Weekly Commentary: Q4 2018 Z.1 "Flow of Funds"

I’ve been anxiously awaiting the Fed’s Q4 2018 Z.1 “Flow of Funds” report. It provided the first comprehensive look at how this period’s market instability affected various sectors within the financial system. From ballooning Broker/Dealer balance sheets to surging “repo” lending to record Bank loan growth – it’s chock-full of intriguing data. All in all, and despite a Q4 slowdown, 2018 posted the strongest Credit growth since before the crisis – led, of course, by our spendthrift federal government.

Non-Financial Debt (NFD) rose $2.524 TN during 2018 (5.1%), exceeding 2007’s $2.478 TN and second only to 2004’s $2.915 TN growth. NFD closed 2018 at a record 253% of GDP, compared to 230% to end of 2007 and 189% to conclude the nineties. By major category, Federal borrowings expanded $1.258 TN during the year, up from 2017’s $599 billion, and the strongest growth since 2010’s $1.646 TN. Year-over-year growth in Total Household borrowings slowed ($488bn vs. $570bn), led by a drop in Home Mortgages ($285bn vs. $312bn). Total Corporate borrowings slowed to $532 billion from 2017’s $769 billion. Foreign U.S. borrowings declined to $207 billion from 2017’s $389 billion.

On a percentage basis, NFD increased 4.51% in 2018, up from 2017’s 4.10%. Federal debt grew 7.58%, almost double 2017’s 3.74%, to the strongest percentage growth since 2012 (10.12%). Household debt growth slowed to 3.22% (from 3.90%), with Mortgage borrowings up 2.83% (from 3.19%) and Consumer Credit growth easing slightly to 4.88% (from 5.04%). Total Corporate Debt growth slowed meaningfully from 2017’s 5.71% to 3.69%.

For Q4, on a seasonally-adjusted and annualized basis (SAAR), Non-Financial Debt (NFD) expanded $1.390 TN, the slowest expansion since Q4 2016 (SAAR $941bn). This is largely explained by the sharp drop-off in Federal borrowings (SAAR $444bn vs. Q3’s SAAR $1.180 TN).

Outstanding Treasury Securities ended 2018 at a record $17.842 TN, up $1.411 TN (8.6%) for the year to 85% of GDP. Treasuries have surged $11.791 TN, or 195%, since the end of 2007. Agency Securities (debt and MBS) rose $245 billion during 2018 to a record $9.113 TN (2yr gain $592bn). In total, Treasury and Agency Securities surged $1.656 TN last year – accounting for a full two-thirds of total Non-Financial Debt growth. Combined Treasury and Agency debt ended 2018 at a record $26,955 TN, or 129% of GDP (vs. 2007’s $14.685 TN, or 92%).

Broker/Dealer assets surged nominal $165 billion, or 21% annualized, during the quarter, the biggest quarterly gain since Q1 2010. For the year, Broker/Dealer assets jumped $262 billion (8.4%) to $3.359 TN, the largest annual increase since 2007. Debt Securities holdings jumped by $147 billion during Q4, led by a $162 billion increase in Treasuries to $251 billion (more than doubling y-o-y).

The Household Balance Sheet remains a key Bubble manifestation, during the quarter providing a hint of how quickly perceived household wealth will evaporate during a bear market. Household Assets dropped $3.056 TN during Q4 to $120.9 TN, led by a $3.883 TN decline in total equities holdings (Equities and Mutual Funds). And with Liabilities increasing $133 billion during Q4, Household Net Worth fell $3.190 TN (the largest drop since Q4 2008’s $3.835 TN) to $104.869 TN. Household Real Estate holdings rose $279 billion during the quarter and were up $1.319 TN for 2018.

As large as Q4’s drop in Net Worth was, it erased only somewhat less than the previous six month’s gain. For all of 2018, Household Net Worth increased $1.876 TN, with a gain of $47.586 TN, or 65%, since the end of 2008. With equities already regaining the majority of Q4 losses, I don’t want to read too much into Q4 ratios. But it’s worth noting that Net Worth as a percentage of GDP dropped to 512% from Q3’s record 523% - yet remains significantly above previous cycle peaks (484% in Q1 2007 and 435% to end 1999).

The Rest of World (ROW) balance sheet is also fundamental to Bubble Analysis. For the year, ROW U.S. asset holdings declined $192 billion, the first drop since 2008. And while ROW holdings of total Equities declined $650 billion (mostly on lower prices), Corporate Debt fell $283 billion (also largest drop since 2008). Notable as well, ROW Treasury holdings declined $63bn (to $6.222 TN) in 2018 after jumping $282 billion in 2017.

Q4 market instability left its mark on Z.1 data. Broker/Dealer Assets surged SAAR $544 billion ($165bn nominal), the biggest quarterly gain since Q1 2010. Broker/Dealer Treasury holdings jumped nominal $162 billion (SAAR $685bn), the largest rise since the unstable global backdrop of Q4 2011. The Asset “Security Repurchase Agreements” (Repos) jumped nominal $150 billion (SAAR $602bn) to $1.315 TN, the high since Q4 2013. This was the largest gain since tumultuous Q3 2011. Repo Liabilities jumped $213bn (SAAR $851bn) to $1.698 TN – the high since Q1 2014. Q4’s Repo Liabilities increase was the largest going all the way back to Q1 2010.

The full category “Federal Funds & Securities Repurchase Agreements” ballooned $317 billion (SAAR $1.235 TN), the largest gain since Q1 2010. Fed Funds and Repo ended 2018 at $3.881 TN – an almost five-year high. Ballooning “repo” Assets and Liabilities – and Broker/Dealer balance sheets more generally – reflected Q4 market instability and illiquidity.

I’ll infer that the Broker/Dealer community was being called upon to provide liquidity – both through purchasing securities and offering securities Credit to the marketplace (leveraged speculating community, in particular). They were also forced to warehouse leveraged loans and such -awaiting the return of buyers. Moreover, it’s a fair assumption that major trading/liquidity issues were unfolding throughout the derivatives marketplace.

