Sunday, December 14, 2014

Weekly Commentary, March 21, 2014: April/May/June Dynamic

Last week I posited that “Ukraine and China pose clear and present dangers to global financial markets.” At least for the week, Russian troops stayed put on their side of the Russia/Ukraine border. And while the West ratcheted up sanctions against Russia, at this point leaders on both sides of this crisis appear keen to avoid actions with real economic impact. At the same time, Putin’s chilling speech Monday supported my view of a darkening geopolitical backdrop – a potential inflection point of historical significance.

So let’s direct some attention to China. The Chinese renminbi declined 1.22% this week, boosting its one-month drop to 2.16%. A Thursday Bloomberg headline read “China’s Yuan Slumps Most Since 2008 as Central Bank Cuts Fixing.” My “headline”: Beggar thy neighbor? Ramifications and consequences – financial, economic, geopolitical? After trading near multi-year lows on Thursday, Friday saw Chinese stocks spring to life with a 2.7% surge. The bullish take is that more aggressive fiscal stimulus is in the offing, while the People’s Bank of China (PBOC) is in the process of weakening the currency and is about to ease monetary policy. The increasingly confident bearish view holds that Chinese policymakers are more worried by what appears an acceleration of financial instability and economic weakness.

I am reminded that the S&P500 shot to a record high in late-2007, even as the mortgage finance Bubble faltered. The “VIX” (equities volatility/risk) index even traded at a remarkably low 20 in early September 2008, as seemingly fearless markets headed right into October’s near collapse. Clearly, markets, financial systems and economies turn highly unstable late in the “terminal phase” of Bubble excess, especially when activist policymakers begin responding to faltering Bubbles and attendant economic vulnerability. This can work for a while to feed the segments of the Bubble still demonstrating inflationary biases. To be sure, this dynamic is integral to the heightened systemic risks associated with financial imbalances and unbalanced economies.

From my perspective, all key indicators point to the beginning of the end to China’s historic Credit and economic Bubbles. Although it appears controllable at the moment (recall subprime?), keep in mind the crisis is in the earliest phase. There was another significant default this week (real estate developer), while corporate bond spreads widened further (see “China Bubble Watch”). Finance has tightened markedly, especially for real estate developers and players along the supply chain. Over time, this will more meaningfully impact local government finance that has grown highly dependent upon real estate transactions.

Data this week suggest Chinese home price inflation has slowed markedly in most major markets. This supports the view of an important change in market psychology, although this type of thing usually plays out over months. Nervous lenders and waning availability of mortgage Credit would speed the process. Importantly, the vast majority of markets still show strong year-on-year price gains and there isn’t much yet to suggest that homebuyers are losing access to Credit. The same cannot be said for the weaker developers.

The unfolding crisis in China will turn significantly more problematic as home prices and transaction volumes fall in tandem. This will likely usher in a problematic decline in overall system Credit growth, with waning Credit and liquidity exposing myriad problems. For now, there are indications of mounting apartment inventories. Meanwhile, building additional housing units (apartments) remains an important component of Chinese stimulus programs. The pesky “law diminishing marginal returns” lurks throughout Chinese stimulus and Credit more generally.

In the near-term, there are the unknown consequences related to the PBOC’s decision to devalue the yuan. Asian currencies in general were under further pressure this week. The currency devaluation issue will also evolve over weeks and months. Whether there are geopolitical factors at play in China’s move is unclear.

And while it has been only a 2% devaluation (versus the dollar) thus far, enormous amounts of “hot money” had flooded into China in anticipation of ongoing currency appreciation. Potential dislocations related to a reversal of speculative flows now create significant uncertainty. This uncertainty is compounded by what are believed to be large speculative flows associated with commodity financing deals. Copper, iron ore and other industrial commodities prices have recently been under significant pressure. Between bad debts, defaults, sinking commodity prices and an unexpected weaker currency, there’s some real pain being inflicted. But where?

Since 2008, Chinese international reserves have grown $2.293 TN, or 150% - from $1.528 TN to end December 2013 at $3.821 TN. Over a similar period, Federal Reserve Credit inflated $3.135 TN, or almost 370%, to $4.0 TN. For the past five years I’ve argued that the Fed’s balance sheet and Chinese Credit are closely interrelated facets of the “global government finance Bubble.” And these days both the Federal Reserve and People’s Bank of China are in the process of major policy adjustments. The “bulls” are generally dismissive of policy changes having much economic and market relevance. From a global Credit Bubble perspective, I don’t think one can overstate the importance of unfolding monetary developments in Beijing and Washington.

In the four months September through December, Chinese international reserve holdings jumped almost $270bn. This rise in reserves (largely Treasuries, bunds, sovereign debt, etc.) appeared related to a surge of “hot money” inflows to China. Chinese officials had last year responded to record Credit growth with measures meant to tighten financial conditions. Meanwhile, resulting higher Chinese market yields only strengthened the allure of an already powerful liquidity magnet (operating in over-liquefied and highly speculative global markets).

