Sunday, December 14, 2014

Weekly Commentary, April 27, 2014: Money and Credit and the Current Backdrop

Over the years, money and the “Moneyness” of Credit have remained focal points of my Macro Credit Analytical Framework. From my perspective, money is fundamentally defined by perceptions. “Money” is a financial claim perceived as safe and a liquid store of nominal value. Understandably, this definition is troubling to monetary purists. Yet in the spirit of Ludwig von Mises and his notion of broad money/“fiduciary media,” my view of contemporary “money” is focused on an array of financial claims and their functionality.

Importantly, money has throughout history proven itself dangerous. And the insatiable demand it enjoys is at the root of its vulnerability. Folks simply just can’t get enough of it, which ensures it will eventually suffer from over-issuance. On occasion it will be created in catastrophic excess and be completely discredited. Traditionally, monetary inflations occurred through the over-issuance of currency, bank lending/deposits and government debt. Leading up to the tech Bubble, the over-expansion of GSE liabilities provided a key unappreciated source of inflationary “money.”

Traditionally, to safeguard the attributes of safety and store of value, money was backed by gold or real economic wealth (i.e. capital investment). Uniquely, contemporary “money” is to a large extent backed by nothing. This explains why I generally use “finance” rather than “capital” – in the context of financial flows as opposed to capital flows. Contemporary finance – “money” and Credit – amounts to electronic debit and Credit entries in this massive global general ledger. Traditional “capital” has been relegated to a thing of the past. Today, too much of “finance” retains its value based solely on the perception of central bank and government backing. This is a recipe for serious trouble.

Back in 1999, I really enjoyed Peter Warburton’s book “Debt and Delusion: Central Bank Follies That Threaten Economic Disaster.” Peter and I shared similar concerns back then. We believed central bank manipulation of interest rates, accommodation of Credit and speculative excesses and market intrusion were destabilizing the global financial system and economy. Peter and I saw crises as inevitable. And we both had no idea to what extent the Fed and global central banks would be willing to “print money,” monetize debt and manipulate markets.

It was five years ago (April 2009) that I began warning of the unfolding “global government finance Bubble.” I feared the “Granddaddy of All Bubbles.” The Fed resorted to previously unimaginable measures; for me the worst-case scenario. I never believed they would be able to “exit” from their ballooned post-QE1 balance sheet. I assumed ongoing balance sheet growth. But I never imagined they would resort to massive monetary inflation in the face of record stock prices, conspicuous speculative excess (tech Bubble 2.0, biotech, etc.), highly speculative Credit markets, along with surging prices for real estate, farm land, art and collectables, Manhattan apartments, etc.

Those of us aghast at the course of contemporary monetary management clung to the view that markets would discipline central bankers if they pushed the envelope too far. Instead, the markets have cheered central banks into only deeper market intervention, manipulation and “money” printing. The critical lesson is that central bank-induced market excess can over a protracted period transform a marketplace from an effective self-adjusting/correcting mechanism into a dysfunctional speculative Bubble where Excess Begets Excess.

In the past, I’ve posited that a Bubble financed by junk bonds, while problematic, would not get to the point of creating deep systemic risk. The basic premise is that marketplace demand for high-risk debt is limited. When issued in excess, there will come a point when the market loses its appetite for taking on additional risk. Importantly, a junk Bond Bubble would not inflate long enough nor big enough to impart deep structural maladjustment upon the overall financial system and economic structure.

I grew increasingly concerned about the nineties Bubble specifically because of the far-reaching mutation of contemporary Credit. “Moneyness of Credit” had become a critical issue. With both their explicit and implied federal guarantees, the GSEs (chiefly Fannie, Freddie and FHLB) enjoyed unlimited market demand for their debt and MBS issues (especially during periods of market tumult!). The Fed pegging rates and backstopping market liquidity ensured the fundamental transformation of contemporary Credit. GSE securities – and securitizations/“Wall Street Finance” more generally – had been afforded money-like qualities. And with the markets (leveraged speculators!) perceiving safe and liquid financial instruments, a New Age Credit system enjoyed insatiable market demand – hence the capacity to fuel a historic Credit and economic boom.

