“Congratulations Mr. Bernanke. I’m happy, my assets’ values go up. But as a responsible citizen I have to say the monetary policies of the U.S. will destroy the world.” Marc Faber, investor, analyst and writer extraordinaire, September 14, 2012, Bloomberg Television
The S&P 400 Mid-cap Index enjoyed a two-week gain of 5.7%, closing today at a new record high. The small cap Russell 2000 gained 6.5% in 9 sessions, with the Nasdaq composite up 3.8%. Notable sector gains include the 16.1% two-week surge by the S&P 500 Homebuilding index (up 99% y-t-d). The KWB Bank index jumped 9.4% in two weeks, increasing 2012 gains to 31%. The Morgan Stanley Cyclical index rose 8.1% over the past 9 sessions. The Morgan Stanley Retail Index gained 6.2% in two weeks and closed today at a record high (up 23.5% y-t-d). Gains have certainly not been limited to the U.S. Spain’s IBEX 35 index has gained 14.7% in 10 sessions, outgained by the 14.9% rise in Italy’s MIB index. Germany’s DAX has gained 10.9% in two weeks to increase y-t-d gains to 25.7%. India’s Sensex enjoyed a two-week gain of 8.8%, with South Korea’s Kospi up 7.0%, Brazil’s Bovespa up 9.4% and Mexico’s Bolsa up 7.2%.
Thursday morning, as markets waited anxiously for the release of the FOMC policy statement, a CNBC anchor noted that a Twitter “Bernanke” imposter had tweeted something along these lines: “I put my pants on in the morning just like anyone else, one leg at a time. And when I have my pants on - I print money!”
If I can chuckle perhaps it will hold back the tears. It’s difficult not to be reflective – to ponder how things could ever have come to this. Thursday was another historic day for policymaking, for markets and for the perpetuation of history’s most spectacular financial mania. In the past I’ve noted that, in comparable circumstances, I have viewed my 14-year weekly chronicle of history’s greatest Credit Bubble as pretty much a great waste of effort. I have tried to warn of the dangers of an unanchored global financial “system.” I’ve done my best to illuminate the dangerous interplay between an unwieldy global pool of speculative finance and aggressive “activist” central bankers. I have forewarned of the perils of discretionary (as opposed to rules-based) policymaking - in particular highlighting the (long ago appreciated) fear that too much discretion ensures that monetary policy mistakes will only be followed by yet greater mistakes. I took strong objection to Dr. Bernanke’s doctrine and framework when he arrived at the Fed in 2002 and protested in vein when he was appointed Federal Reserve Chairman in early-2006.
In my initial CBB back in 1999, I tried to explain how an unfettered explosion of non-bank liabilities was fueling a dangerous Credit Bubble. Back then the consensus view held that “only banks created Credit.” What little Bubble analysis that existed at the time focused chiefly on Internet stocks. I was arguing that a radically changing financial landscape called for a new “Contemporary Theory of Money and Credit.” I also warned that new finance beckoned for judicious monetary management. Some years later (2007) Pimco’s Paul McCulley introduced the world to the phrase “shadow banking.”
I’ve never been fond of the term “shadow banking,” believing that the entire line of analysis was missing (avoiding) the most critical aspects of contemporary finance. From my analytical perspective, the issue was not so much that there were financial entities and institutions operating outside traditional banking channels and regulation. Rather, the momentous transformation of financial sector liabilities from (“staid”) bank loans/deposits to (“dynamic”) marketable debt instruments/obligations was altering traditional relationship between finance, the financial markets, asset prices and real economies.
Importantly, unfettered Credit expansion was being driven by an explosion of securities and instruments changing hands – at, I might add, ever higher prices - in increasingly over-liquefied and ebullient markets. Certainly not coincidentally, this was unfolding concurrently with the unprecedented proliferation of hedge funds, proprietary trading operations, derivatives and so forth. Our central bank was oblivious.
The confluence of proliferations in marketable debt and leveraged speculation profoundly altered the financial landscape. Fundamentally, there were no longer any restraints on Credit expansion. The old “fractional reserve banking” “deposit multiplier” was supplanted by the “infinite multiplier” associated with contemporary marketable Credit.
Essentially, speculative financial leveraging created an unlimited supply of Credit/marketplace liquidity. Unlimited supply, then, led to a wholesale mispricing (under-pricing) of finance. This was particularly problematic for asset markets, where the over-abundance of cheap Credit fueled asset price inflation. Higher asset prices, then, created heightened demand for additional Credit, which was satisfied at ongoing low borrowing costs. As Credit will do if not restrained, it all became self-reinforcing – or “recursive.” And as the quantity of unlimited, mispriced and asset-centric Credit exploded, resources throughout the entire economy were badly misallocated. A decade or so ago I explained the dangers of “Financial Arbitrage Capitalism.” Somehow, the notion that our system needs only greater quantities of mispriced and misallocated finance has yet to be discredited.
It was apparent by 1999 that the Greenspan Federal Reserve needed to respond aggressively to the changed financial landscape. The non-bank lenders, especially the GSEs, Wall Street firms and hedge funds, needed to come under more intensive regulation. Either that or Fed monetary management had to tighten significantly as part of a policy of “leaning against the wind” of rampant Credit expansion and associated asset inflation and Bubbles. Mounting systemic excesses were beckoning for tough love – but the Fed became comfortable doling out candy. It was always my hope that the Federal Reserve would eventually appreciate and respond to the increasingly obvious dangers associated with contemporary unfettered Credit and financial leveraging. As of approximately 12:30 p.m. Thursday, the little sliver of remaining hope was officially pronounced dead.
Instead of moving prudently to rein in egregious Credit and speculative excess, the Greenspan/Bernanke Fed’s went in the opposite direction and repeatedly provided extraordinary accommodation. Amazingly, each bursting Bubble led to only more aggressive monetary largess and more power for dysfunctional (Bubble-prone) markets. Thursday’s policy move by the Bernanke Fed essentially indicates full capitulation to what has become a highly speculative global marketplace. There is at this point no doubt in my mind that we are witnessing the greatest monetary fiasco ever.
In early-2009 I pleaded, “While I understand the necessity of stemming financial collapse, please don’t go down the policy path of fueling a Treasury and government finance Bubble – one at the very heart of our Credit system.” Never at the time could I have imagined the extent to which the Bernanke Fed would be willing to inflate history’s greatest Bubble. Chairman Bernanke has gone from resorting to radical policies during a period of acute financial crisis to one of imposing only more radical policymaking three years into recovery. He has gone from trying to stem Credit contraction to aggressively promoting rapid (non-productive) Credit expansion. Dr. Bernanke has evolved from radical liquidity injections meant to reverse marketplace illiquidity, to pre-committing to years of open-ended money printing in the midst of heightened inflationary pressures and dangerously speculative financial markets. Of course, justification and rationalization are everywhere. History will be unkind.
I have no reason to doubt the commonly held view that Dr. Bernanke is a decent and honorable man. I wish he was a scoundrel – then perhaps someone would do something to rein him in. Many of our nation’s leading economist lavish praise on Dr. Bernanke latest move, while some, amazingly, say he still hasn’t done enough. Quite regrettably, it will require a terrible crisis for the establishment to change policy doctrine, along with economic analysis more generally.
There’s no reasonable justification for Dr. Bernanke taking such extreme risks with financial and economic stability. And I struggle to understand how he doesn’t see the likely consequences. After the cult of Greenspan, I thought we had learned a lesson from having one individual exert such power and influence. Indeed, the Federal Reserve has now grossly overstepped its role. Never was it anticipated that the Fed would resort to massive purchases of Treasury bonds and mortgage-backed securities in a non-crisis environment. Never was it contemplated that our central bank would resort to pre-committing to massive ongoing money printing in the name of reducing the unemployment rate.
I’ll state what others hesitate to admit: this week our central bank took a giant leap from radical to virtual rogue central banking. If Bernanke’s plan was to leapfrog the audacious Draghi ECB, our sinking currency – even against the euro – is confirmation of his success. If his goal was to provide markets a Benjamin Strong-like “coup de whiskey” – he should instead fear the dangerous instability central bankers have wrought on global markets and economies. And I am all too familiar to the adversities of being a naysayer in the midst of Bubble mania. I’ve read about it, I’ve lived it and I’m ok with it – and actually am motivated by it. I highlighted last week the ominous divergence between world fundamentals and the markets. And this week, well, global markets enjoyed just a spectacular time of it. Away from the Bloomberg screen, it sure seemed like a less than comforting week for the world at large.
As an analyst of Bubbles, I often quip that they tend to “go to incredible extremes - and then double.” Timing the bursting of a Bubble is a very challenging – if not nearly impossible – proposition. Yet this in no way should cloud the harsh reality that the longer a Bubble is accommodated the more devastating the unavoidable consequences. It is, as well, the nature of speculative manias for things to turn crazy in the destabilizing terminal-phase. The past few weeks – with more than ample Bubble accommodation and craziness - really make me fear that eventual day of reckoning.
For the Week:
The S&P500 jumped 1.9% (up 16.6% y-t-d), and the Dow rose 2.2% (up 11.3%). The broader market continued to outperform. The S&P 400 Mid-Caps rose 2.2% (up 16.8%), and the small cap Russell 2000 jumped 2.7% (up 16.7%). The Morgan Stanley Cyclicals surged 4.3% (up 16.5%), and the Transports jumped 2.8% (up 3.9%). The Morgan Stanley Consumer index added 0.8% (up 10.0%), while the Utilities declined 0.4% (down 0.7%). The Banks were up 4.8% (up 31.1%), and the Broker/Dealers were 4.5% higher (up 7.6%). The Nasdaq100 was up 1.1% (up 25.4%), and the Morgan Stanley High Tech index increased 2.1% (up 19.8%). The Semiconductors gained 1.3% (up 11.6%). The InteractiveWeek Internet index rose 2.3% (up 16.2%). The Biotechs increased 2.1% (up 41.5%). With bullion gaining $35, the HUI gold index jumped 7.0% (up 3.8%).
One-month Treasury bill rates ended the week at 7 bps and three-month bills closed at 9 bps. Two-year government yields were unchanged at 0.25%. Five-year T-note yields ended the week up 7 bps to 0.72%. Ten-year yields jumped 20 bps to 1.87%. Long bond yields rose 27 bps to 3.09%. Benchmark Fannie MBS yields dropped 6 bps to 2.23%. The spread between benchmark MBS and 10-year Treasury yields narrowed 26 to a record low 36 bps. The implied yield on December 2013 eurodollar futures declined 3.5 bps to 0.38%. The two-year dollar swap spread declined 3 to 12.5 bps, and the 10-year dollar swap spread sank 10 to 3 bps. Corporate bond spreads narrowed further. An index of investment grade bond risk dropped 7 to a 19-month low 83 bps. An index of junk bond risk sank 54 to a 14-month low 444 bps.
Debt issuance was exceptionally strong. Investment grade issuers this week included Walgreen $3.25bn, Merck $2.5bn, Transocean $1.5bn, Oneok Partners $1.3bn, Dominion Resources $1.15bn, News America $1.0bn, Tyco Flow Control $900 million, Nissan Motor Acceptance $750 million, Computer Sciences $700 million, Clorox $600 million, Conagra $500 million, Tech Data $350 million, Peco Energy $350 million, Agilent Technologies $400 million, Public Service Electric & Gas $350 million, Duke Realty $300 million, and Tuscon Electric Power $150 million.
Junk bond funds saw inflows rise to $951 million (from Lipper). Junk issuers included Reynolds Group $3.25bn, First Data $2.15bn, NRG Energy $990 million, Continental Rubber $950 million, Tesoro $925 million, Cablevision Systems $750 million, Midstate Petroleum $600 million, D.R. Horton $350 million, DJO $710 million, Ladder $325 million and American Gilsonite $270 million.
I saw no convertible debt issued.
International dollar bond issuers included Poland $2.0bn, Gazprom $1.5bn, Commonwealth Bank of Australia $3.25bn, Siam Commercial Bank $1.1bn, Drill Rig Holdings $800 million, Zambia $750 million, Korea Hydro & Nuclear $700 million, Iamgold $650 million, and Eurasian Development Bank $500 million.
Spain's 10-year yields jumped 16 bps to 5.73% (up 69bps y-t-d). Italian 10-yr yields declined 3 bps to 4.99% (down 204bps). German bund yields jumped 19 bps to 1.70% (down 12bps), and French yields rose 5 bps to 2.25% (down 89bps). The French to German 10-year bond spread narrowed 14 bps to 55 bps. Ten-year Portuguese yields declined 3 bps to 7.77% (down 501bps). The new Greek 10-year note yield sank 74 bps to 20.26%. U.K. 10-year gilt yields surged 28 bps to 1.96% (down one basis point). Irish yields were 40 bps lower to 5.08% (down 318bps).
The German DAX equities index jumped 2.7% (up 25.7% y-t-d). Spain's IBEX 35 equities index rose 3.5% (down 4.8%), and Italy's FTSE MIB gained 3.2% (up 10.2%). Japanese 10-year "JGB" yields declined 2 bps to 0.79% (down 19bps). Japan's Nikkei gained 3.2% (up 8.3%). Emerging markets were mostly much higher. Brazil's Bovespa equities index jumped 6.5% (up 9.4%), and Mexico's Bolsa increased 1.6% (up 9.8%). South Korea's Kospi index jumped 4.0% (up 10.0%). India’s Sensex equities index surged 4.4% (up 19.5%). China’s Shanghai Exchange slipped 0.2% (down 3.4%).
Freddie Mac 30-year fixed mortgage rates were unchanged at 3.55% (down 54bps y-o-y). Fifteen-year fixed rates slipped one basis point to 2.85% (down 45bps). One-year ARMs were unchanged at 2.61% (down 20bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.19% (down 60bps).
Federal Reserve Credit rose $8.3bn to $2.806 TN. Fed Credit was down $38bn from a year ago, or 1.3%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/12) slipped $1.9bn to $3.577 TN. "Custody holdings" were up $157bn y-t-d and $102bn year-over-year, or 2.9%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $380bn y-o-y, or 3.7% to a record $10.609 TN. Over two years, reserves were $2.030 TN higher, for 24% growth.
M2 (narrow) "money" supply jumped $17bn to a record $10.089 TN. "Narrow money" has expanded 6.8% annualized year-to-date and was up 6.3% from a year ago. For the week, Currency increased $1.3bn. Demand and Checkable Deposits jumped $96.6bn, while Savings Deposits sank $78.6bn. Small Denominated Deposits declined $2.5bn. Retail Money Funds were little changed.
Total Money Fund assets increased $8.0bn to $2.578 TN. Money Fund assets were down $117bn y-t-d and $55bn over the past year, or down 2.1% y-o-y.
Total Commercial Paper outstanding declined $6.6bn to $1.015 TN. CP was up $56bn y-t-d, while having declined $28bn from a year ago, or down 2.7%.
Currency Watch:
The U.S. dollar index dropped 1.8% to 78.847 (down 1.7% y-t-d). For the week on the upside, the euro increased 2.5%, the Danish krone 2.4%, the Mexican peso 2.1%, the New Zealand dollar 2.0%, the Swiss franc 1.9%, the Australian dollar 1.6%, the Taiwanese dollar 1.3%, the British pound 1.3%, the Singapore dollar 1.3%, the South Korean won 1.3%, the Brazilian real 0.8%, the Canadian dollar 0.7%, the Swedish krona 0.6% and the Norwegian krone 0.6%. On the downside, Japanese yen declined 0.2% and the South African rand 0.4%.
Commodities Watch:
September 12 – Bloomberg (Jeff Wilson): “The U.S. soybean crop will drop to the lowest in nine years after the hottest and driest June and July in the Midwest since 1936, the government said. Prices rose the most in three weeks. The harvest will total 2.634 billion bushels (71.69 million metric tons), down from 3.056 billion in 2011 and the lowest since 2003… ‘A third straight year of reduced U.S. production means soybean buyers face an unprecedented tight supply for the next 12 months,’ Jerry Gidel, the chief feed-grain analyst at Rice Dairy LLC in Chicago…”
September 12 – Bloomberg (Supunnabul Suwannakij and Luzi Ann Javier): “Thailand, the world’s largest rice shipper, will sell more than half of its record inventory to governments including China, according to Commerce Minister Boonsong Teriyapirom… The country will sell a total of 7.328 million metric tons…”
September 14 – Bloomberg (Debarati Roy and Maria Kolesnikova): “Platinum rose, capping the longest rally in 25 years, after the Federal Reserve took steps to bolster the U.S. economy and as strikes halted output at mines in South Africa, the world’s largest producer.”
The CRB index jumped 3.0% this week (up 5.1% y-t-d). The Goldman Sachs Commodities Index rose 2.6% (up 7.6%). Spot Gold jumped 2.0% to $1,770 (up 13.2%). Silver gained 2.9% to $34.66 (up 24%). October Crude jumped $2.58 to $99.00 (unchanged). October Gasoline was little changed (up 14%), while October Natural Gas surged 9.7% (down 1%). December Copper jumped 5.1% (up 12%). September Wheat added 1.4% (up 38%), while September Corn declined 2.2% (up 20%).
Global Credit Watch:
September 12 – Bloomberg (Karin Matussek): “Germany’s top constitutional court rejected efforts to block a permanent euro-area rescue fund, handing a victory to Chancellor Angela Merkel, who championed the 500 billion-euro ($645bn) bailout. The Federal Constitutional Court in Karlsruhe dismissed motions that sought to block the European Stability Mechanism, while ruling Germany’s 190 billion-euro contribution can’t be increased without legislative approval. The court said Germany can ratify the ESM if it includes binding caveats that it won’t be forced to assume higher liabilities without its consent. ‘We are an important step closer to our goal of stabilizing the euro,’ German Economy Minister and Vice Chancellor Philipp Roesler told reporters… ‘It has always been the goal of this government’ to establish a ‘clear limit and to include parliament in all important decisions.’”
September 14 – Bloomberg (Emma Ross-Thomas): “Spanish regions’ debt load continued to swell in the second quarter, as the cash-strapped local administrations urged the government to speed up its planned bailout fund. The regions’ debt rose to 14.2% of gross domestic product from 13.8% in the first three months of the year, the Bank of Spain in Madrid said… The overall public debt load rose to 75.9% of GDP from 72.9% in the prior quarter.”
September 11 – Bloomberg (Ben Sills): “Prime Minister Mariano Rajoy said he won’t allow the European Union or the European Central Bank to stipulate how Spain narrows its budget deficit as a condition for buying the country’s bonds. Rajoy pledged that Spain will meet its targets for reducing its budget shortfall this year and next and defended his government’s right to set spending limits on individual policies, in his first television interview since taking office in December. ‘We need to meet the budget deficit commitment, which is the most important challenge we have as a country,’ Rajoy said… ‘I won’t accept them telling us which are the specific policies where we have to cut or not.’”
September 12 – Bloomberg (Emma Ross-Thomas): “Spanish leaders said they can delay a decision on seeking a bailout as its bond yields ease, with their focus on ensuring any rescue doesn’t roil markets. Prime Minister Mariano Rajoy told Parliament it’s not clear if Spain needs help as the European Central Bank’s crisis plan has cut borrowing costs. There’s no ‘urgency’ because the ECB’s move put the Treasury in a more ‘comfortable’ position, Deputy Economy Minister Fernando Jimenez Latorre said. ‘The important thing is that when whatever assistance that is needed is requested, that it should be well received in the markets,’ Jimenez Latorre told reporters…”
September 14 – Bloomberg (Ben Sills and Emma Ross-Thomas): “Catalan President Artur Mas said Spain should debate staying in the euro as leaders consider seeking a European bailout, becoming the most senior Spanish official to question the nation’s single-currency membership. ‘If we want to have a serious debate, the first question has to be whether we want to be in the euro or not,’ Mas said… ‘If you say yes, you have to accept the rules of this game. You could say no.’ Catalonia, which accounts for 20% of the nation’s economy and is home to some of the country’s biggest companies, is battling Prime Minister Mariano Rajoy for greater control over taxes as austerity measures have undermined voters’ willingness to subsidize poorer regions. Mas raised the stakes this week, saying if Rajoy doesn’t give his administration in Barcelona greater autonomy, he’ll push for full independence. Mas said Catalonia and Spain are ‘tired of each other’…”
September 13 – Bloomberg (Jeff Black and Stelios Orphanides): “European Central Bank Governing Council member Panicos Demetriades said the bank might not have to spend a cent on government bonds. The threat of unlimited buying under the ECB’s new bond- purchase program may mean that ‘in the end, action is not needed,’ Demetriades, who heads the Central Bank of Cyprus… ‘No one will speculate against the unlimited firepower of a central bank. This is what stabilizes currencies of countries where investors know that. One wouldn’t gamble against the Federal Reserve, for example.’ Spanish and Italian bond yields have plunged since ECB President Mario Draghi pledged on July 26 to do what’s needed to preserve the euro.”
