Saturday, March 23, 2019

Weekly Commentary: Doing Harm with Uber-Dovish

This week’s FOMC meeting will be debated for years – perhaps even decades. The Fed essentially pre-committed to no rate hike in 2019. The committee downgraded both its growth and inflation forecasts. Having all at once turned of little consequence, we can now dismiss the 3.8% unemployment rate and the strongest wage growth in a decade. Moreover, the Fed announced it would be scaling back and then winding down balance sheet “normalization” by September. This put an impressive exclamation mark on a historic policy shift since the December 19th meeting. At least for me, it hearkened back to a Rick Santelli moment: “What’s the Fed afraid of?”

Markets came into the meeting fully anticipating a dovish Fed. Our central bank returned to the old playbook of beating expectations. In the process, the Federal Reserve doused an already flaming fixed-income marketplace with additional fuel.

After trading to 3.34% during November 8th trading, ten-year Treasury yields ended this week a full 90 bps lower at 2.44%, trading Friday at the lowest yields since December 2017. Yields were down 15 bps this week – 17 bps from Tuesday’s (pre-Fed day) close - and 28 bps so far in March. And with three-month T-bill rates at 2.40%, the three-month/10-year Treasury curve flattened to the narrowest spread since 2007 (briefly inverting Friday). Five-year Treasury yields ended the week inverted 16 bps to three-month T-bills – and two-year Treasuries were inverted about eight bps.

Collapsing sovereign yields were a global phenomenon. Japan’s 10-year JGB yields declined four bps Friday to negative eight bps (-0.08%), the lowest yields since September 2016. With Germany’s Markit Manufacturing index sinking to the lowest level since 2012 (44.7), bund yields dropped seven bps to negative 0.015% - also lows going back to September 2016. Swiss 10-year yields sank 12 bps this week to negative 0.45%. Two-year German yields closed out the week at negative 0.57%. UK 10-year yields dropped 20 bps (1.01%), Spain 12 bps (1.07%) and France 11 bps (0.35%).

The destabilizing impact of the Fed’s shift back to an Uber-Dovish posture was more conspicuous by week’s end. The S&P500 dropped 1.9% in Friday trading, with financial stocks coming under heavy pressure. In three sessions, the KBW Bank Index was slammed 8.2% and the Broker/Dealers (NYSE Arca) lost 5.6%.

It wasn’t only the banks’ shares under pressure. Bank Credit default swap (CDS) prices reversed sharply higher this week, with European bank debt in the spotlight. Deutsche Bank 5yr CDS surged 24 bps this week to 168 bps, the largest weekly gain since late-November. UniCredit CDS jumped 22 bps (150bps), Intesa Sanpaulo 21 bps (159bps) and Credit Suisse 16 bps (84bps). An index of European subordinated bank debt surged 31 bps this week (to 177bps), the largest weekly gain since October 2014. Pressure on European bank CDS spilled over into European corporates. After trading to one-year lows in Tuesday's session, a popular European high-yield CDS (iTraxx Crossover) reversed 22 bps higher in three sessions (to 281bps) – posting its worst week since mid-December.

Friday trading saw European CDS instability jump the Atlantic. Late-week losses saw most major U.S. bank CDS rise modestly for the week. After closing Tuesday near one-year lows, U.S. investment-grade corporate CDS jumped 10 bps in three sessions to end the week about 10 bps higher. This index suffered its largest weekly gain (higher protection costs) since the week of December 21 (reducing y-t-d decline to 20bps). The week saw junk bonds notably underperform. Sinking financial stocks, widening spreads and rising CDS prices fed into equities volatility. After ending last week at the lows (12.88) since early-October, the VIX popped to 16.48 (also the largest weekly gain since the week of December 21).

It’s now commonly accepted that the Federal Reserve erred in raising rates 25 bps in December. I hold the view that Chairman Powell had hoped to lower the “Fed put” strike price. The Fed was willing to disregard some market instability, hoping to begin the process of the markets standing on their own. The Fed just didn’t appreciate the degree of latent market fragility that had been accumulating over the years. I don’t fault them for trying.

In the name of promoting financial stability after a decade of extraordinary stimulus measures, it was prudent for the Fed to adhere to a course of gradual rate normalization even in the face of some market weakness. GDP expanded at a 3.4% rate in Q3 and slowed somewhat to 2.6% during Q4. After a decade-long expansion, periods of economic moderation should be expected (and welcomed).

Some analysts see this week’s dovish posture as part of a FOMC effort to rectify its December misdeeds. Markets now see about a 60% probability of a 2019 rate cut – with zero likelihood of a hike through January 2020. The Fed’s dot plot - still with one additional rate increase in 2020 – has lost all market credibility.

March 22 – Bloomberg (Matthew Boesler and Jeanna Smialek): “Federal Reserve policy makers have concluded that when in doubt, do no harm. Welcome to the new abnormal. Six months ago, U.S. central bankers thought they’d soon be returning to the days of on-target inflation, full employment and interest rates that, while lower than in decades past, would still need to rise into growth-restricting territory to keep things on track. But in a watershed moment, the Federal Reserve surprised investors… by slashing rate projections to show no hike this year. Officials signaled expectations for a slowdown in the economy… and they no longer expect inflation to rise above their 2% target. The move was a serious about-face. Since September 2017, they had signaled they would probably need to eventually raise rates above their estimate of the so-called neutral level for the economy… to slow the expansion and protect against the possibility of higher inflation. That was based on a longstanding view in the economics profession about how the economy works: If central bankers allow the unemployment rate to fall too far below its lowest sustainable level by keeping rates too low, then inflation will rise.”