It’s worth noting that Goldman Sachs Credit default swap (5yr CDS) prices ended Q3 at 61 bps. Prices finished 2018 at 106 bps and then spiked to as high as 129 bps on January 3rd – the high since Q1 2016’s China/market tumult. After ending Q3 at 55 bps, Morgan Stanley CDS traded to 106 bps on January 3rd. Over this period, JP Morgan CDS jumped from 40 bps to as high as 78 bps, and Bank of America Merrill Lynch CDS spiked from 45 bps to 83 bps. Investment-grade corporate CDS also traded to highs since 2016, as did junk bond spreads. As I espoused at the time, there’s no mystery why Chairman Powell orchestrated his abrupt U-Turn on January 4th. The system was rapidly approaching the de-risking/deleveraging/derivatives dislocation/market illiquidity precipice.

It wasn’t only the Broker/Dealers and “repo” market that experienced noteworthy quarters. Bank Assets jumped nominal $267 billion, or 5.7% annualized, to a record $19.299 TN. Robust Bank growth was led by a record $263 billion (SAAR $868bn) surge in Loans (almost 10% annualized), surpassing the previous high ($260bn) back in the Bubble heyday Q3 2007. In addition, Bank “repo” assets (lending against securities) jumped a record $161 billion (SAAR $643bn) to $703 billion (high since Q3 ’08). Meanwhile, Debt Securities holdings rose $129 billion (SAAR $286bn), the biggest increase since Q1 2012 (ending the year at a record $4.304 TN). During the quarter, Banks added aggressively to Treasuries (up SAAR $246bn) and Agency- GSE-backed Securities (up SAAR $187bn), while liquidating Corporate Bonds (down SAAR $121bn). Between Broker/Dealer and Bank buying, there’s no mystery surrounding the Q4 collapse in Treasury yields.

Speaking of collapsing yields: German bund yields dropped 11 bps this week to 0.065%, trading to the lowest yields since October 2016. French yields sank 17 bps to 0.41% - also a low since 2016. Italian yields dropped 23 bps this week to 2.50%, the low since July.

March 7 – Reuters (Francesco Canepa, Frank Siebelt and Balazs Koranyi): “European Central Bank President Mario Draghi caught even dovish rate-setters off guard by pushing… for unexpectedly generous stimulus after forecasts showed a large drop in economic growth, four sources familiar with the discussion said. At its policy meeting, the ECB delayed its first post-crisis rate hike into 2020 and offered banks more ultra-cheap loans…”

Yet sinking yields weren’t limited to Europe. Ten-year Treasury yields dropped 12 bps to 2.63% - with yields now down five bps for the year. Japan’s JGB yields declined three bps to negative 0.3%, near early-January market instability lows.

The wide – and widening – divergence between booming risk markets and more than resilient safe haven sovereign bond prices narrowed just a bit this week. The Shanghai Composite was slammed 4.4% Friday (reducing y-t-d gains to 19.1%) on fears Beijing is increasingly alarmed by speculative securities markets. They should be. More dismal data (i.e. February exports down 16.6%) – along with indications that the U.S./China trade deal is not the done deal many have been presuming – pressured markets from China to the U.S. Mixed signals – i.e. paltry February job gains (20k) in the face of a stronger-than-expected ISM Non-Manufacturing index – provide little clarity regarding underlying U.S. economic momentum.

For the most part, markets have been mesmerized by a flock of dovish global central bankers – while ignoring gathering storm clouds. Yet Z.1 data are a reminder of how quickly the markets buckled back in the fourth quarter. By now, I’ll assume the vigorous short squeeze and unwind of hedges have pretty much run their course. It has me pondering the next leg down in the unfolding bear market.

At some point, it’s not going to be as easy for central bankers and Beijing to reverse faltering markets. A big surge in Broker/Dealer assets, “repo” and bank lending would prove problematic if, instead of recovering, markets continue sinking into illiquidity. Financial conditions would tighten dramatically. No junk – or investment-grade issuance. Q4 ETF outflows and derivative issues offered a hint of what’s to come. Foreign buyers have been losing interest in U.S. securities. And definitely don’t rule out a quick $10 TN drop in Household Net Worth – with attendant major economic ramifications. Silly me. Annual $2.0 Trillion federal deficits effortlessly monetized by our accommodating central bank will cure all ills – financial, economic, social, geopolitical and otherwise. Global policymakers will regret becoming so adept at stoking speculative excess.


For the Week:

The S&P500 fell 2.2% (up 9.4% y-t-d), and the Dow dropped 2.2% (up 9.1%). The Utilities increased 0.7% (up 8.8%). The Banks lost 3.1% (up 13.6%), and the Broker/Dealers sank 5.6% (up 7.4%). The Transports fell 3.3% (up 10.3%). The S&P 400 Midcaps dropped 3.4% (up 11.9%), and the small cap Russell 2000 sank 4.3% (up 12.9%). The Nasdaq100 declined 1.9% (up 10.8%). The Semiconductors fell 3.3% (up 14.1%). The Biotechs sank 5.4% (up 15.2%). With a volatile bullion gaining $5, the HUI gold index recovered 3.2% (up 5.9%).

Three-month Treasury bill rates ended the week at 2.39%. Two-year government yields dropped nine bps to 2.46% (down 3bps y-t-d). Five-year T-note yields sank 13 bps to 2.43% (down 8bps). Ten-year Treasury yields fell 12 bps to 2.63% (down 5bps). Long bond yields dropped 11 bps to 3.01% (unchanged). Benchmark Fannie Mae MBS yields sank 15 bps to 3.38% (down 12bps).

