one-year low 4.35% (down 5bps y-o-y). Fifteen-year rates fell three bps to 3.78% (down 7bps). Five-year hybrid ARM rates dropped four bps to 3.84% (up 19bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down seven bps to 4.35% (down 1bps).

Federal Reserve Credit last week dropped $36.5bn to $3.952 TN. Over the past year, Fed Credit contracted $417bn, or 9.5%. Fed Credit inflated $1.141 TN, or 41%, over the past 328 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $5.1bn last week to $3.432 TN. "Custody holdings" increased $19bn y-o-y, or 0.6%.

M2 (narrow) "money" supply added $6.7bn last week to a record $14.488 TN. "Narrow money" gained $640bn, or 4.6%, over the past year. For the week, Currency was little changed. Total Checkable Deposits fell $27.9bn, while Savings Deposits jumped $32.9bn. Small Time Deposits increased $2.2bn. Retail Money Funds were about unchanged.

Total money market fund assets declined $7.9bn to $3.072 TN. Money Funds gained $228bn y-o-y, or 8.0%.

Total Commercial Paper was little changed at $1.061 TN. CP declined $34bn y-o-y, or 3.1%.

Currency Watch:

The U.S. dollar index declined 0.4% to 96.507 (up 0.3% y-t-d). For the week on the upside, the British pound increased 1.3%, the Canadian dollar 0.8%, the South African rand 0.6%, the Mexican peso 0.6%, the Swiss franc 0.5%, the Singapore dollar 0.4%, the euro 0.4%, the South Korean won 0.3%, and the Norwegian krone 0.3%. For the week on the downside, the Brazilian real declined 1.2%, the Swedish krona 0.7%, the New Zealand dollar 0.3%, the Japanese yen 0.2% and the Australian dollar 0.2%. The Offshore Chinese renminbi gained 0.89% versus the dollar this week (up 2.45% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.4% (up 14.7% y-t-d). Spot Gold added 0.5% to $1,328 (up 3.6%). Silver jumped 1.7% to $16.012 (up 3.0%). Crude rose another $1.67 to $57.26 (up 26%). Gasoline gained 2.4% (up 24%), and Natural Gas rose 3.5% (down 8%). Copper surged 5.3% (up 12%). Wheat fell 3.0% (down 2%). Corn increased 0.5% (up 3%).

Market Dislocation Watch:

February 18 – Wall Street Journal (Daniel Kruger): “Investors around the globe are effectively paying governments to hold more than $11 trillion of their bonds, a fresh sign of ebbing economic confidence in Europe and Japan. Negative-yielding government bonds outstanding through mid-January have risen 21% since October, reversing a steady decline that took place over the course of 2017 and much of last year, according to… Bank of America Merrill Lynch. While the stock of negative-yielding debt still remains below its 2016 high, the proliferation of these bonds… underscores the uncertainty over the growth prospects in much of the developed world. ‘Europe is an absolute quagmire,’ said Matt Freund, co-chief investment officer at Calamos Investments. ‘There are significant headwinds that we’ve been talking about for a long time—now they’re showing up in the numbers.’”

Trump Administration Watch:

February 18 – Reuters (Jeff Mason and David Lawder): “U.S. President Donald Trump said… that trade talks with China were going well and suggested he was open to pushing off the deadline to complete negotiations, saying March 1 was not a ‘magical’ date. Tariffs on $200 billion worth of Chinese imports are scheduled to rise to 25% from 10% by March 1 if the world’s two largest economies do not settle their trade dispute, but Trump has suggested several times that he would be open to postponing the deadline. ‘They are very complex talks. They’re going very well,’ Trump told reporters... ‘I can’t tell you exactly about timing, but the date is not a magical date. A lot of things can happen.’”

