Credit Bubble Bulletin : October 2019

Any central bank head that passes through an eight-year term without once raising rates has some explaining to do. To leave monetary policy extremely loose for such an extended period comes with major consequences (can we at least agree on that?). So, what went wrong? How did policy measures not operate as expected? With the benefit of hindsight, what could have been done differently?

What will be Draghi’s legacy? How will history view his stewardship over eurozone monetary policy? The years sure pass by. I still ponder how history will judge Alan Greenspan and Ben Bernanke. At this point, with securities prices (equities and bonds) basically at all-time highs, contemporary monetary policy - and its major architects - are held in high regard. I don’t expect this to remain the case following the next crisis.

A reporter question from Draghi’s Thursday press conference: “A recent survey by the Bank of America reveals that impotence and ineffectiveness of central banks, including the ECB, are the second risk perceived by investors. My question is: do you think that these investor concerns are justified? In other words, is there a risk of financial bubbles?”

Mario Draghi: “…You asked whether the expansionary monetary policies of central banks is the second-largest risk. I can answer for the eurozone; in the eurozone, and it’s a question we ask ourselves every day, many times a day, and I’m saying this because we monitor market developments very closely. We see some segments of financial markets where valuations are overstretched. One case is real estate, for example, and especially prime commercial real estate. Now, the causes of these overstretched valuations often don’t lead directly to our monetary policies. For prime commercial real estate, it’s the action of international investors… We may have other segments to watch, but frankly, all in all we don’t see bubbles. When we see some bubbles, they are local bubbles that should be, for example, some segments of the bond market, the high-yield leveraged bond market – which by the way is not a big issue in Europe. It's more of a big issue in another jurisdiction… Certainly the other important issue is that much of this danger, much of this risk, much of this search for yield happens in the non-banking sector and more specifically in the so-called shadow banking sector. Unfortunately there, the perimeter of macro-prudential policies does not include that sector. We have some visibility, pretty good visibility, into what happens in the banking sector… But we don't have much visibility for the rest of the financial sector. I’m talking for the non-banks, so for the shadow banking sector.”

Reminiscent of mortgage finance Bubble era Alan Greenspan, Draghi references “local Bubbles.” Yet Draghi concludes his term staring eye-to-eye with one of history’s most spectacular Bubbles – and it’s anything but “local” and it is not in real estate or high-yield. I’ll assume when ECB officials are monitoring markets “very closely” and pondering risks “many times a day,” perhaps sovereign bond markets garner some occasional attention.

Greek yields were at 22.31% when Mario Draghi began his term on November 1, 2011. Italian yields were at 6.09%, with Portuguese yields at 11.79%, Spanish at 5.54%, French at 3.10% and German yields at 2.03%. At 2011/12 highs, Italian yields reached 7.26%, Spain 7.62%, Portugal 17.39% and Greece 31.68%.

The collapse of eurozone yields has been nothing short of miraculous. Greek 10-year yields ended this week at 1.20%, and Italian yields closed at 0.95%. Portuguese and Spanish yields are down to 0.22% and 0.27% - and those are among the high/positive-yielding instruments. German and French yields ended the week at negative 0.36% and negative 0.06%. Other negative-yielding eurozone 10-year bonds include Netherlands (-0.24%), Austria (-0.14%), Finland (-0.14%) and Belgium (-0.08%). Latvia’s 10-year yields ended the week at zero, slightly ahead of Slovakia (0.03%), Ireland (0.04%), Slovenia (0.08%) and Cyprus (0.46%). It’s curious that history’s greatest bond market inflation didn’t garner so much as a mention during Draghi’s final ECB press conference.

Scant interest in the ECB’s holdings as well. The ECB balance sheet doubled in size over the course of Draghi’s eight-year term. Total ECB Assets ended October 2011 at 2.333 TN euros, having already inflated dramatically from 2005’s one TN (euro). ECB assets are now at 4.687 TN ($5.230TN). There were the Long-Term Refinancing Operations (LTRO), Outright Monetary Transactions (OMT), and Quantitative Easing (QE). ECB assets surged 2.6 TN euros during the 2015 QE program that ran through the end of 2018. After a brief hiatus, the restart of QE (20 billion euro monthly) was announced in September.

Draghi will forever be known for “whatever it takes…” (“...and believe me, it will be enough”). He is hailed as having saved the euro. The dire consequences of a collapsing monetary union certainly afforded him extraordinary leeway. When the euro stabilized, he then leaned on the ECB’s inflation mandate to basically do whatever he wanted. Similar to central bankers around the world, global disinflationary forces associated with globalization, manufacturing over-investment, technological advancement, and changes in the nature of output (i.e. digitization) were used to justify unrelenting monetary stimulus and policy experimentation. When these inflation mandates were created, did anyone ever contemplate that they would be justification for creating Trillions of new “money” through the monetization of government bonds and other securities?

Central banking has a long history of prudence and conservatism. After all, risks associated with bold measures and experimentation are too great: inflation, Bubbles, wealth redistribution, loss of trust, wars and so on. The role of central banks should be well contained; the scope of mandates limited in nature. Allow central bankers to drift into the domain of bolstering securities markets and you’re asking for trouble. Any “buyer of last resort” crisis-period operation should be concluded at the earliest available juncture. Never promise a market backstop. Efforts to use inflating securities markets as a mechanism for system reflation – to boost spending, borrowing, investment and incomes – is fraught with great risk. And to have a central bank assume the role of savior for an ill-conceived monetary union guarantees precarious runaway monetary inflation.

There were momentous unintended consequences when Dr. Bernanke in 2008 unleashed his monetary experiment. Mario Draghi was a paramount one. I doubt Draghi would have even been considered for the ECB’s top post if not for Bernanke’s radical stimulus gambit. With the guardian of the world’s reserve currency having flung open the doors to rank inflationism, traditional central bankers in Germany were blown back on their heels. All the uncertainty and confusion created an opening. Articulate, diplomatic and with deep experience (including a stint as Goldman Sachs vice chairman and managing director), the smooth Italian fatefully overcame opposition from the sound money Germans to win the job.