The “hot money” surge complicated the PBOC’s efforts to “lean against the wind” of lending and speculative excess. This torrent of foreign-sourced “money” required the PBOC to further inflate domestic Credit and, in the process, exacerbated financial and economic risks. It also required “recycling” the incoming dollar (along with other foreign currencies) balances back into Treasuries and other debt instruments. Surely, at $3.8 TN, Chinese authorities might today question the wisdom of accumulating more IOUs from the U.S. and others. A change in currency policy might serve Chinese interests on multiple fronts.

Meanwhile, chair Yellen’s first FOMC meeting and press conference didn’t go off without a hitch. The bond market was walloped. Ten-year bond yields jumped 10 bps Wednesday to 2.77%. More significantly, shorter maturities surged higher as the yield curve flattened. Wednesday’s action saw five-year Treasury yields jump 16 bps to 1.71%, the high since early-January. Three-year yields increased 13 bps, with yields ending the week at 0.90%, near the highest level since last August. Those crowded into the perceived safety of short-maturities were kicked in the teeth. I would be curious to know the degree of leverage that has built up in short-term instruments and myriad yields curve trades.

Wednesday was one of those intriguing days in the markets. As Treasury yields shot higher, the U.S. dollar rallied and EM currencies fell under immediate pressure. It was reminiscent of the “May/June Dynamic” from 2013. Last year’s so-called “taper tantrum” revolved around mounting market fears that waning Fed-induced global liquidity and attendant risk aversion might exacerbate EM outflows. This would not only further pressure EM currencies, bonds, financial systems and economies, but might also force EM central banks to liquidate Treasuries (and other reserves) as they were forced to employ reserves in an effort to stabilize faltering currencies. There was potential for contagion and a “non-virtuous” cycle.

Last year’s “May/June Dynamic” saw Treasury yields surging higher simultaneous with sinking prices in equities, commodities and throughout EM. Many leveraged “risk parity” strategies abruptly faced highly correlated losses across what were supposed to be well-diversified and risk-protected strategies. A continuation of this market dynamic would have tested a key perception of these strategies: superior risk management complimented by leverage.

Meanwhile (last spring), the enormous and still ballooning ETF (exchange-traded fund) complex faced a major reversal of flows in some EM and fixed income products. Rapidly growing funds had been providing strong market support. Suddenly, they turned sellers in what in some cases were less-than-liquid underlying securities markets (i.e. muni and EM debt). A continuation of this market dynamic would have tested one of the key perceptions of the ETF marketplace: superior liquidity.

Last year’s “May/June Dynamic” was a critical juncture for what had evolved into highly speculative markets. Key bullish perceptions were in the process of being tested. On the positive side, some excesses were finally beginning to be wrung out of an exuberant marketplace. Yet there was going to be some inevitable market pain and negative economic consequences both domestically and globally. And it was going to come at an inopportune time – as they tend to do.

First it was New York Fed president Dudley. Other Fed doves quickly lined up. And then “Bernanke’s Comment” explicitly stated the Fed was prepared to “push back” against a “tightening of financial conditions”. The Fed would even contemplate boosting QE instead of tapering. The markets got the message loud and clear: The Fed was right there willing and able to support the markets in the event of any trouble. Instead of bullish misperceptions coming to the fore – or mounting excess beginning to be wrung out – it was the polar opposite: the bulls and speculators were further emboldened by the notion that the Federal Reserve was backstopping the markets and eliminating downside risk.

Last week I discussed “tail risk” and the type of backdrop conducive to market dislocations. Are markets at risk of another “May/June Dynamic”? A 2014 variety - April/May/June Dynamic? One the one hand, markets would appear to confront similar issues – the potential for higher market yields, EM vulnerability, waning Fed liquidity, etc. On the other hand, complacency still abounds after the Fed ensured the markets more than persevered through last year’s bout of tumult.

Chinese defaults and acute financial fragility weren’t issues a year ago. Confidence in Chinese finance and economic fundamentals was much stronger. Geopolitical risks were much lower. And, importantly, the market was clear on China’s policy of steady currency appreciation versus the dollar. This year’s “April/May/June Dynamic” could easily incorporate a major Chinese component. Chinese reserve holdings declined only slightly last May and June, before “hot money” flows returned with a vengeance by late summer. The prospect of China selling Treasuries was not a market concern.

Everything is just so much bigger than before: The Fed’s balance sheet; PBOC international reserves and the Chinese Credit system; the leveraged speculating community; the big “macro” hedge funds; the powerful “quant” funds; the sovereign wealth funds; the ETF complex; the big mutual fund companies. As history has shown, epic financial Bubbles by their nature spur a concentration of financial power. I often ponder how a marketplace dominated by big players tends to function differently than traditional decentralized marketplaces. Then I contemplate how such a “centralized” marketplace operates with assurances of ongoing central bank support. In my mind – and I see evidence for as much in the marketplace – the markets become more of a game, more speculative and increasingly detached from fundamental prospects.

Janet Yellen has a really tough job ahead of her. The markets Wednesday got a glimpse of why she was not the Administration’s first choice. As the bond market was getting hammered, she was rambling on about the minutia of labor statistics. In a period of what I expect to be only rising market uncertainties (particularly Fed policy, China, EM and geopolitical), I fear our new Fed chair will not inspire confidence.