February 19 – Bloomberg (Michael Schuman): “Optimism that the U.S. and China can reach a trade deal is rising, with another round of intensive negotiations in Washington this week. What buoyant investors are ignoring, however, is that the talks have become a test of strength between the world’s two great powers -- or, more accurately, a test of how accurate each nation’s sense of its own strength is. The inconvenient fact is that neither country possesses the power to impose its will on the other. The U.S. is not on its own capable of compelling Chinese leaders to do its bidding, nor is China strong enough to shun the Western world. Until they face up to that reality, they’ll never be able to reach a lasting accommodation.”

February 18 – Reuters (Steve Holland): “U.S. President Donald Trump… warned members of Venezuela’s military who remain loyal to socialist President Nicolas Maduro that they are risking their future and their lives and urged them to allow humanitarian aid into the country. Speaking to a cheering crowd mostly of Venezuelan and Cuban immigrants in Miami, Trump said if the Venezuelan military continues supporting Maduro, ‘you will find no safe harbor, no easy exit and no way out. You’ll lose everything.’”

February 18 – Reuters: “U.S. President Donald Trump has promised European Commission President Jean-Claude Juncker that he will not impose additional import tariffs on European cars for the time being, Juncker was quoted… as saying… A confidential U.S. Commerce Department report sent to Trump over the weekend is widely expected to clear the way for him to threaten tariffs of up to 25% on imported autos and auto parts by designating the imports a national security threat. ‘Trump gave me his word that there won't be any car tariffs for the time being. I view this commitment as something you can rely on,’ Juncker told the German daily Stuttgarter Zeitung…”

Federal Reserve Watch:

February 20 – Reuters (Ann Saphir, Jason Lange and Trevor Hunnicutt): “The Federal Reserve… signaled they will soon lay out a plan to stop letting go of $4 trillion in bonds and other assets, but policymakers are still debating how long their newly adopted ‘patient’ stance on U.S. rates policy will last. For now, policymakers see little risk to leaving interest rates alone while they take time to assess rising risks, including a global slowdown, according to the Fed’s minutes from their Jan. 29-30 meeting…”

February 20 – Bloomberg (Christopher Condon and Craig Torres): “Federal Reserve officials widely favored ending the runoff of the central bank’s balance sheet this year while expressing uncertainty over whether they would raise interest rates again in 2019, minutes of their January meeting showed. ‘Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year,’ according to the record of the Federal Open Market Committee’s Jan. 29-30 gathering…”

February 19 – Reuters (Howard Schneider, Jonathan Spicer, Trevor Hunnicutt): “New York Fed President John Williams… said he was comfortable with the level U.S. interest rates are at now and that he sees no need to raise them again unless economic growth or inflation shifts to an unexpectedly higher gear… ‘I don’t think that it would take a big change, but it would be a different outlook either for growth or inflation’ to return to hiking rates, Williams… a key voice on rate policy, told Reuters.”

February 19 – Reuters (Jason Lange): “The U.S. Federal Reserve may need to raise interest rates in 2019 but it could still end its efforts to trim its massive bond portfolio before the end of the year, Cleveland Federal Reserve President Loretta Mester said… Mester’s comments are an example of the complexity of the U.S. central bank’s efforts to establish new norms for setting monetary policy at a time when the economic outlook appears increasingly uncertain… ‘I would think that we probably have to raise interest rates a little bit later this year,’ Mester told reporters…”

February 21 – CNBC (Jeff Cox): “The Federal Reserve is likely near the end of interest rate increases and the program to reduce the bonds it holds on its balance sheet, St. Louis Fed President James Bullard said… ‘I think the message from my point of view is the normalization process in the United States is coming to an end,’ the central bank official told CNBC... Bullard added that he thinks rates are actually too high now but acknowledged that his view is in the minority on the policymaking Federal Open Market Committee.”

U.S. Bubble Watch:

February 21 – Reuters (Lucia Mutikani): “New orders for key U.S.-made capital goods unexpectedly fell in December amid declining demand for machinery and primary metals, pointing to a further slowdown in business spending on equipment that could crimp economic growth. The moderation in business investment was also underscored by another report… showing a measure of factory activity in the mid-Atlantic region contracted in February for the first time since May 2016… Orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, dropped 0.7%. Data for November was revised down to show these so-called core capital goods orders falling 1.0%...”