For posterity, a few headlines. “Mario Draghi, Hailed as the Euro’s Savior, Leaves With the ECB Divided” (Wall Street Journal). “How Mario Draghi Brought Determination to Calm Market Turmoil” (Financial Times). “Mario Draghi Reaches the End of His Fight to Save the Euro” (Bloomberg). “Mario Draghi Leaves Europe Near Recession, in a Deflation Trap – and Out of Ammunition” (UK Telegraph). And my personal favorite from Axios: “ECB Head Mario Draghi Saved by the Bell as the Eurozone’s Mess Escalates.” A more forward-looking headline: “Lagarde Will Seek to Heal ECB Policy Split with Review Plan.”

Question: “What advice are you giving to Christine Lagarde – that you can tell us about anyway?”

Draghi: “…No advice is needed. She knows perfectly well what she has to do. By the way, she has a long period of time ahead during which she will have to form her own view, together with the Governing Council, about what to do.”

Bernanke and Yellen left Chairman Powell in a difficult predicament. It was up to him to move forward with a much delayed “normalization” (brought to a screeching halt in less than a year). Draghi has essentially set a policy course that will run much beyond the end of his term. There are no expectations for any so-called “normalization.” Negative deposit rates will continue indefinitely, as will QE. No difficult decisions anywhere on the horizon. The Governing Council will surely present a unified front. Christine Lagarde will have an easy time of it – that is, until trouble strikes.

The “ammo” issue will not be going away. The entire world will deeply regret having disregarded the sordid history of inflationism. And that has been the momentous unintended consequence of Bernanke and Draghi’s grand monetary experiment: once you travel down the path of using monetary stimulus to reflate financial and economic systems, there will be no turning back.

I don’t believe Draghi saved the euro – he merely postponed monetary breakdown. In so many ways, delaying the day of reckoning only makes things (much) worse. The world over the past couple weeks has experienced riots in an expanding number of countries – including Lebanon, Egypt, Iraq, Spain, Chile, Bolivia, Ecuador and Hong Kong. Wait until the global Bubble bursts. Similarly, wait as it expands further, with wealth inequalities mounting and social and geopolitical stress festering.

It’s crazy that central bankers have expended such precious resources to sustain the unsustainable. What does the ECB have remaining in its arsenal to expend when the next crisis erupts? One thing: Trillions of QE. And markets are perfectly aware of this reality, which explains the historic speculative Bubble that has engulfed eurozone and European bonds. European yields have been a major force pulling international bond markets along for the ride - and why not? The next crisis will be global, with the ECB’s Trillions of QE joined by Trillions from the Fed, BOJ, PBOC, BOE, SNB and the rest.

It’s fitting that Mario Draghi’s final meeting in charge of the ECB came with the S&P500 trading right at all-time highs, while Italy’s two-year bond issue was oversubscribed with a yield of negative 0.11%. And then there was the announcement of the U.S. fiscal deficit of almost $1 TN, despite decent growth, unemployment at a 60-year low and historically low funding costs.

There are scores of developments that were only possible because of the superhuman feats of “Helicopter Ben” and “Super Mario.” Paul Krugman has referred to Draghi as “the greatest central banker of modern times.” I’ll assume Dr. Bernanke is a close runner-up.

I’m convinced China’s historic Credit Bubble would not have inflated to such extremes without unprecedented monetary stimulus from the Fed, ECB and BOJ. The Chinese banking system doesn’t inflate to $40 TN without China’s massive holdings of international reserves underpinning its currency. China’s currency doesn’t sustain its international value without devaluations in the world’s reserve currency, along with the euro and the yen. And it was all made possible by Team Bernanke and Draghi, with the resulting Chinese-led investment boom a major factor behind global downward pressure on technology and manufactured goods prices.

Consequences of unprecedented monetary stimulus are now used as justification for only more outrageous monetary stimulus. Sinking “real rates” – “the natural rate” – “r star” – the “neutral rate” – now apparently demand lower for longer (and more QE!). And markets appreciate that global central bankers are trapped – nowhere to go but ongoing aggressive stimulus. With a straight face, investment managers assert on Bloomberg and CNBC that Federal Reserve policy is “too tight.”

Even with the S&P at highs, unemployment at lows, financial conditions loose, and “money” growing crazily, the Fed apparently has no alternative but to cut rates for a third time in three months - to avoid at all cost the Scourge of Disappointing Markets. At the minimum, the Fed should signal it will now pause. Most view this as unlikely, as such a bold maneuver risks upsetting fragile markets (trading at record highs). It’s hard to believe the FOMC is comfortable having highly speculative markets dictate monetary policy, but it’s similarly difficult to see them willing to break this dynamic. Right, no appetite for rattling booming markets.

I’ll be really curious to see how history views this cast of characters. When asked about his future, Draghi said “ask my wife.” I’ll assume he’ll follow in Dr. Bernanke’s footsteps – rake in millions. It’s an absolutely wonderful time to be an ex head of one of the world’s major experimental central banks. Such powerful incentives to keep the game going – Bubbles inflating. “‘Never Give Up!’ Draghi Tells Lagarde as He Leaves ECB,” read a Reuters headline.

For the Week:

The S&P500 rose 1.2% (up 20.6% y-t-d), and the Dow added 0.7% (up 15.6%). The Utilities increased 0.6% (up 22.0%). The Banks surged another 3.7% (up 22.1%), and the Broker/Dealers rose 1.7% (up 10.6%). The Transports jumped 3.3% (up 18.4%). The S&P 400 Midcaps gained 1.2% (up 17.8%), and the small cap Russell 2000 jumped 1.5% (up 15.6%). The Nasdaq100 advanced 2.0% (up 26.8%). The Semiconductors surged 3.7% (up 42.7%). The Biotechs jumped 2.7% (up 4.1%). With bullion jumping $15, the HUI gold index rose 2.8% (up 33.3%).