Yet only time will tell if I end up at some point titling a CBB “Yellen’s Comment.” How will she – how will the Fed – respond to a bout of destabilizing market de-risking/de-leveraging? Interestingly, Dallas Fed head Fisher stated Friday that the “Fed had taken a great deal of volatility out of the market” and that “some more market volatility would be healthy.” For the bond market, it appeared participants this week were finally forced to face up to the reality of a more hawkish bent at the FOMC. There is an increasingly assertive contingent that wants to move beyond Bernanke inflationism and get back to more traditional central banking. That would mean winding down balance sheet expansion as soon as practical and then preparing to lift rates off the “zero bound.”

And all of this really begs the question: to what degree can the Federal Reserve’s balance sheet be counted on as the markets’ future liquidity backstop? Actually, whether the Fed builds its holdings (“prints money”) or not is of seemingly little concern to the markets - that is so long as the markets remain buoyant (as they’ve been). Yet an eruption of de-risking/de-leveraging would have this backstop issue quickly elevated to the top of market worries. Moreover, this liquidity issue would be significantly compounded if the change in China’s currency policy incites a reversal of “hot money” flows and, perhaps, a resulting turnabout in China’s international reserve holdings.

For The Week:

The S&P500 gained 1.4% (up 1.0% y-t-d), and the Dow rose 1.5% (down 1.7%). The Utilities were little changed (up 6.4%). The Banks surged 4.5% (up 5.0%), and the Broker/Dealers jumped 2.7% (up 1.6%). The Morgan Stanley Cyclicals were up 2.4% (up 1.3%), and the Transports added 0.5% (up 1.6%). The S&P 400 Mid-caps gained 1.2% (up 2.8%), and the small cap Russell 2000 rose 1.0% (up 2.6%). The Nasdaq100 increased 0.7% (up 1.7%), and the Morgan Stanley High Tech index jumped 2.5% (up 3.6%). The Semiconductors advanced 3.6% (up 8.9%). The Biotechs dropped 1.8% (up 15.3%). With bullion dropping $48, the HUI gold index sank 8.6% (up 19.4%).

One-month Treasury bill rates ended the week at 4 bps, and three-month bills closed at 5 bps. Two-year government yields were up 8 bps to 0.43% (up 5bps y-t-d). Five-year T-note yields surged 17 bps to 1.71% (down 4bps). Ten-year yields gained 9 bps to 2.74% (down 29bps). Long bond yields increased one basis point to 3.61% (down 36bps). Benchmark Fannie MBS yields were up 8 bps to 3.45% (down 16bps). The spread between benchmark MBS and 10-year Treasury yields narrowed one to 71 bps. The implied yield on December 2014 eurodollar futures increased 2.5 bps to 0.35%. The two-year dollar swap spread was little changed at 14 bps, and the 10-year swap spread was about unchanged at 12 bps. Corporate bond spreads were mixed. An index of investment grade bond risk increased 3 to 70.5 bps. An index of junk bond risk dropped 21 bps to 315 bps. An index of emerging market (EM) debt risk fell 12 bps to 315 bps.

Debt issuance was steady. Investment-grade issuers included Exxon $4.0bn, DIRECTV $1.25bn, SES Global Americas $1.0bn, Dominion Resources $400 million, Oklahoma Gas & Electric $250 million, Hartfold Healthcare Corp $160 million and Entergy Mississippi $100 million.

Junk bond funds saw inflows of $455 million (from Lipper). Junk issuers included MPH Acquisitions $1.0bn, Walter Energy $650 million, KB Home $400 million, Lee Enterprises $400 million, iGATE $325 million, Kennedy-Wilson $300 million and First Cash Financial Services $200 million.

Convertible debt issuers included YY Inc $400 million, Navistar $375 million, Vector Group $225 million, National Health Investors $175 million, Emerald Oil $140 million, and GPT Property Trust $100 million.

International dollar debt issuers included Hungary $3.0bn, Sweden $2.0bn, Standard Chartered $2.0bn, Mizuho Financial Group $1.5bn, Skandinaviska Enskilda $1.5bn, Wynn Macau $1.35bn, Macquarie Bank $1.25bn, Alfa $1.0bn, Digicel Group $1.0bn, Kommunalbanken $1.0bn, Dexia Credit $770 million, Navios maritime $670 million, Ocean Rig $500 million, EOG Resources $500 million, Aurico Gold $325 million, Merna Reinsurance $300 million, BCP Singapore $275 million, Altagas $200 million and European Investment Bank $100 million.

Ten-year Portuguese yields sank 34 bps to 4.26% (down 187bps y-t-d). Italian 10-yr yields increased one basis point to 3.41% (down 71bps). Spain's 10-year yields gained 2 bps to 3.36% (down 80bps). German bund yields jumped 9 bps to 1.63% (down 30bps). French yields gained 4 bps to 2.16% (down 40bps). The French to German 10-year bond spread narrowed 5 to 53 bps. Greek 10-year note yields fell 31 bps to 6.92% (down 150bps). U.K. 10-year gilt yields rose 8 bps to 2.75% (down 27bps).