Global Bubble Watch:
September 13 – Wall Street Journal (Jon Hilsenrath and Kristina Peterson): “The Federal Reserve, frustrated by persistently high U.S. unemployment and the torpid recovery, launched an aggressive program to spur the economy through open-ended commitments to buy mortgage-backed securities and a promise to keep interest rates low for years. In the most significant of its new moves, the Fed said Thursday it would buy $40 billion of mortgage-backed securities every month and would keep buying them until the job market improves, an unusually strong commitment by the central bank. ‘We want to see more jobs,’ Fed Chairman Ben Bernanke said… explaining the rationale for the Fed's actions. ‘We want to see lower unemployment. We want to see a stronger economy that can cause the improvement to be sustained.’ The Fed's announcement sent investors piling into stocks, gold, the euro and other assets seen as likely to benefit from the extra liquidity."
September 14 – Associated Press: “Egan-Jones is downgrading its rating on U.S. debt to AA- from AA, citing Federal Reserve plans to try to stimulate the economy. The credit rating agency says the Fed's plans to buy mortgage bonds will likely hurt the economy more than help it. Egan-Jones says the plan will reduce the value of the dollar and raise the price of oil and other commodities, hurting businesses and consumers.”
September 14 – Bloomberg (Sarika Gangar): “Corporate bond offerings in the U.S. soared this week to the busiest pace in six months as borrowing costs tumbled and the Federal Reserve unleashed its third round of quantitative easing to stimulate the economy. Walgreen… and …AstraZeneca Plc led borrowers selling at least $43.2 billion in bonds, the most since $60 billion was issued in the week ended March 9… Yields on speculative-grade debt dropped to an unprecedented low, breaking the previous record set more than 15 months ago.”
September 11 – Bloomberg (Bradley Keoun): “JPMorgan… and Bank of America… are helping clients find an extra $2.6 trillion to back derivatives trades amid signs that a shortage of quality collateral will erode efforts to safeguard the financial system. Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market. The solution: At least seven banks plan to let customers swap lower-rated securities that don’t meet standards in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed ‘collateral transformation.’ That’s raising concerns among investors, bank executives and academics that measures intended to avert risk are hiding it instead. ‘The dealers look after their own interests, and they won’t necessarily look after the systemic risks that are associated with this,’ said Darrell Duffie, a finance professor at Stanford University who has studied the derivatives and securities-lending markets. ‘Regulators are probably going to become aware of it once the practice gets big enough.’”
September 11 – Bloomberg (John Detrixhe): “Moody’s… said it may join Standard & Poor’s in downgrading the U.S.’s credit rating unless Congress next year reduces the percentage of debt- to-gross-domestic-product during budget negotiations. The U.S. economy will probably tip into recession next year if lawmakers and President Barack Obama can’t break an impasse over the federal budget and if George W. Bush-era tax cuts expire in what’s become known as the ‘fiscal cliff,’ according to a report by the nonpartisan Congressional Budget Office…”
September 14 – Bloomberg (Lisa Abramowicz): “Measures of [bond market] stress are at the lowest in more than two years following Federal Reserve Chairman Ben S. Bernanke’s unveiling of additional stimulus measures.”
September 14 – Bloomberg (Lisa Abramowicz): “Ben S. Bernanke is sending junk-bond bears into hiding. The number of shares borrowed to bet against State Street Corp.’s exchange-traded high-yield bond fund has plunged 49% since Aug. 30, pushing its price to a 15-month high… The most distressed securities are outperforming the highest speculative- grade tier this month by the most since February…”
September 12 – Bloomberg (Josiane Kremer): “Norway’s banks may face stricter lending rules as the country’s financial regulator fights to prevent a repeat of a 1980s housing market bust that triggered a banking crisis and plunged the economy into a recession. ‘The longer a situation where debt is growing more than income and housing prices grow substantially more than income, the higher the risk is for this development to end in a bubble that eventually bursts,’ Morten Baltzersen, director general at the Financial Supervisory Authority, said… ‘This development gives reason for concern.’ Property prices, already at a record, are rising an annual 8% on average as credit growth drives private debt burdens to more than 200% of disposable incomes next year, the central bank estimates. The FSA is stepping up its warnings one year after urging banks to rein in lending in the world’s third-richest nation per capita amid evidence overheating is threatening financial stability.”
September 14 – Bloomberg (Shamim Adam): “The Federal Reserve’s third round of quantitative easing prompted Hong Kong to say the monetary stimulus risks pushing up the city’s property prices while Thailand said it was a ‘good sign’ for the global economy. ‘The launch of QE3 and the short-term improvement of the European debt crisis will increase the risk of overheating in Hong Kong’s asset market,’ Norman Chan, chief executive of the Hong Kong Monetary Authority, said…”
Germany Watch:
September 13 – Reuters: “Eurosceptical German media said… the country’s top court had cast doubt on the legality of European Central Bank bond-buying in a ruling upholding the euro zone's bailout fund widely seen as political victory for Chancellor Angela Merkel. The Federal Constitutional Court gave the green light… to the European Stability Mechanism (ESM) in a verdict that brought relief to anxious financial markets. The respected judges insisted the German parliament must have a veto right over any increase in Berlin's contribution to the 500 billion euro ($644bn) ESM. But conservative newspapers opposed to bailouts of troubled euro zone member states highlighted a passage of the ruling which said that ECB bond-buying or leveraging the ESM at the central bank could be illegal. The judges said that for the ESM to deposit government bonds at the ECB as a security for loans would violate an EU treaty ban on direct financing of governments, effectively ruling out giving the rescue fund a bank licence as France has proposed. They also said ECB bond-buying on the secondary market ‘aiming at financing the members' budgets independently of the capital markets is prohibited as well, as it would circumvent the prohibition of monetary financing’. Some German legal experts saw this as a veiled threat to the ECB…”
September 11 – Bloomberg (Dalia Fahmy and Tony Czuczka): “Billionaire investor George Soros said Berlin homes are at risk of becoming overvalued because demand is being fueled by buyers seeking a safe place to put their money amid the European sovereign-debt crisis. ‘You have a serious danger of a housing bubble developing in Berlin,’ he said… ‘It has a lot to do with the flight of capital and negative real interest rates.’ Private-equity firms, affluent individuals and insurance companies are buying Berlin apartments, attracted by cheaper prices than other European cities, a stable economy and a dearth of alternatives as central banks keep interest rates at record lows. Apartment prices in Berlin jumped about 17% in the past 12 months, compared with a 7% nationwide increase…”
China Watch:
September 11 – Bloomberg: “China’s new lending was the highest of any August on record as the government tries to reverse an economic slowdown that threatens to cost jobs and undermine support for the Communist Party. New local-currency lending was 703.9 billion yuan ($111bn) last month… That was more than the 600 billion yuan median estimate… and 540 billion yuan in July. The pickup in lending follows interest-rate cuts in June and July, government approvals for subway and road projects and a warning from the labor ministry that the slowdown is starting to hit the job market.”
September 12 – Bloomberg: “Chinese banks’ profitability may ‘slump’ over the next few years as the economy falters after lenders built up ‘massive latent credit risks,’ Standard & Poor’s said. Rising corporate delinquencies, narrower net interest margins and ‘increasingly strained’ liquidity management will test the resilience of Chinese banks over the next three to five years, the… ratings company said… China’s 3,800 banks last month reported an increase in total non-performing loans for a third straight quarter, the longest deterioration in eight years, while profit growth slowed to 23% in the second quarter from 24% in the previous three months… ‘A credit turndown is unfolding in China,’ S&P’s Hong Kong-based analyst Ryan Tsang wrote… ‘Massive market-driven consolidation may be in the cards for many players as credit quality becomes dramatically polarized.”
September 12 – Bloomberg: “Massive stimulus measures would be ‘detrimental’ to China’s sustainable economic growth, the official Xinhua News Agency wrote… While growth in the world’s second-biggest economy has slowed for six-straight quarters, such fiscal spending is unlikely, according to Xinhua. Authorities are aware of the limitations of a possible stimulus plan, Xinhua writer Liu Jie said… The 4 trillion yuan stimulus in 2008 led to large local-government debts and bad loan risks… This time steps are focused on invigorating the private sector and market forces through measures including tax cuts… There is room for further interest rate cuts, Xinhua added”
September 14 – Bloomberg: “China’s largest steel mills are resorting to the most short-term funding in at least three years as slumping profits make it harder to repay debt. Listed steelmakers had 35% more outstanding loans maturing within 12 months on June 30 than a year earlier, according to a Sept. 4 report from China International Capital Corp. The number reporting net negative cash flow rose to 21 from 10… ‘This is a bad sign for the steelmakers, as they may be forced to tap short-term loans to pay off longer-term debt,’ said Luo Wei, an analyst at CICC. ‘If the current situation lasts for two to three years, it would become a big issue for their liquidity.’”
September 13 – Bloomberg: “To live out his retirement years, He Zhongkui was counting on steady income from an investment that promised interest payments five times higher than what he could earn in a Chinese bank. Now He, a 62-year-old former municipal official in Wenzhou who rides a rusty bicycle, is cutting back on food and gasoline, having found himself one of a growing number of victims of China’s nebulous world of shadow banking. A ‘friend,’ who he said had been paying him 2,400 yuan ($379) a month after He gave him one-third of his 600,000-yuan life savings to invest in real estate, suddenly disappeared. So did the payments and principal. ‘I called, but the number was no longer in existence,’ said He… China’s slowest economic growth in three years and a slumping property market, where many so-called shadow-banking investments are parked, are squeezing millions of Chinese who have invested the money of friends and acquaintances chasing higher yields to honor those payments. The slowdown also is putting pressure on the government to rein in private lending to avoid a spate of defaults that could increase the number of victims and lead to social unrest.”
India Watch:
September 13 – Bloomberg (Unni Krishnan): “India’s growth outlook is waning as the longest fall in capital-goods output since 2009 signals weaker investment, adding pressure on Prime Minister Manmohan Singh to salvage his development agenda. Capital-goods production… slid in July for a fifth straight month, the longest stretch since declines over most of 2009… India’s economic growth potential may have fallen to 6% to 6.5% a year, below the Reserve Bank of India’s 7.5% estimate, JPMorgan Chase & Co. said. Singh’s attempts to implement policies to revive investment have been derailed by his fractious ruling coalition and graft allegations that paralyzed Parliament. Inflation near 7% has limited room for interest-rate cuts…”
September 12 – Bloomberg (Unni Krishnan): “Indian industrial production rose less than economists estimated in July, adding to signs that Asia’s third-largest economy is faltering. Production at factories, utilities and mines climbed 0.1% from a year earlier...”
Latin America Watch:
September 12 – Bloomberg (Raymond Colitt): “Brazil’s banking industry is ceding market share to the government as state-controlled rivals boost lending as part of President Dilma Rousseff’s bid to stoke growth in Latin America’s biggest economy. State banks led by Banco do Brasil SA and Caixa Economica Federal increased loans 12.3% this year through July, almost four times the 3.4% pace for non-government lenders. That helped boost state-backed lenders’ share of outstanding loans to 45.4%, the most since 2000… Non-state banks are extending loans at the slowest pace in three years, ignoring the most aggressive interest-rate cuts among Group of 20 nations as default rates soar and lending margins shrink to the narrowest since December 2007. Brazil, whose 17.7% annual credit growth in July exceeded China’s 16.1% increase, risks saddling the state banks with bad loans and prompting non-government lenders to retrench at a time when Rousseff is seeking to revive an economy posting its slowest growth since 2009, according CIBC World Markets.”
September 14 – Bloomberg (Gabrielle Coppola and Blake Schmidt): “In Brazil’s new bond market for infrastructure projects, the nation is counting on its own investors to spark demand for debt intended to finance a half-trillion dollars of roads, factories and airports… Brazil is seeking to finance construction of 1 trillion reais of highways, bridges and stadiums as it prepares to host the 2014 World Cup and 2016 Olympics.”
September 14 – Bloomberg (Boris Korby): “Banco Cruzeiro do Sul SA will be liquidated by Brazil’s central bank after attempts to find a buyer failed, prompting Latin America’s biggest corporate-bond default in more than 10 years. Officials appointed to run the Sao Paulo-based company found a ‘serious violation’ and unfunded liabilities that made it impossible to resume normal operations, Brazil’s central bank said…”
European Economy Watch:
September 14 – Bloomberg (Scott Hamilton): “Euro-area inflation accelerated for the first time in 11 months in August as rising energy costs threatened to exacerbate the economic slump. Consumer prices in the 17-nation currency bloc increased 2.6% from a year earlier…”
September 10 – Bloomberg (Lorenzo Totaro): “Italy’s economy contracted more than initially reported in the second quarter, indicating the country’s fourth recession since 2001 is deepening amid the biggest fall in household spending in almost two decades. Gross domestic product shrank 0.8% from the previous three months… From a year earlier, economic activity contracted 2.6%, instead of 2.5%, Rome-based Istat said today in its final report on the quarter. The euro-region’s third-biggest economy entered a recession at the end of 2011…”
U.S. Bubble Economy Watch:
September 11 – Bloomberg (Martin Z. Braun): “Public pension funds in 16 states and the District of Columbia last year had assets of 80% or more of what is need to pay promised benefits to retirees, down from 18 in 2010, Loop Capital Markets said. The median ratio of assets to liabilities for 149 state- level pensions dropped to 73% in 2011 from 76% the year before… Eighty percent is a common threshold of sustainability for retirement plans, according to Loop. Illinois was the lowest- funded state, at 44%. ‘State and local government pension plans’ fiscal health continued to deteriorate slightly over the last year, although the falloff is not significant for the vast majority of plans,’ Loop said…”
Fiscal Watch:
September 14 – Associated Press (Daniel Wagner): “The U.S. federal budget deficit increased by $191 billion in August and has topped $1 trillion for the fourth straight year. The deficit for the first 11 months of the 2012 budget year totaled $1.16 trillion… That’s 6% less than the $1.23 trillion in the same period last year. The fiscal year ends Sept. 30…. The White House in July forecast that the budget gap will total $1.2 trillion this year, down from $1.3 trillion last year. Next year, the administration expects the deficit to fall just short of $1 trillion, at $991 billion. This year's gap is equal to about 7.4% of the U.S. Economy…”
Saturday, November 8, 2014
Weekly Commentary, September 7, 2012: Diverging Like It's 1929
Spanish 10-year yields dropped 123 bps this week to 5.57%. Yields are now down 194 bps from July 24 highs (7.51%). Italian 10-year bond yields sank 80 bps this week to 5.02%, and are down 153 bps from July highs (6.55%). Spanish stocks (IBEX) have rallied 34% off July lows, slashing its 2012 loss to only 8%. And after its 32% rally from July lows, Italian stocks (MIB) now sport a 6.8% y-t-d gain. The German DAX has gained 14% from July lows, increasing its 2012 gain to 22.3%.
Here in the U.S., tens of Trillions of (government, corporate, and mortgage-related) bonds are priced at or near record high levels (low yields). The S&P 400 Mid-Cap equities index, up 14.3% y-t-d, is only 0.4% below its all-time high. The small cap Russell 2000 (up 13.7% y-t-d) is 0.6% below its record high. The S&P 500 traded this week to the highest level since May 2008. The Nasdaq (“NDX”) 100 now enjoys a 2012 gain of 24.0% - and traded this week to its highest level going all the way back to 2000. Junk bond spreads traded this week to a 13-month low.
As regional and global economic downturns gain momentum, the ECB this week significantly lowered its forecasts for Eurozone growth. ECB staff now project 2012 economic activity to contract in the range of between 0.2% and 0.6%. Thursday the Organization for Economic Cooperation and Development (OECD) revised downward its estimates for G7 economic growth. The German economy is now projected to slip into recession, with Q3 GDP forecast at an annualized negative 0.5%. Economic activity is expected to weaken further to negative 0.8% in Q4. The French economy is expected to contract 0.4% in Q3, before recovering for 0.2% growth in Q4. The Italian economy is forecast to contract 2.9% during Q3 and 1.4% in Q4. The British economy is seen contracting 0.7% in Q3, before recovering for 0.2% growth in Q4. Japan’s economy is now expected to contract 2.3% (annualized) in Q3. U.S. growth is expected to improve mildly to a 2.0% rate during Q3 and 2.4% in Q4. Outside of the G7, the Greek and Spanish economies are unmitigated disasters.
With the financial world fixated on Draghi, Bernanke and endless QE, global markets now wildly diverge from economic fundamentals. Many are content to celebrate, holding firm to the view that financial conditions tend to lead economic activity. Markets discount the future, of course. And, traditionally, an easing of monetary policy would loosen Credit and financial conditions - spurring lending, spending, investing and stronger economic activity.
Importantly, traditional rules and analysis no longer apply. Monetary policy has been locked in super ultra-loose mode now entering an unprecedented fifth year. Here in the U.S., financial conditions can’t get meaningfully looser. The Federal Reserve has pushed corporate and household borrowing costs to record lows. Liquidity abundance will ensure near-record 2012 corporate debt issuance. “Loose money” has already had too long a period to impact decision making throughout the economy – with decidedly unimpressive results. Arguably, previous unfathomable monetary measures some time ago created dependencies and addictions that are increasingly difficult to satisfy.
Clearly, monetary policy is exerting a much greater impact on the financial markets than it is on real economic activity. In the U.S. and globally, market gains are in the double-digits, while economic growth is measured in dinky decimals. The vulnerability associated with elevated securities markets has tended to only compound the issue of systemic fragility, and policymakers have responded to heightened stress with only more extraordinary policy measures. Recent weeks have provided important confirmation of the Bubble Thesis.
Amazingly, in the face of exceptionally buoyant securities markets and an expanding economy, the Federal Reserve is apparently about to embark on yet another round of quantitative easing (“money printing”). Few expect this to have much impact on the real economy, but it is clearly having a major impact on already speculative financial markets.
I’ve always feared such a scenario: Severely maladjusted Bubble Economies responding poorly to aggressive monetary stimulus, spurring policymakers into only more aggressive stimulus measures. Meanwhile, financial fragility mounts, as Credit systems continue to rapidly expand non-productive debt. Securities markets become dangerously speculative and detached from underlying fundamentals.
Students of the late-1920s appreciate how late-cycle policy-induced market and economic distortions laid the groundwork for financial collapse and depression. Especially in 1928 and early-1929, highly speculative financial markets diverged from faltering global economic fundamentals. Our nation’s business came to be precariously dominated by “money changers,” financial leveraging and market speculation.
But we don’t have to look back to late-cycle “Roaring Twenties” excess for examples of the danger of markets disconnecting from fundamentals. From April 1997 to July 1998 the Nasdaq Composite jumped 90%. The marketplace had turned quite speculative, although excesses were beginning to be wrung out during the August-October 1998 Russian collapse and LTCM crisis. Fatefully, the Federal Reserve bailed out LTCM and the leveraged speculating community, while orchestrating a liquidity backstop for financial markets generally. The consequences continue – and they’re no doubt momentous.
Rather than chastened, the speculator community was emboldened back in late-1998. Not surprisingly, loose monetary policy combined with a central bank market backstop had the greatest impact on the fledging Bubble at the time gathering momentum in technology stocks. The Nasdaq Composite then rose from about 1,000 in early-October 1998 to its historic March 2000 high of 4,816.