Greek 10-year yields rose 13 bps to 3.76% (down 59bps y-t-d). Ten-year Portuguese yields fell 14 bps to 1.35% (down 37bps). Italian 10-year yields sank 23 bps to 2.50% (down 24bps). Spain's 10-year yields dropped 15 bps to 1.05% (down 37bps). German bund yields fell 11 bps to 0.07% (down 17bps). French yields sank 17 bps to 0.41% (down 30bps). The French to German 10-year bond spread narrowed six to 34 bps. U.K. 10-year gilt yields dropped 11 bps to 1.19% (down 9bps). U.K.'s FTSE equities index was little changed (up 5.6% y-t-d).

Japan's Nikkei 225 equities index fell 2.7% (up 5.1% y-t-d). Japanese 10-year "JGB" yields declined three bps to negative 0.03% (down 4bps y-t-d). France's CAC40 slipped 0.6% (up 10.6%). The German DAX equities index declined 1.2% (up 8.5%). Spain's IBEX 35 equities index fell 1.5% (up 6.9%). Italy's FTSE MIB index declined 1.0% (up 11.8%). EM equities were mostly lower. Brazil's Bovespa index increased 0.8% (up 8.5%), while Mexico's Bolsa dropped 2.4% (down 0.1%). South Korea's Kospi index fell 2.6% (up 4.7%). India's Sensex equities index gained 1.7% (up 1.7%). China's volatile Shanghai Exchange declined 0.8% (up 19.1%). Turkey's Borsa Istanbul National 100 index dropped 1.7% (up 11.2%). Russia's MICEX equities index was little changed (up 5.0%).

Investment-grade bond funds saw inflows of $1.993 billion, while junk bond funds posted outflows of $1.907 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped six bps to 4.41% (down 5bps y-o-y). Fifteen-year rates gained six bps to 3.83% (down 11bps). Five-year hybrid ARM rates increased three bps to 3.87% (up 24bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.40% (down 19bps).

Federal Reserve Credit last week declined $10.6bn to $3.929 TN. Over the past year, Fed Credit contracted $425bn, or 9.8%. Fed Credit inflated $1.118 TN, or 40%, over the past 330 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $23.6bn last week to $3.466 TN. "Custody holdings" gained $25.6bn y-o-y, or 0.7%.

M2 (narrow) "money" supply rose $16.5bn last week to $14.480 TN. "Narrow money" gained $604bn, or 4.4%, over the past year. For the week, Currency declined $0.4bn. Total Checkable Deposits dropped $19.2bn, while Savings Deposits jumped $30.2bn. Small Time Deposits added $1.9bn. Retail Money Funds gained $4.0bn.

Total money market fund assets surged $33.9bn to $3.113 TN. Money Funds rose $256bn y-o-y, or 9.0%.

Total Commercial Paper declined $3.4bn to $1.067 TN. CP declined $26.4bn y-o-y, or 2.4%.

Currency Watch:

March 8 – Bloomberg (Tian Chen and Katherine Greifeld): “Hong Kong’s de facto central bank bought the local dollar for the first time since August after the city’s exchange rate fell to the weak end of its trading band against the greenback. The Hong Kong Monetary Authority spent HK$1.507 billion ($192 million)…”

The U.S. dollar index gained 0.8% to 97.306 (up 1.2% y-t-d). For the week on the upside, the Japanese yen increased 0.7% and the New Zealand dollar added 0.1%. For the week on the downside, the Brazilian real declined 2.3%, the Norwegian krone 2.1%, the Swedish krona 1.8%, the South African rand 1.5%, the British pound 1.4%, the euro 1.1%, the Mexican peso 1.1%, the South Korean won 1.0%, the Canadian dollar 0.9%, the Swiss franc 0.9%, the Australian dollar 0.5% and the Singapore dollar 0.3%. The Offshore Chinese renminbi declined 0.23% versus the dollar this week (up 2.08% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index was little changed (up 12.7% y-t-d). Spot Gold recovered 0.4% to $1,298 (up 1.2%). Silver rallied 0.6% to $15.349 (down 1.2%). Crude increased 27 cents to $56.07 (up 24%). Gasoline surged 4.1% (up 38%), while Natural Gas added 0.2% (down 3%). Copper declined 1.3% (up 10%). Wheat sank 3.9% (down 13%). Corn dropped 2.3% (down 3%).

Trump Administration Watch:

March 7 – Bloomberg (Saleha Mohsin and Emily Barrett): “President Donald Trump wants the stock market to celebrate if he strikes a trade deal with China. Investors may struggle to deliver. The outcome of the talks could fall short of the definitive resolution of trade tensions that equities investors have priced in. Instead, the most likely scenario is an accord with few details, or a paucity of specifics on which tariffs will stay and which may go. Or, as Secretary of State Michael Pompeo pointed out this week, Trump could walk away from the table during a meeting with China’s Xi Jinping -- as he did with North Korea’s Kim Jong Un -- potentially taking trade tension to a new level. The reality is that trade friction could remain a fixture of American policy.”

March 5 – Reuters (Susan Heavey): “U.S. President Trump will reject a U.S.-China trade deal that is not perfect, but the United States would still keep working on an agreement, U.S. Secretary of State Mike Pompeo said… ‘Things are in a good place, but it’s got to be right,’ Pompeo told Sinclair Broadcasting Group…”

March 8 – Wall Street Journal (Lingling Wei, Jeremy Page and Bob Davis): “A U.S.-China trade accord is facing a new roadblock, as Chinese officials balk at committing to a presidential summit until the two countries have a firm deal in hand, according to people familiar with Beijing’s thinking. A week ago, the sides appeared to be closing in on a draft accord. But Chinese leaders were taken aback by President Trump’s failed meeting in Vietnam with North Korean leader Kim Jong Un… Mr. Trump’s decision to break off those talks and walk away sparked concern that China’s President Xi Jinping could be pressured with take-it-or-leave-it demands at a potential summit at Mr. Trump’s Mar-a-Lago estate in Florida late this month, these people said. As a result, China wants a summit to be more of a signing ceremony than a final negotiating session that could break down…”

March 6 – Associated Press (Josh Boak and Christopher Rugaber): “The world’s two largest economies are locked in negotiations that may soon produce a deal to suspend their trade war. Yet despite signals from Chinese and U.S. officials that some truce could be forthcoming, there are few signs of any truly transformed trade relationship. Beijing’s longstanding policy of subsidizing its own businesses and charges that it illicitly obtains U.S. technology remain key obstacles to any meaningful U.S.-China trade deal. In the meantime, the government said… that the trade deficit in goods with China… hit a record $419.2 billion last year.”