Japan's Nikkei equities index declined another 0.7% (down 12.7% y-t-d). Japanese 10-year "JGB" yields fell 3 bps to 0.60% (down 14bps). The German DAX equities index rallied 3.2% (down 2.2% y-t-d). Spain's IBEX 35 equities index jumped 2.5% (up 1.4%). Italy's FTSE MIB index rose 3.1% (up 10.6%). Emerging equities markets bounced higher. Brazil's Bovespa index rallied 5.4% (down 8.0%), and Mexico's Bolsa surged 5.5% (down 6.3%). South Korea's Kospi index increased 0.8% (down 3.8%). India’s Sensex equities index slipped 0.3% (up 2.8%). China’s Shanghai Exchange ended the week up 2.2% (down 3.2%). Turkey's Borsa Istanbul National 100 index rallied 2.1% (down 4.8%). Russia's RTS equities index recovered 5.7% (down 13.1%).

Freddie Mac 30-year fixed mortgage rates declined 5 bps to 4.32% (up 78bps y-o-y). Fifteen-year fixed rates were down 6 bps to 3.32% (up 60bps). One-year ARM rates increased one basis point to 2.49% (down 14bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 4 bps to a seven-week high 4.44% (up 21bps).

Federal Reserve Credit jumped $39.1bn last week to a record $4.174 TN. During the past year, Fed Credit expanded $1.007 TN, or 31.8%. Fed Credit inflated $1.363 TN, or 48%, over the past 71 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week sank $67.8bn to a 15-month low $3.206 TN (2-week decline of $148bn). "Custody holdings" were down $96.8bn from a year ago, or 2.9%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $781bn y-o-y, or 7.1%, to a record $11.721 TN. Over two years, reserves were $1.456 TN higher for 14% growth.

M2 (narrow) "money" supply jumped $23.7bn to a record $11.137 TN. "Narrow money" expanded $711bn, or 6.8%, over the past year. For the week, Currency increased $5.2bn. Total Checkable Deposits dropped $27.4bn, while Savings Deposits surged $48.2bn. Small Time Deposits slipped $1.0bn. Retail Money Funds declined $1.5bn.

Money market fund assets sank $31.4bn to a 22-week low $2.646 TN. Money Fund assets were up $21bn, or 0.8%, from a year ago.

Total Commercial Paper declined $1.8bn to $1.019 TN. CP was down $26.5bn year-to-date, while increasing $3bn over the past year, or 0.3%. 

Currency Watch: 

March 20 – Bloomberg (Lilian Karunungan): “China’s yuan slid the most since 2008 in onshore trading after the central bank weakened the currency’s reference rate by 0.18%, matching a March 10 cut that was the biggest since July 2012. The People’s Bank of China lowered the daily fixing today to 6.1460 per dollar, the lowest level since Nov. 6. The yuan has dropped 1.32% this month, after February’s record 1.38% slide… ‘The PBOC has been very aggressive in trying to engineer short-term yuan weakness,’ said Andy Ji, a currency strategist… at Commonwealth Bank of Australia. ‘They want to kill appreciation expectations once and for all and also to wipe out most of the speculative positioning.’”

The U.S. dollar index gained 0.8% to 80.105 (up 0.1% y-t-d). For the week on the upside, the Brazilian real increased 0.9% and the Australian dollar gained 0.6%. For the week on the downside, the South African rand declined 2.0%, the Norwegian krone 1.3%, the Swiss franc 1.2%, the Canadian dollar 1.0%, the British pound 1.0%, the Danish krone 0.9%, the Taiwanese dollar 0.9%, the Japanese yen 0.9%, the euro 0.9%, the South Korean won 0.7%, the Singapore dollar 0.7%, the Swedish krona 0.6% and the Mexican peso 0.2%.

Commodities Watch:

The CRB index declined 1.1% this week (up 6.9% y-t-d). The Goldman Sachs Commodities Index slipped 0.5% (up 1.4%). Spot Gold lost 3.5% to $1,335 (up 10.7%). May Silver sank 5.2% to $20.31 (up 5%). May Crude increased 90 cents to $99.46 (up 1%). April Gasoline fell 1.8% (up 4%), and April Natural Gas dropped 2.5% (up 2%). May Copper ended unchanged (down 13%). May Wheat gained 0.9% (up 15%). May Corn declined 1.4% (up 14%).

U.S. Fixed Income Bubble Watch:

March 19 – Bloomberg (Mary Childs): “The junk-bond bonanza that’s doubled the market to almost $2 trillion since the credit crisis has Jeffrey Gundlach heading toward the exit. Less than 12 months after saying the Federal Reserve’s stimulus and a plunge in defaults would support the market for speculative-grade debt for another four years, the head of DoubleLine Capital LP is trimming its allocations… ‘They’ve squeezed all the toothpaste out of the tube,’ the bond manager said… ‘There is interest-rate risk that’s just being masked by fund flows holding up the prices of junk bonds.’”