Three-month Treasury bill rates ended the week at 1.63%. Two-year government yields rose four bps to 1.62% (down 87bps y-t-d). Five-year T-note yields gained five bps to 1.62% (down 89bps). Ten-year Treasury yields rose four bps to 1.80% (down 89bps). Long bond yields gained four bps to 2.29% (down 73bps). Benchmark Fannie Mae MBS yields jumped six bps to 2.78% (down 71bps).

Greek 10-year yields dropped 10 bps to 1.20% (down 320bps y-t-d). Ten-year Portuguese yields added two bps to 0.22% (down 150bps). Italian 10-year yields increased three bps to 0.95% (down 179ps). Spain's 10-year yields rose three bps to 0.27% (down 114bps). German bund yields added two bps to negative 0.36% (down 60bps). French yields increased two bps to negative 0.06% (down 77bps). The French to German 10-year bond spread was unchanged at 30 bps. U.K. 10-year gilt yields declined three bps 0.68% (down 60bps). U.K.'s FTSE equities index surged 2.4% (up 8.9% y-t-d).

Japan's Nikkei Equities Index gained 1.4% (up 13.9% y-t-d). Japanese 10-year "JGB" yields dipped one basis point to negative 0.14% (down 14bps y-t-d). France's CAC40 rose 1.5% (up 21.0%). The German DAX equities index jumped 2.1% (up 22.1%). Spain's IBEX 35 equities index gained 1.1% (up 10.4%). Italy's FTSE MIB index advanced 1.3% (up 23.4%). EM equities were mostly higher. Brazil's Bovespa index jumped 2.5% (up 18.0%), and Mexico's Bolsa added 0.5% (up 4.2%). South Korea's Kospi index rose 1.3% (up 2.3%). India's Sensex equities index declined 0.6% (up 18.5%). China's Shanghai Exchange increased 0.6% (up 18.5%). Turkey's Borsa Istanbul National 100 index jumped 1.8% (up 9.8%). Russia's MICEX equities index surged 4.4% (up 21.3%).

Investment-grade bond funds saw inflows of $3.133 billion, and junk bond funds posted inflows of $1.224 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained six bps to 3.75% (down 111bps y-o-y). Fifteen-year rates rose three bps to 3.18% (down 111bps). Five-year hybrid ARM rates increased five bps to 3.40% (down 74bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates down a basis point to 4.11% (down 67bps).

Federal Reserve Credit last week increased $23.5bn to $3.933 TN. Over the past year, Fed Credit contracted $203bn, or 4.9%. Fed Credit inflated $1.122 Trillion, or 40%, over the past 363 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $7.6bn last week to $3.420 TN. "Custody holdings" fell $14.7bn y-o-y, or 0.4%.

M2 (narrow) "money" supply gained $15.2bn last week to a record $15.161 TN. "Narrow money" gained $922bn, or 6.5%, over the past year. For the week, Currency increased $1.8bn. Total Checkable Deposits jumped $56.8bn, while Savings Deposits fell $46.9bn. Small Time Deposits were little changed. Retail Money Funds increased $2.9bn.

Total money market fund assets rose $15.6bn to $3.486 TN. Money Funds gained $599bn y-o-y, or 20.7%.

Total Commercial Paper gained $8.6bn to $1.088 TN. CP was little changed year-over-year.

Currency Watch:

The U.S. dollar index recovered 0.7% to 97.831 (up 1.7% y-t-d). For the week on the upside, the Brazilian real increased 2.7%, the South African rand 1.1%, the South Korean won 0.7%, the Canadian dollar 0.5%, the Mexican peso 0.2% and the Singapore dollar 0.1%. On the downside, the British pound declined 1.2%, the Swiss franc 1.0%, the euro 0.8%, the New Zealand dollar 0.5%, the Australian dollar 0.5%, the Norwegian krone 0.4%, the Swedish krone 0.4% and the Japanese yen 0.2%. The Chinese renminbi increased 0.23% versus the dollar this week (down 2.65% y-t-d).

Commodities Watch:

The Bloomberg Commodities Index gained 1.1% this week (up 3.3% y-t-d). Spot Gold added 1.0% to $1,505 (up 17.3%). Silver jumped 2.6% to $18.035 (up 16.1%). WTI crude surged $2.88 to $56.66 (up 25%). Gasoline rose 3.1% (up 26%), while Natural Gas declined 0.9% (down 22%). Copper gained 1.5% (up 2%). Wheat dropped 2.7% (up 3%). Corn fell 1.1% (up 3%).

Market Instability Watch:

October 21 – Bloomberg (Tracy Alloway and Stephen Spratt): “JPMorgan… says the money-market stress that sent short-term borrowing rates surging last month is likely to get much worse despite the Federal Reserve’s attempts to inject billions of dollars into the financial system… JPMorgan says it’s not convinced the Fed has resolved the issues in the funding markets, according to a note from analysts led by Joshua Younger… ‘Given the benefits of our newfound perspective, we recommend viewing these moves as highlighting the limitations of the Fed’s chosen solution to their operational issues… With year-end coming up, this is all likely to get much worse, in our view, before it gets better.’”

October 19 – Financial Times (Chris Flood): “Bond funds holding assets worth about $1.7tn could face difficulties in repaying investors promptly if volatility increases, according to the IMF, which warned that problems in fixed-income markets could potentially destabilise the global financial system. The warning coincides with mounting fears that a dangerous pricing bubble has developed in fixed-income markets where bonds worth $15tn — about a quarter of the debt issued by governments and companies globally — are trading with negative yields. Negative yields imply that prices have risen so high that investors will get back less than they paid, via interest and principal, if they hold the bond to maturity. Creditors, in effect, pay to hold debt. This bizarre reversal of normal practice has triggered alarm bells because bonds are a core holding for institutional investors worldwide.”