February 21 – Bloomberg (Jeff Kearns and Katia Dmitrieva): “Sales of previously owned U.S. homes fell to the weakest pace since November 2015, indicating that the housing market remained in a slowdown despite a drop in mortgage rates. Contract closings decreased 1.2% in January from the prior month to an annual rate of 4.94 million…, below economists’ estimates for 5 million. The median sales price rose 2.8% from a year ago, the smallest increase since February 2012, while the inventory of available homes saw a sixth straight increase.”

February 19 – Financial Times (John Plender): “We know that changes in the household sector balance sheet, particularly in relation to the balance between savings and consumption, matter greatly for the real economy. That said, what is unusual at present is that the exposure of US household balance sheets to the stock market is running at record levels. This is an under-acknowledged part of the explanation for the recent weakening of economic data and especially the spectacular decline in retail sales. As TS Lombard, a research firm, points out, share prices are not the only determinant of spending but they count more than they used to because equities make up a bigger percentage of household net worth than real estate for only the third time since the end of the second world war. An important difference in the current cycle compared with the previous two occasions is that so much of the increase in ownership reflects net purchases as opposed to simply being the passive result of a valuation uplift in a strong bull market.”

February 19 – MarketWatch (Andrea Riquier): “The National Association of Home Builders’ monthly confidence index jumped 4 points to a seasonally adjusted reading of 62 in February… The February gain was the second in a row and put the sentiment index, which some economists view as an early read on the pace of residential construction, back to its mid-autumn level. It easily beat the Econoday consensus forecast of a one-point increase.”

February 16 – Bloomberg (Alexandre Tanzi): “Student-loan delinquencies surged last year, hitting consecutive records of $166.3 billion in the third quarter and $166.4 billion in the fourth. Bloomberg calculated the dollar amounts from the Federal Reserve Bank of New York’s quarterly household-debt report… That percentage has remained around 11% since mid-2012, but the total increased to a record $1.46 trillion by December 2018, and unpaid student debt also rose to the highest ever.”

February 18 – Reuters (Ishita Chigilli Palli): “U.S. discount retailer Payless ShoeSource Inc on Monday filed for voluntary Chapter 11 bankruptcy protection for the second time, along with its North American subsidiaries, and said it would wind down all North American stores by the end of May. The retailer will close about 2,500 stores in North America starting from the end of March and wind down its e-commerce operations.”

China Watch:

February 18 – Associated Press (Joe McDonald): “China’s government… accused the United States of trying to block its industrial development after Vice President Mike Pence said Chinese equipment poses a threat to countries that are rolling out next-generation mobile communications… The U.S. government is trying to ‘fabricate an excuse for suppressing the legitimate development’ of Chinese enterprises, said a foreign ministry spokesman, Geng Shuang. He accused the United States of using ‘political means’ to interfere in economic activity, ‘which is hypocritical, immoral and unfair bullying.’”

February 20 – Reuters (Ben Blanchard): “The United States should respect China’s right to develop and become prosperous, the Chinese government’s top diplomat told a visiting U.S. delegation, reiterating that the country’s doors to the outside world would open wider… ‘Just like the United States, China also has the right to development, and the Chinese people also have the right to have a good life,’ the foreign ministry paraphrased Wang as saying…”¬¬

February 21 – Financial Times (Gabriel Wildau): “A rare public spat has erupted between Chinese premier Li Keqiang and the central bank after he expressed concern about record credit expansion in January, a result of monetary stimulus intended to support flagging economic growth. Since assuming the premiership in 2013 alongside President Xi Jinping, Mr Li has been a consistent critic of the large-scale stimulus that their predecessors launched in response to the 2008 financial crisis, which economists said led to wasteful investment and a dangerous increase in debt. Analysts said Mr Li’s latest comments reflected concern his credibility would suffer if the government was seen as backsliding on its commitment to avoid heavy-handed stimulus.”