The New Millennium’s “mortgage finance Bubble” took “Moneyness of Credit” to a whole new level. With the Greenspan Fed aggressively reflating – and Fed governor Bernanke talking helicopter money and the government printing press – an increasingly speculative marketplace had reason to believe that the Fed, GSEs and the Treasury would fully backstop mortgage Credit. Mortgage debt in general was perceived as money-like – and unprecedented issuance ensured total outstanding mortgage debt doubled in just over six years. That phase of the Credit Bubble took nineties excesses to an unprecedented level, ensuring a much more systemic impact on the overall financial system and, even more importantly, the economic structure.

Fundamental to the “Grandaddy” “Global Government Finance Bubble” thesis has been my view that gross excess had finally reached the heart of the global financial system: government debt and central bank “money.” Yet the important ramifications for what I believe is the final phase of a historic Credit Bubble go unappreciated.

First of all, “money’s” attribute of insatiable demand plays prominently. By the end of the year, the Fed’s $4.5 Trillion balance sheet will have expanded 400% in six years. And there seems today little that would get in the way of the Fed expanding to $10 Trillion. The Bank of Japan is similarly unrestrained in its “money” printing operations, and the same would likely hold true for the ECB if it were to proceed with its own QE. However, the same cannot be said for most “developing” central banks.

Today’s markets would react negatively to any major expansion of central bank Credit from the likes of Brazil, Russia, Turkey, India, Indonesia or South Africa. This market dynamic provides a huge competitive advantage to developed central banks, markets and economies. Increasingly, this competitive advantage along with the destabilizing global role of Federal Reserve “money” are sources of heightened global animosities. More than ever before, EM economies see developed “money” printing as a force for rising inequality.

In a broader context, I believe QE (developed central banking monetary inflation) promotes inequitable wealth distribution. Here at home, monetary policy that prominently inflates asset prices provides a wealth advantage to those with significant assets. Moreover, asset inflation provides a competitive advantage to those that are most sophisticated in generating speculative profits from government policies. The Fed’s QE operations – where massive liquidity has been injected directly into the markets – has generated an incredible wealth transfer, where a small segment of the population is enriched while much of society sees little benefit.

So I view this Credit Bubble phase as especially damaging in terms of international relations along with latent domestic social tension. I see the rapidly deteriorating geopolitical backdrop in this context. Many EM countries today see themselves as suffering from an unjust global financial system. The wealth illusion during the Bubble phase has given way to faltering Bubble disillusionment. Moreover, I expect the damage this monetary inflation has wrought upon the fabric of society to become more apparent come the next downturn. At this point, the wealth redistribution issue has been well-masked by the re-inflation of asset prices (securities and real estate) and the perception that the economic recovery is generally sound and sustainable.

I argue strongly that central bank Credit is by far the most powerful “money” when it comes to inflating securities prices and distorting market perceptions. When the Fed expands “money,” it creates inflationary purchasing power (especially for securities markets), while also emboldening the view that this unlimited source of “money” will continue to underpin the markets and economy. This makes Fed “money” the most dangerous monetary fuel yet, and certainly the most seductive. The Fed has convinced itself that its capacity to inflate asset prices provides profound system benefits. The Fed believes its QE operations stabilize the markets and promote growth. I see QE as extraordinarily destabilizing, in terms of securities market prices and risk perceptions.

I see money and Credit theory as particularly instructive in the current market environment. Going on six years of QE have fueled a long inflationary cycle in securities prices. QE3 sent enormous amounts of liquidity into equities, in the process inciting “terminal phase” excess. In particular, a torrent of speculative finance stoked a full-fledged technology Bubble. In a replay of the late-nineties, the interplay of rampant monetary inflation and intense speculative excess has fueled a destabilizing “arms race” of over- and mal-investment throughout the “tech” sector. From my analytical framework, such monetary disorder ensures a bust. Today’s backdrop is reminiscent of early 2000.