October 24 – Wall Street Journal (Mike Bird): “China’s property developers have used falling U.S. interest rates this year to issue swaths of dollar debt. Yet the state of the country’s housing market—now past its prime—suggests investors would do well to steer clear. Developers in Hong Kong and mainland China account for 41% of the net issuance in Asian dollar-denominated bonds included in the ICE Bank of America Merrill Lynch Asian Dollar index this year, rising to 67% in the high-yield segment, where they now make up almost half of the total market. Even investors who haven’t opted to take direct exposure to the sector may now find it creeping into their portfolios: 14.1% of the same broad Asian Dollar Index is now made up of Chinese and Hong Kong property bonds, up from 11.2% at the end of 2018… Average yields on high-yield Chinese bonds broadly have fallen considerably this year, to around 8.4% from a high of 11.7% as recently as November 2018…”

October 22 – Financial Times (Robert Smith): “The longer that central banks have tried to pump up the economy by keeping interest rates low, the staler the jokes about ‘the formerly high-yield bond market’ have grown. The term was originally coined to make a virtue of a negative. Bankers began calling debt from companies with less than pristine credit ratings ‘high yield’ — instead of the more pejorative term, ‘junk’ — to emphasise their chunky coupons. Ever since the European Central Bank began buying investment-grade rated corporate bonds three years ago, however, as part of a general effort to boost growth and inflation, high-yield bonds have often belied their name… Still, it is striking to see just how tiny yields on some European junk bonds have become. Crown Holdings on Tuesday raised what many onlookers believe is the lowest yielding junk bond ever seen in Europe, raising €550m of four-year debt at just 0.75%.”

Trump Administration Watch:

October 19 – Reuters (Lindsay Dunsmuir): “The U.S. government ended fiscal year 2019 with the largest budget deficit in seven years as gains in tax receipts were offset by higher spending and growing debt service payments… It is the first time since the early 1980s that the budget gap has widened over four consecutive years… The U.S. budget deficit widened to $984 billion, which was 4.6% of the nation’s gross domestic product. The previous fiscal year deficit was $779 billion, with a deficit-to-GDP-ratio of 3.8%. Total receipts increased by 4% to $3.5 trillion but outlays rose by 8.2% to $4.4 trillion.”

October 24 – Reuters (Susan Heavey): “An initial pact on U.S-China trade will include much of a scrapped May deal’s agreement regarding intellectual property and will target enforcement mechanisms, White House trade adviser Peter Navarro said…, adding that he hopes the Chinese negotiate in ‘good faith.’ ‘The good news about this phase one ... is it adopted virtually the entire chapter in the deal last May that they reneged on for IP,’ Navarro told Fox Business… ‘Practically it means, if they steal our IP we’ll be able to take retaliatory action without them retaliating.’”

October 23 – New York Times (Ana Swanson): “The Trump administration is divided over how aggressively to restrict China’s access to United States technology as it looks for ways to protect national security without undercutting American industry. President Trump and many of his top advisers have identified China’s technological ambitions as a national security threat and want to limit the type of American technology that can be sold overseas. But a plan to do just that has encountered stiff resistance from some in the administration, who argue that imposing too many constraints could backfire and undermine American industry. The debate underscores the extent to which Mr. Trump’s trade fight with China has left many issues unresolved. The president announced plans this month to sign a ‘Phase 1’ trade agreement that would require China to buy more farm products and agree to some technology protections in exchange for a pause in new American tariffs.”

October 21 – Reuters (Susan Heavey): “White House economic adviser Larry Kudlow on Monday expressed optimism about ongoing U.S.-China trade talks, and said that tariffs scheduled for December could be withdrawn if negotiations continue to go well. The talks, which are expected to continue with calls this week, were ‘looking pretty good,’ Kudlow said…”

Federal Reserve Watch:

October 24 – Wall Street Journal (Michael S. Derby): “The Fed’s expanded offerings of liquidity to the financial system saw strong demand Thursday from eligible banks. The Federal Reserve Bank of New York intervened twice Thursday morning with what is called an overnight repurchase-agreement operation and via a 14-day repo operation. The New York Fed had said Wednesday it was raising its minimum offerings for overnight repos to $120 billion from a minimum of $75 billion, with the next two-term repo operation increased to $45 billion from a minimum of $35 billion. The Thursday term repo saw dealers submit $62.15 billion in securities and the Fed take in $45 billion in Treasurys, agency and mortgage securities. The overnight operation was also well bid, with dealers offering and the Fed taking $89.154 billion in securities. The Thursday overnight repo operation was much bigger than the one-day operation Wednesday, where the Fed added $49.845 billion in one-day liquidity.”

October 22 – Financial Times (Colby Smith): “The Federal Reserve could soon own 12% of the market for US Treasury bills, according to Oxford Economics… Earlier this month the Fed announced it would buy $60bn of Treasury bills… each month until the end of the second quarter of next year. When the Fed buys bills to expand its balance sheet, it credits commercial banks with an equal amount of reserves. The intervention aims to replenish those reserves to a level where even a spike in demand for cash will not send short-term borrowing costs significantly higher… In order to get reserves back to the roughly $1.5tn level it says is adequate for the system to run smoothly by early 2020, the Fed needs to buy approximately $300bn of the shorter-dated debt.”

U.S. Bubble Watch:

October 22 – Wall Street Journal (Sam Goldfarb): “An array of business challenges is hitting low-rated companies across the U.S. economy, driving selling in the bottom tier of the corporate-debt market that contrasts with gains in stocks and other riskier assets. In recent months, consumer demands for wireless phones and high-speed internet have helped push one landline telecom company, Windstream Holdings Inc., into bankruptcy protection and another, Frontier Communications Corp., into restructuring talks with its creditors. Meanwhile, competition from cheap natural gas and renewable-energy sources has caused at least seven coal producers to file for chapter 11 protection over the past year. Opioid lawsuits and the threat of legislation that would curb surprise medical bills have exposed vulnerabilities at some highly leveraged health-care companies. Retailers continue to be pressured by the shift to online shopping. And a wave of financial distress has again hit the oil patch due in part to persistently low commodity prices.”