February 20 – Reuters (Kevin Yao, Lee Chyenyee and Twinnie Siu): “China has not and will not change its prudent monetary policy and will not resort to ‘flood-like’ stimulus, Premier Li Keqiang said… Market speculation is growing over whether authorities will take more aggressive policy steps after recent weak data. ‘I reiterate that the prudent monetary policy has not changed and will not change. We are determined not to engage in ‘flood-like’ stimulus,’ Li said at a cabinet meeting…”

February 20 – Reuters (Kevin Yao): “China’s central bank is not yet ready to cut benchmark interest rates to spur the slowing economy, despite cooling inflation and a stronger yuan, which have fanned market expectations of such a move, policy sources told Reuters. But the People’s Bank of China (PBOC) is likely to cut market-based rates and further lower banks’ reserve ratios (RRR) to boost credit growth and reduce firms’ borrowing costs… ‘We cannot rule out a (benchmark) rate cut, but we still need to watch economic data for a few months,’ one said. ‘There is no sufficient reason for cutting benchmark rates if we look at the huge amount of new loans in January.’”

February 19 – Financial Times (Gabriel Wildau and Yizhen Jia): “Pity the Chinese state-owned bank trying to obey ever-changing instructions from policymakers in Beijing. For years, banks preferred to lend to giant state-owned enterprises — both because of the implicit government guarantee that such debt has traditionally carried, and because SOEs were seen as national champions that deserved support. But now the script is shifting as China’s economy slows. Many foreign investors are focused on the impact of the trade dispute with the US, but the effect of a domestic crackdown on shadow banking — which has closed off access to credit for privately owned companies that relied on non-bank channels — is probably more important. Private companies generate 60% of China’s economic growth and 90% of new jobs, according to an industry association… That is why China’s cabinet last week issued guidelines urging banks, among other intermediaries, to step in to the void to increase support for private companies.”

February 18 – Associated Press (Joe McDonald): “China’s auto sales fell for an eighth month in January, extending a painful decline for the biggest global market as demand cooled amid a slowing economy and tariffs standoff with the U.S. Purchases of sedans, SUVs and minivans fell 15% from a year earlier to just over 2 million vehicles, according… the China Association of Automobile Manufacturers. Cooling growth and trade tensions with Washington are prompting jittery buyers to put off purchases.”

February 18 – Financial Times (Don Weinland): “Police in China have stepped up a crackdown on peer-to-peer lenders, freezing Rmb10bn ($1.5bn) across 380 companies and dispatching teams across Asia in pursuit of financial fugitives. The operation, called ‘Fox Hunt’ …detained 62 people in 16 countries including Cambodia and Thailand. So-called P2P lending — a $120bn business that connects private lenders with borrowers online — was once a thriving industry in China, with little government oversight over thousands of companies that rapidly opened shop. Business leaders often touted the market as one that regulators had left largely untouched, in order to promote innovation.”

February 18 – Financial Times (Don Weinland): “Property developers have found a new play on the Chinese market: buying up the soured debts of their rivals. The property market is a linchpin of China’s economy. A slowdown in sales and falling prices in some large cities have sparked concerns of a deeper downturn if economic growth continues to stutter. Demand for homes, despite recent monetary policy easing, has been muted… China’s economic slowdown has also resulted in record sales of bad debt, with Rmb1.75tn ($259bn) in non-performing loans sold off to distressed asset investors last year… Within that mountain of debt, loans backed by property have become a hot commodity on the market for bad assets, often fetching prices far higher than loans that have other assets as collateral. Property developers are among the most indebted companies in China, with Rmb385bn in bonds set to mature in 2019.”