It’s certainly not uncommon for individual stocks - or markets - to enjoy their most spectacular gains right as they confront rising fundamental headwinds. Indeed, whether it was the Dow Jones Industrial Average in 1929 or technology stocks in late-99/early-2000, deteriorating fundamentals actually played an instrumental role in respective dramatic market rallies. In both case, bearish short positions had been initiated in expectation of profiting from the wide gulf between inflating stock prices and deflating fundamental backdrops. In both cases, short squeezes played a prevailing role in fueling “blow off” speculative rallies.
Actually, the most precarious backdrops unfold during a confluence of serious fundamental deterioration, perceived acute systemic fragilities, aggressive monetary policy easing and an already highly speculative market environment. This was the backdrop during 1929 and 1999, and I would argue it is consistent with the current environment. Excess liquidity and rampant speculation drove prices higher in ’29 and ’99, as the unwinding of short positions (and the attendant speculative targeting of short squeezes) created rocket fuel for a speculative melt-up. Over time, intense greed and fear and episodes of panic buying overwhelmed the marketplace. Would be sellers moved to the sidelines and markets dislocated (extraordinary demand and supply imbalances fostered dramatic spikes in market pricing and emotions). Market dislocations - and resulting price jumps - were only exacerbated when those watching prudently from the sidelines were forced to capitulate and jump aboard.
The technology Bubble was spectacular – but it was also more specific to an individual sector than it was systemic. Today’s Bubble is unique in the degree to which it encompasses global markets and economies. Systemic fragilities these days make 1999 appear inconsequential in comparison. The backdrop has more similarities to 1929 – and, not coincidently, policymakers are absolutely resolved to avoid a similar fate. Thus far, policy measures have notably succeeded in fostering over-liquefied and highly speculative markets on a manic course divergent from troubling underlying fundamentals.
The Draghi Plan was unveiled this week, and expectations have the Fed coming imminently with QE3. I don’t anticipate measures from the ECB or the Fed to have much effect on economic fundamentals. At the same time, Drs. Draghi and Bernanke already have had huge impacts on global risk markets. Their policies have dramatically skewed the markets in the direction of rewarding the “bulls” and severely punishing the “bears”. History will not be kind. Policies have, once again, incentivized speculation and emboldened speculators. Policymakers have further energized the expansive global “government finance” Bubble.
There are many articles discussing the details of the Draghi Plan. I will instead focus my attention on the interplay between ECB and Federal Reserve policymaking and dysfunctional global markets.
The markets’ immediate response to Friday’s weak U.S. payrolls report was telling: bonds rallied strongly, the dollar weakened, gold jumped, and the stock market melt-up ran unabated – as markets readied for QE3. Ongoing dollar devaluation is critical for sustaining the inflationary bias throughout global commodities and non-dollar securities markets - not to mention incredibly inflated bond and fixed income prices. Fed policymaking seemingly ensures ongoing enormous trade deficits that expel liquidity around the globe. Fed-induced weakness also works to stem “safe haven” and speculative inflows to the dollar, flows that have risked inciting problematic capital flight and risk aversion in markets around the world.
For some time now, the global speculator community has been successfully positioned for ongoing dollar liquidity abundance and devaluation. For the past two years, the unfolding European debt crisis has repeatedly been at the precipice of unleashing powerful global de-risking/de-leveraging dynamics. The Draghi Plan is being crafted specifically to backstop troubled Spanish and Italian debt, faltering markets that were in the process of inciting a catastrophic crisis of confidence in the euro currency.
In unsubtle terms, the Draghi Plan has directly targeted those with bearish positions in European debt instruments and the euro. In this respect, it has been both effective and destabilizing. Draghi has dramatically skewed the marketplace to the benefit of the longs and to the detriment of the shorts – throughout European debt, equity and currency markets. And with simultaneous “open-ended QE” rhetoric from the Bernanke Federal Reserve, shorts have suddenly found themselves in the crosshairs worldwide. A huge short squeeze has unfolded, fomenting market dislocation – and an only wider divergence between inflating market prices and deteriorating underlying fundamentals. Panicked covering of short positions and the unwind of derivative hedges has thrown gasoline on already wildly speculative securities markets.
In previous CBBs I have noted how asymmetrical central bank policymaking and market backstops over the past two decades nurtured a multi-trillion global leveraged speculating community. I have also explained how massive central bank liquidity injections have bypassed real economies on their way to be part of an increasingly unwieldy global pool of speculative finance. I have further noted how global markets have regressed into one big dysfunctional “crowded trade.” And now the Draghi and Bernanke Plans have dealt a severe blow to those positioned bearishly around the globe. We can now contemplate the behavior of highly speculative and over-liquefied markets perhaps operating without the typical checks and balances provided by shorting and bearish positioning.
Draghi and European policymakers must be giddy watching the bears get completely run over. The truth of the matter, however, is that the shorts are in no way responsible for what ails Europe. Indeed, the deep financial and economic structural deficiencies were created during environments where long-side debt market speculation was rife – and the resulting over-abundance of mis-priced finance sowed the seeds for future crises. Regrettably, this process remains very much alive, as policymaking ensures Bubble Dynamics become further embedded in all corners of the world.
From my perspective, the key issue is not whether the ECB finally has a (Draghi) plan that will resolve Europe’s debt crisis - the coveted big bazooka. Monetary policy won’t solve Europe’s deep structural problems anymore than QE will resolve U.S. economic maladjustment and global imbalances. Indeed, there is little doubt that the Draghi and Bernanke Plans will only exacerbate global systemic fragilities. They have bought some additional time, but at rapidly inflating costs. We desperately needed global policymakers to work assiduously to extricate themselves from market interventions and manipulations. They’ve again done the very opposite.
For the Week:
The S&P500 jumped 2.2% (up 14.3% y-t-d), and the Dow gained 1.6% (up 8.9%). The broader market outperformed. The S&P 400 Mid-Caps jumped 3.4% (up 14.3%), and the small cap Russell 2000 rose 3.7% (up 13.7%). The Morgan Stanley Cyclicals rallied 3.6% (up 11.7%), and the Transports gained 1.1% (up 1.1%). The Banks surged 4.4% (up 25.1%), and the Broker/Dealers jumped 5.7% (up 3.0%). The Morgan Stanley Consumer index rose 1.5% (up 9.1%), and the Utilities gained 0.5% (down 0.3%). The Nasdaq100 was up 1.9% (up 24%), and the Morgan Stanley High Tech index gained 2.3% (up 17.4%). The Semiconductors increased 1.3% (up 10.1%). The InteractiveWeek Internet index jumped 3.2% (up 13.7%). The Biotechs gained 3.3% (up 38.5%). With bullion surging $44, the HUI gold index jumped 5.5% (down 3.1%).
One-month Treasury bill rates ended the week at 9 bps and three-month bills closed at 10 bps. Two-year government yields were up 3 bps to 0.25%. Five-year T-note yields ended the week 5 bps higher to 0.64%. Ten-year yields gained 12 bps to 1.67%. Long bond yields jumped 15 bps to 2.82%. Benchmark Fannie MBS yields increased 2 bps to 2.29%. The spread between benchmark MBS and 10-year Treasury yields narrowed 10 to 62 bps. The implied yield on December 2013 eurodollar futures increased a basis point to 0.415%. The two-year dollar swap spread declined 3 to 15 bps, while the 10-year dollar swap spread was little changed at 11 bps. Corporate bond spreads narrowed meaningfully. An index of investment grade bond risk sank 9 to a 5-month low 93 bps. An index of junk bond risk sank 45 to a 13-month low 499 bps.
Debt issuance began September with a bang. Investment grade issuers this week included GE Capital $4.0bn, Wellpoint $3.25bn, Berkshire Hathaway $2.28bn, EOG Resources $1.25bn, John Deere $1.0bn, SLM Corp $800 million, Norfolk Southern $600 million, Waste Management $500 million, American Honda Finance $1.5bn, Public Service Colorado $800 million, CMR Group $750 million, Rock-Tenn $700 million, Nissan Motor Acceptance $650 million, Principal Financial $600 million, NVR $600 million, Flowserve $500 million, Union Electric $485 million, Avalonbay Communities $450 million, Air Products & Chemicals $400 million, Verisk Analytics $350 million, Marriott International $350 million, Portmarnock Leasing $190 million, and Associate Banc-Corp $155 million, .
Junk bond funds saw inflows slow to $201 million (from Lipper). Junk issuers included QEP Resources $650 million, American Axle & Manufacturing $550 million, Starz $500 million, Catalent Pharma Solution $350 million, and Carrizo Oil & Gas $300 million.
I saw no convertible debt issued.
International dollar bond issuers included Vale $1.5bn, Digicel Group $1.5bn, BNP Paribas $1.25bn, Kommunalbanken $1.2bn, Banco Santander $1.3bn, Bancolombia $1.15bn, Inter-American Development Bank $1.0bn, Overseas Chinese Banking $1.0bn, Korea Development Bank $750 million, Australia & New Zealand Bank $3.0bn, Smurfit Kappa $300 million, WPP Finance $800 million, Hub International $740 million, Banco Cred Inver $600 million, Hudbay Minerals $500 million and Aruba $250 million.
Spain's 10-year yields sank123 bps to 5.72% (up 53bps y-t-d). Italian 10-yr yields dropped 80 bps to 5.02% (down 201bps). German bund yields rose 19 bps to 1.52% (down 31bps), and French yields increased 5 bps to 2.19% (down 94bps). The French to German 10-year bond spread narrowed 14 bps to 68 bps. Ten-year Portuguese yields fell 119 bps to 7.80% (down 497bps). The new Greek 10-year note yield sank 172 bps to 21.00%. U.K. 10-year gilt yields jumped 22 bps to 1.68% (down 30bps). Irish yields were down 29 bps to 5.48% (down 278bps).
The German DAX equities index jumped 3.5% (up 22.3% y-t-d). Spain's IBEX 35 equities index surged 6.2% (down 8.0%), and Italy's FTSE MIB jumped 6.7% (up 6.8%). Japanese 10-year "JGB" yields rose 3 bps to 0.81% (down 17bps). Japan's Nikkei increased 0.4% (up 4.9%). Emerging markets were higher. Brazil's Bovespa equities index gained 2.2% (up 8.1%), and Mexico's Bolsa rose 1.6% (up 8.0%). South Korea's Kospi index added 1.3% (up 5.7%). India’s Sensex equities index gained 1.5% (up 14.4%). China’s Shanghai Exchange rallied 3.9% (down 3.3%).
Freddie Mac 30-year fixed mortgage rates fell 4 bps to 3.55% (down 57bps y-o-y). Fifteen-year fixed rates were unchanged at 2.86% (down 47bps). One-year ARMs were down 2 bps to 2.61% (down 23bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 3 bps to 4.18% (down 69bps).
Federal Reserve Credit declined $5.6bn to $2.798 TN. Fed Credit was down $42.8bn from a year ago, or 1.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/5) jumped $11.1bn to a record $3.579 TN. "Custody holdings" were up $159bn y-t-d and $101bn year-over-year, or 2.9%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $375bn y-o-y, or 3.7% to a record $10.600 TN. Over two years, reserves were $2.028 TN higher, for 24% growth.
M2 (narrow) "money" supply jumped $26.3bn to a record $10.070 TN. "Narrow money" has expanded 6.7% annualized year-to-date and was up 5.5% from a year ago. For the week, Currency increased $3.2bn. Demand and Checkable Deposits declined $3.6bn, while Savings Deposits jumped $19.9bn. Small Denominated Deposits dipped $1.5bn. Retail Money Funds added $1.1bn.
Total Money Fund assets were little changed at $2.570 TN. Money Fund assets were down $125bn y-t-d and $79bn over the past year, or 3.0%.
Total Commercial Paper outstanding declined $9.8bn to $1.022 TN. CP was up $63bn y-t-d, while having declined $44bn from a year ago, or down 4.1%.
Currency Watch:
The U.S. dollar index dropped 1.2% to 80.25 (up 0.1% y-t-d). For the week on the upside, the South African rand increased 2.8%, the Danish krone 1.9%, the euro 1.9%, the Mexican peso 1.6%, the Norwegian krone 1.4%, the New Zealand dollar 1.1%, the Swiss franc 1.1%, the Singapore dollar 0.9%, the British pound 0.9%, the Canadian dollar 0.8%, the Australian dollar 0.6%, the Taiwanese dollar 0.5%, the Swedish krona 0.5%, the South Korean won 0.4%, the Japanese yen 0.2% and the Brazilian real 0.1%.
Commodities Watch:
September 4 - Bloomberg (Claudia Carpenter): “Trading in iron ore, the world’s second-biggest commodity cargo after oil, rose to a record last month as prices dropped to a two-year low on slowing demand from China, the world’s biggest user of the steel ingredient… Ore with 62% iron content delivered to the Chinese port of Tianjin dropped 24 percent last month, the most in 10 months, and fell to $86.90 a so-called dry ton today, the lowest since October 2009.”
September 5 – Bloomberg (Jack Kaskey): “There’s ‘mounting evidence’ that Monsanto Co. corn that’s genetically modified to control insects is losing its effectiveness in the Midwest, the U.S. Environmental Protection Agency said. The EPA commented in response to questions about a scientific study last month that found western corn rootworms on two Illinois farms had developed resistance to insecticide produced by Monsanto’s corn. Rootworms affect corn’s ability to draw water and nutrients from the soil and were responsible for about $1 billion a year in damages and pesticide bills until seeds with built-in insecticide were developed a decade ago.”
The CRB index added 0.7% this week (up 2.1% y-t-d). The Goldman Sachs Commodities Index added 0.2% (up 4.9%). Spot Gold surged 2.6% to $1,736 (up 11%). Silver rose 7.1% to $33.69 (up 21%). October Crude slipped 5 cents to $96.42 (down 2%). October Gasoline jumped 1.5% (up 14%), while October Natural Gas fell 4.2% (down 10%). December Copper rallied 5.4% (up 6%). September Wheat rose 1.7% (up 36%), while September Corn declined 1.0% (up 23%).
Global Credit Watch:
September 7 – Bloomberg: “European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond-purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup. The program ‘will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,’ Draghi said… ‘Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”
September 7 – Bloomberg (Emma Ross-Thomas): “Spanish Deputy Prime Minister Soraya Saenz de Santamaria said the government needs time to decide whether to take a bailout as the nation’s business lobby urged the government to accept help. ‘This is a decision that can’t be made without considering all the elements,’ Saenz told reporters after a Cabinet meeting in Madrid… ‘It’s an issue on which the future of the country and many Spaniards depends.”
September 5 - Bloomberg (Maria Petrakis): “Greek Prime Minister Antonis Samaras faces a week of wrangling as his coalition government tries to find common ground on two more years of austerity to persuade international lenders to keep the country in the euro. Inspectors from the European Commission, European Central Bank and International Monetary Fund, known as the troika, are due back in Athens on Sept. 7 to complete a review begun in July. They are likely to find that the three coalition partners are still working on an 11.5 billion-euro ($14.5bn) blueprint that may test the cohesion of Samaras’s government.”
September 5 - Financial Times (Guy Dinmore): “Italy’s worsening economic crisis and high debt costs have led senior officials in Rome to warn that the country may be forced by the end of the year to apply for an EU bond-buying programme in exchange for implementing further tough economic reforms. Rome’s public position is that it does not need to request purchases of its sovereign bonds by the eurozone’s bailout fund – for the moment – but that if it did, only ‘light’ conditions should be attached, given the measures already adopted by Mario Monti since he became prime minister last November. But Mr Monti’s hand could be forced within months, according to officials involved in internal discussions, who say Germany, among others, is likely to insist on tough conditions... For the time being, Italy and investors holding its €2tn sovereign debt are waiting to see if the European Central Bank will reveal more details of its planned bond-purchasing programme...”
September 5 - Bloomberg (Jeff Kearns and Tom Keene): “Italy may be ‘first and foremost’ among European nations with unsustainable debt, said Simon Johnson, a former International Monetary Fund chief economist. Resolving Europe’s financial crisis will ‘take a long time’ and involves ‘a major shift in how people think about debt and how they think about risk around the world,” Johnson said… ‘These countries will try and do many things to avoid that kind of restructuring and this is going to be a long and painful process,’ said Johnson, a professor at the Massachusetts Institute of Technology… ‘These countries haven’t had major debt defaults since the 1930s.’”
September 4 - Bloomberg (Angeline Benoit): “Jerez de La Frontera, a Spanish town of 214,000 in southern Andalusia, is negotiating with unions to fire 13% of the 2,000 government workers who absorb 80% of its budget. ‘It’s not easy because these are people and families,’ said deputy mayor Antonio Saldana. With a quarter of Spain’s workforce already jobless, Prime Minister Mariano Rajoy’s efforts to retain investor confidence by shaving more than two-thirds off the nation’s budget deficit by 2014 will worsen the highest unemployment rate in the European Union… ‘There’s going to be less hiring and more firing for the spending cuts to be made,’ said Ricardo Santos, an economist at BNP Paribas SA in London who sees unemployment climbing to 27% next year from 24.6% currently.”
Germany Watch:
August 7 – Reuters: “Germany's conservative newspapers on Friday accused ECB chief Mario Draghi of writing a "blank cheque" to troubled euro zone states that could put the entire currency at risk, with top-selling Bild warning his policies could make the euro ‘kaputt’… For the country’s conservative newspapers, many of which have taken an increasingly euro-sceptic stance as the three-year-old euro zone debt crisis wears on, Draghi's latest measures went too far. ‘Help without end for crisis countries,’ said Bild on its front cover, adding that Draghi had signed a ‘blank cheque’ and that his policy endangered the independence of the ECB. It cited German politicians saying the ECB had gone beyond its mandate of safeguarding the stability of the currency. ‘Draghi sets off Germany's alarm bell,’ was the headline in the conservative daily Die Welt. Business daily Handelsblatt, which often voices concern at the financial burden of the bailouts on German taxpayers and business, had a cover story on ‘the Rise, Fall and Resurrection of the Bundesbank’ and gave prominence to Weidmann's warnings. Inside, Handelsblatt criticized ‘the democratic deficit of the euro rescuers’ - and linked the ECB's chosen path to next week's ruling by Germany's Constitutional Court on the legality of the euro zone's new bailout mechanism and budget rules.”
September 7 – Bloomberg (Brian Parkin): “European Central Bank President Mario Draghi’s plan to shore up the euro by buying bonds is a ‘black day’ for the currency ‘with no turning back, said Germany’s Bild newspaper, siding with the Bundesbank. The newspaper’s chief political columnist, Nikolaus Blome, said in an editorial that the blueprint outlined by Draghi yesterday undermines conditions tied to bailout programs. Draghi’s plan turns the currency’s rescue program ‘on its head’ by letting states like Spain dodge strict terms for gaining help… ‘No, Herr Draghi, you’re not returning the euro to health by doing this -- you’re making it sick!,’ said Blome… The plan ‘is as ludicrously wrong as putting sugar cubes in the salt shaker,’ said Blome… An ARD television poll published today showed 13% of Germans support ECB bond buying. Germany’s Frankfurter Allgemeine Zeitung newspaper shares Bild’s observation, saying in an editorial today that implementing Draghi’s plan means ‘there will no longer be a separation between fiscal and monetary’ policy in the euro area. ‘First the no-bailout ban for states in the EU treaty was dropped and now the ban on the ECB financing states via monetary policy.’”
September 5 - Bloomberg (Patrick Donahue and Francine Lacqua): “Germany will back European Central Bank bond purchases to help overcome the euro-area debt crisis only if such an operation is limited and recipient countries agree to strict conditions, said a senior ally of Chancellor Angela Merkel. Michael Fuchs, a deputy parliamentary caucus leader in Merkel’s Christian Democratic Union, said that Germany would oppose any ECB plan that foresaw ‘too much’ bond buying without ensuring countries in need of help commit to overhaul their economies. ‘Germany is a country which is very much afraid about inflation,’ Fuchs told Bloomberg… ‘We don’t want to have the ECB just buy on the market, either in the primary or secondary market… The ECB can do it only if there are certain conditionalities, if the countries are really doing their homework.’”