Meanwhile, “developed” central bank monetary inflation fomented historic boom and bust dynamics throughout EM. I believe the reversal of flows from EM and the resulting deteriorating financial and economic backdrop are largely responsible for the rapidly deteriorating geopolitical backdrop. Indeed, I fear the worsening situation in Ukraine reflects a troubling new era of global disagreement and conflict. Monetary instability, economic fragility and wealth inequalities have ushered in another “cold war” that hopefully remains cold. I don’t expect our exuberant markets to remain so complacent forever.

For the Week:

The S&P500 was little changed (up 0.8% y-t-d), while the Dow slipped 0.3% (down 1.3%). The Utilities jumped 1.9% (up 13.3%). The Banks fell 0.7% (down 1.0%), while the Broker/Dealers were unchanged (down 3.9%). The Morgan Stanley Cyclicals slipped 0.1% (up 2.3%), and the Transports declined 0.6% (up 2.5%). The S&P 400 Mid-caps slipped 0.3% (up 0.4%), and the small cap Russell 2000 fell 1.3% (down 3.5%). The Nasdaq100 was unchanged (down 1.6%), and the Morgan Stanley High Tech index sank 2.5% (down 1.2%). The Semiconductors fell 1.1% (up 6.9%). The Biotechs dropped 1.2% (up 3.7%). With bullion gaining $9, the HUI gold index rallied 4.1% (up 15.7%).

One-month Treasury bill rates ended the week at zero and three-month rates closed at one basis point. Two-year government yields increased 4 bps to 0.43% (up 5bps y-t-d). Five-year T-note yields slipped a basis point to 1.73% (down 2bps). Ten-year Treasury yields were down 6 bps to 2.66% (down 37bps). Long bond yields fell 8 bps to 3.44% (down 53bps). Benchmark Fannie MBS yields dropped 10 bps to 3.34% (down 27bps). The spread between benchmark MBS and 10-year Treasury yields declined 4 to 68 bps. The implied yield on December 2015 eurodollar futures declined 2.5 bps to 1.08%. The two-year dollar swap spread declined 3 to 11 bps, while the 10-year swap spread slipped one to 11 bps. Corporate bond spreads were mostly wider. An index of investment grade bond risk was little changed at 67 bps. An index of junk bond risk jumped 6 to 347 bps. An index of emerging market (EM) debt risk surged 12 to 298 bps.

Debt issuance picked up. Investment-grade issuers included Morgan Stanley $4.3bn, Glencore $2.0bn, Fifth Third Bank $1.5bn, Citigroup $1.75bn, Capital One Financial $1.5bn, US Bank $1.5bn, Goldman Sachs $1.3bn, PNC Financial $750 million, Huntington National $750 million, Suntrust Banks $650 million, Senior Housing Properties Trust $650 million, Progressive $350 million and Georgetown University $100 million.

Junk funds saw inflows of $250 million (from Lipper). Junk issuers included Antero Resources $600 million, Laba Royalty $450 million, Nine West $425 million, Hearthside Group $300 million, Centene $300 million and Woodside Homes $270 million.

Convertible debt issuers this week included Citrix Systems $1.25bn.

International dollar debt issuers included CNOOC $4.0bn, Numericable Group $3.78bn, Altice $2.9bn, Tencent $2.5bn, Inter-American Development Bank $2.0bn, Woori Bank $2.0bn, Everglades RE $500 million, Dominican Republic $1.25bn, GTL Trade Finance $1.1bn, Rabobank Nederland $1.0bn, Mdc-Gmtn $750 million, Sinochem Offshore Capital $500 million, Korea Expressway $500 million, Banglalink Digital Communication $300 million, Sector RE $290 million, Camposol $200 million and Garda World Security Corp $140 million.

Ten-year Portuguese yields fell 6 bps to 3.68% (down 245bps y-t-d). Italian 10-yr yields declined 2 bps to 3.11% (down 102bps). Spain's 10-year yields fell 2 bps to 3.06% (down 109bps). German bund yields declined 3 bps 1.48% (down 45bps). French yields dipped a basis point to 1.97% (down 59bps). The French to German 10-year bond spread widened 2 to 49 bps. Greek 10-year yields jumped 27 bps to 6.33% (down 209bps). U.K. 10-year gilt yields declined 3 bps to 2.64% (down 38bps).