There’s been a bevy of interesting analysis the past few days. The “New Abnormal” from the above Bloomberg article headline caught my attention. Responding to “New Normal” (Pimco) pontification, I titled an October 2009 CBB “The Newest Abnormal.” My argument almost a decade ago was that “activist” central banks were just doing what they had done repeatedly – only more aggressively: responding to bursting Bubbles with reflationary policymaking that would ensure the inflation of only bigger and more precarious Bubbles.

I didn’t back then believe it possible for central banks to orchestrate a successful inflation. I have great conviction in this analysis today. The popular notion of inflating out of debt problems is way too simplistic. Just inflate the general price level and reduce real debt burdens, as the thinking goes. The problem is that debt levels have expanded greatly, right along with securities and asset prices – and speculative excess. Aggregate measures of consumer prices, meanwhile, were left in the dust. The Great Credit Bubble has ballooned uncontrollably; asset price Bubbles have significantly worsened; and speculative Bubbles have become only more deeply embedded throughout global finance.

Bond markets were anything but oblivious to Bubble Dynamics back in 2007 - and have become only more keenly fixated here in 2019. I strongly argue that dysfunctional global markets are in a more precarious position today than in 2007, a view anything but diminished by this week’s developments. Wednesday’s statement and Powell press conference were viewed as confirming that the Fed is preparing to reinstitute aggressive policy stimulus.

With acute fragilities revealed in December, the Fed and global central bankers are on edge and scrambling. Markets see the Fed’s aggressive dovish push suggesting that the Fed – after December’s missteps – is now poised to err on the side of being early and aggressive with stimulus measures. In safe haven bond land, the Fed has evoked vivid images of monetary “shock and awe.”

Analysts are focusing on sovereign yields and an inverted Treasury curve as foreshadowing recession. I would counter with the view that bond markets appreciate global Bubble fragilities and are now pricing in the inevitability of rate cuts and new QE programs. Yield curves (at home and abroad) are more about market dynamics and prospective monetary policy than the real economy. As such, the strong correlations between safe haven and risk assets are no confounding mystery. Safe haven assets these days have no fear of “risk on.” After all, surging global risk markets only exacerbate systemic risk, ensuring more problematic Bubbles, central bankers operating with hair triggers, and the near certainty of aggressive future monetary stimulus.

Friday’s market instability had market participants searching for an explanation. Is there a significant development moving markets? Negative news coming from the China/U.S. trade front?

There could be something out there spooking the markets. Or perhaps the big story of the week was that Fed Uber-Dovishness pushed global bond markets and fixed-income derivatives toward dislocation. From the above Bloomberg article: “Federal Reserve policy makers have concluded that when in doubt, do no harm.” Maybe the Fed, trying too hard to compensate for December, is Doing Harm to market stability.

DoubleLine Capital’s Jeffrey Gundlach (from Reuters): “This U-Turn - on nothing fundamentally changing - is unprecedented. Three months ago, we were on ‘autopilot’ with the balance sheet - and now the bond market is priced for a rate cut this year. The reversal in their stance is stunning.”

Perhaps the disorderly drop in safe haven yields has led to a problematic widening of Credit spreads. The easy returns being made long higher-yielding Credit instruments versus a short in Treasuries have come to an abrupt conclusion. Could serious problems be unfolding in the derivatives markets, along with major losses for levered players caught on the wrong side of illiquid and rapidly moving markets. Is the Fed’s stunning “U-turn” market destabilizing – with great irony, fomenting “risk off” deleveraging?

What is the Federal Reserve’s reaction function? What factors will be driving policy decisions going forward? The Fed set rates at about zero (0 to 25bps) in January 2009 and left them unchanged for six years. The Fed then raised rates 25 bps in December 2015, 25 bps in December 2016 – and then cautiously increased rates six more times spaced over the next three years. The Fed’s balance sheet was roughly stable from Q4 2014 through Q4 2017 and has since been in gradual/predictable runoff for the past five quarters. For years now, Fed policy has been usually certain. Rate and balance sheet “normalization” were to proceed at an extraordinarily measured pace. No surprises. Bypassing a tightening of financial conditions, the “autopilot” Fed was conducive to aggressive market positioning/speculation (and leveraging).

An unusual era of monetary policy stability/predictability formally ended Wednesday. Balance sheet “normalization” is being brought to an early conclusion. Markets now assume the next rate move is lower. And with the Fed apparently turning its focus to persistently undershooting consumer price inflation, it is reasonable to assume it’s only a matter of time until the Fed resorts once again to QE. But when and at what quantity?

Especially as three years of rate “normalization” ends with Fed funds at only 2.25% to 2.50%, markets well-recognize there’s meager stimulus potential available in rate policy. Will the Fed even bother with rate cuts – or be compelled to move directly to QE? Suddenly, the future of monetary policy appears awfully murky.

Come the next serious stimulus push, it will be the Fed’s balance sheet called upon to do the heavy lifting. And, for those pondering a likely catalyst, I’d say look no further than a global market accident – omen December. As such, it now matters greatly that QE has evolved from an extreme policy response necessary to counter the “worst crisis since the Great Depression” - to a prominent tool in the Fed’s (and global central banking) toolkit readily available to counter risks of economic weakness and stock market instability.

Throw in the concept of late-cycle “Terminal Excess” – appreciating that policymakers, from Beijing to Tokyo to Frankfurt, London, Canberra, Toronto, Washington and beyond, are prolonging a most precarious cycle – and one can build a solid case for big trouble and big QE brewing. With this in mind, it’s not difficult to get quite concerned for the stability of global bond markets, along with securities, derivatives and asset markets more generally. And with markets unsettled, it probably didn't help to have the largest ever monthly federal deficit ($234bn), with the y-t-d deficit after five months ($544bn) running 40% ahead of fiscal 2018 - or that President Trump announced the nomination of Stephen Moore to the Federal Reserve.