March 20 – Bloomberg (Dave Michaels): “U.S. regulators concerned that banks and brokerage firms remain too dependent on risky types of short-term funding are weighing new rules designed to reduce reliance on parts of what is often called the shadow banking system. Now the SEC is weighing new funding rules for brokers as well as a limit on leverage similar to those used by the Federal Reserve and other regulators for banks… The initiatives are aimed at financing tools such as repurchase agreements, or repos, that were relied on by Bear Stearns Cos. and Lehman Brothers Holdings Inc. until their failures accelerated the 2008 financial crisis… ‘We all learned during the crisis that the shadow banking system, of which broker-dealers are a part, is subject to runs just like banks,’ said Phillip L. Swagel, a professor at the University of Maryland who served as a Treasury Department assistant secretary during the crisis. ‘What seems like highly liquid collateral can turn illiquid during the next crisis.’ Federal Reserve officials have warned for years that the $4.5 trillion web of repo deals remains prone to unravel during a panic, potentially leading to fire sales of assets that could spread losses across the financial system.”

Federal Reserve Watch:

March 21 – Reuters: “A top U.S. Federal Reserve official critical of the U.S. central bank's super-easy monetary policy on Friday questioned the very core of the Fed’s current approach, which rests on giving markets a better sense of the future path of interest rates. That approach, known as forward guidance, received a makeover on Wednesday, when Janet Yellen wrapped her first policy-setting meeting as Fed chair with a decision to jettison narrow economic guideposts in favor of a much broader set of measures to determine the timing and pace of future rate hikes. Dallas Federal Reserve President Richard Fisher… appeared to question even the basis of that approach, which Yellen has credited with keeping borrowing costs lower than otherwise… ‘Is 'Forward Guidance' a crotchet .... to which exaggerated importance is attributed?,’ Fisher said… ‘Have we at the (Fed) just taken up another fad? Or is this a real, lasting practice?’”

March 21 – Bloomberg (Jeff Kearns): “Federal Reserve Bank of St. Louis President James Bullard defended Janet Yellen’s comments on interest-rate increases, saying her outlook is in line with private surveys on when the central bank might start tightening policy. Treasury yields jumped March 19 after Yellen said in her first press conference as Fed chair that rates could rise ‘around six months’ after asset purchases end, most likely in the fall.”

U.S. Bubble Watch:

March 18 – Wall Street Journal (Tony C. Dreibus, Leslie Josephs and Julie Jargon): “Surging prices for food staples from coffee to meat to vegetables are driving up the cost of groceries in the U.S., pinching consumers and companies that are still grappling with a sluggish economic recovery. Federal forecasters estimate retail food prices will rise as much as 3.5% this year, the biggest annual increase in three years, as drought in parts of the U.S. and other producing regions drives up prices for many agricultural goods. The Bureau of Labor Statistics… reported that food prices gained 0.4% in February from the previous month, the biggest increase since September 2011, as prices rose for meat, poultry, fish, dairy and eggs.”

March 17 – Bloomberg (Isaac Arnsdorf and Alex Nussbaum): “‘Blind luck’ is how Jack Johns characterized his 16% profit on something he read about on the Internet called Master Limited Partnerships. Johns, a retired postal worker… said he sold his MLP investments within a year because he realized he didn’t really know what he’d bought. ‘I always assumed when I got to this stage of my life, I’d be investing in Treasury bills and insured certificates of deposit,’ said Johns, 65. Because of the Federal Reserve’s record-low interest rates, Johns said he sought higher returns in riskier assets. ‘MLPs fit into that category,’ he said. MLPs are more popular than ever. They’re tax-exempt, publicly traded companies that own pipelines, storage tanks and other cash-generating energy infrastructure and give practically all their income to investors. In 2013, there were a record 21 initial public offerings valued at $8.8 billion and an all-time high of more than $11.9 billion flowed into funds investing in MLPs…”

March 19 – Bloomberg (Alexis Xydias and Elisa Martinuzzi): “Customized trades may generate half the equity-derivatives revenue at Citigroup Inc. within two years as investment banks seek to offset lower profit from stock broking and clients demand services beyond traditional dealing. Equity solutions, such as structured products that allow clients to bet on a particular theme, will increase from the current low-double-digit share of the revenue generated by the bank’s derivatives and Delta One desk, Mike Pringle, Citigroup’s global head of equity trading, said… The equity business ‘is undergoing the most rapid reinvention of the client base and what the stock market actually means,’ London-based Pringle said… ‘That is only going to continue at an extremely rapid pace.’”

Ukraine/Russia Watch:

March 18 – Interfax: “Russia is grateful to China and India for their stance on Ukraine and Crimea, Russian President Vladimir Putin said in his appeal to the Russian Federal Assembly on Tuesday. ‘We treat with gratitude everyone, who approached our step in Crimea with understanding. We are grateful to the Chinese people, whose leadership has considered and is considering the situation concerning Ukraine and Crimea in its entire historical and political complexity,’ Putin said. ‘We highly appreciate India's constraint and objectivity,’ the Russian president said.”