Japan's Nikkei equities index declined 0.6% (down 11.4% y-t-d). Japanese 10-year "JGB" yields were up 2 bps to 0.62% (down 12bps). The German DAX equities index was about unchanged (down 1.6% y-t-d). Spain's IBEX 35 equities index added 0.1% (up 3.9%). Italy's FTSE MIB index fell 0.8% (up 13.0%). Emerging equities were mostly lower. Brazil's Bovespa index declined 1.4% (down 0.2%). Mexico's Bolsa dropped 1.7% (down 5.9%). South Korea's Kospi index fell 1.6% (down 2.0%). India’s Sensex equities index added 0.3% (up 7.2%). China’s Shanghai Exchange was down 2.9% (down 3.8%). Turkey's Borsa Istanbul National 100 index dropped 2.8% (up 5.3%). Russia's RTS equities index sank 5.6% (down 14.9%).

Freddie Mac 30-year fixed mortgage rates increased 6 bps to 4.33% (up 93bps y-o-y). Fifteen-year fixed rates rose 6 bps to 3.39% (up 78bps). One-year ARM rates were unchanged at 2.44% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 2 bps to 4.64% (up 72bps).

Federal Reserve Credit last week expanded $7.8bn to a record $4.246 TN. During the past year, Fed Credit expanded $975bn, or 29.8%. Fed Credit inflated $1.435 TN, or 51%, over the past 76 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt declined $6.1bn to $3.295 TN. "Custody holdings" were down $2.8bn from a year ago, or 0.1%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $770bn y-o-y, or 6.9%, to a record $11.868 TN. Over two years, reserves were $1.432 TN higher for 14% growth.

M2 (narrow) "money" supply jumped $25.2bn to a record $11.217 TN. "Narrow money" expanded $666bn, or 6.3%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits jumped $26.0bn, while Savings Deposits were little changed. Small Time Deposits were about unchanged. Retail Money Funds declined $2.5bn.

Money market fund assets increased $7.3bn to $2.584 TN. Money Fund assets were down $134bn y-t-d and $9bn from a year ago, or 0.3%.

Total Commercial Paper declined $1.7bn to $1.043 TN. CP was down $2.9bn year-to-date, while increasing $33bn over the past year, or 3.3%.

Currency Watch:

April 24 – Bloomberg (Fion Li): “China’s yuan fell to the lowest level in 16 months after a report yesterday indicated the country’s manufacturing contracted for a fourth month. The yuan dropped 0.18%, the biggest decline in two weeks, to close at 6.2489 per dollar… The currency has declined 3.1% this year, the biggest loss among Asia’s 11 most-used currencies.”

The U.S. dollar index was little changed at 79.75 (down 0.4% y-t-d). For the week on the upside, the Japanese yen increased 0.3%, the Swiss franc 0.2%, the Danish krone 0.2%, the Swedish krona 0.2%, the euro 0.2% and the British pound 0.1%. For the week on the downside, the South African rand declined 1.5%, the Mexican peso 0.6%, the Australian dollar 0.6%, the Norwegian krone 0.6%, the South Korean won 0.4%, the Singapore dollar 0.3%, the Brazilian real 0.3%, the Taiwanese dollar 0.3%, the Canadian dollar 0.1% and the New Zealand dollar 0.1%.

Commodities Watch:

The CRB index slipped 0.2% this week (up 10.9% y-t-d). The Goldman Sachs Commodities Index declined 0.5% (up 4.0%). Spot Gold gained 0.7% to $1,303 (up 8.1%). May Silver was up 0.5% to $19.72 (up 2%). May Crude was hit for $2.77 to $100.60 (up 2%). May Gasoline added 0.7% (up 10%), while May Natural Gas fell 2.0% (up 10%). July Copper jumped 1.9% (down 9%). May Wheat gained 1.3% (up 16%). May Corn advanced 2.5% (up 20%).