For the Week:

In a wild week, the S&P500 declined 0.8% (up 11.7% y-t-d), and the Dow fell 1.3% (up 9.3%). The Utilities added 0.4% (up 11.1%). The Banks sank 8.3% (up 7.0%), and the Broker/Dealers fell 5.3% (up 4.9%). The Transports dropped 2.5% (up 9.6%). The S&P 400 Midcaps lost 2.2% (up 11.5%), and the small cap Russell 2000 dropped 3.1% (up 11.7%). The Nasdaq100 increased 0.3% (up 15.7%). The Semiconductors gained 0.6% (up 21.2%). The Biotechs sank 3.8% (up 17.3%). While bullion gained $11, the HUI gold index fell 1.9% (up 7.8%).

Three-month Treasury bill rates ended the week at 2.40%. Two-year government yields dropped 12 bps to 2.32% (down 17bps y-t-d). Five-year T-note yields fell 15 bps to 2.24% (down 27bps). Ten-year Treasury yields dropped 15 bps to 2.44% (down 24bps). Long bond yields fell 14 bps to 2.87% (down 14bps). Benchmark Fannie Mae MBS yields sank 22 bps to 3.10% (down 40bps).

March 21 – Financial Times (Joe Rennison): “The primary measure of the US yield curve watched by the Federal Reserve has fallen to its lowest level since 2007, after a policy shift by the central bank has raised fears over the outlook for the US economy. Benchmark 10-year Treasury yields sank to 2.52% on Thursday and short-dated, three-month yields marched higher to 2.47%. It means the difference between the two interest rates now stands at just 5 bps, sinking below the previous low of 15 bps hit in January to notch its lowest level since 2007.”

Greek 10-year yields slipped three bps to 3.75% (down 60bps y-t-d). Ten-year Portuguese yields declined five bps to 1.26% (down 45bps). Italian 10-year yields fell five bps to 2.45% (down 29bps). Spain's 10-year yields dropped 12 bps to 1.07% (down 34bps). German bund yields sank 10 bps to negative 0.015% (down 25bps). French yields dropped 11 bps to 0.35% (down 36bps). The French to German 10-year bond spread narrowed one to about 37 bps. U.K. 10-year gilt yields sank 20 bps to 1.01% (down 26bps). U.K.'s FTSE equities index slipped 0.3% (up 7.1% y-t-d).

Japan's Nikkei 225 equities index added 0.8% (up 8.1% y-t-d). Japanese 10-year "JGB" yields dropped four bps to negative 0.07% (down 7bps y-t-d). France's CAC40 dropped 2.5% (up 11.4%). The German DAX equities index fell 2.8% (up 7.6%). Spain's IBEX 35 equities index declined 1.5% (up 7.7%). Italy's FTSE MIB index added 0.2% (up 15.0%). EM equities were mixed. Brazil's Bovespa index sank 5.4% (up 6.7%), while Mexico's Bolsa added 0.2% (up 1.6%). South Korea's Kospi index increased 0.5% (up 7.1%). India's Sensex equities index gained 0.4% (up 5.8%). China's volatile Shanghai Exchange jumped 2.7% (up 24.5%). Turkey's Borsa Istanbul National 100 index sank 3.4% (up 9.4%). Russia's MICEX equities index increased 0.6% (up 5.7%).

Investment-grade bond funds saw inflows of $5.135 billion, and junk bond funds posted inflows of $1.796 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined three bps to a 13-month low 4.28% (down 17bps y-o-y). Fifteen-year rates fell five bps to 3.71% (down 20bps). Five-year hybrid ARM rates were unchanged at 3.84% (up 16bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to a one-year low 4.28% (down 32bps).

Federal Reserve Credit last week declined $3.5bn to $3.928 TN. Over the past year, Fed Credit contracted $433bn, or 9.9%. Fed Credit inflated $1.117 TN, or 40%, over the past 332 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $7.2bn last week to $3.479 TN. "Custody holdings" gained $39.3bn y-o-y, or 1.1%.

M2 (narrow) "money" supply rose $9.1bn last week to $14.500 TN. "Narrow money" gained $578bn, or 4.1%, over the past year. For the week, Currency slipped $0.5bn. Total Checkable Deposits dropped $37.5bn, while Savings Deposits jumped $37.5bn. Small Time Deposits added $2.1bn. Retail Money Funds rose $9.1bn.

Total money market fund assets sank $47.2bn to $3.065 TN. Money Funds rose $240bn y-o-y, or 8.5%.

Total Commercial Paper surged $20.9bn to $1.083 TN. CP expanded $17.3bn y-o-y, or 1.6%.

Currency Watch:

March 18 – Financial Times (Siddarth Shrikanth): “Hong Kong has spent nearly $1bn so far in March defending the local currency’s peg to the US dollar, which has come under pressure after a rise in US interest rates in 2018 and amid an increase in money flows into China’s stock market. The Hong Kong Monetary Authority (HKMA) intervened… on Monday, selling $256m and buying HK$2.01bn, the third time this month that the de facto central bank has stepped in to support the Hong Kong dollar. This leaves its aggregate balance, which represents the level of interbank liquidity, at HK$68.9bn.”