October 21 – Wall Street Journal (Gunjan Banerji): “Stocks and bonds have staged a rare simultaneous ascent, logging the best performance in a quarter-century. The S&P 500 has advanced 20% in 2019, while Treasurys have rallied. The last time the benchmark stock index rose more than 10% while the Treasury yield fell more than a percentage point in the first three quarters of the year was in 1995, according to Dow Jones Market Data. That trend continued as the fourth quarter kicked off… In data going back to 1984, the S&P 500, crude oil and gold have never jumped at least 10% together through the first three quarters of the year while the yield on the 10-year Treasury note fell more than 1 percentage point…”

October 21 – Bloomberg (Lu Wang and Sarah Ponczek): “High on the list of things bulls dread this earnings season is that it become the scene of a big downward cut in next year’s estimates. It happened last year, helping foment the worst fourth quarter of the bull market. And though it’s very early, it’s happening now. Despite a week of decent results, analysts last week chopped estimates for combined S&P 500 earnings in 2020 by almost $1, to $178.40 a share. Down 0.5%, the decline was the biggest for any week since January…”

October 22 – Reuters (Lindsay Dunsmuir): “U.S. home sales fell more than expected in September as the market continues to struggle with a dearth of properties for sale, especially for cheaper homes. The National Association of Realtors said… existing home sales fell 2.2% to a seasonally adjusted annual rate of 5.38 million units last month, reversing two straight months of gains. August’s sales pace was upwardly revised to 5.50 million units… There were 1.83 million homes in the market last month, a decline of 2.7% compared to a year ago. It was the fourth consecutive month of year-on-year inventory declines.”

October 23 – Bloomberg (Prashant Gopal): “Home prices in the U.S. are up 25% in five years, according to the S&P CoreLogic Case-Shiller index. Unlike during the property fever of the 2000s, new construction has been slow, so policymakers and even employers are reaching for ways to make housing affordable. There’s a similar trend in global cities.”

October 24 – Reuters (Lindsay Dunsmuir): “Sales of new U.S. single-family homes fell in September as low inventories continue to weigh on sales even as prices saw the biggest monthly fall in five years. …New home sales declined 0.7% to a seasonally adjusted annual rate of 701,000 units last month, matching expectations… The median new house price fell 8.8% to $299,400 in September from a year ago.”

October 23 – CNBC (Diana Olick): “Mortgage rates have been on a roller coaster in recent months, and last week’s climb caused a drop in mortgage demand. Mortgage application volume fell 11.9% compared with the previous week, according to the Mortgage Bankers Association’s seasonally adjusted index… Mortgage applications to purchase a home, which are less sensitive to weekly rate moves, fell 4% for the week but were 6% higher compared with the same week one year ago.”

October 24 – Reuters (Lindsay Dunsmuir): “New orders for key U.S.-made capital goods fell more than expected in September and shipments also declined, a sign that business investment remains soft amid the continuing fallout from the U.S.-China trade war. …Orders for non-defense capital goods excluding aircraft, which are seen as a measure of business spending plans on equipment, fell 0.5% last month on weak demand for transportation equipment, motor vehicle parts and computers and electronic products.”

October 19 – New York Times (Noam Scheiber): “At first glance, it may seem like a paradox: Even as the economy rides a 10-year winning streak, tens of thousands of workers across the country, from General Motors employees to teachers in Chicago, are striking to win better wages and benefits. But, according to those on strike, the strong growth is precisely the point. Autoworkers, teachers and other workers accepted austerity when the economy was in a free fall, expecting to share in the gains once the recovery took hold. In recent years, however, many of those workers have come to believe that they fell for a sucker’s bet, as they watched their employers grow flush while their own incomes barely budged.”

October 23 – Reuters (David Randall): “U.S. companies are responding to the lowest unemployment rate in almost 50 years by increasing their focus on automation in order to maintain healthy margins as labor costs tick higher, a Reuters analysis of corporate earnings transcripts shows. The attempt to save money through technology does not come down to just installing more robots in factories. Instead, companies appear to be confronting the lack of low-cost workers by investing in software and machines that can perform tasks ranging from human resources management to filling prescriptions.”

October 25 – Bloomberg (Adam Tempkin): “A growing percentage of Santander Consumer USA Holdings Inc.’s subprime auto loans are turning out to be clunkers soon after the cars are driven off the lot. Some loans made last year are souring at the fastest rate since 2008, with more consumers than usual defaulting within the first few months of borrowing, according to analysts at Moody’s... Many of those loans were packaged into bonds. Santander Consumer is one of the largest subprime auto lenders in the market.”

October 23 – Bloomberg (Reade Pickert): “The economy has added millions of jobs and pay gains have accelerated in recent years, but Americans aren’t crazy about their work. A poll released Wednesday showed just 40% of employed Americans say they’re in good jobs, versus 44% in mediocre jobs and 16% in bad jobs. How respondents ranked the quality of their job had a strong correlation with their quality of life: Seventy-nine percent of workers in good jobs report a high quality of life, versus only a third of those in bad jobs.”

October 22 – Reuters (Dominic Roshan): “U.S. companies’ borrowing to spend on capital investments rose 18% in September from a year earlier, the Equipment Leasing and Finance Association (ELFA) said… Borrowings rose 9% from the previous month. ‘Consumer spending continues to fuel the economy, notwithstanding signs of caution and concern raised by some over the impact of trade frictions with China, a pull-back in the U.S. manufacturing sector and recent geopolitical events in Syria, Hong Kong and elsewhere,’ ELFA Chief Executive Officer Ralph Petta said…”

China Watch:

October 25 – Bloomberg (Carolynn Look and Jenny Leonard): “China fired back at Vice President Mike Pence’s criticism on human rights, calling his speech ‘lies’ and chiding him for ignoring U.S. problems like racism and wealth disparity. Pence… gave a long-anticipated speech in which he criticized China’s actions against protesters in Hong Kong while calling for greater engagement between the world’s two biggest economies. He said the U.S. stands with demonstrators in Hong Kong and accused Beijing of curtailing the rights and liberties of the city’s residents. Hua Chunying, a spokeswoman for China’s foreign ministry, blasted Pence’s ‘arrogance’ and said no force would stop the country’s progress. She accused him of seeking ‘to disrupt China’s unity or internal stability’ and called Hong Kong, Taiwan and the far west region of Xinjiang ‘internal affairs.’ ‘The U.S. has already abandoned and cast aside its morality and credibility,’ Hua said. ‘We hope these Americans can look at themselves in the mirror to fix their own problems and get their own house in order.’”