September 4 – MarketNews International: “Further European integration may require popular referenda to ensure democratic legitimacy, European Central Bank Executive Board member Joerg Asmussen said Friday… We can only head towards further integration ‘when this is democratically legitimized - when the population wants this,’ Asmussen said. ‘There will be a point, especially in Germany, when the population will have to be asked directly,’ he said, adding that he expects German Finance Minister Wolfgang Schaeuble to make this clear.”
September 6 – DPA: “Germans give European Central Bank (ECB) president Mario Draghi low ratings, an opinion poll for Stern magazine said Thursday. Some 42% had little or no trust in him, the weekly said, as against just 18% who rate him highly.”
European Economy Watch:
September 7 – Bloomberg (Angeline Benoit): “Spanish industrial production fell for an 11th straight month in July amid a second recession in the euro area’s fourth-largest economy since 2009 and increased budget cuts to curb the nation’s borrowing costs. Output at factories, refineries and mines adjusted for the number of working days fell 5.4% from a year earlier, after declining a revised 6.1% in June…”
September 6 – Bloomberg (Mark Deen): “French unemployment rose to a 13-year high in the second quarter as companies cut staff to cope with a stalled economy, adding pressure on President Francois Hollande to fulfil a campaign pledge to revive growth. The jobless rate… climbed to 10.2% of the population from 10% in the previous three months…”
September 5 - Bloomberg (Kati Pohjanpalo): “Finland’s economy shrank the most in three years last quarter as the euro area debt crisis hits even the bloc’s top rated nations through falling exports. Gross domestic product… contracted 1.1% from the prior three months, when it grew a revised 0.9%...”
U.S. Bubble Economy Watch:
September 4 - Bloomberg (Alan Bjerga): “A record 46.7 million Americans received food stamps in June, up 0.4% from the previous month… Participation was 3.3% higher than a year earlier... Food-stamp spending, which has more than doubled in four years to a record $75.7 billion in the fiscal year ended Sept. 30, 2011, is the USDA’s biggest annual expense.”
September 5 - Bloomberg (Alison Vekshin): “Police officers and firefighters in San Jose, California, are rushing to get in on a disability retirement program that dozens have used to obtain lifetime pension payments before taking jobs elsewhere. The benefit allows the city’s public-safety workers to retire in their 30s and 40s after citing injuries and collect pensions partially exempt from state and federal taxes. It also provides a way for former police and fire employees who are already retired to change their pensions to claim the tax break. ‘People are trying to get their applications considered under the old system, which is very, very loose,’ San Jose Mayor Chuck Reed, 64, said… ‘Anybody who wants it can make the application and it’s almost always granted.’ San Jose, California’s third-largest city… is among communities throughout the state struggling to contain pension costs as the recession and housing meltdown erode sales and property tax revenue… With a population of about 971,000, San Jose has seen retirement costs surge in the past decade to $245 million in fiscal 2012 from $73 million in fiscal 2002. Benefits consume more than 50% of payroll and account for more than 20% of the general fund, according to the city’s website.”
September 4 – United Press International: “...Visa said its survey indicates the ‘Tooth Fairy’ left an average $3-per-tooth for U.S. children this year. Jason Alderman, Visa's senior director of global financial education, said the company's telephone survey of 2,000 U.S. adults indicates the amount of money left by the ‘Tooth Fairy’ this year increased 15% over the average from 2011. ‘The Tooth Fairy may be the canary in the economic coal mine. She's showing signs of life by leaving 40 cents more per tooth this year,’ Alderman said. ‘This is not only good news for kids, but an ideal teachable moment for parents to engage their children in thinking about how to budget their windfall by saving a portion.’”
Central Bank Watch:
September 6 – Bloomberg (Johan Carlstrom and Josiane Kremer): “Sweden’s Riksbank cut its benchmark interest rate for the first time since February, caving in to calls from exporters, as the krona’s strength and deepening euro crisis threaten the nation’s trade competitiveness. The repo rate was cut by a quarter point to 1.25%...”
September 6 – Bloomberg (Scott Hamilton and Svenja O’Donnell): “The Bank of England persisted with its quantitative-easing program today after Prime Minister David Cameron reiterated his budget plans, leaving the central bank carrying the burden of reviving Britain’s economy. With Cameron reaffirming his strategy to reduce the deficit, ministers are stressing the role of the central bank in getting the U.K. out of a recession. The Monetary Policy Committee kept its bond-purchase target at 375 billion pounds ($596bn)…”
Here in the U.S., tens of Trillions of (government, corporate, and mortgage-related) bonds are priced at or near record high levels (low yields). The S&P 400 Mid-Cap equities index, up 14.3% y-t-d, is only 0.4% below its all-time high. The small cap Russell 2000 (up 13.7% y-t-d) is 0.6% below its record high. The S&P 500 traded this week to the highest level since May 2008. The Nasdaq (“NDX”) 100 now enjoys a 2012 gain of 24.0% - and traded this week to its highest level going all the way back to 2000. Junk bond spreads traded this week to a 13-month low.
As regional and global economic downturns gain momentum, the ECB this week significantly lowered its forecasts for Eurozone growth. ECB staff now project 2012 economic activity to contract in the range of between 0.2% and 0.6%. Thursday the Organization for Economic Cooperation and Development (OECD) revised downward its estimates for G7 economic growth. The German economy is now projected to slip into recession, with Q3 GDP forecast at an annualized negative 0.5%. Economic activity is expected to weaken further to negative 0.8% in Q4. The French economy is expected to contract 0.4% in Q3, before recovering for 0.2% growth in Q4. The Italian economy is forecast to contract 2.9% during Q3 and 1.4% in Q4. The British economy is seen contracting 0.7% in Q3, before recovering for 0.2% growth in Q4. Japan’s economy is now expected to contract 2.3% (annualized) in Q3. U.S. growth is expected to improve mildly to a 2.0% rate during Q3 and 2.4% in Q4. Outside of the G7, the Greek and Spanish economies are unmitigated disasters.
With the financial world fixated on Draghi, Bernanke and endless QE, global markets now wildly diverge from economic fundamentals. Many are content to celebrate, holding firm to the view that financial conditions tend to lead economic activity. Markets discount the future, of course. And, traditionally, an easing of monetary policy would loosen Credit and financial conditions - spurring lending, spending, investing and stronger economic activity.
Importantly, traditional rules and analysis no longer apply. Monetary policy has been locked in super ultra-loose mode now entering an unprecedented fifth year. Here in the U.S., financial conditions can’t get meaningfully looser. The Federal Reserve has pushed corporate and household borrowing costs to record lows. Liquidity abundance will ensure near-record 2012 corporate debt issuance. “Loose money” has already had too long a period to impact decision making throughout the economy – with decidedly unimpressive results. Arguably, previous unfathomable monetary measures some time ago created dependencies and addictions that are increasingly difficult to satisfy.
Clearly, monetary policy is exerting a much greater impact on the financial markets than it is on real economic activity. In the U.S. and globally, market gains are in the double-digits, while economic growth is measured in dinky decimals. The vulnerability associated with elevated securities markets has tended to only compound the issue of systemic fragility, and policymakers have responded to heightened stress with only more extraordinary policy measures. Recent weeks have provided important confirmation of the Bubble Thesis.
Amazingly, in the face of exceptionally buoyant securities markets and an expanding economy, the Federal Reserve is apparently about to embark on yet another round of quantitative easing (“money printing”). Few expect this to have much impact on the real economy, but it is clearly having a major impact on already speculative financial markets.
I’ve always feared such a scenario: Severely maladjusted Bubble Economies responding poorly to aggressive monetary stimulus, spurring policymakers into only more aggressive stimulus measures. Meanwhile, financial fragility mounts, as Credit systems continue to rapidly expand non-productive debt. Securities markets become dangerously speculative and detached from underlying fundamentals.
Students of the late-1920s appreciate how late-cycle policy-induced market and economic distortions laid the groundwork for financial collapse and depression. Especially in 1928 and early-1929, highly speculative financial markets diverged from faltering global economic fundamentals. Our nation’s business came to be precariously dominated by “money changers,” financial leveraging and market speculation.
But we don’t have to look back to late-cycle “Roaring Twenties” excess for examples of the danger of markets disconnecting from fundamentals. From April 1997 to July 1998 the Nasdaq Composite jumped 90%. The marketplace had turned quite speculative, although excesses were beginning to be wrung out during the August-October 1998 Russian collapse and LTCM crisis. Fatefully, the Federal Reserve bailed out LTCM and the leveraged speculating community, while orchestrating a liquidity backstop for financial markets generally. The consequences continue – and they’re no doubt momentous.
Rather than chastened, the speculator community was emboldened back in late-1998. Not surprisingly, loose monetary policy combined with a central bank market backstop had the greatest impact on the fledging Bubble at the time gathering momentum in technology stocks. The Nasdaq Composite then rose from about 1,000 in early-October 1998 to its historic March 2000 high of 4,816.
It’s certainly not uncommon for individual stocks - or markets - to enjoy their most spectacular gains right as they confront rising fundamental headwinds. Indeed, whether it was the Dow Jones Industrial Average in 1929 or technology stocks in late-99/early-2000, deteriorating fundamentals actually played an instrumental role in respective dramatic market rallies. In both case, bearish short positions had been initiated in expectation of profiting from the wide gulf between inflating stock prices and deflating fundamental backdrops. In both cases, short squeezes played a prevailing role in fueling “blow off” speculative rallies.
Actually, the most precarious backdrops unfold during a confluence of serious fundamental deterioration, perceived acute systemic fragilities, aggressive monetary policy easing and an already highly speculative market environment. This was the backdrop during 1929 and 1999, and I would argue it is consistent with the current environment. Excess liquidity and rampant speculation drove prices higher in ’29 and ’99, as the unwinding of short positions (and the attendant speculative targeting of short squeezes) created rocket fuel for a speculative melt-up. Over time, intense greed and fear and episodes of panic buying overwhelmed the marketplace. Would be sellers moved to the sidelines and markets dislocated (extraordinary demand and supply imbalances fostered dramatic spikes in market pricing and emotions). Market dislocations - and resulting price jumps - were only exacerbated when those watching prudently from the sidelines were forced to capitulate and jump aboard.
The technology Bubble was spectacular – but it was also more specific to an individual sector than it was systemic. Today’s Bubble is unique in the degree to which it encompasses global markets and economies. Systemic fragilities these days make 1999 appear inconsequential in comparison. The backdrop has more similarities to 1929 – and, not coincidently, policymakers are absolutely resolved to avoid a similar fate. Thus far, policy measures have notably succeeded in fostering over-liquefied and highly speculative markets on a manic course divergent from troubling underlying fundamentals.
The Draghi Plan was unveiled this week, and expectations have the Fed coming imminently with QE3. I don’t anticipate measures from the ECB or the Fed to have much effect on economic fundamentals. At the same time, Drs. Draghi and Bernanke already have had huge impacts on global risk markets. Their policies have dramatically skewed the markets in the direction of rewarding the “bulls” and severely punishing the “bears”. History will not be kind. Policies have, once again, incentivized speculation and emboldened speculators. Policymakers have further energized the expansive global “government finance” Bubble.
There are many articles discussing the details of the Draghi Plan. I will instead focus my attention on the interplay between ECB and Federal Reserve policymaking and dysfunctional global markets.
The markets’ immediate response to Friday’s weak U.S. payrolls report was telling: bonds rallied strongly, the dollar weakened, gold jumped, and the stock market melt-up ran unabated – as markets readied for QE3. Ongoing dollar devaluation is critical for sustaining the inflationary bias throughout global commodities and non-dollar securities markets - not to mention incredibly inflated bond and fixed income prices. Fed policymaking seemingly ensures ongoing enormous trade deficits that expel liquidity around the globe. Fed-induced weakness also works to stem “safe haven” and speculative inflows to the dollar, flows that have risked inciting problematic capital flight and risk aversion in markets around the world.
For some time now, the global speculator community has been successfully positioned for ongoing dollar liquidity abundance and devaluation. For the past two years, the unfolding European debt crisis has repeatedly been at the precipice of unleashing powerful global de-risking/de-leveraging dynamics. The Draghi Plan is being crafted specifically to backstop troubled Spanish and Italian debt, faltering markets that were in the process of inciting a catastrophic crisis of confidence in the euro currency.
In unsubtle terms, the Draghi Plan has directly targeted those with bearish positions in European debt instruments and the euro. In this respect, it has been both effective and destabilizing. Draghi has dramatically skewed the marketplace to the benefit of the longs and to the detriment of the shorts – throughout European debt, equity and currency markets. And with simultaneous “open-ended QE” rhetoric from the Bernanke Federal Reserve, shorts have suddenly found themselves in the crosshairs worldwide. A huge short squeeze has unfolded, fomenting market dislocation – and an only wider divergence between inflating market prices and deteriorating underlying fundamentals. Panicked covering of short positions and the unwind of derivative hedges has thrown gasoline on already wildly speculative securities markets.
In previous CBBs I have noted how asymmetrical central bank policymaking and market backstops over the past two decades nurtured a multi-trillion global leveraged speculating community. I have also explained how massive central bank liquidity injections have bypassed real economies on their way to be part of an increasingly unwieldy global pool of speculative finance. I have further noted how global markets have regressed into one big dysfunctional “crowded trade.” And now the Draghi and Bernanke Plans have dealt a severe blow to those positioned bearishly around the globe. We can now contemplate the behavior of highly speculative and over-liquefied markets perhaps operating without the typical checks and balances provided by shorting and bearish positioning.
Draghi and European policymakers must be giddy watching the bears get completely run over. The truth of the matter, however, is that the shorts are in no way responsible for what ails Europe. Indeed, the deep financial and economic structural deficiencies were created during environments where long-side debt market speculation was rife – and the resulting over-abundance of mis-priced finance sowed the seeds for future crises. Regrettably, this process remains very much alive, as policymaking ensures Bubble Dynamics become further embedded in all corners of the world.
From my perspective, the key issue is not whether the ECB finally has a (Draghi) plan that will resolve Europe’s debt crisis - the coveted big bazooka. Monetary policy won’t solve Europe’s deep structural problems anymore than QE will resolve U.S. economic maladjustment and global imbalances. Indeed, there is little doubt that the Draghi and Bernanke Plans will only exacerbate global systemic fragilities. They have bought some additional time, but at rapidly inflating costs. We desperately needed global policymakers to work assiduously to extricate themselves from market interventions and manipulations. They’ve again done the very opposite.
For the Week:
The S&P500 jumped 2.2% (up 14.3% y-t-d), and the Dow gained 1.6% (up 8.9%). The broader market outperformed. The S&P 400 Mid-Caps jumped 3.4% (up 14.3%), and the small cap Russell 2000 rose 3.7% (up 13.7%). The Morgan Stanley Cyclicals rallied 3.6% (up 11.7%), and the Transports gained 1.1% (up 1.1%). The Banks surged 4.4% (up 25.1%), and the Broker/Dealers jumped 5.7% (up 3.0%). The Morgan Stanley Consumer index rose 1.5% (up 9.1%), and the Utilities gained 0.5% (down 0.3%). The Nasdaq100 was up 1.9% (up 24%), and the Morgan Stanley High Tech index gained 2.3% (up 17.4%). The Semiconductors increased 1.3% (up 10.1%). The InteractiveWeek Internet index jumped 3.2% (up 13.7%). The Biotechs gained 3.3% (up 38.5%). With bullion surging $44, the HUI gold index jumped 5.5% (down 3.1%).
One-month Treasury bill rates ended the week at 9 bps and three-month bills closed at 10 bps. Two-year government yields were up 3 bps to 0.25%. Five-year T-note yields ended the week 5 bps higher to 0.64%. Ten-year yields gained 12 bps to 1.67%. Long bond yields jumped 15 bps to 2.82%. Benchmark Fannie MBS yields increased 2 bps to 2.29%. The spread between benchmark MBS and 10-year Treasury yields narrowed 10 to 62 bps. The implied yield on December 2013 eurodollar futures increased a basis point to 0.415%. The two-year dollar swap spread declined 3 to 15 bps, while the 10-year dollar swap spread was little changed at 11 bps. Corporate bond spreads narrowed meaningfully. An index of investment grade bond risk sank 9 to a 5-month low 93 bps. An index of junk bond risk sank 45 to a 13-month low 499 bps.
Debt issuance began September with a bang. Investment grade issuers this week included GE Capital $4.0bn, Wellpoint $3.25bn, Berkshire Hathaway $2.28bn, EOG Resources $1.25bn, John Deere $1.0bn, SLM Corp $800 million, Norfolk Southern $600 million, Waste Management $500 million, American Honda Finance $1.5bn, Public Service Colorado $800 million, CMR Group $750 million, Rock-Tenn $700 million, Nissan Motor Acceptance $650 million, Principal Financial $600 million, NVR $600 million, Flowserve $500 million, Union Electric $485 million, Avalonbay Communities $450 million, Air Products & Chemicals $400 million, Verisk Analytics $350 million, Marriott International $350 million, Portmarnock Leasing $190 million, and Associate Banc-Corp $155 million, .
Junk bond funds saw inflows slow to $201 million (from Lipper). Junk issuers included QEP Resources $650 million, American Axle & Manufacturing $550 million, Starz $500 million, Catalent Pharma Solution $350 million, and Carrizo Oil & Gas $300 million.
I saw no convertible debt issued.
International dollar bond issuers included Vale $1.5bn, Digicel Group $1.5bn, BNP Paribas $1.25bn, Kommunalbanken $1.2bn, Banco Santander $1.3bn, Bancolombia $1.15bn, Inter-American Development Bank $1.0bn, Overseas Chinese Banking $1.0bn, Korea Development Bank $750 million, Australia & New Zealand Bank $3.0bn, Smurfit Kappa $300 million, WPP Finance $800 million, Hub International $740 million, Banco Cred Inver $600 million, Hudbay Minerals $500 million and Aruba $250 million.
Spain's 10-year yields sank123 bps to 5.72% (up 53bps y-t-d). Italian 10-yr yields dropped 80 bps to 5.02% (down 201bps). German bund yields rose 19 bps to 1.52% (down 31bps), and French yields increased 5 bps to 2.19% (down 94bps). The French to German 10-year bond spread narrowed 14 bps to 68 bps. Ten-year Portuguese yields fell 119 bps to 7.80% (down 497bps). The new Greek 10-year note yield sank 172 bps to 21.00%. U.K. 10-year gilt yields jumped 22 bps to 1.68% (down 30bps). Irish yields were down 29 bps to 5.48% (down 278bps).
The German DAX equities index jumped 3.5% (up 22.3% y-t-d). Spain's IBEX 35 equities index surged 6.2% (down 8.0%), and Italy's FTSE MIB jumped 6.7% (up 6.8%). Japanese 10-year "JGB" yields rose 3 bps to 0.81% (down 17bps). Japan's Nikkei increased 0.4% (up 4.9%). Emerging markets were higher. Brazil's Bovespa equities index gained 2.2% (up 8.1%), and Mexico's Bolsa rose 1.6% (up 8.0%). South Korea's Kospi index added 1.3% (up 5.7%). India’s Sensex equities index gained 1.5% (up 14.4%). China’s Shanghai Exchange rallied 3.9% (down 3.3%).
Freddie Mac 30-year fixed mortgage rates fell 4 bps to 3.55% (down 57bps y-o-y). Fifteen-year fixed rates were unchanged at 2.86% (down 47bps). One-year ARMs were down 2 bps to 2.61% (down 23bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 3 bps to 4.18% (down 69bps).
Federal Reserve Credit declined $5.6bn to $2.798 TN. Fed Credit was down $42.8bn from a year ago, or 1.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/5) jumped $11.1bn to a record $3.579 TN. "Custody holdings" were up $159bn y-t-d and $101bn year-over-year, or 2.9%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $375bn y-o-y, or 3.7% to a record $10.600 TN. Over two years, reserves were $2.028 TN higher, for 24% growth.