March 19 – Financial Times (Peter Wells): “If you thought the equity market looked calm at the moment, it can’t hold a candle to foreign exchange, where levels of volatility are hovering around their lowest levels since 2014. Diminished expectations for US interest rate rises this year have helped drive measures of equity market volatility lower in recent months, subsequently propping up stocks, and also pushed down currency market volatility. That trend has been further reinforced thanks to the European Central Bank, which is set to keep interest rates lower for longer in a bid to rev up economic growth in the bloc…”

The U.S. dollar index was little changed at 96.651 (up 0.5% y-t-d). For the week on the upside, the Japanese yen increased 1.4%, the Swiss franc 0.9%, the South Korean won 0.6%, the Mexican peso 0.6%, the New Zealand dollar 0.5% and the Singapore dollar 0.1%. For the week on the downside, the Brazilian real declined 2.4%, the Canadian dollar 0.7%, the South African rand 0.7%, the British pound 0.6%, the Swedish krona 0.5%, the Norwegian krone 0.3% and the euro 0.2%. The Offshore Chinese renminbi slipped 0.07% versus the dollar this week (up 2.39% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index added 0.4% (up 16% y-t-d). Spot Gold gained 0.9% to $1,314 (up 2.4%). Silver recovered 0.5% to $15.407 (down 0.9%). Crude added 52 cents to $59.04 (up 30%). Gasoline jumped 3.7% (up 48%), while Natural Gas fell 1.5% (down 6%). Copper dropped 2.2% (up 8%). Wheat increased 0.8% (down 7%). Corn gained 1.3% (up 1%).

Trump Administration Watch:

March 19 – Bloomberg (Jenny Leonard, Saleha Mohsin and Jennifer Jacobs): “Some U.S. negotiators are concerned that China is pushing back against American demands in trade talks, according to people familiar with the negotiations… Chinese officials have shifted their stance because after agreeing to changes to their intellectual-property policies, they haven’t received assurances from the Trump administration that tariffs imposed on their exports would be lifted… Beijing has also stepped back from its initial promises over data protection of pharmaceuticals, didn’t offer details on plans to improve patent linkages, and refused to give ground on data-service issues, one person familiar with the U.S.’s views said. Beijing is trying to bring in wording that would ensure rules in the trade agreement have to comply with Chinese laws, the person added.”

March 19 – Wall Street Journal (Bob Davis): “Negotiators for the U.S. and China have scheduled a new round of high-level trade talks in Beijing and Washington, aiming to close a deal by late April to end the yearlong dispute between the world’s two largest economies. U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin plan to fly to Beijing next week to meet with Chinese Vice Premier Liu He… The following week, a Chinese delegation led by Mr. Liu is expected to continue talks in Washington… People tracking the negotiations said the talks appear to be in their final stages, following a rocky patch after Chinese leaders were unnerved by President Trump’s decision to abruptly break off nuclear-disarmament talks with North Korean leader Kim Jong Un in February.”

March 20 – Bloomberg (Jennifer Jacobs and Andrew Mayeda): “President …Trump said he’ll keep tariffs on China until he’s sure Beijing is complying with any trade deal, refuting expectations that the two nations will agree to roll back duties as part of a lasting truce to their trade war. ‘We’re not talking about removing them, we’re talking about leaving them for a substantial period of time, because we have to make sure that if we do the deal with China that China lives by the deal,’ Trump told reporters… ‘They’ve had a lot of problems living by certain deals.’ The president’s comments dim hopes that round-the-clock trade negotiations between the world’s two biggest economies could lead to them removing the roughly $360 billion in tariffs they’ve imposed on each other’s imports. Beijing has pushed the Trump administration to remove tariffs as part of any deal.”

March 20 – CNN (Haley Byrd): “President Donald Trump placed more pressure on the stalled trade talks with the European Union…, threatening tariffs on European automobiles if no deal is reached. ‘The European Union has been very tough on the United States for many years,’ Trump told reporters…, saying the auto tariffs were under review. ‘We're looking at something to combat it.’ Trump received a report from the Commerce Department last month with the findings of an investigation into whether imports of automobiles and auto parts could qualify for tariffs as a national security threat… Trump has until the middle of May to choose a course of action. On Wednesday, Trump said his decision would hinge on how talks with the EU proceed. He has long threatened to impose hefty tariffs on European autos and auto parts.”

March 18 – Wall Street Journal (Michelle Hackman and Josh Mitchell): “The White House is calling on Congress to cap how much graduate students and parents of undergraduates can borrow in federal student loans, a proposal it said is aimed at curbing rising college costs. White House officials publicized the proposal as part of a broader set of ideas it is urging Congress to adopt as lawmakers undertake a rewrite of the Higher Education Act, a 1965 law that governs student loans. The law hasn’t been reauthorized since 2008, and Democrats and Republicans agree it is due for an overhaul given the growth of online and other nontraditional degree programs. The package of proposals… focuses primarily on the cost of college and workforce training.”

Federal Reserve Watch:

March 21 – Bloomberg (Sarah Ponczek, Vildana Hajric and Reade Pickert): “Conventional wisdom held it would be difficult for the Federal Reserve to deliver a second dovish surprise in as many meetings. It was wrong, and the equity market didn’t quite know what to make of it. Stocks initially erased losses on the prospect of rates not rising for the foreseeable future. Then the rebound faltered and equities closed slightly lower. It’s partly a reflection of how far they’d rallied on the first dovish turn, nearly 20% so far this year. And it raised the question of what it’s going to take to reclaim September highs, if not a decidedly accommodative Fed.”

March 20 – Bloomberg (Robert Burgess): “The Federal Reserve managed to exceed expectations on Wednesday by scaling back its projected interest-rate increases this year to zero and saying it would stop shrinking its balance sheet assets in September. Before the announcement, the markets were generally expecting the central bank to keep one rate hike on the table and allow its balance sheet to contract through the end of the year – so it’s no surprise that stocks rose from their lows of the day and bonds soared. But the big questions are, why so dovish and at what cost?”