March 5 – Associated Press (Martin Crutsinger): “The federal government recorded a budget surplus in January. But so far this budget year, the total deficit is 77% higher than the same period a year ago. The… deficit for the first four months of this budget year, which began Oct. 1, totaled $310.3 billion. That’s up from a deficit of $175.7 billion in the same period a year ago… The higher deficit reflected greater spending in areas such as Social Security, defense and interest payments on the national debt. Meanwhile, the government collected lower taxes from individuals and corporations…”

March 6 – Reuters (Lucia Mutikani): “The U.S. goods trade deficit surged to a record high in 2018 as strong domestic demand fueled by lower taxes pulled in imports, despite the Trump administration’s ‘America First’ policies, including tariffs, aimed at shrinking the trade gap. President Donald Trump is pursuing a protectionist trade agenda to shield U.S. manufacturing from what he says is unfair foreign competition. Trump, who has dubbed himself ‘the tariff man,’ pledged on both the campaign trail and as president to reduce the deficit by shutting out more unfairly traded imports and renegotiating free trade agreements. The Commerce Department said… that a 12.4% jump in the goods deficit in December had contributed to the record $891.3 billion goods trade shortfall last year. The overall trade deficit surged 12.5% to $621.0 billion in 2018, the largest since 2008.”

March 1 – Reuters (David Lawder and Alexandra Alper): “The Trump administration filed another salvo at the World Trade Organization…, saying U.S. trade policy was not going to be dictated by the international body and defending its use of tariffs to pressure China and other trade partners. A report drawn up by the U.S. Trade Representative outlining the White House’s trade agenda for 2019 said the United States will continue to use the… WTO to challenge what it sees as unfair practices. However, ‘the United States remains an independent nation, and our trade policy will be made here – not in Geneva. We will not allow the WTO Appellate Body and dispute settlement system to force the United States into a straitjacket of obligations to which we never agreed,’ the report said.’”

Federal Reserve Watch:

March 3 – Reuters (Katanga Johnson and Steve Holland): “President Donald Trump… renewed criticism of the Federal Reserve and said the U.S. central bank’s tight monetary policy was contributing to a strong dollar and hurting the United States’ competitiveness. ‘We have a gentleman that likes a very strong dollar at the Fed,’ Trump said at the annual Conservative Political Action Conference… ‘I want a strong dollar, but I want a dollar that’s great for our country not a dollar that is so strong that it is prohibitive for us to be dealing with other nations.’”

March 3 – Bloomberg (Saleha Mohsin): “President Donald Trump’s attempts to blame Federal Reserve Chairman Jerome Powell for any hiccups in the U.S. economy have made a comeback -- this time directed at his conservative base as he gears up for a tough 2020 re-election campaign… Trump may be lining up his hand-picked choice to lead the Fed as a scapegoat in case his trade and tax policies don’t succeed: firing off a series of tweets, interviews and off-the-cuff remarks -- unprecedented for an American president -- that have at times shaken financial markets.”

March 3 – Financial Times (Gavyn Davies): “The US Federal Reserve has announced that it will conduct a root and branch review of its monetary policy framework in the next 18 months. The results could be of first order importance for financial markets, especially the bond market. Richard Clarida, the Fed’s vice-chairman said last month that the motivation was not any great dissatisfaction with the present policy. Both of the twin objectives — maximum employment and stable prices — were close to target. Instead, the Federal Open Market Committee seems concerned that inflation is failing to respond to recovering economic activity, implying that it might be difficult to cope with even lower inflation when the economy next enters a recession.”

March 6 – Bloomberg (Matthew Boesler): “The Federal Reserve can afford to ‘wait’ and watch incoming data amid a slowdown in U.S. economic growth before making another monetary policy move, said New York Fed President John Williams. ‘The base case outlook is looking good, but various uncertainties continue to loom large,’ Williams said… ‘Therefore, we can afford to be flexible and wait for the data to guide our approach.’ Fed officials have signaled they’re undecided about whether they will continue raising interest rates this year…”

March 6 – Reuters (Michelle Price and Pete Schroeder): “The U.S. Federal Reserve said… it would no longer flunk banks based on operational or risk management lapses during its annual health check of the country’s domestic banks. The ‘qualitative’ portion of the 2019 test, however, will still apply to the U.S. subsidiaries of five foreign banks subject to the annual exam. The move, which is a big win for major banks, such as Goldman Sachs…, Morgan Stanley and JP Morgan, Bank of America and Citigroup, forms part of a broader effort by the Fed to overhaul its annual ‘stress-testing’ process…”

March 5 – Wall Street Journal (Michael S. Derby): “Dallas Federal Reserve leader Robert Kaplan said the rising level of borrowing by nonfinancial companies is something that is increasingly on his radar screen… ‘I will continue to closely monitor the level, growth and credit quality of corporate debt. Vigilance is warranted as these issues have the potential to impact corporate investment and spending plans,’ Mr. Kaplan said in an essay… Mr. Kaplan said he was sensitive to the issue of corporate debt because its growth comes at a time where U.S. government borrowing also has increased. ‘An elevated level of corporate debt, along with the high level of U.S. government debt, is likely to mean that the U.S. economy is much more interest rate sensitive than it has been historically,’ he wrote.”