February 19 – Financial Times (David Bond): “Chinese hackers have increased attacks on global telecoms companies in the past year, suggesting an escalation in Beijing’s cyber espionage operations as the US pushes allies to block Huawei from future 5G networks. According to… CrowdStrike, the… cyber security company that first attributed the 2016 hack on the US Democratic National Committee to Russia, 2018 saw an overall increase in Chinese cyber attacks, especially against US targets. The company said the increase was explained by growing tensions over trade between Washington and Beijing but added that the specific targeting of telecoms companies worldwide pointed to a wider surge in spying by Chinese state-backed cyber warriors.”

February 18 – Bloomberg: “At least 11 Chinese cities have eased restrictions on residency-permits this year, potentially giving their ailing property markets a boost. The moves are seen as part of a ‘stealth easing’ of property curbs that have helped keep a lid on housing prices. New-home prices rose at the slowest pace in eight months in December, the most recent data show. While combating property speculation is one of President Xi Jinping’s signature policies, a deepening economic slowdown is prompting some city governments to loosen the screws.”

February 16 – Reuters (Eric Lam): “The trade war between the U.S. and China and slowing retail sales dragged Hong Kong’s economic growth down at the end of last year, with exports showing almost ‘zero growth.’ Gross domestic product in the fourth quarter was ‘less than 1.5%,’ according to… Financial Secretary Paul Chan. The ‘significant slowdown’ was well below the 2.9% seen in the previous three months.”

Central Bank Watch:

February 19 – Wall Street Journal (Joseph Wallace and Pat Minczeski): “Market participants are growing confident that the European Central Bank will soon try to boost the eurozone’s ailing economy by rebooting its program of ultracheap long-term loans to the banking system. The ECB’s Governing Council meets early next month against a backdrop of slowing growth across the region. The downturn comes at a time when the central bank has already used some of its firepower to boost the economy, having ended its €2.6 trillion ($2.9 trillion) bond-buying program in December—although it is still reinvesting the proceeds from maturing assets. Its key interest rate stands at minus 0.4%, where it is expected to stay into 2020. The most feasible action the ECB could take would be to pump cheap credit into commercial banks at unusually long maturities.”

February 21 – Bloomberg (Piotr Skolimowski): “European Central Bank officials are setting up their meeting in two weeks as a key session to decide if the euro-area slowdown is bad enough to warrant action. Policy makers have demanded that analysis on long-term loans for banks is done quickly, though they haven’t fully committed to implementing a new round of funding. Given that more than 700 billion euros ($795bn) of existing loans will mature next year, they said they’ll give ‘some consideration’ to the issue.”

February 18 – Bloomberg (Henry Hoenig): “In a rare explicit coupling of policy and the yen, Governor Haruhiko Kuroda said the Bank of Japan would have to consider additional stimulus if the exchange rate affected Japan’s inflation and economy. He was responding to a lawmaker’s question about the BOJ’s options if the yen rose further… Speaking to parliament…, Kuroda said the BOJ’s options included lowering bond yields and increasing asset purchases.”

Brexit Watch:

February 20 – Reuters (Richard Leong): “Fitch Ratings said… it may downgrade the United Kingdom’s ‘AA’ debt rating based on growing uncertainty about the negotiations between Britain and the European Union over the nation’s departure from the economic bloc next month.”

EM Watch:

February 19 – Bloomberg (Asli Kandemir): “Turkey’s government is making cheap credit a key part of its campaign, pushing banks to take on greater risks in an economy that’s already teetering on the brink of recession. President Recep Tayyip Erdogan’s administration is urging state-owned lenders to extend cheap loans to industries spanning agriculture to soccer clubs and help consumers pay off their credit cards or get below-market interest rates on mortgages. The government hopes this will force other banks to come to the party after they pulled back on extending credit to deal with billions of dollars in debt-restructuring requests and a growing pile of bad loans.”

February 18 – Bloomberg (Ugur Yilmaz and Cagan Koc): “Turkey cut the amount of cash lenders are required to hold in reserves for the first time in six months as the central bank tries to rouse credit growth without signaling a more drastic change in its tight policy stance. With its crisis-level monetary settings on hold for three consecutive meetings, the central bank announced over the weekend that it’s lowering reserve-ratio requirements.”