U.S. Bubble Watch:

March 22 – MarketWatch (Steve Goldstein): “The IHS Markit flash purchasing managers index for manufacturing in March fell to a 21-month low, while the services PMI weakened to a two-month low. The flash manufacturing PMI fell to 52.5 from 53 in February, while the services PMI fell to 54.8 from 56.”

March 22 – Reuters (Jason Lange): “U.S. home sales surged in February to their highest level in 11 months, a sign that a pause in interest rate hikes by the Federal Reserve was starting to boost the U.S. economy. The National Association of Realtors said on Friday existing home sales jumped 11.8% to a seasonally adjusted annual rate of 5.51 million units last month… ‘(It’s) quite a powerful recovery that’s taking place,’ said Lawrence Yun, chief economist with the National Association of Realtors.”

March 17 – Financial Times (Rana Foroohar): “Hyman Minsky would have had a field day with last week’s US inflation numbers. One of the key points in the late, great economist’s Financial Instability Hypothesis was that there are two kinds of prices — prices for goods and services, and asset prices. Inflation in the two areas should, as a result, differ. And indeed they have, quite markedly. The latest Consumer Price Index figures show that almost all core inflation, which was weaker than expected, was in rent or the owner’s equivalent of rent (up 0.3%). Core goods inflation, meanwhile, was down 0.2%. Very simply, this means that the housing market is once again completely out of sync with the rest of the economy. A decade on from the subprime bubble, housing… is the only major component of the CPI with a national inflation rate that is consistently above the overall number.”

March 18 – CNBC (Hugh Son): “J.P. Morgan Chase CEO Jamie Dimon said that the U.S. economy has essentially been split into those benefiting from thriving corporations and those who are left behind. ‘I don’t want to be a tone deaf CEO; while the company is doing fine, it is absolutely obvious that a big chunk of [people] have been left behind,’ Dimon said. ‘40% of Americans make less than $15 an hour. 40% of Americans can’t afford a $400 bill, whether it’s medical or fixing their car. 15% of Americans make minimum wages, 70,000 die from opioids’ annually. ‘If you travel around to most neighborhoods where companies live, they’re doing fine,’ Dimon said. ‘So we’ve kind of bifurcated the economy.’”

March 17 – Wall Street Journal (Theo Francis): “The strong U.S. economy has created millions of jobs and pushed up wages for many Americans. It also helped many big-company CEOs secure another raise and total compensation worth $1 million a month. Median compensation for 132 chief executives of S&P 500 companies reached $12.4 million in 2018, up from $11.7 million for the same group in 2017… The gains were driven by robust corporate profits and strong stock market returns for much of the year.”

March 21 – Wall Street Journal (Ben Eisen and Laura Kusisto): “High-end home buyers are turning cautious, a blow to banks that refocused their mortgage businesses around wealthy borrowers in the years after the financial crisis. Originations for jumbo mortgages, which are loans too big to be sold to Fannie Mae and Freddie Mac , dropped 12% last year by dollar volume, outpacing the 7% decline in mortgages that meet the standards for Fannie and Freddie’s government backing. The $281 billion in jumbo originations was off 27% from its postcrisis peak two years earlier…”

China Watch:

March 20 – South China Morning Post (Guo Rui): “A group of heavyweight Chinese economists sat down with Japanese counterparts in Beijing on Tuesday to discuss whether China can avoid its own ‘lost decades’, as the government looks to negotiate a deal to end the US-China trade war. Japan engaged in a lengthy trade dispute with the United States in the 1980s, with a series of deals over currency and market access blamed in some quarters for the decades of economic stagnation that followed. It is known that many in Beijing are worried that a bad trade deal with the US could result in China following a similar trajectory, with currency exchange rate and market access high on the list of demands of Washington’s negotiators.”

March 16 – Wall Street Journal (Lingling Wei): “China’s spending spree during the global financial crisis helped pull the world economy out of recession. This time, Beijing’s stimulus might not pack the same punch. China’s leadership is adopting what some traders dub a ‘cocktail approach’ to arresting its economic slowdown. Its remedies include a mix of greater deficit spending, tax cuts and easier credit. In a national address…, Premier Li Keqiang announced the government will cut taxes and fees for businesses by a total of 2 trillion yuan ($298bn), or 2% of China’s $13 trillion economy. That includes reductions in value-added taxes… and required corporate contributions to pensions…. Mr. Li also announced big-ticket spending initiatives, including an investment of 800 billion yuan in railway construction and 1.8 trillion yuan to build roads and waterway transportation.”

March 17 – Bloomberg (Christopher Balding): “China’s banks may have a flood of bad loans waiting in the wings. Not that you’d know it from looking at official levels for 2018, which suggest the problem was broadly contained. The reality is that newly soured debt was coming through the front door as fast as banks could shovel it out the back. Authorities worked hard to restrain financial-system leverage in 2018. Outstanding credit increased a relatively modest 10%... The government accomplished this primarily by tightening restrictions on shadow banking and moving that lending into the formal banking system, which recorded a 13% jump in new loans last year. To make way for that increase, and with new deposits falling 1% last year, banks sold a lot of nonperforming debt to asset management companies. Sales to AMCs and other disposals totaled almost 1.8 trillion yuan ($268bn), according to… Jason Bedford, executive director of Asian financials research at UBS…”

March 19 – Financial Times (Gabriel Wildau and Yizhen Jia): “Listed Chinese banks will need to raise about $260bn in fresh capital over the next three years as regulations force shadow-bank loans back on to balance sheets and global rules on systemically important groups impose extra requirements on the largest lenders. A recent lending surge by Chinese banks in response to monetary stimulus designed to support China’s slowing economy is also adding to the banks’ capital needs, by accelerating the expansion of their balance sheets. China’s bank regulator has forcefully implemented the global Basel III rules on bank capital adequacy as it seeks to fortify lenders against financial risks from a decade of rapid debt growth, which is now leading to record defaults.”