October 21 – Reuters (Ben Blanchard): “China and the United States have achieved some progress in their trade talks, Vice Foreign Minister Le Yucheng said…, and any problem could be resolved as long as both sides respected each other. No country can prosper without working with other nations, Le said… The world wants China and the United States to end their trade war, he said. That required openness rather than a ‘de-coupling’ of countries or a new Cold War.”

October 21 – Bloomberg (Elena Popina and Tian Chen): “China’s central bank used open-market operations to inject the largest amount of cash into the banking system since May, as upcoming corporate tax payments tighten liquidity conditions. The People’s Bank of China on Tuesday net injected 250 billion yuan ($35bn) via seven-day reverse repurchase agreements…”

October 20 – Reuters (Yawen Chen and Ryan Woo): “New home prices in China grew at a steady pace in September, with fewer cities reporting price gains, a relief for policymakers who remain wary of high debt and bubble risk and are refraining from stimulating the sector as the economy cools… Average new home prices in China’s 70 major cities rose 0.5% in September from August… Home prices in September rose 8.4% from a year earlier, slowing from an 8.8% gain in August, and the slowest since September last year.”

October 20 – Bloomberg: “China’s home-price growth slowed for a fourth month in September, as cash-strapped developers cut prices to speed up sales… Prices in the secondary market, which is free from government intervention, suggest the slowdown may be more even more pronounced. Twenty-eight cities saw a drop in secondary house prices, the most in 3 1/2 years…”

October 20 – Reuters (Ryan Woo): “Many privately held firms in Shandong, China’s third-biggest province by economic output, are struggling to repay short-term debt due to declining industry fundamentals, entangled cross guarantees and ill-managed investments, S&P Global Ratings said. China’s slowing economy and enforcement of environmental protection rules have pressured the profitability and cash flow of Shandong companies in over-capacity sectors including oil refining, petrochemicals, steel, aluminium and textiles, S&P said.”

October 21 – Wall Street Journal (Jacky Wong): “A twist on traditional bank deposits has become wildly popular in China. Authorities are reining it in, once again treating the financial system’s symptoms without addressing the disease. The country’s banking regulator laid out tighter rules… on regulating so-called structured deposits, which amounted to 10.8 trillion yuan ($1.5 trillion) as of September. Yields on such deposits are linked to the prices of other assets from foreign currencies to commodities so they could potentially offer higher returns than conventional deposits. The amount outstanding had doubled since the end of 2016, outpacing 27% growth in traditional deposits overall. The new rules will make it harder for customers to put money into such deposits while creating more stringent criteria on who can offer them… Smaller banks will be particularly hard hit by the latest crackdown. Two-thirds of structured deposits in China are with them—some 8.2% of deposits…”

October 22 – Bloomberg (Manuel Baigorri): “China Inc. is struggling to offload overseas businesses and the accompanying debt in an increasingly volatile market. In just a few weeks, companies from yacht makers to luxury clothing and pizza outlets -- acquired by Chinese firms in recent years -- have either scrapped planned initial public offerings or sought alternatives to reduce their debt piles. Ferretti SpA, the Italian superyacht maker controlled by China’s SHIG–Weichai Group, shelved its planned Milan listing last week… Shandong Ruyi Technology Group Co., which spent over $4 billion on purchases including U.K. trench coat maker Aquascutum, introduced a local state-owned firm as its second-largest shareholder amid rising pressure to repay debt. Chinese firms started selling off assets two years ago when the government tightened curbs on capital outflows and stepped up scrutiny on foreign acquisitions…”

October 20 – Reuters (Aislinn Laing and Natalia A. Ramos Miranda): “China’s defence minister, Wei Fenghe, said… that resolving the ‘Taiwan question’ is his country’s ‘greatest national interest’, and that no force could prevent China’s ‘reunification’. Separatist activities are doomed to failure, Wei said... Tensions between China and Taiwan have ratcheted up ahead of the self-ruled island’s presidential election in January. Taiwan is China’s most sensitive territorial issue. ‘China is the only major country in the world that is yet to be completely reunified,’ Wei said.”

Central Banking Watch:

October 24 – Financial Times (Ayla Jean Yackley): “Turkey’s central bank… cut its benchmark interest rate by 2.5 percentage points, deeper than economists had expected, citing an improving inflation outlook.”

October 23 – Reuters (Dave Sherwood): “Chile´s central bank… slashed its benchmark interest rate to 1.75% from 2%, its third major rate cut since June, as protests over economic inequality rocked the South American nation.”

October 21 – Bloomberg (Dana Khraiche): “Lebanon’s central bank will slash $2.9 billion from the country’s local-currency interest payments and commercial lenders will pay a one-time tax under a government plan to wipe out the budget deficit almost entirely next year. Lebanon’s prime minister, finance minister and central bank governor will see the program through, the secretary general of the council of ministers, Mohammad Makiyeh, said in a televised news conference…”

Brexit Watch:

October 24 – Reuters (Kate Holton, Elizabeth Piper and Kylie MacLellan): “Prime Minister Boris Johnson called on Thursday for a general election on Dec. 12 to break Britain’s Brexit impasse, conceding for the first time he will not meet his ‘do or die’ deadline to leave the European Union next week. Johnson said in a letter to opposition Labour leader Jeremy Corbyn he would give parliament more time to approve his Brexit deal but lawmakers must back a December election, Johnson’s third attempt to try to force a snap vote.”

October 24 – Reuters (Guy Faulconbridge and Michel Rose): “The United Kingdom will ultimately leave the European Union on the terms of Prime Minister Boris Johnson’s deal, a senior Downing Street source said on Thursday, as EU leaders mulled offering London a three-month flexible Brexit delay. More than three years after voting 52%-48% to be the first sovereign country to leave the European project, the United Kingdom is waiting for the EU to decide how long the latest delay to Brexit should be.”