March 20 – Reuters (Noah Barkin): “On a Sunday in early March, a day after Vladimir Putin won parliamentary backing for an invasion of Ukraine, Angela Merkel called him to demand an explanation. The German leader was shaken by what she heard, sources within her party say. For weeks, in a series of phone calls, the Russian president, speaking mainly in the German he perfected as a KGB agent in East Germany, had assured the chancellor he would respect the territorial integrity of his western neighbor and had no plans to intervene militarily. Merkel, in turn, had been preaching caution on punishing Russia in her talks with the United States, hopeful that Putin would eventually back down and accept proposals to ease the crisis. But on the March 2 call, according to German sources, Putin dropped all pretence and coldly admitted to sending Russian troops into Crimea. The conversation seems to have sapped what little faith Merkel still had in Putin, according to officials in Berlin and Washington."

March 18 – Bloomberg (Matthew Campbell and Morgane Lapeyre): “Russian companies have made $180 billion in deals globally in the past two years, providing steady profits to London bankers, lawyers, and image crafters as the city has become a hub for such transactions. Sanctions being imposed by the U.S. and European Union threaten that business. The potential fallout highlights the web of connections linking Russia to the global financial system. Since many large Russian companies are controlled by the state or by billionaires with close ties to President Vladimir Putin, even narrowly targeted sanctions could hurt their global operations…‘There’s a huge amount of business, both industrial and financial, in both directions between the West and Russia,’ said Dominic Sanders, a partner in Moscow at law firm Linklaters. ‘The further the sanctions and retaliation go, the greater the pain.’”

March 21 – Bloomberg (Simon Kennedy): “Europe’s economy is vulnerable to ripple effects from the crisis in Russia and Ukraine. As the European Union, the U.S. and Canada look to take coordinated action to pressure Russia to back off its annexation of Crimea, economists at Morgan Stanley and Deutsche Bank AG released reports yesterday analyzing the potential for fallout on Europe’s economy should the crisis spread. The impact could be transmitted through finance if Russia grabs assets or if the creditworthiness of its assets declines… Among other channels, world trade may be roiled by a drop in Russian imports or if Russia holds back exports of its energy. ‘On all these counts, the European Union would come firmly first among those affected,’ said Moec and Stringa.”

Global Bubble Watch:

March 20 – Bloomberg (Fabio Benedetti-Valentini): “Dominique Strauss-Kahn, the former head of the International Monetary Fund who last year became chairman of a Luxembourg-based bank, is planning to raise $2 billion for a hedge fund he’s setting up. The move is part of efforts Strauss-Kahn, or DSK as he’s known in France, has been making to rebuild his post-IMF life after he was charged in 2011…”EM 

Bubble Watch:

March 21 – Bloomberg (Weiyi Lim): “Chinese equity funds are posting their biggest outflows on record as concern deepens that the world’s second-largest economy is slowing. Investors pulled out a net $1.5 billion in the week through March 19, of which $1.3 billion came from exchange-traded funds, Citigroup Inc. said… Emerging-market funds had outflows of $4.1 billion in the 21st straight week of withdrawals…”

March 19 – Bloomberg (Blake Schmidt): “Brazil’s deteriorating state finances are threatening to exacerbate a bond rout triggered by the federal government’s own fiscal woes. The debt levels of states and municipalities swelled to 2.65% of the nation’s gross domestic product last year… That’s the highest since Brazil passed a fiscal responsibility law in 2000 to rein in local governments that required a bailout three years earlier. The latest data show that a record 10 states are in breach of spending limits in the law, requiring pay and hiring freezes. The Brazilian government has made matters worse by boosting federally-guaranteed loans to states and municipalities by 53% last year to a record, deepening concern among bond investors over the nation’s own financial health…”

China Bubble Watch:

March 18 – Financial Times (Minxin Pei): “Finally, Chinese leaders have admitted what the market has been saying for some time: defaults by Chinese borrowers are all but inevitable, possibly on a significant scale. Responding to questions at a news conference last week, Li Keqiang, the Chinese premier, admitted that ‘isolated cases of default will be unavoidable’. Few are likely to share Mr Li’s optimistic view that only ‘isolated cases of default’ will occur. Still, by speaking publicly of the possibility that investors will suffer losses on credit products, he indicated that Beijing may be ready to face the consequences of its decision to prop up growth with credit-fuelled investment. In the past five years credit has grown at an average of 20% a year, more than double the average rate of economic growth over the same period. An astonishing $14tn of new credit has been extended since 2008. Much of this has been spent on building fixed assets such as infrastructure, real estate and factories. Unfortunately a large portion of this investment – it is impossible to say how much – has been squandered on speculative property ventures, useless infrastructure and excess manufacturing capacity. To make matters worse, inadequate financial regulation has allowed borrowers of doubtful standing to gorge on a seemingly endless flow of loans.”