March 20 – Bloomberg: “China’s banks are setting fundraising records in a rush to strengthen their balance sheets. Firms have used equity and debt offerings to raise $48 billion this year, the most for a first quarter… The flurry of issuance has had banks reach deep into the fundraising toolbox -- especially bonds that count as capital. That includes the first-ever perpetual sold domestically by a Chinese lender as well as rarely-used convertible bonds and dollar-denominated debt… ‘Banks have been asked to increase their lending to the private sector,’ said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis SA in Hong Kong. ‘They need to increase their loan book, and to that end, their capital. All of this is to keep growth afloat.’”

March 20 – CNBC (Weizhen Tan): “An economic slowdown and extremely tight credit conditions pushed corporate debt to a record high in China last year, according to experts. Defaults for Chinese corporate bonds — issued in both U.S. dollars and the Chinese yuan — soared last year… Yuan-denominated debt rose to an ‘unprecedented’ 119.6 billion yuan ($17.8bn) — four times more than 2017, according to… Singapore bank DBS. …Nomura’s estimates… were even higher, putting the size of defaults in onshore bonds — or yuan-denominated bonds — at 159.6 billion yuan ($23.8bn) last year. That number is roughly four times more than its 2017 estimate. Offshore corporate dollar bonds, or U.S. dollar-denominated debt…, followed the same trend. Nomura said the amount of such debt rose to $7 billion in 2018, from none the year before.”

March 19 – Reuters (Choonsik Yoo): “Confidence among Asian companies held near three-year lows in the first quarter as a U.S.-China trade dispute dragged on, pulling down a global economy that is already on a downward path, a Thomson Reuters/INSEAD survey found. The Thomson Reuters/INSEAD Asian Business Sentiment Index tracking firms’ six-month outlook was flat in the March quarter from the previous quarter’s 63, compared with a near three-year low of 58 set in the September quarter.”

March 20 – Bloomberg (David Tweed and Enda Curran): “Hong Kong’s chief executive cautioned that the Asian financial hub continued to face the risk of collateral damage from the China-U.S. trade war, saying the tensions were one reason why she’s joined the ranks of those tracking President Donald Trump’s tweets. ‘Last night, he was shouting to the media that things were good,’ Carrie Lam said of Trump… ‘I certainly want to see this trade discussion leading to some positive outcome. But I don’t think the problem will go away just like that. We will probably be seeing more tension in other areas.’”

Central Bank Watch:

March 17 – Bloomberg (Piotr Skolimowski): “The European Central Bank is approaching the point where it needs to decide whether if negative interest rates are more problem than solution. Since officials pushed back plans to tighten policy, warnings have increased that the potency of a key instrument used to rekindle growth in the 19-nation bloc is diminishing the longer it remains in place. France’s Francois Villeroy de Galhau… is loudest in voicing concern that sub-zero rates may prevent stimulus from reaching the economy because they’re hurting bank profitability. The argument isn’t unique to Europe. Banks in Japan are urging policy makers to watch that negative interest rates aren’t causing side effects, and officials at the Federal Reserve… argue it could cause problems for the U.S. financial system.”

March 21 – Wall Street Journal (Brian Blackstone): “Abrupt changes in the policies of the world’s largest central banks have rippled through smaller economies, leaving them with the prospect of low and even negative interest rates for years to come despite having mostly healthy economies. The danger is that these easy-money policies could fuel destabilizing bubbles in real estate and other asset markets. They may also leave banks with little ammunition to respond to the next economic downturn. Economies like Switzerland’s, whose central bank signaled no change in its negative-rate policies for years to come, are small compared with the U.S. and eurozone. Still, they are home to major global banks and companies that are sensitive to exchange rates and financial conditions. With financial markets so interconnected, problems in small countries can quickly spread to larger ones.”

Brexit Watch:

March 19 – Financial Times (George Parker, Laura Hughes and Sebastian Payne): “Theresa May’s cabinet has split over whether the UK should request a long delay to Brexit if MPs continue to block the prime minister’s exit deal. Eight Eurosceptic ministers said in tetchy exchanges during a meeting of Mrs May’s cabinet… that any extension of the Article 50 exit process should last no longer than June 30… These ministers added that Britain should be prepared to leave the EU at that point — without a deal if necessary. But Europhile ministers — including chancellor Philip Hammond — argued the prospect of a longer delay to Brexit was needed to keep pressure on Eurosceptic Conservative MPs to finally back Mrs May’s deal.”

March 19 – Financial Times (Gillian Tett): “Another week, another round of baffling Brexit political farce. But if you want a different perspective on these dramas, ponder a topic that (almost) no British politician ever bothers to discuss: the state of London’s gigantic derivatives market after leaving the EU. For while this topic is arcane, it matters deeply — not just because derivatives have financial stability implications, but also because the issue is sparking some extraordinary behind-the-scenes battles, now with transatlantic consequences. The issue at stake revolves around the clearing of derivatives trades. In recent years, the London Clearing House has dominated the swaps and futures sector, regularly clearing more than $3tn of trades each day, of which a quarter are euro-denominated and almost half in dollars.”

Europe Watch:

March 18 – Bloomberg (Carolynn Look): “The slowdown in Europe’s largest economy is unlikely to have enjoyed a long-awaited turnaround at the start of 2019 as German industry continued to stumble. ‘The basic cyclical trend of the German economy remained subdued after the turn of theyear. This was mainly due to the continuing slowdown in industrial momentum,’ the Bundesbank said… ‘Greater catch-up effects in the country’s auto industry ‘are no longer expected for the current quarter.’”