Europe Watch:

October 24 – Market Watch (Steve Goldstein): “The German economy is continuing to struggle…, with the difficulties of its export-oriented base extending to the service sector as global trade dries up. The IHS Markit flash German manufacturing PMI inched up to 41.9 in October from September’s decade-worst 41.7… The flash German services PMI meanwhile fell to a 37-month low of 51.2 in October from 51.4.”

EM Watch:

October 23 – Financial Times (Michael Stott): “Troops on the streets in Chile. Riots in Ecuador. Street protests in Argentina. Populism on the march in Brazil and Mexico. Bolivians burning ballot boxes. Political turmoil in Paraguay and Peru. While each of the crises breaking out across Latin America has some unique characteristics, there is one overarching reason: this is the world’s worst-performing region in terms of economic output. ‘Latin America is just not growing,’ said Shannon K O’Neil, senior fellow for Latin American Studies at the Council on Foreign Relations… ‘So the pie for everyone to share is not getting any bigger . . . It is not about ‘are they going left or right’ — even the best politicians are finding that there is not a lot to hand out, there is not a lot to work with.’ Chile is perhaps the best example of this phenomenon. Although it is one of Latin America’s best economic performers this year and frequently cited as a model of good macroeconomic policy, the capital Santiago experienced its worst violence in three decades last weekend as citizens vented their anger at entrenched wealth inequality and the high cost of living.”

October 22 – Bloomberg (Divya Patil): “A health check on India’s shadow banks shows the crisis in the industry is far from over. Indicators from liquidity to share performance show weakness… In recent weeks, another financier defaulted, it got harder for investors to cut losses in the sector’s debt and a mortgage lender altered financing plans due to waning appetite for shadow bank bonds. Banking system liquidity stayed lower last month, the premium that investors demand to hold shadow lender bonds over sovereign notes remained elevated and a custom gauge of shares of 20 financial firms and other companies impacted by the crisis was stagnant.”

October 22 – Bloomberg (Saritha Rai): “The dust had barely settled at Infosys Ltd. when Asia’s No. 2 software services firm once more found itself grappling with a potential leadership crisis. For the second time in about as many years, the Indian icon synonymous with the country’s technological ascendancy is being forced to answer accusations of impropriety. In the most recent of a stream of grievances aired anonymously over past years, whistle-blowers accused Chief Executive Officer Salil Parekh of instigating employees to inflate profits, mis-represent the lucrativeness of deals, even of abusing travel privileges.”

October 23 – Bloomberg (Anurag Joshi and Rahul Satija): “Indian companies have defaulted on a record 76 billion rupees ($1.1bn) of local-currency and international bonds so far this year after the shadow bank crisis triggered a credit squeeze, and it doesn’t look like the worst is over. Those firms that delayed or missed debt payments in 2019 still have the equivalent of $17 billion of notes and loans outstanding including the defaulted securities…”

Japan Watch:

October 24 – Reuters (Daniel Leussink): “Japanese factory activity shrank at the fastest pace in over three years in October, largely hurt by slumping new orders and output, in yet another sign of broadening economic cracks in the face of slowing global demand and trade frictions… The Jibun Bank Flash Japan Manufacturing Purchasing Managers’ Index (PMI) in October contracted at the quickest pace since June 2016, slipping to 48.5 on a seasonally adjusted basis from a final 48.9 in the previous month.”

October 20 – Reuters (Daniel Leussink): “Japan’s exports contracted for a 10th straight month in September, adding to speculation the central bank could ease monetary policy as soon as next week to support an economy hit by a slowdown in global demand… Exports in September slumped 5.2% from a year earlier…, dragged down by car and airplane parts to the United States and semiconductor production equipment to South Korea.”

Global Bubble Watch:

October 21 – CNBC (Yen Nee Lee): “Jamie Dimon, chief executive officer of U.S. banking giant J.P. Morgan Chase, told CNBC-TV18 that lowering interest rates is not a game-changer in driving up borrowing and lifting economic growth. ‘I think when they did it earlier on, there was a notion that we are saving the European Union, the monetary union, which is one thing. I think as a permanent part of policy, it is a really bad idea. It has adverse consequences which we do not fully understand,’ he said… Dimon joins the ranks of an increasing number of business executives and economists speaking up against adopting such a policy for long, as central banks around the world try to boost growth by continuing to slash interest rates, some into negative territory.”

October 21 – Bloomberg (Hannah Levitt): “More than half of the world’s banks are already in a weak position before any downturn that may be coming, according to a report from… McKinsey & Co. A majority of banks globally may not be economically viable because their returns on equity aren’t keeping pace with costs, McKinsey said in its annual review of the industry… It urged firms to take steps such as developing technology, farming out operations and bulking up through mergers ahead of a potential economic slowdown. ‘We believe we’re in the late economic cycle and banks need to make bold moves now because they are not in great shape,’ Kausik Rajgopal, a senior partner at McKinsey, said… ‘In the late cycle, nobody can afford to rest on their laurels.’”

October 23 – Bloomberg (Jan-Henrik Foerster and Nabila Ahmed): “In the M&A world, autumn is rainmaking season. This year, it’s looking like a drought. Takeover volumes since the start of September have fallen to the lowest level in eight years… The U.S. Labor Day holiday is typically the start of fall dealmaking, so that’s left bankers to worry whether CEOs will be able to shrug off the year’s anxieties and again consider transactions… There have been about $201 billion in takeovers announced globally since Sept. 1, down 33% year-on-year. That’s the lowest level for that period since 2011… And it isn’t just autumn jitters. Global takeover volumes have fallen 12% since the start of the year, to $1.8 trillion, with communications, utilities, energy and financial services deals down sharply.”

October 20 – Bloomberg (Jason Scott): “China should put the brakes on its lending in the South Pacific to avoid lumping economically vulnerable nations with unsustainable debt, according to a report released by an Australian think tank. ‘The sheer scale of China’s lending and its lack of strong institutional mechanisms to protect the debt sustainability of borrowing countries poses clear risks,’ the Lowy Institute said in a report... ‘China cannot remain a major lender in the Pacific at the same scale as in the past without fueling significant’ dangers, it said.”