M2 (narrow) "money" supply jumped $26.3bn to a record $10.070 TN. "Narrow money" has expanded 6.7% annualized year-to-date and was up 5.5% from a year ago. For the week, Currency increased $3.2bn. Demand and Checkable Deposits declined $3.6bn, while Savings Deposits jumped $19.9bn. Small Denominated Deposits dipped $1.5bn. Retail Money Funds added $1.1bn.
Total Money Fund assets were little changed at $2.570 TN. Money Fund assets were down $125bn y-t-d and $79bn over the past year, or 3.0%.
Total Commercial Paper outstanding declined $9.8bn to $1.022 TN. CP was up $63bn y-t-d, while having declined $44bn from a year ago, or down 4.1%.
Currency Watch:
The U.S. dollar index dropped 1.2% to 80.25 (up 0.1% y-t-d). For the week on the upside, the South African rand increased 2.8%, the Danish krone 1.9%, the euro 1.9%, the Mexican peso 1.6%, the Norwegian krone 1.4%, the New Zealand dollar 1.1%, the Swiss franc 1.1%, the Singapore dollar 0.9%, the British pound 0.9%, the Canadian dollar 0.8%, the Australian dollar 0.6%, the Taiwanese dollar 0.5%, the Swedish krona 0.5%, the South Korean won 0.4%, the Japanese yen 0.2% and the Brazilian real 0.1%.
Commodities Watch:
September 4 - Bloomberg (Claudia Carpenter): “Trading in iron ore, the world’s second-biggest commodity cargo after oil, rose to a record last month as prices dropped to a two-year low on slowing demand from China, the world’s biggest user of the steel ingredient… Ore with 62% iron content delivered to the Chinese port of Tianjin dropped 24 percent last month, the most in 10 months, and fell to $86.90 a so-called dry ton today, the lowest since October 2009.”
September 5 – Bloomberg (Jack Kaskey): “There’s ‘mounting evidence’ that Monsanto Co. corn that’s genetically modified to control insects is losing its effectiveness in the Midwest, the U.S. Environmental Protection Agency said. The EPA commented in response to questions about a scientific study last month that found western corn rootworms on two Illinois farms had developed resistance to insecticide produced by Monsanto’s corn. Rootworms affect corn’s ability to draw water and nutrients from the soil and were responsible for about $1 billion a year in damages and pesticide bills until seeds with built-in insecticide were developed a decade ago.”
The CRB index added 0.7% this week (up 2.1% y-t-d). The Goldman Sachs Commodities Index added 0.2% (up 4.9%). Spot Gold surged 2.6% to $1,736 (up 11%). Silver rose 7.1% to $33.69 (up 21%). October Crude slipped 5 cents to $96.42 (down 2%). October Gasoline jumped 1.5% (up 14%), while October Natural Gas fell 4.2% (down 10%). December Copper rallied 5.4% (up 6%). September Wheat rose 1.7% (up 36%), while September Corn declined 1.0% (up 23%).
Global Credit Watch:
September 7 – Bloomberg: “European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond-purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup. The program ‘will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,’ Draghi said… ‘Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”
September 7 – Bloomberg (Emma Ross-Thomas): “Spanish Deputy Prime Minister Soraya Saenz de Santamaria said the government needs time to decide whether to take a bailout as the nation’s business lobby urged the government to accept help. ‘This is a decision that can’t be made without considering all the elements,’ Saenz told reporters after a Cabinet meeting in Madrid… ‘It’s an issue on which the future of the country and many Spaniards depends.”
September 5 - Bloomberg (Maria Petrakis): “Greek Prime Minister Antonis Samaras faces a week of wrangling as his coalition government tries to find common ground on two more years of austerity to persuade international lenders to keep the country in the euro. Inspectors from the European Commission, European Central Bank and International Monetary Fund, known as the troika, are due back in Athens on Sept. 7 to complete a review begun in July. They are likely to find that the three coalition partners are still working on an 11.5 billion-euro ($14.5bn) blueprint that may test the cohesion of Samaras’s government.”
September 5 - Financial Times (Guy Dinmore): “Italy’s worsening economic crisis and high debt costs have led senior officials in Rome to warn that the country may be forced by the end of the year to apply for an EU bond-buying programme in exchange for implementing further tough economic reforms. Rome’s public position is that it does not need to request purchases of its sovereign bonds by the eurozone’s bailout fund – for the moment – but that if it did, only ‘light’ conditions should be attached, given the measures already adopted by Mario Monti since he became prime minister last November. But Mr Monti’s hand could be forced within months, according to officials involved in internal discussions, who say Germany, among others, is likely to insist on tough conditions... For the time being, Italy and investors holding its €2tn sovereign debt are waiting to see if the European Central Bank will reveal more details of its planned bond-purchasing programme...”
September 5 - Bloomberg (Jeff Kearns and Tom Keene): “Italy may be ‘first and foremost’ among European nations with unsustainable debt, said Simon Johnson, a former International Monetary Fund chief economist. Resolving Europe’s financial crisis will ‘take a long time’ and involves ‘a major shift in how people think about debt and how they think about risk around the world,” Johnson said… ‘These countries will try and do many things to avoid that kind of restructuring and this is going to be a long and painful process,’ said Johnson, a professor at the Massachusetts Institute of Technology… ‘These countries haven’t had major debt defaults since the 1930s.’”
September 4 - Bloomberg (Angeline Benoit): “Jerez de La Frontera, a Spanish town of 214,000 in southern Andalusia, is negotiating with unions to fire 13% of the 2,000 government workers who absorb 80% of its budget. ‘It’s not easy because these are people and families,’ said deputy mayor Antonio Saldana. With a quarter of Spain’s workforce already jobless, Prime Minister Mariano Rajoy’s efforts to retain investor confidence by shaving more than two-thirds off the nation’s budget deficit by 2014 will worsen the highest unemployment rate in the European Union… ‘There’s going to be less hiring and more firing for the spending cuts to be made,’ said Ricardo Santos, an economist at BNP Paribas SA in London who sees unemployment climbing to 27% next year from 24.6% currently.”
Germany Watch:
August 7 – Reuters: “Germany's conservative newspapers on Friday accused ECB chief Mario Draghi of writing a "blank cheque" to troubled euro zone states that could put the entire currency at risk, with top-selling Bild warning his policies could make the euro ‘kaputt’… For the country’s conservative newspapers, many of which have taken an increasingly euro-sceptic stance as the three-year-old euro zone debt crisis wears on, Draghi's latest measures went too far. ‘Help without end for crisis countries,’ said Bild on its front cover, adding that Draghi had signed a ‘blank cheque’ and that his policy endangered the independence of the ECB. It cited German politicians saying the ECB had gone beyond its mandate of safeguarding the stability of the currency. ‘Draghi sets off Germany's alarm bell,’ was the headline in the conservative daily Die Welt. Business daily Handelsblatt, which often voices concern at the financial burden of the bailouts on German taxpayers and business, had a cover story on ‘the Rise, Fall and Resurrection of the Bundesbank’ and gave prominence to Weidmann's warnings. Inside, Handelsblatt criticized ‘the democratic deficit of the euro rescuers’ - and linked the ECB's chosen path to next week's ruling by Germany's Constitutional Court on the legality of the euro zone's new bailout mechanism and budget rules.”
September 7 – Bloomberg (Brian Parkin): “European Central Bank President Mario Draghi’s plan to shore up the euro by buying bonds is a ‘black day’ for the currency ‘with no turning back, said Germany’s Bild newspaper, siding with the Bundesbank. The newspaper’s chief political columnist, Nikolaus Blome, said in an editorial that the blueprint outlined by Draghi yesterday undermines conditions tied to bailout programs. Draghi’s plan turns the currency’s rescue program ‘on its head’ by letting states like Spain dodge strict terms for gaining help… ‘No, Herr Draghi, you’re not returning the euro to health by doing this -- you’re making it sick!,’ said Blome… The plan ‘is as ludicrously wrong as putting sugar cubes in the salt shaker,’ said Blome… An ARD television poll published today showed 13% of Germans support ECB bond buying. Germany’s Frankfurter Allgemeine Zeitung newspaper shares Bild’s observation, saying in an editorial today that implementing Draghi’s plan means ‘there will no longer be a separation between fiscal and monetary’ policy in the euro area. ‘First the no-bailout ban for states in the EU treaty was dropped and now the ban on the ECB financing states via monetary policy.’”
September 5 - Bloomberg (Patrick Donahue and Francine Lacqua): “Germany will back European Central Bank bond purchases to help overcome the euro-area debt crisis only if such an operation is limited and recipient countries agree to strict conditions, said a senior ally of Chancellor Angela Merkel. Michael Fuchs, a deputy parliamentary caucus leader in Merkel’s Christian Democratic Union, said that Germany would oppose any ECB plan that foresaw ‘too much’ bond buying without ensuring countries in need of help commit to overhaul their economies. ‘Germany is a country which is very much afraid about inflation,’ Fuchs told Bloomberg… ‘We don’t want to have the ECB just buy on the market, either in the primary or secondary market… The ECB can do it only if there are certain conditionalities, if the countries are really doing their homework.’”
September 4 – MarketNews International: “Further European integration may require popular referenda to ensure democratic legitimacy, European Central Bank Executive Board member Joerg Asmussen said Friday… We can only head towards further integration ‘when this is democratically legitimized - when the population wants this,’ Asmussen said. ‘There will be a point, especially in Germany, when the population will have to be asked directly,’ he said, adding that he expects German Finance Minister Wolfgang Schaeuble to make this clear.”
September 6 – DPA: “Germans give European Central Bank (ECB) president Mario Draghi low ratings, an opinion poll for Stern magazine said Thursday. Some 42% had little or no trust in him, the weekly said, as against just 18% who rate him highly.”
European Economy Watch:
September 7 – Bloomberg (Angeline Benoit): “Spanish industrial production fell for an 11th straight month in July amid a second recession in the euro area’s fourth-largest economy since 2009 and increased budget cuts to curb the nation’s borrowing costs. Output at factories, refineries and mines adjusted for the number of working days fell 5.4% from a year earlier, after declining a revised 6.1% in June…”
September 6 – Bloomberg (Mark Deen): “French unemployment rose to a 13-year high in the second quarter as companies cut staff to cope with a stalled economy, adding pressure on President Francois Hollande to fulfil a campaign pledge to revive growth. The jobless rate… climbed to 10.2% of the population from 10% in the previous three months…”
September 5 - Bloomberg (Kati Pohjanpalo): “Finland’s economy shrank the most in three years last quarter as the euro area debt crisis hits even the bloc’s top rated nations through falling exports. Gross domestic product… contracted 1.1% from the prior three months, when it grew a revised 0.9%...”
U.S. Bubble Economy Watch:
September 4 - Bloomberg (Alan Bjerga): “A record 46.7 million Americans received food stamps in June, up 0.4% from the previous month… Participation was 3.3% higher than a year earlier... Food-stamp spending, which has more than doubled in four years to a record $75.7 billion in the fiscal year ended Sept. 30, 2011, is the USDA’s biggest annual expense.”
September 5 - Bloomberg (Alison Vekshin): “Police officers and firefighters in San Jose, California, are rushing to get in on a disability retirement program that dozens have used to obtain lifetime pension payments before taking jobs elsewhere. The benefit allows the city’s public-safety workers to retire in their 30s and 40s after citing injuries and collect pensions partially exempt from state and federal taxes. It also provides a way for former police and fire employees who are already retired to change their pensions to claim the tax break. ‘People are trying to get their applications considered under the old system, which is very, very loose,’ San Jose Mayor Chuck Reed, 64, said… ‘Anybody who wants it can make the application and it’s almost always granted.’ San Jose, California’s third-largest city… is among communities throughout the state struggling to contain pension costs as the recession and housing meltdown erode sales and property tax revenue… With a population of about 971,000, San Jose has seen retirement costs surge in the past decade to $245 million in fiscal 2012 from $73 million in fiscal 2002. Benefits consume more than 50% of payroll and account for more than 20% of the general fund, according to the city’s website.”
September 4 – United Press International: “...Visa said its survey indicates the ‘Tooth Fairy’ left an average $3-per-tooth for U.S. children this year. Jason Alderman, Visa's senior director of global financial education, said the company's telephone survey of 2,000 U.S. adults indicates the amount of money left by the ‘Tooth Fairy’ this year increased 15% over the average from 2011. ‘The Tooth Fairy may be the canary in the economic coal mine. She's showing signs of life by leaving 40 cents more per tooth this year,’ Alderman said. ‘This is not only good news for kids, but an ideal teachable moment for parents to engage their children in thinking about how to budget their windfall by saving a portion.’”
Central Bank Watch:
September 6 – Bloomberg (Johan Carlstrom and Josiane Kremer): “Sweden’s Riksbank cut its benchmark interest rate for the first time since February, caving in to calls from exporters, as the krona’s strength and deepening euro crisis threaten the nation’s trade competitiveness. The repo rate was cut by a quarter point to 1.25%...”
September 6 – Bloomberg (Scott Hamilton and Svenja O’Donnell): “The Bank of England persisted with its quantitative-easing program today after Prime Minister David Cameron reiterated his budget plans, leaving the central bank carrying the burden of reviving Britain’s economy. With Cameron reaffirming his strategy to reduce the deficit, ministers are stressing the role of the central bank in getting the U.K. out of a recession. The Monetary Policy Committee kept its bond-purchase target at 375 billion pounds ($596bn)…”
Weekly Commentary, August 31, 2012: Risk #3
August 30 – Bloomberg (Mark Deen): “Yale University professor Stephen Roach said Federal Reserve Chairman Ben S. Bernanke shouldn’t be given a third term because of his role in managing the U.S. economy before the financial crisis. ‘I think Bernanke tried his best post-crisis, but he’s part of the problem pre-crisis,’ Roach said… ‘He and Alan Greenspan condoned asset bubbles at a time the economy needed more discipline.’ …For Roach, Bernanke’s work to calm markets following the financial crisis doesn’t mean his part in inflating asset bubbles in previous years should be overlooked. ‘To reward him for post-crisis, very valiant efforts of public service completely overlooks the role he played in getting the U.S. asset markets and an asset-dependent economy into this mess in the first place…”
Chairman Bernanke titled his 2012 Jackson Hole presentation “Monetary Policy since the Onset of the Crisis.” His review begins with the Fed’s initial response to the unfolding mortgage crisis in August 2007. The paper then details five years of policy measures, with section headings “Balance Sheet Tools,” “Communication Tools,” “Economic Prospects,” and “Making Policy with Nontraditional Tools: A Cost-Benefit Framework.” Dr. Bernanke concludes with coded dovish messages, including “grave concern” that “high levels of unemployment will wreak structural damage” – after earlier signaling support for the Draghi Plan (“recent policy proposals in Europe have been quite constructive in my view, and I urge our European colleagues to press ahead…”).
As noted above by the astute Stephen Roach, Dr. Bernanke played an instrumental intellectual role in crafting policy with Chairman Greenspan that fatefully nurtured the mortgage finance Bubble. In arguably history’s greatest monetary policy misadventure, the Greenspan/Bernanke Fed purposely ignored the unfolding Bubble, choosing instead to commit the Federal Reserve to aggressive post-Bubble “mopping up” strategies. Five years into the crisis, the extent of required “mopping up” remains an unfolding saga that will be analyzed and debated for decades to come. To be sure, the Federal Reserve’s framework for monetary policy cost-benefit analysis during the post-technology Bubble reflationary period (2002-2007) was an abject failure. Most of us strive to learn from our big mistakes.
Chairman Bernanke, not surprisingly, made it clear in Jackson Hole that he is prepared to move further into the uncharted waters of “non-traditional” monetary tools. His review came out on the side of benefits outweighing “manageable” costs, although perhaps to placate the hawks he cautioned, “The hurdle for using nontraditional policies should be higher than for traditional policies. At the same time, the costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant.”
Before delving into his cost-benefit framework, it is worth mentioning that the word “Bubble” is nowhere to be found in Bernanke’s paper. I strongly argue that the issue of whether the Fed is once again accommodating a Credit (“government finance”) Bubble is today’s prevailing – potentially catastrophic - policy risk. The possible role that non-traditional policy tools might be playing in nurturing Bubble dynamics should be the focal point of any cost-benefit analysis related to the Fed’s experimental policymaking endeavor. Regrettably, it’s completely disregarded - hear no evil, speak no evil, and see no evil.
Dr. Bernanke highlights four potential costs of large-scale asset purchases (LSAP): 1) Impairment to the functioning of securities markets (“Fed dominance” “degrading liquidity and discovery”). 2) Substantial Fed balance sheet expansion could reduce public confidence (i.e. exit strategy and inflation expectation issues). 3) Risks to financial stability (i.e. “could induce imprudent reach for yield by some investors”). 4) “The possibility that the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent.”
I take exception with those calling Bernanke’s presentation “balanced.” He again misjudges and woefully understates risk. My analytical focus is directed at Risk #3, with the view that the Bernanke Fed is again disregarding myriad risks to financial stability associated with marketplace interventions and manipulations. Indeed, it would appear that risks to financial stability are escalating in concert with the escalation in the course of global monetary management. Dr. Bernanke’s “imprudent reach for yield by some” contrasts with my fear of the greatest financial Bubble in the history of mankind.
From Bernanke’s paper: “Of course, one objective of both traditional and nontraditional policy during recoveries is to promote a return to productive risk-taking; as always, the goal is to strike the appropriate balance. Moreover, a stronger recovery is itself clearly helpful for financial stability. In assessing this risk, it is important to note that the Federal Reserve, both on its own and in collaboration with other members of the Financial Stability Oversight Council, has substantially expanded its monitoring of the financial system and modified its supervisory approach to take a more systemic perspective. We have seen little evidence thus far of unsafe buildups of risk or leverage, but we will continue both our careful oversight and the implementation of financial regulatory reforms aimed at reducing systemic risk.”
I will first note that the Greenspan Federal Reserve was caught completely off-guard by the market excesses that their policies had nurtured back during the (then) aggressive 1992/93 reflation period. It's worth noting that the hedge fund community has expanded about 20-fold since, to a record $2.1 TN. Global derivatives markets have mushroomed to hundreds of Trillions. Importantly, derivatives markets as well as the global “leveraged speculating community” have continued to grow post-2008 crisis – only further bolstered by aggressive policy regimes. The failure of JPMorgan’s “whale” derivatives trades to garner the attention of regulators (prior to disclosure) does not inspire confidence that the Federal Reserve can satisfactorily gauge the amount of leverage or other risks that have accumulated in the amorphous world of global securities and derivatives markets.
That non-traditional monetary policy tools today work similarly to how traditional measures functioned historically is one of the great policy myths of this period. There remains this notion, furthered again by chairman Bernanke, that some quantity of quantitative easing (additional debt purchases/liquidity creation/Fed balance sheet growth) today would equate to, say, a 25 bps point cut in the Fed funds rate 25 years ago. Yet the entire monetary policy transfer mechanism has been radically altered, foremost by the transformation of system Credit expansion from primarily bank loan-driven to one dominated by marketable debt and myriad risk intermediation channels.
Traditionally, central bank stimulus would entail adding reserves into the banking system to effectively reduce the cost of funds, thereby incentivizing additional bank lending. Today, Federal Reserve monetary stimulus is transmitted primarily through incentivizing risk-taking and leveraging in the securities, derivatives and other risk asset markets. We now have about 20 years experience in support of the thesis that there exists a dangerously powerful interplay between activist central banking, marketable debt and financial speculation. Yet the Fed somehow seems to ensure that its analysis avoids addressing the associated risks of an ever-increasing Federal Reserve role in the pricing and trading dynamics of an ever-expanding quantity of securities, derivatives and market speculation.
The media continue with this focus on the timing of the Fed’s QE3 announcement. This now seems archaic. Global central bankers, whether Draghi at the ECB, or the Bernanke Fed, the Bank of England, the Swiss National Bank (SNB), or others, now actively pursue the power of “open-ended” monetary and market support/intervention. No quantification necessary. This escalation to unconstrained monetary stimulus was the motivation for last week’s “Do Whatever it Takes!” Drs. Draghi and Bernanke have done nothing less than to signal to the marketplace that they at any point and to any extent deemed necessary will be there to backstop the markets. Worries – albeit those associated with so-called “exit strategies” or inflation risks – have been completely overshadowed by a resolute determination to avert another global crisis. It may have been subtle; it’s no doubt radical. The Draghi and Bernanke “puts” have been significantly bolstered and manifestly communicated. Sophisticated global speculators operate knowing central bankers are unequivocally determined to quell so-called “tail” risk of illiquid and faltering securities markets.