U.S. Bubble Watch:

March 5 – Reuters (Andrea Ricci): “The U.S. federal government posted a $9 billion surplus in January… Analysts polled by Reuters had expected a $25 billion surplus for the month. The Treasury said federal spending in January was $331 billion, up 6% from the same month in 2018, while receipts were $340 billion, down 6% compared to January 2018. The deficit for the fiscal year to date was $310 billion, compared with $176 billion in the comparable period the year earlier. When adjusted for calendar effects, the budget was in balance in January 2019, compared with a $30 billion surplus the prior year.”

March 6 – Wall Street Journal (Paul Kiernan and Josh Zumbrun): “The U.S. trade deficit in goods hit a record in 2018, defying President Trump’s efforts to narrow the gap, as imports jumped and some exports, including soybeans and other farm products, got hammered by retaliation against U.S. trade policies. The deficit in goods grew 10% last year to $891.3 billion, the widest on record… U.S. trade gaps with China and Mexico, already the nation’s largest, reached new records. The picture looked less dire when services including tourism, higher education and banking are counted, though this deficit still deteriorated markedly. With services included, the trade gap grew 12% last year to $621 billion, the widest since 2008.”

March 8 – Reuters (Lucia Mutikani): “U.S. employment growth almost stalled in February, with the economy creating only 20,000 jobs, adding to signs of a sharp slowdown in economic activity in the first quarter. The meager payroll gains… were the weakest since September 2017, with a big drop in the weather-sensitive construction industry. They also reflected a decline in hiring by retailers and utility companies as well as the transportation and warehousing sector, which is experiencing a shortage of drivers.”

March 5 – Associated Press: “U.S. service companies grew in February at the fastest pace in three months, rebounding after a decline in January. The Institute for Supply Management, an association of purchasing managers, reported Tuesday that its service index rose to 59.7 percent last month, up from 56.7 % in January. The January reading was the lowest since July 2018…”

March 6 – Reuters (Howard Schneider): “Slowing global growth and the 35-day partial federal government shutdown weighed on the U.S. economy in the first weeks of 2019, but it continued growing amid still-tight labor markets, the Federal Reserve reported… ‘Economic activity continued to expand in late January and February,’ even as concerns took root at the U.S. central bank about a possible slowdown, the Fed said in its… ‘Beige Book’ compendium of anecdotes compiled from industry and business contacts around the country. The pace of growth was ‘slight-to-moderate’ in 10 of the Fed’s 12 districts, with those in Philadelphia and St. Louis reporting ‘flat economic conditions.’”

March 5 – KRON (Alexa Mae Asperin): “Welcome to the Bay Area -- where you (mostly, your rent) can only go up from here! If you thought rent in San Francisco couldn't get any higher -- you were very wrong. Apparently San Francisco rent has reached a new peak of $3,690, according to home and apartment rental app Zumper. That's also a rise of nearly 9% from the same time last year, the survey found…”

March 3 – Bloomberg (Sophie Alexander and Tom Maloney): “Kylie Jenner, the founder of Kylie Cosmetics, has become the world’s youngest self-made billionaire after her company signed an exclusive partnership with Ulta Beauty Inc. Jenner, 21, is worth $1.02 billion, according to the Bloomberg Billionaires Index, which assumes that she owns 90% of her company and ascribes the rest to her mother Kris, who takes a management fee in exchange for handling public relations and finance. Forbes, relying on a different methodology, reported earlier Tuesday that Jenner had achieved the milestone.”

China Watch:

March 7 – New York Times (Keith Bradsher and Ana Swanson): “President Trump says he is optimistic that a landmark trade deal with China is close. Chinese officials are not so sure. The two sides in recent weeks agreed to the broad outlines of an agreement that would roll back tariffs in both countries… The trade deal looks like a good one for Beijing, since it would largely spare the government from making substantive changes to its economy. But some of the biggest details — like the enforcement mechanism to ensure China complies and the timing for the removal of tariffs — still haven’t been hammered out. Beijing officials are wary that the final terms may be less favorable, especially given Mr. Trump’s propensity for last-minute changes…”

March 6 – Bloomberg: “China won’t make big concessions to the U.S. in order to seal a trade deal, former finance minister Lou Jiwei said…, calling some U.S. demands for change ‘unreasonable.’ ‘China’s concessions probably won’t be very big because a lot of their demands are what we already plan to reform,’ Lou, who was finance minister until 2016 and now runs the social security fund, said… Some U.S. demands are ‘just nitpicking,’ he said.”

March 5 – Wall Street Journal (Lingling Wei): “‘Made in China 2025,’ a government-led industrial program at the center of the contentious U.S.-China trade dispute, is officially gone—but in name only. During a nearly 100-minute speech to China’s legislature…, Premier Li Keqiang dropped any reference to the plan that the Trump administration has criticized as a subsidy-stuffed program to make China a global technology leader at the expense of the U.S. The policy had been a highlight of Mr. Li’s State-of-the-Nation-like address for three years running. Instead, Mr. Li said the government would promote advanced manufacturing. He ticked off a list of emerging industries to nurture—next-generation information technology, high-end equipment, biomedicine and new-energy automobiles—that were also in ‘Made in China 2025’ and with a similar goal: ‘Buy China.’”

March 5 – Bloomberg (Lu Wang and Melissa Karsh): “China needs to brace for a ‘tough economic battle ahead,’ in the words of its premier. It’s a struggle on two main fronts: there’s U.S. President Donald Trump and his demands to cut away support for state firms or face lingering tariffs, while at home there’s the tussle to help struggling private firms without ramping up debt to even more unsustainable levels. The plan to navigate those challenges was laid out Tuesday…, with Premier Li Keqiang giving himself and President Xi Jinping some wriggle room by lowering the economic growth target for 2019 to a range of 6 to 6.5%, down from ‘about’ 6.5% last year… In all, Li rolled out tax cuts worth almost 2 trillion yuan ($298bn) and pledged further stimulus ahead. While that emphasis on stronger fiscal policy can be seen as a loosening from last year’s vow to curb financial risks and trim the budget, the overall goal is still to buffer the economy without letting debt accelerate once more.”