March 17 – Reuters (Tom Sims and John O’Donnell): “Deutsche Bank and Commerzbank confirmed… they were in talks about a merger, prompting labour union concerns about possible job losses and questions from analysts about the merits of a combination. Germany’s two largest banks issued short statements after separate meetings of their management boards, …indicating a quickening of pace in the merger process, although both also warned that a deal was far from certain.”

March 19 – Financial Times (Michael Peel, Lucy Hornby and Rachel Sanderson): “The last time EU leaders held strategy talks on China was just after the Tiananmen Square massacre in 1989. The 12 heads of state and government imposed sanctions including an arms embargo over what they called the ‘brutal repression’ by the Chinese government. Almost 30 years later, the European Council will use a summit this week to focus once more on China — and decide whether it is time to get tough again. Mounting concerns over Chinese industrial policy, cyber security and trade wars have all combined to put Beijing firmly back on the European agenda. To some in Brussels and member state capitals, this week’s discussion is the EU’s belated awakening to the new sway of China — and to an uncomfortable truth that it has failed to register the full implications of its ascendancy.”

March 19 – Reuters (Leigh Thomas and Yann Le Guernigou): “The French economy should grow about 1.4% this year, Finance Minister Bruno Le Maire said…, revising down the forecast of 1.7% growth in this year’s budget. Le Maire told the Senate’s law and economic affairs commissions that the yellow vest anti-government unrest had in the short-term trimmed 0.2 percentage points off growth in 2018 and 2019.”

March 18 – Financial Times (Joseph Nasr): “German Chancellor Angela Merkel said… she hoped inflation in the euro zone would soon reach the target set by the European Central Bank so the central bank can start raising interest rates. ‘I believe or I hope - we have almost reached the 2% inflation rate - that the ECB can change its policy,’ Merkel said during a town hall meeting… Her comments were in response to complaints from a participant that savers and pension funds were suffering from the record-low interest rates set by the European Central Bank.”

EM Watch:

March 18 – Financial Times (Colby Smith): “And once again, investors are bullish on emerging markets. With the Fed on pause and trade tensions between the US and China ebbing, investors have been quick to forget the crises that hobbled emerging markets last year. But with investor sentiment shifting closer to ‘exuberance,’ as one strategist puts it, and sources for further upside waning, the tide could soon turn against those who have been over-eager… After a trying 2018, investors have poured billions into hard currency emerging market debt since January, with ten consecutive weeks of positive inflows, according to EPFR Global.”

March 21 – Reuters (Marcelo Rochabrun): “Brazil prosecutors on Thursday alleged that detained former president Michel Temer was the leader of a ‘criminal organization’ that diverted 1.8 billion reais ($471.62 million) in funds as part of a scheme related to the construction of a nuclear plant complex. Temer was arrested on Thursday morning in Sao Paulo.”

Global Bubble Watch:

March 18 – Bloomberg (William Horobin): “The people of the world’s richest economies are anxious about everything from money and taxes, to healthcare to pensions -- and they’ve little faith in their governments to do anything about it. According to a survey of 22,000 people in 21 OECD countries, there’s a ‘clear sense of dissatisfaction and injustice’ in advanced economies. A majority believe they wouldn’t easily access benefits if needed, less than 20% say they get a fair share given the taxes they pay, and in many countries most people feel governments ignore their views. The OECD said the exercise in ‘listening to people’ has produced ‘deeply worrying’ results.”

March 20 – CNBC (Kate Rooney): “Corporate giants doing business abroad are painting a dreary picture of the world’s economy. With an ongoing trade war between the U.S. and China, Brexit uncertainty weighing on Europe and the U.K., and new weakness out of Japan, some business leaders say it’s harder than ever to rake in profits. This week, top executives at FedEx, BMW, UBS and others described bleak global business conditions while discussing quarterly results. Fitch Ratings also ‘aggressively’ cut its forecast for the year. The head of UBS was among the latest to blame the world’s backdrop for weaker-than-expected results.”

March 20 – CNBC (Kate Rooney): “A top executive at FedEx is flagging serious concerns in the global economy. The multinational package delivery service reported declining international revenue as a result of unfavorable exchange rates and the negative effects of trade battles. ‘Slowing international macroeconomic conditions and weaker global trade growth trends continue, as seen in the year-over-year decline in our FedEx Express international revenue,’ Alan B. Graf, Jr., FedEx Corp. executive vice president and chief financial officer, said…”

March 19 – Bloomberg (Michael Heath): “The apartment market in Australia’s largest city is ‘quite soft’ due to a sharp rise in supply that’s increased risks to financial stability, a senior central bank official said. Sydney added more than 80,000 apartments in the past few years, increasing the city’s housing stock by about 5%... In Melbourne and Brisbane, which also saw substantial construction, apartment prices have so far held up, she said. ‘Our main concern with this from a financial stability perspective is the potential for this large influx of supply to exacerbate declines in housing prices and so adversely impact households’ and developers’ financial positions,’ Bullock said… ‘Currently, the risks here appear to be elevated but contained.’”

March 19 – Reuters (Fergal Smith): “Canada said… it would issue nearly 20% more bonds in the coming fiscal year to help the Liberal government fund its spending programs, ahead of an October election. The federal budget… projected the deficit would widen to C$19.8 billion ($14.86bn) in 2019-20 from a forecast C$14.9 billion for the current fiscal year ending March 31.”

Japan Watch:

March 17 – Bloomberg (Daniel Moss): “Haruhiko Kuroda is miles from where he wants to be. About 200 miles. That's the distance from Tokyo to Nagoya, where the Bank of Japan governor gave a very upbeat speech last year. Some interpreted those remarks as laying the groundwork for a shift from the ultra-accommodation that's been the central bank's trademark. In terms of monetary policy, Nagoya might as well be on another continent. That's how much the outlook for interest rates, globally, has shifted. Talk of normalization, however gradual, is now passe. If anything, the question among observers has become when and how the BOJ will ease further.”