Fixed-Income Bubble Watch:

October 20 – Wall Street Journal (Gunjan Banerji and Cezary Podkul): “In August, bond-ratings firms Moody’s Corp. and S&P Global Inc. predicted that Newell Brands Inc. would soon reduce its heavy debt load, allowing it to keep its coveted investment-grade bond rating. They made the same prediction in 2018. And in 2017. And in 2016. And in 2015, when the company announced a big merger that quadrupled its debt. Yet bond ratings for the maker of Rubbermaid containers and Sharpie markers haven’t budged… Amid an epic corporate borrowing spree, ratings firms have given leeway to other big borrowers like Kraft Heinz Co. and Campbell Soup Co., allowing their balance sheets to swell. ‘It’s pretty eye-popping if you’ve been doing this for 20-plus years, to see how much more leverage a number of these companies can incur with the same credit rating,’ said Greg Haendel, a portfolio manager at Tortoise… ‘There’s definitely some ratings inflation.’”

October 23 - Bloomberg Businessweek (Lisa Lee, Sally Bakewell and Katherine Doherty): “The collateralized loan obligation, or CLO, is one of those funky creations of Wall Street wizardry that have been around for decades. Just like its close cousin, the much-castigated collateralized debt obligation, it’s a tool used to package a bunch of high-risk debt together—mortgage bonds for CDOs, corporate loans for CLOs—so they can be easily sold to investors hungry for juicy returns. Unlike the CDO, the CLO made it through the financial crisis largely unscathed and has boomed in the decade since. Fueled by the unprecedented $3.5 trillion wave of private equity buyout deals during the past decade, and rock-bottom U.S. interest rates that only stoked investors’ willingness to gamble on riskier assets, the CLO market has more than doubled since 2010, to $660 billion. By providing abundant cheap funding to the less creditworthy end of the market, it’s helped grease the wheels of the longest economic expansion in U.S. history.”

October 20 – Wall Street Journal (Christopher M. Matthews): “Desperate for cash, shale companies are trying to court investors with a new and potentially risky financial instrument that resembles mortgage bonds. The companies are floating a type of asset-backed security that involves existing oil and gas wells. Producers transfer ownership interests in the wells to special entities that then issue bonds to be paid off by the output from the wells over time. Raisa Energy LLC, a Denver-based oil-and-gas company backed by private equity firm EnCap Investments LP, closed the first such offering in September and several others are planned… The bonds will pay nearly 6% interest on the best quality wells, the people said, with higher rates on riskier assets.”

October 19 – Bloomberg (Lisa Lee): “Leveraged loan investors are getting increasingly angsty, and their fear may be a harbinger of more pain coming in credit markets. Money managers are plowing into the least risky junk debt they can find while avoiding the junkiest. Since the start of October, lower rated B loans have dropped about 1%, while less risky BB rated loans have lost just 0.26% through Wednesday. An index of riskier loans is hovering near its lowest level relative to higher-rated loans since mid-2017, according to Credit Suisse… Leveraged loans of all stripes are performing worse than junk bonds, which have risen about 0.1% this month through Wednesday.”

Leveraged Speculation Watch:

October 20 – Bloomberg (Nisha Gopalan): “In its desperation to create more tech stars, South Korea’s government bears some of the blame for spreading moral hazard in the nascent local hedge-fund industry. Lime Asset Management Co., the country’s biggest hedge fund, has frozen $710 million in withdrawals and come under regulatory investigation while struggling to meet redemptions in a dangerously too-good-to-fail form of convertible bonds aimed at boosting tech startups. The government encouraged Lime and other funds to load up with such instruments, but they have found it extremely difficult to exit when a surge of investors have tried to pull out their money.”

Geopolitical Watch:

October 22 – Reuters (Darya Korsunskaya and Tuvan Gumrukcu): “Syrian and Russian forces will deploy in northeast Syria to remove Kurdish YPG fighters and their weapons from the border with Turkey under a deal agreed on Tuesday which both Moscow and Ankara hailed as a triumph. Hours after the deal was announced, the Turkish defense ministry said that the United States had told Turkey the withdrawal of Kurdish militants was complete from the ‘safe zone’ Ankara demands in northern Syria.”

October 19 – Reuters (Anne Marie Roantree and Marius Zaharia): “Police and pro-democracy protesters battled on the streets of Hong Kong on Sunday as thousands of people rallied in several districts in defiance of attempts by the authorities to crack down on demonstrators… Banks and other businesses linked to China were attacked and bonfires lit on Nathan Road, a main road running through the heart of the Kowloon peninsula. Police fired volleys of tear gas and baton charged demonstrators, and also hosed them down from water cannon.”

October 20 – Bloomberg (Juan Pablo Spinetto): “Latin America, the traditional poster child for political risk in financial markets, is back as a source of concern for investors. Chilean President Sebastian Pinera on Saturday became the second leader this month to declare a state of emergency, his hand forced by violent protests in South America’s wealthiest country after an increase in transportation costs. In Ecuador, unrest blew up after President Lenin Moreno ended fuel subsidies. Argentina, meanwhile, is back in the grip of capital controls after voters revolted against President Mauricio Macri’s budget-cutting agenda and handed his opponents a commanding lead ahead of presidential elections on Oct. 27.”

October 20 – Reuters (Aislinn Laing and Natalia A. Ramos Miranda): “Chile’s government will extend a state of emergency to cities in its north and south, President Sebastian Pinera said…, after at least seven people were killed amid violent clashes and arson attacks over the weekend. ‘We are at war against a powerful enemy, who is willing to use violence without any limits,’ Pinera said in a late-night televised statement at army headquarters…”

October 20 – Reuters (Samia Nakhoul and Laila Bassam): “Lebanese Prime Minister Saad al-Hariri agreed on Sunday a package of reforms with government partners to ease an economic crisis that has sparked protests aimed at ousting a ruling elite seen as riddled with corruption and cronyism.”

October 21 – Reuters (Allison Martell): “Canadian Prime Minister Justin Trudeau held on to his job in Monday’s election, securing his spot as one of the world’s few high-profile progressive leaders, but tarnished by scandal and with his power diminished.”