I know most would today consider this whole line of analysis wacko lunatic fringe stuff. I am, as well, confident that in, say, five or so years’ time analysts will look back at this period and state it was obvious that Fed policy had been fueling a Bubble in Treasury and other securities markets. We’ve seen it all before. Yet with markets rallying strongly over the past month and with heady 2012 gains only mounting, the bullish spirit has triumphed. Talk has turned to a new secular bull market, along with visions of the “American Decade” (and century!). If only Washington would get to work on the fiscal issue, sound economic fundamentals would be free from worry – or so the thinking goes.
I’m the first to admit that it’s easy to dismiss the view that, only a month or so ago, rapidly escalating European debt tumult was at the brink of unleashing the forces of global financial and economic crisis. The path from illiquid Spanish and Italian debt markets and a crisis of confidence in the euro to a more globalized panic was not so difficult to discern: illiquid markets, de-risking/de-leveraging dynamics, capital flight, systemic banking stability issues, derivative and counterparty concerns, hedge fund problems and a resulting abrupt tightening of global financial conditions. Draghi surely believed he had no alternative than to go radical – and now Bernanke and others are as well ready to do whatever it takes.
Let’s return to Risk #3. Global markets have rallied strongly. Those bearishly positioned have been mauled. Risk hedges have been unwound. The speculator community has positioned bullishly around the globe to profit from the latest policy-induced bout of “risk on.” Those betting on the power of the policymaker market backstop have been rewarded and emboldened. What if it doesn’t work? What if policymakers have prodded everyone to one side of the boat - and then it tips? Is policymaking bolstering stability or, rather, exacerbating instability? It is now generally accepted that additional monetary stimulus would have little economic impact. Yet moving toward aggressive “open-ended” market interventions is, understandably, having a major impact on marketplace dynamics. Is financial stability again being unwittingly subverted?
Monetary policy will not resolve deep structural financial and economic issues in Europe – nor in the U.S., Japan, China or elsewhere around the world, for that matter. History informs us that it will likely make things worse. With focus on Jackson Hole, it was easy Friday to miss the widening hole in the Spanish bond market. Spain’s 10-year yields jumped 27 bps to 6.81%, with yields up 45 bps for the week. Spain Credit default swap (CDS) prices jumped 21 bps this week (eight-session rise of 62bps) to an almost one-month high 518 bps. Italian CDS ended the week 12 higher to 467 bps. Curiously, precious metals gained this week while most industrial metals declined. Is this evidence of market players willing to bet on policy-induced currency devaluation, while less convinced that impending monetary stimulus will have much real economic impact?
Draghi clearly has his plan – and his wingman at the Federal Reserve. There may be no turning back. At the same time, the European financial, economic and political issues may very well prove insurmountable. Yet why would the speculator community spend much time fretting the next round of “risk off,” not with global central bankers waiting anxiously with bazookas fully loaded. In the end, I suspect policymakers will regret inciting this particular, potentially unwieldy, phase of “risk on” market speculation and financial mania.
For the Week:
The S&P500 slipped 0.3% (up 11.9% y-t-d), and the Dow declined 0.5% (up 7.2%). The S&P 400 Mid-Caps added 0.1% (up 10.5%), and the small cap Russell 2000 rose 0.4% (up 9.6%). The Morgan Stanley Cyclicals fell 1.2% (up 7.8%), and the Transports sank 2.2% (down 0.2%). The Morgan Stanley Consumer index added 0.2% (up 7.5%), while the Utilities fell 1.0% (down 0.8%). The Banks were little changed (up 19.8%), while the Broker/Dealers increased 0.4% (down 2.5%). The Nasdaq100 slipped 0.2% (up 21.7%), and the Morgan Stanley High Tech index declined 1.0% (up 14.8%). The Semiconductors fell 0.7% (up 8.7%). The InteractiveWeek Internet index declined 1.1% (up 10.1%). The Biotechs dipped 0.4% (up 34.2%). With bullion up $46, the HUI gold index added 0.6% (down 8.1%).
One Treasury bill rates ended the week at 8 bps and three-month closed at 7 bps. Two-year government yields were down 5 bps to 0.22%. Five-year T-note yields ended the week down 12 bps to 0.59%. Ten-year yields fell 14 bps to 1.55%. Long bond yields sank 13 bps to 2.67%. Benchmark Fannie MBS yields sank 17 bps to 2.27%. The spread between benchmark MBS and 10-year Treasury yields narrowed 3 to 72 bps. The implied yield on December 2013 eurodollar futures fell 6.5 bps to 0.41%. The two-year dollar swap spread was little changed at 18 bps, and the 10-year dollar swap spread was little changed at 11 bps. Corporate bond spreads ended mixed. An index of investment grade bond risk increased one to 101 bps. An index of junk bond risk declined 3 to 543 bps.
Debt issuance slowed to a trickle. I saw no domestic investment grade debt or junk issued this week.
Junk bond funds saw inflows rise to $1.17bn (from Lipper).
I saw no convertible debt issued.
International dollar bond issuers included China Oilfield $1.0bn, Trancent Holdings $600 million and Manitoba $600 million.
Spain's 10-year yields jumped 45 bps to 6.81% (up 177bps y-t-d). Italian 10-yr yields rose 14 bps to 5.82% (down 121bps). German bund yields declined 2 bps to 1.33% (down 49bps), while French yields jumped 11 bps to 2.15% (down 99bps). The French to German 10-year bond spread widened 13 bps to 82 bps. Ten-year Portuguese yields declined 3 bps to 8.98% (down 379bps). The new Greek 10-year note yield dropped 46 bps to 22.74%. U.K. 10-year gilt yields fell 6 bps to 1.46% (down 51bps). Irish yields were up 4 bps to 5.77% (down 249bps).
The German DAX equities index was unchanged (up 18.2% y-t-d). Spain's IBEX 35 equities index gained another 1.5% (down 13.4%), and Italy's FTSE MIB rose 1.5% (up 0.1%). Japanese 10-year "JGB" yields declined one basis point to 0.79% (down 20bps). Japan's Nikkei sank 2.5% (up 4.6%). Emerging markets were weak. Brazil's Bovespa equities index fell 2.3% (up 0.5%), and Mexico's Bolsa dropped 2.0% (up 6.3%). South Korea's Kospi index slipped 0.8% (up 4.4%). India’s Sensex equities index fell 2.3% (up 12.5%). China’s Shanghai Exchange dropped 2.1% to a three-year low (down 6.9%).
Freddie Mac 30-year fixed mortgage rates fell 7 bps to 3.59% (down 63bps y-o-y). Fifteen-year fixed rates slipped 3 bps to 2.86% (down 53bps). One-year ARMs were down 3 bps to 2.63% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 6 bps to 4.21% (down 68bps).
Federal Reserve Credit declined $7.0bn to $2.804 TN. Fed Credit was down $32bn from a year ago, or 1.1%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/29) rose another $4.5bn to a record $3.568 TN. "Custody holdings" were up $147bn y-t-d and $81bn year-over-year, or 2.3%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $422bn y-o-y, or 4.2% to a record $10.575 TN. Over two years, reserves were $2.015 TN higher, for 24% growth.
M2 (narrow) "money" supply dropped $25.7bn to $10.044 TN. "Narrow money" has expanded 6.5% annualized year-to-date and was up 5.7% from a year ago. For the week, Currency increased $2.1bn. Demand and Checkable Deposits fell $23.4bn, while Savings Deposits increased $1.1bn. Small Denominated Deposits declined $2.6bn. Retail Money Funds fell $3.0bn.
Total Money Fund assets slipped $3bn to $2.571 TN. Money Fund assets were down $124bn y-t-d and $71bn over the past year, or 2.7%.
Total Commercial Paper outstanding increased $6.8bn to $1.032 TN. CP was up $73bn y-t-d, while having declined $66bn from a year ago, or down 6.0%.
Currency Watch:
The U.S. dollar index declined 0.5% to 81.208 (up 1.3% y-t-d). For the week on the upside, the Canadian dollar increased 0.6%, the Norwegian krone 0.6%, the euro 0.5%, the Swiss franc 0.5%, the Danish krone 0.5%, the British pound 0.4%, the Japanese yen 0.4%, the Singapore dollar 0.3%, and the Taiwanese dollar 0.1%. On the downside, the New Zealand dollar declined 1.0%, the Australian dollar 0.8%, the Swedish krona 0.3%, the Brazilian real 0.2%, and the Mexican peso 0.1%.
Commodities Watch:
August 30 – Wall Street Journal (Sameer C. Mohindru): “A Taiwan importers' association bought soybeans Tuesday, in what might seem a routine tender. But it wasn't. Instead of buying one cargo of around 60,000 metric tons, as usual, the… Taiwan's Breakfast Soybean Procurement Association bought three, including one not due for shipping until next July. It was the second time in less than a week that a Taiwanese buyer had taken above-average or far-forward amounts. With prices already in uncharted territory and an even tighter market in the future seeming all but inevitable, soybean importers elsewhere having been locking in supplies, too. Prices for wheat and corn are also soaring... But the time bomb ticking under the global soybean trade is potentially more explosive. Corn and wheat can be substituted for one another for many uses—but soymeal substitutes are limited, and even costlier.”
The CRB index increased 1.2% this week (up 1.4% y-t-d). The Goldman Sachs Commodities Index gained 0.7% (up 4.7%). Spot Gold rose 1.3% to $1,692 (up 8.2%). Silver gained 2.4% to $31.44 (up 12.6%). October Crude rose 32 cents to $96.47 (down 2%). October Gasoline jumped 2.1% (up 12%), and October Natural Gas gained 2.4% (down 6%). December Copper declined 0.9% (up 1%). September Wheat added 0.3% (up 33%), while September Corn was little changed (up 24%).
Global Credit Watch:
August 31 – Dow Jones: “German Chancellor Angela Merkel has asked Italian Prime Minister Mario Monti to delay any bailout request for Italy, El Mundo reported… She will ask the same of Spanish Prime Minister Mariano Rajoy when they meet in Madrid next Thursday, the paper added. The reason behind Ms. Merkel's requests is to calm down tensions with the German Bundesbank head Jens Weidmann, who has been vehemently opposing any action from the European Central Bank to buy Spanish or Italian bonds.”
August 31 – Bloomberg (Jeff Black and Jana Randow): “The euro area’s 17 national central bank governors will have about 24 hours to digest European Central Bank President Mario Draghi’s bond-buying proposal before they start debating it, three officials said. The ECB’s Executive Board will send a list of options for the bond-buying program to the governors on Sept. 4, a day before the Governing Council convenes in Frankfurt… The meeting concludes on Sept. 6, after which Draghi holds his regular press conference. No single policy option has emerged as preeminent, the officials said… The lack of a clear preference, the complexity of the issue and the shortage of time increase the risk that Draghi won’t present a detailed plan next week, according to economists at Commerzbank AG and JPMorgan Chase & Co. The ECB may choose to hold back some details of the plan until the German Constitutional Court rules on the legality of Europe’s permanent bailout fund on Sept. 12, two of the officials said.”
August 29 – Financial Times (Miles Johnson, Ralph Atkins and Claire Jones): “Catalonia will request an emergency €5bn credit line from Spain’s central government as the region struggles to refinance its debts, underscoring anxieties about the eurozone debt crisis a week before the European Central Bank is expected to unveil details of its revamped bond-buying programme. The government of Catalonia, which has debts of €42bn and manages an economy as large as Portugal’s, on Tuesday said it would request the aid from Spain’s regional bailout fund. The region has been locked out of capital markets and will become the second of Spain’s 17 autonomous regions to formally request aid from a €18bn government rescue fund. Francesco Homs, spokesman for the regional government, said it would not accept additional political conditions over budgetary measures already agreed with Madrid ‘because the money is Catalan money’ – a stance that risks fostering further tension with Spain’s central government after Catalonia boycotted a meeting to set regional budgets in late July.”
August 31 – Bloomberg (Angeline Benoit): “Catalonia’s credit rating was cut to junk by Standard & Poor’s after Spain’s most indebted region said it needs to tap a national rescue fund, even as the central government said its budget deficit swelled to 48.5 billion euros ($61bn) in the year through July. The cash-strapped national government in Madrid also moved today to inject capital into the Bankia group ‘immediately’ after the nationalized lender posted a 4.45 billion-euro first- half loss.”
August 30 – Bloomberg (Angeline Benoit): “The Spanish region of Murcia became the third to say it will need emergency loans, and Valencia signaled it needs funds to cover current and past overspending, adding fiscal pressure on Prime Minister Mariano Rajoy. A day after Catalonia said it needed 5 billion euros ($6.3bn) from an 18 billion-euro bailout fund announced by Rajoy last month, an official in southeastern Murcia yesterday put its needs at 700 million euros. In Valencia… 3.5 billion euros would cover only current needs… The country’s regions risk overwhelming a plan to tackle the euro area’s third-biggest budget deficit. They were responsible last year for most of Spain’s overspending, which remained nearly unchanged from 2010 at 8.9% of gross domestic product… Together with Murcia, Valencia and Catalonia, Spain’s two most indebted regions, aim to use more than half of Rajoy’s last bailout fund, created to enable regions to face bond redemptions and finance their deficits in the second half. ‘Everything depends on Andalusia now,’ said Juan Rubio- Ramirez, an economist at Duke University in Durham, North Carolina. ‘If Andalusia asks for aid, it could be a similar amount to Catalonia and that means the fund may not be enough.’ Rubio-Ramirez co-authored a report this month forecasting the regions may run deficits as high as 4% of GDP this year, compared with 3.3 percent last year and a target of 1.5% for 2012.”
August 27 – Bloomberg (Angeline Benoit): “Spanish Prime Minister Mariano Rajoy’s austerity drive will intensify this week as a sales-tax increase tightens the squeeze on consumers whose spending is already plummeting. The move to raise the value-added tax on Sept. 1 will follow a flurry of data showing pressure building on household finances in the euro area’s fourth-biggest economy, home to a third of its unemployed. A report today showed mortgages fell 25.2% from a year ago in June after a 30.5% drop in May. Meanwhile, the Health Ministry… said spending on prescription drugs fell 23.9% from a year ago in July… after the government last month increased the share patients pay for pharmaceuticals.”
August 29 – Reuters (Carlos Ruano and Jesús Aguado): “Nationalised lender Bankia is expected to post first-half losses of more than 4 billion euros (3bn pounds) on Friday, highlighting the need for capital from a European rescue of Spanish banks that is unlikely to arrive before the end of September. Bankia was taken over by the government in May when it asked for 19 billion eurosof state aid after anticipating the steep losses from real estate investments which soured after the property market crashed four years ago.”
August 31 – Bloomberg (James G. Neuger): “Countering arguments made by the German economics establishment since before the introduction of the euro, European Central Bank President Mario Draghi said it’s in Germany’s interest to consent to extraordinary steps to preserve the currency shared by 17 nations. Draghi used the… German weekly Die Zeit to plead for a more expansive role for the central bank and to say that the crisis-struck currency can be stabilized without sacrificing each country’s independence to a unified European political system. In tactical terms, Draghi sought to neutralize protests made by Germany’s top central banker, Jens Weidmann…”
August 27 – Bloomberg (Fred Pals): “Dutch caretaker Prime Minister Mark Rutte, seeking a return to power after Sept. 12 elections, said he would block a third aid package for Greece and defended austerity as the only way out of Europe’s debt crisis. ‘We’ve helped twice and now it’s up to the Greeks to show that they want to stay within the euro,’ Liberal leader Rutte, 45, said… ‘The Netherlands has been severely hit by the debt crisis and the solution is to lower taxes, get government finances in order and make room for investment.’”
August 30 – Bloomberg: “Chinese Premier Wen Jiabao told visiting German Chancellor Angela Merkel that Spain, Italy and Greece must take ‘comprehensive measures’ to prevent a worsening of the euro region’s sovereign-debt crisis. ‘The main worries are two-fold: First is whether Greece will leave the euro zone,’ Wen said… ‘The second is whether Italy and Spain will take comprehensive rescue measures. Resolving these two problems rests with whether Greece, Spain, Italy and other countries have the determination for reform.’”
Global Bubble Watch:
August 31 – Bloomberg (Sarika Gangar): “Sales of corporate bonds globally surged to the most on record for August as issuers rushed to lock in record-low borrowing costs. Siemens AG, Europe’s largest engineering company, and JPMorgan Chase & Co. led borrowers selling $237.6 billion of debt this month, exceeding the $235.3 billion raised in August 2010… Yields fell to an unprecedented low of 3.72% on Aug. 28…”
August 29 – Financial Times (Kandy Wong): “China’s top banks are stepping up their lending activities in the US as large US companies diversify their funding sources and seek to penetrate more deeply into the world’s second-largest economy. Chinese banks’ share of US syndicated lending has risen to 6.1% of the total market so far in 2012, up from 5.1% last year, according to data from Dealogic. So far this year, the total value of syndicated loans from Chinese banks into the US has reached $51bn.”
Germany Watch:
August 28 – MarketNews International: “The European Central Bank will be overextended and no longer able to fulfill its price stability mandate if it engages in more sovereign bond buys, former ECB Executive Board member Juergen Stark wrote in an editorial for German daily Handelsblatt… Stark, who resigned from the ECB in 2011, in large part because of the original SMP bond-buying program, said restarting such a program would lead to inflation dangers down the road and further erode the ECB's political independence. Stark accused the ECB Governing Council members from southern peripheral Eurozone countries of trying to use the ECB to achieve national interests. He said bond buys were ‘hardly’ relevant for monetary policy and instead amounted to ‘de facto’ state financing. ‘The role, which the ECB appears prepared to take on, will over-extend the central bank and further erode its independence from politics. And in the end, the central bank will no longer be able to perform its core task, guaranteeing price stability,’ Stark wrote.”
European Economy Watch:
August 31 – Bloomberg (Jim Brunsden and Rebecca Christie): “The European Central Bank would have the sole power to grant banking licenses under proposals to give it supervisory powers and build a euro-area banking union, a European Union official said. The ECB would have a monopoly on granting all bank licenses within the 17-nation euro area under the plan, due to be unveiled on Sept. 12, the official said, speaking on condition of anonymity… the ECB would also gain discretion over which banks to supervise directly and when it will delegate day-to-day oversight responsibilities, the official said. National regulators will retain control over when and how to close a bank under the proposals. At the same time, the central bank would be able to make recommendations and have a voice in the process.”
August 28 – Bloomberg (Angeline Benoit): “Spain’s recession worsened in the second quarter as the government’s austerity push to reduce the euro area’s third-biggest budget deficit and a slump in consumer spending offset growth in exports. Gross domestic product fell 0.4 percent from the previous quarter, when it declined 0.3%... ‘We fear that things are likely to get worse before they get better,’ said Martin van Vliet, an economist at ING Bank in Amsterdam… ‘With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted toward a more protracted recession.”
August 30 – Bloomberg (Angeline Benoit): “Spanish inflation accelerated more than economists forecast in August as the government stepped up efforts to plug the euro region’s third-largest budget deficit amid a worsening recession. Consumer prices… rose 2.7% from a year earlier after an annual gain of 2.2% in July…”
August 29 – Bloomberg (Stefan Riecher): “German inflation accelerated more than economists forecast in August on higher energy costs. The inflation rate, calculated using a harmonized European Union method, rose to 2.2% from 1.9% in July…”
August 31 – Bloomberg (Chiara Vasarri and Tommaso Ebhardt): “Giovanni Cimmino filled up his Fiat Multipla in Croatia before returning to Italy after his summer holiday, avoiding Europe’s highest gasoline prices. ‘You need a smart strategy to save on gas,’ said Cimmino, 37, who manages a metals trading company near Milan. With pump prices at a record in Italy, ‘I tend to use more public transportation and avoid driving when it’s not necessary.’ Unleaded fuel has climbed to more than 2 euros ($2.50) a liter, about $9.50 a gallon, in some areas of Italy…”
August 28 – Bloomberg (Jana Randow): “Lending to households and companies in the 17-nation euro area increased for the first time in three months in July after European leaders committed to new measures to solve the debt crisis. Loans to the private sector rose 0.1% from a year earlier after dropping an annual 0.2% in June… Lending increased 0.3% from June, the first gain since January.”