February 20 – Financial Times (Joseph Cotterill): “South Africa has unveiled the largest bailout in the country’s history for Eskom, the struggling state power monopoly, whose financial troubles have pushed it to the brink of collapse and caused rolling national blackouts. The government will inject R69bn ($4.8bn) over three years to stabilise Eskom’s $30bn debt as it attempts a turnround, …South Africa’s finance minister, said… The risk of a collapse at Eskom is a serious threat to South Africa’s already stretched public finances as its debt is mostly state-guaranteed. Without a plan to control Eskom’s rising costs, a bailout could also imperil the country’s last remaining investment-grade credit rating, with Moody’s.”

February 20 – Bloomberg (Michael Cohen and Gordon Bell): “The sorry state of South Africa’s state power utility starkly illustrates just how far the country slipped during former President Jacob Zuma’s scandal-marred rule and the enormity of the task of rebuilding the nation’s stricken finances. From the heady days of the 2000s, when growth topped 5% a year, the economy has struggled through two recessions, and debt ratios have tripled. There have been almost daily revelations of state corruption, the nation's final investment-grade rating is hanging by a thread and budget surpluses have turned to ever-widening shortfalls.”

February 19 – Bloomberg (Subhadip Sircar): “India is struggling to sell its bonds at recent auctions, and that’s even before Prime Minister Narendra Modi embarks upon a record borrowing program. Underwriters rescued a longer-tenor bond sale on Friday following poor buying support that’s seen the bid-to-cover ratio -- a gauge of demand -- drift lower in the last two auctions from levels seen in January. Concerns about an over-supply of longer maturity bonds have increased after the government on Feb. 1 said it plans to borrow almost $100 billion for the year starting April 1”

Global Bubble Watch:

February 17 – New York Times (Steven Erlanger and Katrin Bennhold): “European leaders have long been alarmed that President Trump’s words and Twitter messages could undo a trans-Atlantic alliance that had grown stronger over seven decades. They had clung to the hope that those ties would bear up under the strain. But in the last few days of a prestigious annual security conference in Munich, the rift between Europe and the Trump administration became open, angry and concrete, diplomats and analysts say. A senior German official… shrugged his shoulders and said: ‘No one any longer believes that Trump cares about the views or interests of the allies. It’s broken.’”

February 16 – Bloomberg (Marc Champion): “If China and the U.S. are in the midst of a divorce, Europeans look increasingly like the children. That was the impression given by a series of back-to-back appearances on Saturday, from U.S. Vice President Mike Pence, Chinese politburo member Yang Jiechi, Russian Foreign Minister Sergei Lavrov and German Chancellor Angela Merkel. The speeches put growing great power rivalries on display, but with Europe more the object of a custody battle than a participant. Speaking at the annual Munich Security Conference, Yang looked like he was trying to drive a wedge between the U.S. and its European Union allies… He spent much of his speech extolling the virtues of cooperation, international organizations and free trade, popular in Europe, and attacked the dangers of ‘protectionism,’ as well as ‘hegemony and power politics.’ The U.S. wasn’t named, but the target was clear.”

February 19 – Reuters (Tom Miles): “A quarterly leading indicator of world merchandise trade slumped to its lowest reading in nine years…, which should put policymakers on guard for a sharper slowdown if trade tensions continue, the World Trade Organization said… The WTO’s quarterly outlook indicator, a composite of seven drivers of trade, showed a reading of 96.3, the weakest since March 2010 and down from 98.6 in November. A reading below 100 signals below-trend growth in trade.”

February 18 – Bloomberg (Denise Wee): “Asia’s dollar bond markets have staged a blistering rally this year, but for a group of borrowers that sit on the cusp of a junk rating, there’s no relief in sight. As worsening global macro-economic conditions put firms under pressure, concerns over so-called fallen angels, or investment-grade companies that are cut to junk, are mounting in Asia and globally. Man Group Plc, the world’s largest publicly traded hedge fund manager, warned investors in December of the ‘astonishing bubble’ in BBB level debt.”