March 19 – Reuters (Leika Kihara): “Bank of Japan policymakers disagreed on how quickly the central bank should ramp up monetary stimulus, minutes of their January rate review showed…, as heightening overseas risks threatened to derail the country’s fragile economic recovery. While most members agreed it was appropriate to maintain the BOJ’s current stimulus program, one of them said the central bank must stress its readiness to take ‘quick, flexible and bold’ action including additional easing, the minutes showed.”

March 17 – Reuters (Tetsushi Kajimoto): “Japan’s exports fell for a third month in February in a sign of growing strain on the trade-reliant economy, suggesting the central bank might be forced to offer more stimulus eventually… Slowing global growth, the Sino-U.S. trade war and complications over Britain’s exit from the European Union have already forced many policymakers to shift to an easing stance over recent months.”

March 19 – Reuters (Tetsushi Kajimoto and Izumi Nakagawa): “Confidence among Japanese manufacturers hit its weakest in two-and-a-half years in March, a Reuters poll showed… The monthly poll, which tracks the Bank of Japan’s (BOJ) closely watched tankan quarterly survey, found confidence fell for a fifth straight month while sentiment in the service sector held steady…”

March 20 – Reuters (Leika Kihara): “Japanese Prime Minister Shinzo Abe said… he sees the central bank’s inflation target as a means to achieve the more important goal of reviving the economy, in a sign that firing up inflation may no longer be a priority for the government. The premier’s comments followed those from Finance Minister Taro Aso, who warned the Bank of Japan last week against insisting on hitting its price goal. Abe defended the BOJ for missing its 2% inflation target, telling parliament that the government gives a passing grade to its policies for boosting jobs and economic growth.”

Fixed-Income Bubble Watch:

March 21 – Bloomberg (Christopher DeReza): “The influx of investor cash into U.S. corporate-bond funds accelerated, helping to keep the market on track for its biggest quarterly gain in three years. Investors added $5.14 billion to investment-grade funds in the week ended March 20, the biggest net increase since March 2017, Lipper data show. That followed a $3.29 billion inflow the previous week and marked the eighth straight week of gains with investors pouring $21 billion of cash into the funds.”

March 15 – Reuters (Gertrude Chavez-Dreyfuss): “Foreign investors sold U.S. Treasury bonds and notes for a third straight month in January…, a trend that has been in place for several years. They sold $11.99 billion in Treasuries in January, compared with a record $77.35 billion the previous month… Selling was mainly from foreign official accounts.”

March 18 – Bloomberg (Russell Ward): “When returns on safe assets are low, investors look for riskier places to put their money. In Japan, where yields have been near zero for some traders’ entire careers, an increasingly popular investment is bundled U.S. corporate loans known as CLOs, or collateralized loan obligations. Some observers have drawn parallels to the collateralized debt obligations, or CDOs, that helped turn packaged U.S. mortgages into bombs that laid waste to global financial markets in 2008. Japanese regulators have drafted a rule that could limit their risk… Japanese banks have been buying CLOs and other securities abroad because the central bank’s ultra-easy monetary policy has made it extremely difficult to profit from domestic bonds and loans. They hold at least 10% of the $750 billion global market for CLOs…”

Leveraged Speculator Watch:

March 22 – Financial Times (Chris Flood): “New hedge fund launches have sunk to their lowest level since the start of the century as untried managers struggled to attract capital in 2018, a year of widespread disappointment for investors in the asset class. Hedge fund portfolios run by institutional investors delivered average returns of just 1.6% in the first 11 months of 2018, well below expectations of 7.2%, according to a survey of 425 respondents by Deutsche Bank. Just 13% of the investors surveyed achieved their expected performance target… Just 561 new hedge funds were launched in 2018, the lowest number since 2000, according to HFR…”

Geopolitical Watch:

March 16 – Reuters (Sanjeev Miglani and Drazen Jorgic): “The sparring between India and Pakistan last month threatened to spiral out of control and only interventions by U.S. officials, including National Security Advisor John Bolton, headed off a bigger conflict, five sources familiar with the events said. At one stage, India threatened to fire at least six missiles at Pakistan, and Islamabad said it would respond with its own missile strikes ‘three times over’, according to Western diplomats and government sources…”

March 19 – Reuters (Ben Blanchard): “Pakistan Foreign Minister Shah Mahmood Qureshi told his Chinese counterpart… of the ‘rapidly deteriorating situation’ and rights violations in Indian Kashmir, and called for India to look again at its policies there. India launched an air strike on a militant camp inside Pakistan last month following an attack on an Indian paramilitary convoy in disputed Kashmir. The Feb. 14 attack that killed at least 40 paramilitary police was the deadliest in Kashmir’s 30-year-long insurgency, escalating tension between the neighbors, and the subsequent air strike had heightened fears that nuclear-armed India and Pakistan could slide into a fourth war.”

March 19 – Reuters (Philip Pullella): “High-level U.S.-Russian talks on how to defuse Venezuela’s crisis ended… with the two sides still at odds over the legitimacy of President Nicolas Maduro. Russia has said Maduro remains the country’s only legitimate leader whereas the United States and many other Western countries back Juan Guaido, head of the opposition-controlled National Assembly who invoked a constitutional provision in January to assume an interim presidency.”

March 20 – Reuters (Yimou Lee and Twinnie Siu): “China urged the United States… not to allow Taiwan President Tsai Ing-wen to stop over in Hawaii next week when she makes a tour of the island’s diplomatic allies in the Pacific, adding another irritant to Beijing-Washington ties.”