March 8 – Bloomberg (Sofia Horta e Costa): “It started with a single sell rating on one stock. By the time China’s exchanges shut on Friday, equity investors were sitting on $345 billion of losses and the realization that Beijing is in no mood for another bubble. The bearish call on shares of a state-owned insurer, delivered by analysts at China’s biggest state-owned brokerage, was widely interpreted as a sign that the government wants this year’s world-beating surge in Chinese stocks to slow down. The Shanghai Composite Index tumbled 4.4%, snapping an eight-week winning streak…”

March 8 – Reuters (Samuel Shen and John Ruwitch): “China’s banking watchdog has punished two lenders for illegally channeling money into the stock market, the official Securities Times said on Friday, a possible signal that this year’s sharp share gains are prompting regulators to tight supervision.”

March 7 – Reuters (Stella Qiu and Ryan Woo): “China’s exports tumbled the most in three years in February while imports fell for a third straight month, pointing to a further slowdown in the economy and stirring talk of a ‘trade recession’, despite a spate of support measures… February exports fell 20.7% from a year earlier, the largest decline since February 2016…”

March 3 – Bloomberg: “China’s worst car-market slump in a generation is forcing manufacturers and dealers to resort to generous discounts and loan offers to lure buyers, as the slowdown hits automakers’ profits. Incentives and reductions equivalent to more than 10% of the sticker price are now commonplace and interest-free loan offers abound as carmakers and dealerships struggle to bring buyers back to showrooms… But buyers aren’t biting, with car sales continuing to decline this year after the first annual drop in more than two decades.”

March 5 – Wall Street Journal (Nathaniel Taplin): “Li Keqiang, China’s premier, has a few ideas for 2019: keep overall debt growth in check, cut taxes, accelerate government bond issuance, and boost lending to small businesses. If that sounds like a lot to ask—and contradictory—it is. Some of these goals will fall by the wayside. Getting banks to lend more to small businesses without overall credit growth accelerating will be near impossible. And significantly higher government debt sales will require more banking system liquidity to keep rates from rising… That means more monetary easing: probably not a 2015-like flood, but definitely a rising tide. Beijing rightly recognizes that its two previous rounds of stimulus in the past decade, funded largely off the government’s books through state bank loans to state-owned enterprises, created a lot of bad debt for the buck.”

March 4 – Reuters (Zhang Min and Lusha Zhang): “China set a 2019 budget deficit target that’s higher than last year’s ratio and said its fiscal policy would be more ‘proactive and effective’. The Ministry of Finance said… that it is targeting a budget deficit of 2.8% of gross domestic product (GDP) for this year, compared with 2018’s 2.6% target.”

March 4 – Bloomberg: “China signaled it may be open to loosening controls over the housing market, after President Xi Jinping’s mantra that property isn’t for speculation was omitted from a key report to the National People’s Congress. Xi’s famous vow that ‘houses are built to be inhabited, not for speculation’ didn’t appear in Premier Li Keqiang’s work report delivered Tuesday to the annual parliamentary gathering… Dropping the wording, which became ubiquitous after Xi used it in a speech in 2017, may spur speculation that the government will tolerate an easing of property curbs as it grapples with a sharp economic slowdown.”

March 5 – Financial Times (Don Weinland): “Chinese property developers have rushed back to the market for US dollar debt in the first two months of the year, more than doubling issuance to a record $19bn while stoking unease over rising leverage. Among the issuers are some of China’s most heavily indebted groups, such as Evergrande, Vanke Real Estate and Country Garden. As of last year, Evergrande alone had accrued nearly $100bn in debt. China’s property sector is a pillar of the country’s economy… As growth wanes, developers are raising more money than they need to roll over existing borrowings, amplifying concerns for the stability of the market. ‘Chinese developers have kicked the can down the road,’ S&P Global Ratings analyst Aeon Liang said in a report…”

March 3 – Bloomberg: “China’s sputtering growth has turned cash-strapped local government financing vehicles into darlings of the bond market. Just a couple of years ago, local government borrowing units’ debt was on everyone’s top worry list as authorities vowed to cut state backing for those platforms. Now, policy makers have again turned to them to carry out infrastructure projects to resuscitate the sluggish economy. Their resurgence to national importance status has underpinned the big rush into LGFV bonds. The bullish wave has pushed down yields on LGFVs’ debentures to below those of similarly rated corporate bonds, with the negative spread now just shy of the record reached in August 2016.”

March 4 – Bloomberg (Shuli Ren): “Investors trying to gauge how much appetite China has for stimulus should ignore official targets and look at local government bond issues instead… In reality, though, Beijing has found a new way to finance its spending, off the books and under the radar for outside observers. Special purpose bonds are the new fad. Just like debt issued by local-government financing vehicles, or LGFVs, these aren’t included in the balance sheets of municipal authorities… China tiptoed into these bonds in 2015, when Beijing was starting to phase out LGFVs… By the end of 2018, the country had amassed 7.4 trillion yuan ($1.1 trillion) of such bonds…”

March 7 – Reuters (Ben Blanchard): “China’s ruling Communist Party is ramping up calls for political loyalty in a year of sensitive anniversaries, warning against ‘erroneous thoughts’ as officials fall over themselves to pledge allegiance to President Xi Jinping and his philosophy. This year is marked by some delicate milestones: 30 years since the bloody crackdown on pro-democracy demonstrators in and around Tiananmen Square; 60 years since the Dalai Lama fled from Tibet into exile; and finally, on Oct. 1, 70 years since the founding of Communist China… ‘This year is the 70th anniversary of the founding of new China,’ Xi told legislators… ‘Maintaining sustained, healthy economic development and social stability is a mission that is extremely arduous.’”