China Watch:
August 31 - South China Morning Post (Teddy Ng): “Premier Wen Jiabao voiced his fears about the European debt crisis yesterday after a meeting with visiting German Chancellor Dr Angela Merkel. ‘The European debt crisis has continued to worsen, giving rise to serious concerns in the international community. Frankly speaking, I am also worried,’ Wen said. ‘The main worries are two-fold. First is whether Greece will leave the euro zone, and the second is whether Italy and Spain will ask for comprehensive rescue measures.’ He called on Greece, Spain and Italy to embrace budget cuts and other reforms to restore confidence in the fragile euro zone.”
August 28 – Bloomberg: “China’s corporate bonds are set for their first monthly loss this year as more than half of issuers reported profit growth slowed. Company debt in the world’s second-biggest economy has lost 0.8% in August, paring gains for the year to 3.6% compared with 6.4% in 2011… Issuance has increased 53% in 2012 from the year earlier, weighing on demand… Among listed issuers, 55% said profit fell from a year earlier and 9% reported losses, according to China International Capital Corp…. ‘The whole economy is slowing, which is obviously leading to a decline in company profits,’ and putting pressure on bond returns, said Fan Wei, a fixed-income analyst at Hongyuan Securities Co…. Premier Wen Jiabao has encouraged companies to sell debt to replace state-owned bank loans. Corporate bonds accounted for a record amount of total financing in the economy in July… Issuance of the securities has jumped to 2.3 trillion yuan this year from 1.5 trillion yuan for the same period last year…”
August 27 – Bloomberg: “Chinese industrial companies’ profits fell in July by the most this year, a government report showed today, adding to evidence the nation’s economic slowdown is deepening. Income dropped 5.4% last month from a year earlier to 366.8 billion yuan ($57.7bn), the fourth straight decline… That compares with a 1.7% slide in June and a 5.3% drop in May.”
August 29 – Bloomberg: “Health-care spending in China will almost triple to $1 trillion annually by 2020 driven by an aging population and government efforts to broaden insurance coverage, according to a McKinsey & Co. report… China will spend more on drugs, medical devices and hospital treatments as it lifts spending to 7% of gross domestic product, from 5.5%, or $350 billion, in 2010, McKinsey said. This will make it the biggest market globally by 2020 after the U.S., which in 2009 spent $2.5 trillion, or 17.6% of its GDP, on health care…”
Japan Watch:
August 31 – Bloomberg (Andy Sharp and Toru Fujioka): “Japan’s consumer prices slid at a faster pace in July and industrial production unexpectedly slumped, raising the danger that the world’s third-largest economy has slipped back into a contraction. The benchmark price gauge, which excludes fresh food, fell 0.3% in July from a year before, putting the central bank’s 1% inflation goal further from reach… Industrial output fell 1.2%. A private measure of manufacturing for August was the lowest since the aftermath of the record March 2011 earthquake.”
U.S. Bubble Economy Watch:
August 28 – Reuters (Carlos Ruano and Jesús Aguado): “America’s 50 state governments owe $4.19 trillion, including outstanding bonds, unfunded pension commitments and budget gaps, according to a new report. At $617.6 billion, California had by far the biggest total debt, more than twice the total of No. 2, New York, with $300.1 billion owed, according to State Budget Solutions, a research and non-partisan advocacy group.”
August 27 – Bloomberg (Shobhana Chandra and Sandrine Rastello): “The worst U.S. drought in at least 50 years may restrain consumer confidence and spending as it pushes Americans’ grocery bills higher later this year. Food prices will increase an average 4% annual rate in the nine months ending June 2013, up from 1.5% currently, said Michael Feroli, chief U.S. economist at JPMorgan… That may trim real disposable incomes by 0.3 percentage point from the fourth quarter of 2012 through the first half of next year and reduce spending by a similar amount, he estimates. The projected food-price increase will squeeze budgets of households already contending with a 13% gain in gasoline prices since early July and unemployment that is stuck above 8% three years into the economic recovery… ‘Energy is hitting us now, food is going to hit us later,” Feroli said. ‘It will be a headwind for consumers. It’s going to damp people’s perceptions of the economy.’”
August 29 – Wall Street Journal (John D. McKinnon and Scott Thurm): “More big U.S. companies are reincorporating abroad despite a 2004 federal law that sought to curb the practice. One big reason: Taxes. Companies cite various reasons for moving, including expanding their operations and their geographic reach. But tax bills remain a primary concern. A few cite worries that U.S. taxes will rise in the future, especially if Washington revamps the tax code next year to shrink the federal budget deficit."
Central Bank Watch:
August 31 - Wall Street Journal (Jon Hilsenrath): "Fed Chairman Ben Bernanke wasn't expecting he would have to make another speech like the one he will deliver here Friday. A few months ago the Federal Reserve seemed to be on cruise control as the economy healed. Many officials at the central bank hoped they were done with launching complicated programs to spur a sluggish economy. But Mr. Bernanke and his colleagues, once again disappointed by slow growth and small employment gains this year, are formulating another new dose of monetary stimulus to be considered at their next policy meeting... Mr. Bernanke has argued that when the Fed buys long-term Treasury securities or mortgage bonds, it pushes down long-term interest rates and pushes up prices of assets such as stocks. Fed officials also believe the purchases help weaken the dollar."
August 31 – Bloomberg (Joshua Zumbrun and Jeff Kearns): “Federal Reserve Chairman Ben S. Bernanke, lamenting the suffering caused by unemployment of more than 8% and defending his unprecedented actions, made the case for further monetary easing. ‘The costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant,’ Bernanke said… Bernanke, speaking two weeks before the next meeting of the Federal Open Market Committee, emphasized that a new round of bond purchases is an option. Stocks and Treasuries climbed and the dollar weakened to a more than three-month low as investors speculated steps to boost the economy may come as soon as next month. ‘The door is wide open to the Fed contemplating additional action,” said Josh Feinman, a former Fed senior economist who helps oversee $219 billion at Deutsche Bank AG’s asset management unit in New York. ‘It reaffirms other messages sent by the Fed that additional action is still very much on the table. By the end of the year we’ll probably get both rate guidance extension and more asset purchases.’”
Muni Watch:
August 29 – Bloomberg (Michelle Kaske): “Illinois, which has the worst-funded pension system among U.S. states, had the rating on its general-obligation debt cut one level to A by Standard & Poor’s and may face more downgrades. The change followed state lawmakers’ failure to agree to reduce retirement costs during a special session Aug. 17. The outlook for the fifth-most populous state’s debt, which now has S&P’s sixth-highest grade, is negative. California, with an A- ranking, one level below Illinois, remains S&P’s lowest-rated state.”
Chairman Bernanke titled his 2012 Jackson Hole presentation “Monetary Policy since the Onset of the Crisis.” His review begins with the Fed’s initial response to the unfolding mortgage crisis in August 2007. The paper then details five years of policy measures, with section headings “Balance Sheet Tools,” “Communication Tools,” “Economic Prospects,” and “Making Policy with Nontraditional Tools: A Cost-Benefit Framework.” Dr. Bernanke concludes with coded dovish messages, including “grave concern” that “high levels of unemployment will wreak structural damage” – after earlier signaling support for the Draghi Plan (“recent policy proposals in Europe have been quite constructive in my view, and I urge our European colleagues to press ahead…”).
As noted above by the astute Stephen Roach, Dr. Bernanke played an instrumental intellectual role in crafting policy with Chairman Greenspan that fatefully nurtured the mortgage finance Bubble. In arguably history’s greatest monetary policy misadventure, the Greenspan/Bernanke Fed purposely ignored the unfolding Bubble, choosing instead to commit the Federal Reserve to aggressive post-Bubble “mopping up” strategies. Five years into the crisis, the extent of required “mopping up” remains an unfolding saga that will be analyzed and debated for decades to come. To be sure, the Federal Reserve’s framework for monetary policy cost-benefit analysis during the post-technology Bubble reflationary period (2002-2007) was an abject failure. Most of us strive to learn from our big mistakes.
Chairman Bernanke, not surprisingly, made it clear in Jackson Hole that he is prepared to move further into the uncharted waters of “non-traditional” monetary tools. His review came out on the side of benefits outweighing “manageable” costs, although perhaps to placate the hawks he cautioned, “The hurdle for using nontraditional policies should be higher than for traditional policies. At the same time, the costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant.”
Before delving into his cost-benefit framework, it is worth mentioning that the word “Bubble” is nowhere to be found in Bernanke’s paper. I strongly argue that the issue of whether the Fed is once again accommodating a Credit (“government finance”) Bubble is today’s prevailing – potentially catastrophic - policy risk. The possible role that non-traditional policy tools might be playing in nurturing Bubble dynamics should be the focal point of any cost-benefit analysis related to the Fed’s experimental policymaking endeavor. Regrettably, it’s completely disregarded - hear no evil, speak no evil, and see no evil.
Dr. Bernanke highlights four potential costs of large-scale asset purchases (LSAP): 1) Impairment to the functioning of securities markets (“Fed dominance” “degrading liquidity and discovery”). 2) Substantial Fed balance sheet expansion could reduce public confidence (i.e. exit strategy and inflation expectation issues). 3) Risks to financial stability (i.e. “could induce imprudent reach for yield by some investors”). 4) “The possibility that the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent.”
I take exception with those calling Bernanke’s presentation “balanced.” He again misjudges and woefully understates risk. My analytical focus is directed at Risk #3, with the view that the Bernanke Fed is again disregarding myriad risks to financial stability associated with marketplace interventions and manipulations. Indeed, it would appear that risks to financial stability are escalating in concert with the escalation in the course of global monetary management. Dr. Bernanke’s “imprudent reach for yield by some” contrasts with my fear of the greatest financial Bubble in the history of mankind.
From Bernanke’s paper: “Of course, one objective of both traditional and nontraditional policy during recoveries is to promote a return to productive risk-taking; as always, the goal is to strike the appropriate balance. Moreover, a stronger recovery is itself clearly helpful for financial stability. In assessing this risk, it is important to note that the Federal Reserve, both on its own and in collaboration with other members of the Financial Stability Oversight Council, has substantially expanded its monitoring of the financial system and modified its supervisory approach to take a more systemic perspective. We have seen little evidence thus far of unsafe buildups of risk or leverage, but we will continue both our careful oversight and the implementation of financial regulatory reforms aimed at reducing systemic risk.”
I will first note that the Greenspan Federal Reserve was caught completely off-guard by the market excesses that their policies had nurtured back during the (then) aggressive 1992/93 reflation period. It's worth noting that the hedge fund community has expanded about 20-fold since, to a record $2.1 TN. Global derivatives markets have mushroomed to hundreds of Trillions. Importantly, derivatives markets as well as the global “leveraged speculating community” have continued to grow post-2008 crisis – only further bolstered by aggressive policy regimes. The failure of JPMorgan’s “whale” derivatives trades to garner the attention of regulators (prior to disclosure) does not inspire confidence that the Federal Reserve can satisfactorily gauge the amount of leverage or other risks that have accumulated in the amorphous world of global securities and derivatives markets.
That non-traditional monetary policy tools today work similarly to how traditional measures functioned historically is one of the great policy myths of this period. There remains this notion, furthered again by chairman Bernanke, that some quantity of quantitative easing (additional debt purchases/liquidity creation/Fed balance sheet growth) today would equate to, say, a 25 bps point cut in the Fed funds rate 25 years ago. Yet the entire monetary policy transfer mechanism has been radically altered, foremost by the transformation of system Credit expansion from primarily bank loan-driven to one dominated by marketable debt and myriad risk intermediation channels.
Traditionally, central bank stimulus would entail adding reserves into the banking system to effectively reduce the cost of funds, thereby incentivizing additional bank lending. Today, Federal Reserve monetary stimulus is transmitted primarily through incentivizing risk-taking and leveraging in the securities, derivatives and other risk asset markets. We now have about 20 years experience in support of the thesis that there exists a dangerously powerful interplay between activist central banking, marketable debt and financial speculation. Yet the Fed somehow seems to ensure that its analysis avoids addressing the associated risks of an ever-increasing Federal Reserve role in the pricing and trading dynamics of an ever-expanding quantity of securities, derivatives and market speculation.
The media continue with this focus on the timing of the Fed’s QE3 announcement. This now seems archaic. Global central bankers, whether Draghi at the ECB, or the Bernanke Fed, the Bank of England, the Swiss National Bank (SNB), or others, now actively pursue the power of “open-ended” monetary and market support/intervention. No quantification necessary. This escalation to unconstrained monetary stimulus was the motivation for last week’s “Do Whatever it Takes!” Drs. Draghi and Bernanke have done nothing less than to signal to the marketplace that they at any point and to any extent deemed necessary will be there to backstop the markets. Worries – albeit those associated with so-called “exit strategies” or inflation risks – have been completely overshadowed by a resolute determination to avert another global crisis. It may have been subtle; it’s no doubt radical. The Draghi and Bernanke “puts” have been significantly bolstered and manifestly communicated. Sophisticated global speculators operate knowing central bankers are unequivocally determined to quell so-called “tail” risk of illiquid and faltering securities markets.
I know most would today consider this whole line of analysis wacko lunatic fringe stuff. I am, as well, confident that in, say, five or so years’ time analysts will look back at this period and state it was obvious that Fed policy had been fueling a Bubble in Treasury and other securities markets. We’ve seen it all before. Yet with markets rallying strongly over the past month and with heady 2012 gains only mounting, the bullish spirit has triumphed. Talk has turned to a new secular bull market, along with visions of the “American Decade” (and century!). If only Washington would get to work on the fiscal issue, sound economic fundamentals would be free from worry – or so the thinking goes.
I’m the first to admit that it’s easy to dismiss the view that, only a month or so ago, rapidly escalating European debt tumult was at the brink of unleashing the forces of global financial and economic crisis. The path from illiquid Spanish and Italian debt markets and a crisis of confidence in the euro to a more globalized panic was not so difficult to discern: illiquid markets, de-risking/de-leveraging dynamics, capital flight, systemic banking stability issues, derivative and counterparty concerns, hedge fund problems and a resulting abrupt tightening of global financial conditions. Draghi surely believed he had no alternative than to go radical – and now Bernanke and others are as well ready to do whatever it takes.
Let’s return to Risk #3. Global markets have rallied strongly. Those bearishly positioned have been mauled. Risk hedges have been unwound. The speculator community has positioned bullishly around the globe to profit from the latest policy-induced bout of “risk on.” Those betting on the power of the policymaker market backstop have been rewarded and emboldened. What if it doesn’t work? What if policymakers have prodded everyone to one side of the boat - and then it tips? Is policymaking bolstering stability or, rather, exacerbating instability? It is now generally accepted that additional monetary stimulus would have little economic impact. Yet moving toward aggressive “open-ended” market interventions is, understandably, having a major impact on marketplace dynamics. Is financial stability again being unwittingly subverted?
Monetary policy will not resolve deep structural financial and economic issues in Europe – nor in the U.S., Japan, China or elsewhere around the world, for that matter. History informs us that it will likely make things worse. With focus on Jackson Hole, it was easy Friday to miss the widening hole in the Spanish bond market. Spain’s 10-year yields jumped 27 bps to 6.81%, with yields up 45 bps for the week. Spain Credit default swap (CDS) prices jumped 21 bps this week (eight-session rise of 62bps) to an almost one-month high 518 bps. Italian CDS ended the week 12 higher to 467 bps. Curiously, precious metals gained this week while most industrial metals declined. Is this evidence of market players willing to bet on policy-induced currency devaluation, while less convinced that impending monetary stimulus will have much real economic impact?
Draghi clearly has his plan – and his wingman at the Federal Reserve. There may be no turning back. At the same time, the European financial, economic and political issues may very well prove insurmountable. Yet why would the speculator community spend much time fretting the next round of “risk off,” not with global central bankers waiting anxiously with bazookas fully loaded. In the end, I suspect policymakers will regret inciting this particular, potentially unwieldy, phase of “risk on” market speculation and financial mania.
For the Week:
The S&P500 slipped 0.3% (up 11.9% y-t-d), and the Dow declined 0.5% (up 7.2%). The S&P 400 Mid-Caps added 0.1% (up 10.5%), and the small cap Russell 2000 rose 0.4% (up 9.6%). The Morgan Stanley Cyclicals fell 1.2% (up 7.8%), and the Transports sank 2.2% (down 0.2%). The Morgan Stanley Consumer index added 0.2% (up 7.5%), while the Utilities fell 1.0% (down 0.8%). The Banks were little changed (up 19.8%), while the Broker/Dealers increased 0.4% (down 2.5%). The Nasdaq100 slipped 0.2% (up 21.7%), and the Morgan Stanley High Tech index declined 1.0% (up 14.8%). The Semiconductors fell 0.7% (up 8.7%). The InteractiveWeek Internet index declined 1.1% (up 10.1%). The Biotechs dipped 0.4% (up 34.2%). With bullion up $46, the HUI gold index added 0.6% (down 8.1%).
One Treasury bill rates ended the week at 8 bps and three-month closed at 7 bps. Two-year government yields were down 5 bps to 0.22%. Five-year T-note yields ended the week down 12 bps to 0.59%. Ten-year yields fell 14 bps to 1.55%. Long bond yields sank 13 bps to 2.67%. Benchmark Fannie MBS yields sank 17 bps to 2.27%. The spread between benchmark MBS and 10-year Treasury yields narrowed 3 to 72 bps. The implied yield on December 2013 eurodollar futures fell 6.5 bps to 0.41%. The two-year dollar swap spread was little changed at 18 bps, and the 10-year dollar swap spread was little changed at 11 bps. Corporate bond spreads ended mixed. An index of investment grade bond risk increased one to 101 bps. An index of junk bond risk declined 3 to 543 bps.
Debt issuance slowed to a trickle. I saw no domestic investment grade debt or junk issued this week.
Junk bond funds saw inflows rise to $1.17bn (from Lipper).
I saw no convertible debt issued.
International dollar bond issuers included China Oilfield $1.0bn, Trancent Holdings $600 million and Manitoba $600 million.
Spain's 10-year yields jumped 45 bps to 6.81% (up 177bps y-t-d). Italian 10-yr yields rose 14 bps to 5.82% (down 121bps). German bund yields declined 2 bps to 1.33% (down 49bps), while French yields jumped 11 bps to 2.15% (down 99bps). The French to German 10-year bond spread widened 13 bps to 82 bps. Ten-year Portuguese yields declined 3 bps to 8.98% (down 379bps). The new Greek 10-year note yield dropped 46 bps to 22.74%. U.K. 10-year gilt yields fell 6 bps to 1.46% (down 51bps). Irish yields were up 4 bps to 5.77% (down 249bps).
The German DAX equities index was unchanged (up 18.2% y-t-d). Spain's IBEX 35 equities index gained another 1.5% (down 13.4%), and Italy's FTSE MIB rose 1.5% (up 0.1%). Japanese 10-year "JGB" yields declined one basis point to 0.79% (down 20bps). Japan's Nikkei sank 2.5% (up 4.6%). Emerging markets were weak. Brazil's Bovespa equities index fell 2.3% (up 0.5%), and Mexico's Bolsa dropped 2.0% (up 6.3%). South Korea's Kospi index slipped 0.8% (up 4.4%). India’s Sensex equities index fell 2.3% (up 12.5%). China’s Shanghai Exchange dropped 2.1% to a three-year low (down 6.9%).
Freddie Mac 30-year fixed mortgage rates fell 7 bps to 3.59% (down 63bps y-o-y). Fifteen-year fixed rates slipped 3 bps to 2.86% (down 53bps). One-year ARMs were down 3 bps to 2.63% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 6 bps to 4.21% (down 68bps).