March 21 – Bloomberg (Fion Li): “China’s yuan posted a record weekly decline as the central bank cut the currency’s reference rate and on rising concerns over economic growth. The currency slid 1.2% in the first week since its trading band was doubled, the biggest drop in China Foreign Exchange Trade System prices going back to 2007. The decline was also the largest since China unified official and market exchange rates at the start of 1994… ‘Yuan depreciation is likely to persist for a while longer as economic fundamentals are weakening and the PBOC continues to cut the fixings,’ said Daniel Chan, a… strategist at China Silver Global Investment Consultant Ltd. ‘There are also risks that structured-product investors will have to unwind long positions. The prospect of a strengthening dollar will also weigh on the yuan.’”

March 18 – Financial Times (Josh Noble and Patrick McGee): “The renminbi has continued to edge closer to levels analysts warn could have ‘major repercussions’ for the market, as the Chinese currency extended its month-long slide… Analysts have warned that a move past 6.20 would cause heavy losses on billions of dollars of complex hedging products taken out by Chinese companies – often exporters – that wanted to bet on renminbi appreciation. Geoff Kendrick, foreign exchange strategist at Morgan Stanley, estimates that roughly $150bn of such positions remained open when the renminbi began its rapid decline in mid-February, and that current mark-to-market losses on such products stand at more than $2bn.”

March 21 – Bloomberg: “China’s benchmark money-market rate had the biggest five-day jump since December after the central bank drained funds from the banking system for a sixth week. The People’s Bank of China withdrew a net 48 billion yuan ($7.7bn) this week… ‘The market started to feel the impact of the continuous repo sales,’ said Zhang Guoyu, an analyst at Orient Futures Co. in Shanghai. ‘As the yuan’s decline may persist in the very near term, a drop in inflows could add further pressure to the market. Liquidity will probably tighten further.’”

March 17 – Bloomberg: “Chinese new-home price growth slowed last month, led by the four cities the government defines as first tier, amid tighter credit to rein in excessive borrowing and individual city measures to curb property prices. Prices in Beijing and the southern business hub of Shenzhen each rose 0.2% in February from a month earlier… That was the slowest pace since October 2012. They added 0.4% in Shanghai, the smallest increase since November 2012… Prices climbed in 57 of the 70 cities tracked… That compares with 62 in January. ‘Overall, we see the property sector as becoming increasingly a major and more real risk to growth and financial stability this year,’ said Dariusz Kowalczyk, a senior economist and strategist at Credit Agricole…”

March 20 – Dow Jones (Fiona Law): “Growing worries over the health of Chinese property developers is driving down bond prices and drying up trading volumes in the $47 billion market that had been a favorite of global investors. Some of the most poorly rated bonds aren’t trading at all, say fund managers and analysts. Some have fallen up to 7% this month… ‘The thin liquidity in market has exaggerated bond-price movements,’ said Pheona Tsang, head of fixed income at BEA Union Investment Management… There is a ‘negative atmosphere surrounding China.’ Property developers had until recently been flooding the market with record dollar-denominated bonds sold in Hong Kong and Singapore, with international money managers snapping up the high yields on offer. Even this year, $15 billion worth of bonds were issued by Chinese developers, mostly in January. That accounted for 40% of global real-estate bond sales, according to… Dealogic.”

March 21 – Bloomberg (Jeff Kearns): “Industrial & Commercial Bank of China Ltd., the nation’s largest lender by assets, is among banks that have stopped distributing trust products as the risk of defaults mount, the Securities Daily reported today. China Construction Bank Corp. also ceased marketing the high-yield investment products that have been used to raise funds for companies that don’t have access to cheaper financing such as bank loans, the newspaper reported…”

March 21 – Bloomberg: “China’s economy slowed this quarter, with industries including retail and mining showing weaker revenue growth while loans through non-traditional channels became more expensive, according to a private survey… The report adds to signs that Premier Li Keqiang may face difficulties reaching an expansion target of 7.5% this year without stimulus… ‘The pace of Chinese economic expansion has plainly slowed,’ Leland Miller, president of survey publisher CBB International, said… ‘A weaker retail performance is the principal driver of the aggregate trend.’”

March 17 – Bloomberg: “China said it will invest more than 1 trillion yuan ($162bn) redeveloping shantytowns this year as the government detailed how it will boost its urban population to support growth. More than 4.75 million households will be involved, state broadcaster China Central Television reported yesterday, citing the housing ministry. China will build more transportation links, ease some residence-registration rules and let local governments directly issue bonds…”

March 19 – Bloomberg (Tanya Angerer): “Investors are demanding the highest premium to hold Chinese dollar notes in almost seven months as the collapse of a developer and the first onshore bond default fuel speculation missed payments will spread. Yield premiums on securities in the U.S. currency rose to 384 bps on March 17, the highest since Aug. 30… Stocks and bonds of some Chinese developers have slumped after government officials said Zhejiang Xingrun Real Estate Co. collapsed with 3.5 billion yuan ($565 million) of debt… ‘This is merely one example of many distressed small developers in China,’ Bei Fu, a credit analyst at Standard & Poor’s, wrote in a March 18 report. 'The companies have been struggling daily for survival.’ Real estate companies account for about 60% of dollar bond offerings from Chinese borrowers this year...”