Central Bank Watch:

March 5 – Bloomberg (Catherine Bosley): “The Bank for International Settlements cited recent volatility as another instance of the ‘extraordinarily tight’ relationship between policy makers and financial markets that it has questioned in the past. Economics chief Claudio Borio said the linkages in part explain the Federal Reserve’s decision to put interest-rate hikes on hold. He doesn’t criticize the decision, …but also says that as ‘central banks and financial markets dance locked in this embrace, it is sometimes hard to tell their steps apart.’ ‘Financial markets scrutinize central banks’ every word and deed, taking them as the cue for their ups and downs and seeking perennial comfort. Central banks, in turn, scrutinize financial markets to better understand what the future holds for the economy, as markets both reflect and influence activity -- a complex and delicate task.’”

March 7 – Financial Times (Martin Sandbu): “Here is one measure of the extraordinary period of monetary policy we live in: Thursday’s announcements by the European Central Bank mean Mario Draghi is now certain to complete his eight years as the bank’s president without ever having raised interest rates. He started his tenure by reversing the rises put in by his predecessor Jean-Claude Trichet. He will end it in November with rates remaining at their current record lows, which the ECB now promises to keep in place until the end of 2019 at the earliest. That is not the only dovish shift in Frankfurt. The ECB also reconfirmed it would keep constant the amount of financial securities it had acquired as part of its quantitative easing programme until well after interest rates begin to rise — which, given the interest rate announcement, amounts to a delay for when ‘quantitative tightening’ will finally start.”

March 5 – Reuters (Leika Kihara): “Bank of Japan board member Yutaka Harada said… the central bank would need to step up stimulus ‘without delay’ if risks to the economy threatened its efforts to hit its inflation target. But Harada, a vocal advocate of aggressive stimulus, warned it would be hard to affect public perceptions of future price moves with monetary policy alone.”

Brexit Watch:

March 6 – Reuters (Gabriela Baczynska): “Talks with Britain on amending its divorce deal with the European Union have made no headway and no swift solution is in sight, EU officials said…, a week before British lawmakers must vote on the plan to avoid a chaotic Brexit… ‘Things are not looking good,’ one diplomat said after EU negotiators briefed envoys on the previous evening’s talks... Another described the mood as ‘downbeat,’ although Brussels insiders were divided on whether May might yet accept an EU offer by next week — or risk an 11th-hour crisis at a summit on March 22.”

Europe Watch:

March 3 – Financial Times (Stephen Morris, David Crow and Olaf Storbeck): “On an uncharacteristically bright early February day in London, German finance minister Olaf Scholz and his deputy Jörg Kukies spent the afternoon holed up in a series of discreet meetings at their embassy… Amid the chandeliers, Teutonic tapestries and silver service… the duo quizzed a succession of investment bankers from the likes of Goldman Sachs and Bank of America on the issue consuming the German finance sector. Not the slowing economy. Not Brexit. But what can be done to revive Deutsche Bank? And could a merger with Commerzbank save them both? Since the financial crisis, the condition of the two 149-year-old Frankfurt-based lenders has become parlous.”

EM Watch:

March 5 – Financial Times (Colby Smith): “As if muddling through a humanitarian crisis and a sharpening political stand-off between authoritarian Nicolás Maduro and opposition leader Juan Guaidó weren’t bad enough, Venezuela will soon have to wade through what is said to be one of the messiest debt restructurings in history. What will make Venezuela’s forthcoming debt workout so difficult to resolve is not just the amount of IOUs sitting on its balance sheet, but the diversity of its creditor base. Like most metrics in Venezuela, these exact figures are difficult to come by. A new report by the Institute of International Finance (IIF) tries to address this… According to Sergei Lanau, the chief economist at IIF, Venezuela’s external debt has more than doubled in the last decade, from about $60bn in 2007 to roughly $160bn in 2018.”

March 4 – Reuters (Nevzat Devranoglu): “Turkey's economy shrank 2.7% in the fourth quarter, dragging full-year growth down to a below-forecast 2.55%, according to a Reuters poll…, and pulling the country towards recession after a currency crisis. The lira tumbled almost 30% against the dollar last year, driving annual inflation up to a 15-year peak of more than 25% in October.”

March 3 – Financial Times (Edward White): “South Korean manufacturing production slumped to its worst level in nearly four years in February…, in the latest sign of the downturn in global trade hitting economies across Asia. The Nikkei-Markit manufacturing purchasing managers’ index fell to 47.2 last month, from 48.3 in January…”

March 3 – Financial Times (Hudson Lockett): “A survey of Taiwan’s manufacturing sector has yielded the worst reading in three and a half years, with contraction sharpening as export orders tumbled at the fastest rate since November 2011 amid trade war and growth concerns. The Nikkei-Markit manufacturing purchasing managers’ index for Taiwan fell to 46.3 in February…”

March 4 – Reuters (Daina Beth Solomon, Dave Graham and David Alire Garcia): “Ratings agency Standard & Poor’s (S&P)… slashed the credit rating for Mexico’s national oil company Petroleos Mexicanos, or Pemex, piling more pressure on the government to tighten up the debt-laden oil firm’s finances. S&P followed the Pemex cut with lower credit outlooks for a range of major Mexican financial institutions and companies… The agency’s moves highlight overall concerns with the Mexican government’s debt load and spending plans… Mexican President Andres Manuel Lopez Obrador has in the past dismissed ratings agencies’ assessments, and he has repeatedly pledged to revive Pemex, which had financial debt of nearly $106 billion at the end of 2018.”