February 18 – Bloomberg (Daniel Moss): “A new bestseller might be in the offing. If the public could get its hands on it, that is. The Reserve Bank of Australia's board spent a chunk of its interest-rate meeting this month digesting a paper on the housing slump and what it foretells for that famous 27-year growth streak. Consideration of the paper, revealed in minutes of the RBA's Feb. 5 conclave…, may explain a lot… But few things are of as much interest for the local economy or dominate public airwaves like the housing industry. It's a national obsession…. Prices are down from their 2017 peaks in Sydney and Melbourne by 12% and 9%... In the minutes, the RBA called drops in Perth and Darwin ‘significant.’ The word ‘housing’ appears in the minutes more than 30 times, about three times as many as the word ‘China’…”

February 20 – Bloomberg (Jason Scott): “A generation of young Australians priced out of the property market and frustrated at a widening wealth divide could prove pivotal in triggering a change of government in May. The main opposition Labor party has made tackling the growing gap between so-called baby boomers and millennials a key plank of its campaign to win office for the first time since 2013. The center-left party, which is leading Prime Minister Scott Morrison’s government in opinion polls, is pledging to curb tax breaks for property investors that helped drive home prices beyond the reach of many Australians.”

February 20 – Wall Street Journal (Jenny Strasburg and Gretchen Morgenson): “Deutsche Bank AG racked up a loss of $1.6 billion over nearly a decade on a complex municipal-bond investment that it bought in the runup to the 2008 financial crisis, and failed to confront head-on even as markets were upended and regulations tightened. The loss… represents one of Deutsche Bank’s largest ever from a single wager—roughly quadruple its entire 2018 profit—and ranks as one of the banking industry’s biggest soured bets in the last decade.”

Europe Watch:

February 19 – Reuters (Sara Rossi and Emilio Parodi): “Italy’s tax police have carried out a seizure order for more than 700 million euros ($794 million) as part of a probe targeting the country’s top four banks over alleged fraudulent diamond sales, two sources close to the matter said…”

Japan Watch:

February 20 – Reuters (Balazs Koranyi and Tom Sims): “Japan’s exports posted their biggest decline in more than two years as China-bound shipments tumbled, fuelling concerns about slowing global demand as the business mood sours and orders for the country’s machinery goods fell sharply. …Japan’s exports fell 8.4% year-on-year in January, a bigger decline than the 5.5% fall expected… It was the sharpest annual decline since October 2016…”

February 17 – Reuters (Stanley White): “Overseas orders for Japanese machinery posted their biggest tumble in more than a decade in December, as trade frictions dented global supply chain demand and manufacturers predicted further declines in orders this quarter. …Core machinery orders, considered a leading indicator of capital expenditure, fell 0.1% month-on-month in December… Highlighting bigger concerns about the external environment, however, was a 21.9% month-on-month slump in orders from overseas, the biggest fall since November 2007.”

February 17 – Reuters (Leika Kihara): “Japan must ramp up fiscal spending with debt bank-rolled by the central bank, the Bank of Japan’s former deputy governor Kikuo Iwata said, a controversial proposal that highlights the BOJ’s challenge as it tries to reignite an economy after years of sub-par growth. Iwata, an architect of the BOJ’s massive bond-buying programme dubbed ‘quantitative and qualitative easing’ (QQE), warned that inflation will miss the central bank’s 2% target without stronger measures to boost consumption.”

Fixed-Income Bubble Watch:

February 17 – Financial Times (Joe Rennison): “Companies across America are turning to the secured bond market for funding, as the Federal Reserve’s decision to hit the pause button on further interest rate rises has reduced the appeal of previously red-hot loans. Already indebted or lowly rated companies were heavy users of the loan market for much of last year, as investors flocked to financial products whose returns rose in tandem with rising interest rates. However, the prospect that US rate increases have peaked weakens the allure of loans… Instead, investors are putting more money into corporate bonds, which typically offer fixed returns that are more attractive in a world in which rates are likely to flatline — or even fall — over the next year.”