Federal Reserve Credit declined $7.0bn to $2.804 TN. Fed Credit was down $32bn from a year ago, or 1.1%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/29) rose another $4.5bn to a record $3.568 TN. "Custody holdings" were up $147bn y-t-d and $81bn year-over-year, or 2.3%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $422bn y-o-y, or 4.2% to a record $10.575 TN. Over two years, reserves were $2.015 TN higher, for 24% growth.
M2 (narrow) "money" supply dropped $25.7bn to $10.044 TN. "Narrow money" has expanded 6.5% annualized year-to-date and was up 5.7% from a year ago. For the week, Currency increased $2.1bn. Demand and Checkable Deposits fell $23.4bn, while Savings Deposits increased $1.1bn. Small Denominated Deposits declined $2.6bn. Retail Money Funds fell $3.0bn.
Total Money Fund assets slipped $3bn to $2.571 TN. Money Fund assets were down $124bn y-t-d and $71bn over the past year, or 2.7%.
Total Commercial Paper outstanding increased $6.8bn to $1.032 TN. CP was up $73bn y-t-d, while having declined $66bn from a year ago, or down 6.0%.
Currency Watch:
The U.S. dollar index declined 0.5% to 81.208 (up 1.3% y-t-d). For the week on the upside, the Canadian dollar increased 0.6%, the Norwegian krone 0.6%, the euro 0.5%, the Swiss franc 0.5%, the Danish krone 0.5%, the British pound 0.4%, the Japanese yen 0.4%, the Singapore dollar 0.3%, and the Taiwanese dollar 0.1%. On the downside, the New Zealand dollar declined 1.0%, the Australian dollar 0.8%, the Swedish krona 0.3%, the Brazilian real 0.2%, and the Mexican peso 0.1%.
Commodities Watch:
August 30 – Wall Street Journal (Sameer C. Mohindru): “A Taiwan importers' association bought soybeans Tuesday, in what might seem a routine tender. But it wasn't. Instead of buying one cargo of around 60,000 metric tons, as usual, the… Taiwan's Breakfast Soybean Procurement Association bought three, including one not due for shipping until next July. It was the second time in less than a week that a Taiwanese buyer had taken above-average or far-forward amounts. With prices already in uncharted territory and an even tighter market in the future seeming all but inevitable, soybean importers elsewhere having been locking in supplies, too. Prices for wheat and corn are also soaring... But the time bomb ticking under the global soybean trade is potentially more explosive. Corn and wheat can be substituted for one another for many uses—but soymeal substitutes are limited, and even costlier.”
The CRB index increased 1.2% this week (up 1.4% y-t-d). The Goldman Sachs Commodities Index gained 0.7% (up 4.7%). Spot Gold rose 1.3% to $1,692 (up 8.2%). Silver gained 2.4% to $31.44 (up 12.6%). October Crude rose 32 cents to $96.47 (down 2%). October Gasoline jumped 2.1% (up 12%), and October Natural Gas gained 2.4% (down 6%). December Copper declined 0.9% (up 1%). September Wheat added 0.3% (up 33%), while September Corn was little changed (up 24%).
Global Credit Watch:
August 31 – Dow Jones: “German Chancellor Angela Merkel has asked Italian Prime Minister Mario Monti to delay any bailout request for Italy, El Mundo reported… She will ask the same of Spanish Prime Minister Mariano Rajoy when they meet in Madrid next Thursday, the paper added. The reason behind Ms. Merkel's requests is to calm down tensions with the German Bundesbank head Jens Weidmann, who has been vehemently opposing any action from the European Central Bank to buy Spanish or Italian bonds.”
August 31 – Bloomberg (Jeff Black and Jana Randow): “The euro area’s 17 national central bank governors will have about 24 hours to digest European Central Bank President Mario Draghi’s bond-buying proposal before they start debating it, three officials said. The ECB’s Executive Board will send a list of options for the bond-buying program to the governors on Sept. 4, a day before the Governing Council convenes in Frankfurt… The meeting concludes on Sept. 6, after which Draghi holds his regular press conference. No single policy option has emerged as preeminent, the officials said… The lack of a clear preference, the complexity of the issue and the shortage of time increase the risk that Draghi won’t present a detailed plan next week, according to economists at Commerzbank AG and JPMorgan Chase & Co. The ECB may choose to hold back some details of the plan until the German Constitutional Court rules on the legality of Europe’s permanent bailout fund on Sept. 12, two of the officials said.”
August 29 – Financial Times (Miles Johnson, Ralph Atkins and Claire Jones): “Catalonia will request an emergency €5bn credit line from Spain’s central government as the region struggles to refinance its debts, underscoring anxieties about the eurozone debt crisis a week before the European Central Bank is expected to unveil details of its revamped bond-buying programme. The government of Catalonia, which has debts of €42bn and manages an economy as large as Portugal’s, on Tuesday said it would request the aid from Spain’s regional bailout fund. The region has been locked out of capital markets and will become the second of Spain’s 17 autonomous regions to formally request aid from a €18bn government rescue fund. Francesco Homs, spokesman for the regional government, said it would not accept additional political conditions over budgetary measures already agreed with Madrid ‘because the money is Catalan money’ – a stance that risks fostering further tension with Spain’s central government after Catalonia boycotted a meeting to set regional budgets in late July.”
August 31 – Bloomberg (Angeline Benoit): “Catalonia’s credit rating was cut to junk by Standard & Poor’s after Spain’s most indebted region said it needs to tap a national rescue fund, even as the central government said its budget deficit swelled to 48.5 billion euros ($61bn) in the year through July. The cash-strapped national government in Madrid also moved today to inject capital into the Bankia group ‘immediately’ after the nationalized lender posted a 4.45 billion-euro first- half loss.”
August 30 – Bloomberg (Angeline Benoit): “The Spanish region of Murcia became the third to say it will need emergency loans, and Valencia signaled it needs funds to cover current and past overspending, adding fiscal pressure on Prime Minister Mariano Rajoy. A day after Catalonia said it needed 5 billion euros ($6.3bn) from an 18 billion-euro bailout fund announced by Rajoy last month, an official in southeastern Murcia yesterday put its needs at 700 million euros. In Valencia… 3.5 billion euros would cover only current needs… The country’s regions risk overwhelming a plan to tackle the euro area’s third-biggest budget deficit. They were responsible last year for most of Spain’s overspending, which remained nearly unchanged from 2010 at 8.9% of gross domestic product… Together with Murcia, Valencia and Catalonia, Spain’s two most indebted regions, aim to use more than half of Rajoy’s last bailout fund, created to enable regions to face bond redemptions and finance their deficits in the second half. ‘Everything depends on Andalusia now,’ said Juan Rubio- Ramirez, an economist at Duke University in Durham, North Carolina. ‘If Andalusia asks for aid, it could be a similar amount to Catalonia and that means the fund may not be enough.’ Rubio-Ramirez co-authored a report this month forecasting the regions may run deficits as high as 4% of GDP this year, compared with 3.3 percent last year and a target of 1.5% for 2012.”
August 27 – Bloomberg (Angeline Benoit): “Spanish Prime Minister Mariano Rajoy’s austerity drive will intensify this week as a sales-tax increase tightens the squeeze on consumers whose spending is already plummeting. The move to raise the value-added tax on Sept. 1 will follow a flurry of data showing pressure building on household finances in the euro area’s fourth-biggest economy, home to a third of its unemployed. A report today showed mortgages fell 25.2% from a year ago in June after a 30.5% drop in May. Meanwhile, the Health Ministry… said spending on prescription drugs fell 23.9% from a year ago in July… after the government last month increased the share patients pay for pharmaceuticals.”
August 29 – Reuters (Carlos Ruano and Jesús Aguado): “Nationalised lender Bankia is expected to post first-half losses of more than 4 billion euros (3bn pounds) on Friday, highlighting the need for capital from a European rescue of Spanish banks that is unlikely to arrive before the end of September. Bankia was taken over by the government in May when it asked for 19 billion eurosof state aid after anticipating the steep losses from real estate investments which soured after the property market crashed four years ago.”
August 31 – Bloomberg (James G. Neuger): “Countering arguments made by the German economics establishment since before the introduction of the euro, European Central Bank President Mario Draghi said it’s in Germany’s interest to consent to extraordinary steps to preserve the currency shared by 17 nations. Draghi used the… German weekly Die Zeit to plead for a more expansive role for the central bank and to say that the crisis-struck currency can be stabilized without sacrificing each country’s independence to a unified European political system. In tactical terms, Draghi sought to neutralize protests made by Germany’s top central banker, Jens Weidmann…”
August 27 – Bloomberg (Fred Pals): “Dutch caretaker Prime Minister Mark Rutte, seeking a return to power after Sept. 12 elections, said he would block a third aid package for Greece and defended austerity as the only way out of Europe’s debt crisis. ‘We’ve helped twice and now it’s up to the Greeks to show that they want to stay within the euro,’ Liberal leader Rutte, 45, said… ‘The Netherlands has been severely hit by the debt crisis and the solution is to lower taxes, get government finances in order and make room for investment.’”
August 30 – Bloomberg: “Chinese Premier Wen Jiabao told visiting German Chancellor Angela Merkel that Spain, Italy and Greece must take ‘comprehensive measures’ to prevent a worsening of the euro region’s sovereign-debt crisis. ‘The main worries are two-fold: First is whether Greece will leave the euro zone,’ Wen said… ‘The second is whether Italy and Spain will take comprehensive rescue measures. Resolving these two problems rests with whether Greece, Spain, Italy and other countries have the determination for reform.’”
Global Bubble Watch:
August 31 – Bloomberg (Sarika Gangar): “Sales of corporate bonds globally surged to the most on record for August as issuers rushed to lock in record-low borrowing costs. Siemens AG, Europe’s largest engineering company, and JPMorgan Chase & Co. led borrowers selling $237.6 billion of debt this month, exceeding the $235.3 billion raised in August 2010… Yields fell to an unprecedented low of 3.72% on Aug. 28…”
August 29 – Financial Times (Kandy Wong): “China’s top banks are stepping up their lending activities in the US as large US companies diversify their funding sources and seek to penetrate more deeply into the world’s second-largest economy. Chinese banks’ share of US syndicated lending has risen to 6.1% of the total market so far in 2012, up from 5.1% last year, according to data from Dealogic. So far this year, the total value of syndicated loans from Chinese banks into the US has reached $51bn.”
Germany Watch:
August 28 – MarketNews International: “The European Central Bank will be overextended and no longer able to fulfill its price stability mandate if it engages in more sovereign bond buys, former ECB Executive Board member Juergen Stark wrote in an editorial for German daily Handelsblatt… Stark, who resigned from the ECB in 2011, in large part because of the original SMP bond-buying program, said restarting such a program would lead to inflation dangers down the road and further erode the ECB's political independence. Stark accused the ECB Governing Council members from southern peripheral Eurozone countries of trying to use the ECB to achieve national interests. He said bond buys were ‘hardly’ relevant for monetary policy and instead amounted to ‘de facto’ state financing. ‘The role, which the ECB appears prepared to take on, will over-extend the central bank and further erode its independence from politics. And in the end, the central bank will no longer be able to perform its core task, guaranteeing price stability,’ Stark wrote.”
European Economy Watch:
August 31 – Bloomberg (Jim Brunsden and Rebecca Christie): “The European Central Bank would have the sole power to grant banking licenses under proposals to give it supervisory powers and build a euro-area banking union, a European Union official said. The ECB would have a monopoly on granting all bank licenses within the 17-nation euro area under the plan, due to be unveiled on Sept. 12, the official said, speaking on condition of anonymity… the ECB would also gain discretion over which banks to supervise directly and when it will delegate day-to-day oversight responsibilities, the official said. National regulators will retain control over when and how to close a bank under the proposals. At the same time, the central bank would be able to make recommendations and have a voice in the process.”
August 28 – Bloomberg (Angeline Benoit): “Spain’s recession worsened in the second quarter as the government’s austerity push to reduce the euro area’s third-biggest budget deficit and a slump in consumer spending offset growth in exports. Gross domestic product fell 0.4 percent from the previous quarter, when it declined 0.3%... ‘We fear that things are likely to get worse before they get better,’ said Martin van Vliet, an economist at ING Bank in Amsterdam… ‘With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted toward a more protracted recession.”
August 30 – Bloomberg (Angeline Benoit): “Spanish inflation accelerated more than economists forecast in August as the government stepped up efforts to plug the euro region’s third-largest budget deficit amid a worsening recession. Consumer prices… rose 2.7% from a year earlier after an annual gain of 2.2% in July…”
August 29 – Bloomberg (Stefan Riecher): “German inflation accelerated more than economists forecast in August on higher energy costs. The inflation rate, calculated using a harmonized European Union method, rose to 2.2% from 1.9% in July…”
August 31 – Bloomberg (Chiara Vasarri and Tommaso Ebhardt): “Giovanni Cimmino filled up his Fiat Multipla in Croatia before returning to Italy after his summer holiday, avoiding Europe’s highest gasoline prices. ‘You need a smart strategy to save on gas,’ said Cimmino, 37, who manages a metals trading company near Milan. With pump prices at a record in Italy, ‘I tend to use more public transportation and avoid driving when it’s not necessary.’ Unleaded fuel has climbed to more than 2 euros ($2.50) a liter, about $9.50 a gallon, in some areas of Italy…”
August 28 – Bloomberg (Jana Randow): “Lending to households and companies in the 17-nation euro area increased for the first time in three months in July after European leaders committed to new measures to solve the debt crisis. Loans to the private sector rose 0.1% from a year earlier after dropping an annual 0.2% in June… Lending increased 0.3% from June, the first gain since January.”
China Watch:
August 31 - South China Morning Post (Teddy Ng): “Premier Wen Jiabao voiced his fears about the European debt crisis yesterday after a meeting with visiting German Chancellor Dr Angela Merkel. ‘The European debt crisis has continued to worsen, giving rise to serious concerns in the international community. Frankly speaking, I am also worried,’ Wen said. ‘The main worries are two-fold. First is whether Greece will leave the euro zone, and the second is whether Italy and Spain will ask for comprehensive rescue measures.’ He called on Greece, Spain and Italy to embrace budget cuts and other reforms to restore confidence in the fragile euro zone.”
August 28 – Bloomberg: “China’s corporate bonds are set for their first monthly loss this year as more than half of issuers reported profit growth slowed. Company debt in the world’s second-biggest economy has lost 0.8% in August, paring gains for the year to 3.6% compared with 6.4% in 2011… Issuance has increased 53% in 2012 from the year earlier, weighing on demand… Among listed issuers, 55% said profit fell from a year earlier and 9% reported losses, according to China International Capital Corp…. ‘The whole economy is slowing, which is obviously leading to a decline in company profits,’ and putting pressure on bond returns, said Fan Wei, a fixed-income analyst at Hongyuan Securities Co…. Premier Wen Jiabao has encouraged companies to sell debt to replace state-owned bank loans. Corporate bonds accounted for a record amount of total financing in the economy in July… Issuance of the securities has jumped to 2.3 trillion yuan this year from 1.5 trillion yuan for the same period last year…”
August 27 – Bloomberg: “Chinese industrial companies’ profits fell in July by the most this year, a government report showed today, adding to evidence the nation’s economic slowdown is deepening. Income dropped 5.4% last month from a year earlier to 366.8 billion yuan ($57.7bn), the fourth straight decline… That compares with a 1.7% slide in June and a 5.3% drop in May.”
August 29 – Bloomberg: “Health-care spending in China will almost triple to $1 trillion annually by 2020 driven by an aging population and government efforts to broaden insurance coverage, according to a McKinsey & Co. report… China will spend more on drugs, medical devices and hospital treatments as it lifts spending to 7% of gross domestic product, from 5.5%, or $350 billion, in 2010, McKinsey said. This will make it the biggest market globally by 2020 after the U.S., which in 2009 spent $2.5 trillion, or 17.6% of its GDP, on health care…”
Japan Watch:
August 31 – Bloomberg (Andy Sharp and Toru Fujioka): “Japan’s consumer prices slid at a faster pace in July and industrial production unexpectedly slumped, raising the danger that the world’s third-largest economy has slipped back into a contraction. The benchmark price gauge, which excludes fresh food, fell 0.3% in July from a year before, putting the central bank’s 1% inflation goal further from reach… Industrial output fell 1.2%. A private measure of manufacturing for August was the lowest since the aftermath of the record March 2011 earthquake.”
U.S. Bubble Economy Watch:
August 28 – Reuters (Carlos Ruano and Jesús Aguado): “America’s 50 state governments owe $4.19 trillion, including outstanding bonds, unfunded pension commitments and budget gaps, according to a new report. At $617.6 billion, California had by far the biggest total debt, more than twice the total of No. 2, New York, with $300.1 billion owed, according to State Budget Solutions, a research and non-partisan advocacy group.”
August 27 – Bloomberg (Shobhana Chandra and Sandrine Rastello): “The worst U.S. drought in at least 50 years may restrain consumer confidence and spending as it pushes Americans’ grocery bills higher later this year. Food prices will increase an average 4% annual rate in the nine months ending June 2013, up from 1.5% currently, said Michael Feroli, chief U.S. economist at JPMorgan… That may trim real disposable incomes by 0.3 percentage point from the fourth quarter of 2012 through the first half of next year and reduce spending by a similar amount, he estimates. The projected food-price increase will squeeze budgets of households already contending with a 13% gain in gasoline prices since early July and unemployment that is stuck above 8% three years into the economic recovery… ‘Energy is hitting us now, food is going to hit us later,” Feroli said. ‘It will be a headwind for consumers. It’s going to damp people’s perceptions of the economy.’”
August 29 – Wall Street Journal (John D. McKinnon and Scott Thurm): “More big U.S. companies are reincorporating abroad despite a 2004 federal law that sought to curb the practice. One big reason: Taxes. Companies cite various reasons for moving, including expanding their operations and their geographic reach. But tax bills remain a primary concern. A few cite worries that U.S. taxes will rise in the future, especially if Washington revamps the tax code next year to shrink the federal budget deficit."
Central Bank Watch:
August 31 - Wall Street Journal (Jon Hilsenrath): "Fed Chairman Ben Bernanke wasn't expecting he would have to make another speech like the one he will deliver here Friday. A few months ago the Federal Reserve seemed to be on cruise control as the economy healed. Many officials at the central bank hoped they were done with launching complicated programs to spur a sluggish economy. But Mr. Bernanke and his colleagues, once again disappointed by slow growth and small employment gains this year, are formulating another new dose of monetary stimulus to be considered at their next policy meeting... Mr. Bernanke has argued that when the Fed buys long-term Treasury securities or mortgage bonds, it pushes down long-term interest rates and pushes up prices of assets such as stocks. Fed officials also believe the purchases help weaken the dollar."
August 31 – Bloomberg (Joshua Zumbrun and Jeff Kearns): “Federal Reserve Chairman Ben S. Bernanke, lamenting the suffering caused by unemployment of more than 8% and defending his unprecedented actions, made the case for further monetary easing. ‘The costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant,’ Bernanke said… Bernanke, speaking two weeks before the next meeting of the Federal Open Market Committee, emphasized that a new round of bond purchases is an option. Stocks and Treasuries climbed and the dollar weakened to a more than three-month low as investors speculated steps to boost the economy may come as soon as next month. ‘The door is wide open to the Fed contemplating additional action,” said Josh Feinman, a former Fed senior economist who helps oversee $219 billion at Deutsche Bank AG’s asset management unit in New York. ‘It reaffirms other messages sent by the Fed that additional action is still very much on the table. By the end of the year we’ll probably get both rate guidance extension and more asset purchases.’”
Muni Watch:
August 29 – Bloomberg (Michelle Kaske): “Illinois, which has the worst-funded pension system among U.S. states, had the rating on its general-obligation debt cut one level to A by Standard & Poor’s and may face more downgrades. The change followed state lawmakers’ failure to agree to reduce retirement costs during a special session Aug. 17. The outlook for the fifth-most populous state’s debt, which now has S&P’s sixth-highest grade, is negative. California, with an A- ranking, one level below Illinois, remains S&P’s lowest-rated state.”
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