March 3 – Bloomberg (Michelle Jamrisko): “Seven of the top 10 most polluted cities in the world are in India, according to a new study showing South Asia’s battle with deteriorating air quality and the economic toll it’s expected to take worldwide. Gurugram, located southwest of India’s capital New Delhi, led all cities in pollution levels in 2018, even as its score improved from the previous year, according to data released by IQAir AirVisual and Greenpeace. Three other Indian cities joined Faisalabad, Pakistan, in the top five.”

Global Bubble Watch:

March 4 – CNBC (Michael Santoli): “As the 10th anniversary of the climactic March 2009 market bottom arrives this week, many observers are focusing on all the ways this period since the global financial crisis has been extraordinary. The worst economic shock in 75 years felled huge financial institutions, roiled international alliances and ushered in the most aggressive central bank stimulus efforts ever seen, with zero or negative interest rates and purchases of trillions in securities the norm worldwide. Yet perhaps more striking is how very typical this decade has been for stock market investors. Since the S&P 500 sank briefly to 666 on March 6, 2009, and reached its closing low of 676 three days later…”

March 8 – Reuters (Marc Jones): “A $10 billion wipeout over the last week has compounded the worst start to a year for equity flows since 2008, Bank of America Merrill Lynch strategists said… Citing data from flow-tracker EPFR, BAML’s analysts calculated that just over $60 billion has now been yanked out of equities this year. Almost $80 billion has been pulled from developed markets, while $18.5 billion has gone into emerging markets. They added that last week also saw the fourth-biggest inflow on record into ‘investment grade’ bonds at $9.5 billion and that ‘Europe = Japan’ - a reference to long-term anemic growth and low interest rates - was now the most consensus trade in the world by their calculations.”

March 5 – Reuters (Swati Pandey): “Australia’s top central banker sounded sanguine about a sharp slowdown in the country’s property market saying it was unlikely to derail momentum even as data showed the $1.3 trillion economy hit an airpocket last quarter. Domestic activity slowed sharply in the second half of last year…, with gross domestic product (GDP) rising 0.2% in the December quarter following a sub-par 0.3% in the previous three-month period. Annual GDP rose a below-trend 2.3%, the slowest pace since mid-2017…”

Fixed-Income Bubble Watch:

March 5 – Bloomberg (Thomas Beardsworth): “Swollen stocks of corporate debt in the riskiest investment-grade category leave markets vulnerable to a rout if economic weakness triggers bouts of rating downgrades, according to the Bank for International Settlements. Investment-grade bonds classed BBB by ratings firms – one step above junk status -- have proved popular with funds bound by their own rules to hold only low-risk securities. While central banks pursued cheap money policies in the years after the financial crisis, such bonds offered tempting yields while still falling into the low-risk category that made them eligible holdings. In 2018, BBB-rated bonds accounted for about 45% of U.S. and European mutual fund portfolios, up from 20 percent in 2010, according to the BIS.”

Leveraged Speculator Watch:

March 5 – Wall Street Journal (Gabriel T. Rubin): “The standard-setters for the derivatives industry plan to limit the use of a product sold to insure against corporate defaults, following disputes over whether some companies engineered a default to trigger payouts to investors. The proposal by the International Swaps and Derivatives Association is intended to block moves similar to one made between Blackstone Group and Hovnanian Enterprises Inc. Last year, Hovnanian moved to default on its debts to produce a payout to Blackstone’s GSO Capital Partners LP. Hovnanian was healthy enough to meet its payment obligations, prompting a campaign by regulators to get the parties to back down from the arrangement before it was completed.”

March 6 – Financial Times (Laurence Fletcher): “Hedge funds betting on big moves in global currency, bond and stock markets have not enjoyed the best of times of late. These so-called global macro funds are famous for swashbuckling bets such as George Soros’s $1bn profit wagering against the pound in 1992, or successful punts on US bond yields tumbling during the financial crisis. But the reality over much of the past decade has been far less thrilling. An index of mostly macro funds run by data group HFR, for instance, has lost money in two of the past six years, and in the remaining four its biggest gain has been just 5.2%. Funds such as Moore Capital, Graham Capital and H2O are among those that have suffered losses in recent years.”

March 5 – Bloomberg (Lu Wang and Melissa Karsh): “All year, evidence has built that professional money managers reformed their ways after last quarter’s equity rout. Hedge funds stepped back from the market. They put more faith in their stock-picking skills. In one regard, though, equity managers haven’t changed much. It’s their propensity to all own the same thing. That can be seen in a measure of crowdedness in the market that’s higher than it’s been in two years. Goldman Sachs assesses the trend by counting how many companies are among the 50 most-owned by hedge funds and mutual funds alike… Right now it’s 13, the most since early 2017.”

Geopolitical Watch:

March 7 – Financial Times (Rachel Sanderson and Davide Ghiglione): “Giovanni Tria, economy minister in Italy’s anti-establishment, Eurosceptic coalition, took to a stage in Rome before Christmas to praise China’s Belt and Road investment push. The Chinese initiative was creating ‘a circle of virtuous, satisfying and diffuse growth’, Mr Tria told an audience that included former prime ministers Romano Prodi and Enrico Letta, as well as ex-Chinese foreign ministry official Li Baodong. ‘The BRI is a train that Italy cannot afford to miss,’ Mr Tria said at the event, part of the influential Boao Forum.”

Friday Evening Links

[Reuters] Global stocks, dollar fall as global growth worries mount

[Reuters] Trump team has no plan to go to China for trade talks: official

[Reuters] Trump's budget to land with a thud on Monday

[Reuters] What stood out in the February U.S. jobs report

[Reuters] Wall Street's oldest-ever bull market turns 10 years old

[Bloomberg] China’s $345 Billion Stock Rout Shows Beijing’s Fear of Bubbles

[Bloomberg] The World Economy Just Had a Rough Week

[Bloomberg] The $10 Trillion Stock Rally Gets a Reality Check From Slow Growth

[NYT] The Jobs Report Was the Weakest in Months. Here’s Why.

[WSJ] U.S.-China Trade Talks Hit a Bump