February 18 – Wall Street Journal (Telis Demos and Sam Goldfarb): “Corporate borrowers were in a tough spot for a few weeks in January. Things had been looking up after the December market swoon, but there were problems in a part of the market that serves junk-rated companies. Then Japan’s farms and fisheries came to the rescue. Norinchukin Bank, a 95-year-old bank that holds around $600 billion in deposits from Japan’s agricultural and fishing collectives, has amassed a significant share of the estimated $700 billion global market for collateralized loan obligations, or CLOs—complex investment vehicles that buy more than half of U.S. loans to junk-rated companies. The privately held bank’s $62 billion CLO portfolio is larger than those of either of the two biggest U.S. bank buyers, Wells Fargo & Co. and JPMorgan… The CLO market has roughly doubled in size since 2014, helping to fuel the growth of corporate debt to historic levels.”

Geopolitical Watch:

February 21 – Reuters (Andrew Osborn): “President Vladimir Putin has said that Russia is militarily ready for a Cuban Missile-style crisis if the United States wanted one, and that his country currently has the edge when it comes to a first nuclear strike. The Cuban Missile Crisis erupted in 1962 when Moscow responded to a U.S. missile deployment in Turkey by sending ballistic missiles to Cuba, sparking a standoff that brought the world to the brink of nuclear war. More than five decades on, tensions are rising again over Russian fears that the United States might deploy intermediate-range nuclear missiles in Europe, as a landmark Cold War-era arms-control treaty unravels.”

February 20 – Wall Street Journal (Ann M. Simmons): “President Vladimir Putin warned Russia would aim new advanced weapons against the U.S. should it deploy intermediate-range missiles in Europe, raising the stakes after the breakdown of a Cold War-era nuclear treaty. Mr. Putin said Russia wasn’t seeking confrontation with the U.S. and wouldn’t make the first move to deploy the missiles. But if Washington has such plans once it abandons the 1987 Intermediate-range Nuclear Forces Treaty, this ‘will be a serious threat to us’ and Russia will be ‘forced to provide for mirror and symmetrical actions,’ he said. Although Mr. Putin indicated that he remained open to nuclear arms control talks if the U.S. were to initiate them, his rhetoric and revelation of imminent plans to launch Russia’s first unmanned nuclear submarine signaled there was no turning back on abandoning the agreement and heightened the risk of a new arms race.”

February 19 – Wall Street Journal (Bojan Pancevski and Sara Germano): “The German government is leaning toward letting Huawei Technologies Co. participate in building the nation’s high-speed internet infrastructure, several German officials said, the latest sign of ambivalence among U.S. allies over Washington’s push to ostracize the Chinese tech giant as a national security risk. A small group of ministries reached a preliminary agreement two weeks ago that still needs formal approval by the full cabinet and parliament, officials said.”

February 19 – Reuters (Yimou Lee): “Taiwan will not accept any deal that destroys its sovereignty and democracy, President Tsai Ing-wen said… after the island’s opposition KMT party said it could sign a peace deal with China if it wins a presidential election next year. China claims self-ruled and proudly democratic Taiwan as its own and has vowed to bring the island, which it regards as sacred territory, under Beijing’s control, by force if necessary.”

February 15 – Reuters: “Iran warned neighboring Pakistan… it would ‘pay a heavy price’ for allegedly harboring militants who killed 27 of its elite Revolutionary Guards in a suicide bombing near the border earlier this week… Revolutionary Guards chief Major General Mohammad Ali Jafari also accused Tehran’s regional rival Saudi Arabia and the United Arab Emirates of supporting militant Sunni groups that attack Iranian forces, saying they could face ‘reprisal operations.’”