March 18 – Bloomberg (Tanya Angerer and Rachel Evans): “Some 66% of new Chinese developer dollar-denominated bonds sold this year are trading below their issue price amid the collapse of a private real estate company and news the housing market is cooling. About $6.3 billion of notes in the U.S. currency sold by property companies including Guangzhou R&F Properties Co., KWG Property Holding Ltd. and Shimao Property Holdings Ltd. have fallen in secondary market trade… Demand for developer debt is waning after government officials familiar with the matter said yesterday Zhejiang Xingrun Real Estate Co. doesn’t have enough cash to repay 3.5 billion yuan ($566 million) of debt. The value of home sales in the world’s second-biggest economy fell 5% in the first two months of the year after local governments stepped up measures to curb rising prices.”

March 21 – Bloomberg (David Yong): “China is stepping up scrutiny of its bond market after regulators asked insurers to monitor their debt holdings and as the yield on short-term junk notes jumped this week by the most since December. China Insurance Regulatory Commission told insurers to be aware of the risks in their debt investments, especially in local government financing vehicles, the Shanghai Securities News reported… ‘There’s growing pressure on the bond market because liquidity is generally tighter and sentiment has been affected lately,’ Ivan Chung, a senior credit officer… at Standard & Poor’s, said… ‘March and April is also typically a peak season for refinancing.’”

March 21 – Reuters: “China’s insurance regulator has warned of risks in investment programmes marketed by insurance asset management firms, an official newspaper reported on Friday, as concerns grow over the health of domestic debt markets and the broader impact on the economy. The China Insurance Regulatory Commission (CIRC) has recently issued an internal notice warning of risks involving so-called insurance investment programmes, off-balance debt schemes issued by asset management firms of insurance firms to raise money from insurers and other institutional investors to invest in industrial projects… Some issuers are not properly backed up by their parent firms, which are supposed to guarantee the payments if the programmes face financial difficulties, among other problems, it said… Last year, a total of 90 such programmes were launched, raising a combined 287.76 billion yuan ($46bn), with the value equalling to the total of all such programmes launched in the previous seven years…”

March 19 – Reuters (Yimou Lee): “Cash-strapped Chinese are scrambling to sell their luxury homes in Hong Kong, and some are knocking up to a fifth off the price for a quick sale, as a liquidity crunch looms on the mainland. Wealthy Chinese were blamed for pushing up property prices in the former British territory, where they accounted for 43% of new luxury home sales in the third quarter of 2012, before a tax hike on foreign buyers was announced. The rush to sell coincides with a forecast 10% drop in property prices this year as the tax increase and rising borrowing costs cool demand. At the same time, credit conditions in China have tightened… ‘Some of the mainland sellers have liquidity issues - say, their companies in China have some difficulties - so they sold the houses to get cash,’ said Norton Ng, account manager at a Centaline Property real estate office close to the China border, where luxury houses costing up to HK$30 million ($3.9 million) have been popular with mainland buyers.”

March 20 – Bloomberg: “China told commercial banks to offer emergency loans and restructure debt for poultry farmers whose business was hurt by bird flu outbreaks in the past year, said people with Knowledge of the matter. The People’s Bank of China said in a notice dated March 10 that banks should extend the term of loans due between Dec. 1, 2013 and June 30 by as much as one year if farmers can’t repay… Outbreaks of the H7N9 bird flu virus caused 20 billion yuan ($3.2bn) of losses in January as consumption fell…”

March 19 – Bloomberg: “Japan’s use of forced labor during World War II was a ‘serious crime,’ China Foreign Ministry spokesman Hong Lei said…, after a Chinese court accepted a lawsuit against two Japanese companies accused of the practice. The Beijing No. 1 People’s Court agreed yesterday to hear a lawsuit brought by 40 former workers and their family members against Mitsubishi Materials Corp. and Nippon Coke & Engineering… The laborers and their families demanded 1 million yuan ($161,000) compensation for each victim as well as an open apology in both Chinese and Japanese newspapers, including the People’s Daily and Asahi Shimbun… The use of forced laborers during World War II left physical and mental scars on the victims, Hong said… ‘China has been urging the Japanese side to be responsible with history,’ Hong said.”

Europe Watch:

March 19 – Bloomberg (Lorenzo Totaro): “Lurking within Matteo Renzi’s plan to cut Italian taxes and pay state suppliers are dangers the largesse will hamper efforts to trim the 2.09 trillion-euro ($2.9 trillion) public debt. Italy’s newly installed prime minister won applause from labor unions with his March 12 blueprint to trim 10 billion euros from lower-income workers’ tax bills, and a sigh of relief from commercial businesses promised 68 billion euros in arrears payments from the government. Yet, investors and economists say the shifts can’t be offset by this year’s budget cuts with gross domestic product projected to grow less than 1%... ‘Italy’s debt-to-GDP ratio will continue to rise and thus peak later rather than sooner,’ Marc Ostwald, a fixed-income strategist at Monument Securities… ‘Given the rising tide of criticism leveled by the European Commission and the European Central Bank, higher debt means that Renzi’s plans may have to be revised.’”