U.S. Fixed Income Bubble Watch:

April 23 – Bloomberg (Julie Miecamp and Katie Linsell): “Billionaire Patrick Drahi is offering concessions to win over U.S. investors as he finances the acquisition of Vivendi SA’s French phone unit with the world’s biggest junk bond offering. As part of about $23 billion of funding in euro and dollar bonds and loans to buy SFR, Drahi may pay about 7.75% in interest on $2.9 billion of eight-year junk notes with a preliminary B rating from Standard & Poor’s.”

April 25 – Bloomberg (Kristen Haunss): “Collateralized loan obligations were the biggest buyers of leveraged loans in the first quarter, increasing their market share to the most since 2006, according to the Loan Syndications and Trading Association. The funds, which buy the loans that are used to back leveraged buyouts, had a 58% market share during the first three months of the year, an increase from 53% in 2013… CLOs had a 61.1% share in 2006. Sales of CLOs reached $82 billion in 2013, the third- largest year on record, and have topped $32 billion in 2014… Issuance in the U.S. rose to $93 billion at the peak of the market in 2007. Investors have been attracted to the most senior piece of a CLO, the AAA slice, which can offer better returns than similarly- rated debt.”

April 25 – Bloomberg (Kristen Haunss): “The riskiest portions of specialized loan funds that have helped finance the biggest buyouts in history are luring investors with returns that exceed even junk bonds. The equity slices of U.S. collateralized loan obligations, which get whatever money is left-over after more senior investors are paid, returned an average 16% last year, according to JPMorgan… Investors say the prospect for above-average returns remains, even as the Federal Reserve starts to flag that it will raise interest rates as soon as next year. Demand for the equity slices of CLOs is helping fuel issuance, providing money for the neediest borrowers.”

Federal Reserve Watch:

April 22 – Bloomberg (Aki Ito): “Federal Reserve Bank of San Francisco President John Williams said the central bank should avoid encouraging excessive financial risk-taking as it pursues its goals of full employment and stable prices. ‘We’re exactly on the right track’ with current policy, Williams said… Trying to achieve the Fed’s goals sooner ‘would take policy actions that might have more negative effects,’ he said. Williams, who has consistently supported record stimulus, said the Fed is likely to continue paring its asset purchases and end them late this year. Central bankers should take care not to change their forward guidance on the path of interest rates in a way that eases policy too much, he said. ‘Adding more and more stimulus either through asset purchases or even trying to put even stronger forward guidance does create more risks about getting policy right on the exit,’ said Williams… ‘It also raises questions about whether the Fed is ‘contributing to potential risks with financial stability, excessive risk-taking.’”

U.S. Bubble Watch:

April 23 – Bloomberg (Lorraine Woellert): “New-home sales in the U.S. took a surprising plunge in March to the lowest level in eight months as buyers balked at record prices and higher mortgage rates… Sales dropped 14.5% to a 384,000 annualized pace, lower than any forecast… Three of the four regions of the country saw setbacks, with demand in the West slumping to the lowest level in more than two years.”

April 25 – Wall Street Journal (Nick Timiraos): “Mortgage lending declined to the lowest level in 14 years in the first quarter as homeowners pulled back sharply from refinancing and house hunters showed little appetite for new loans… Lenders originated $235 billion in mortgage loans during the January-March quarter, down 58% from the same period a year ago and down 23% from the fourth quarter of 2013, according to… Inside Mortgage Finance.”

April 21 – Bloomberg (Leslie Picker and Mohammed Hadi): “It’s becoming much harder for companies to close initial public offerings. Moelis & Co. and Weibo Corp. were among six issuers seeking $100 million or more in the U.S. that had to accept less than they had anticipated… Only two companies last week raised an amount that was within the range they expected. On average, the eight companies priced their offerings at 12% below the mid-point of their marketed range… That’s the biggest discount since the third week of October, after the U.S. government shut down following a budget impasse… Almost $18 billion of newly issued shares have flooded the U.S. market in 2014… This 60% jump in supply from the same time last year, coupled with a selloff in risky assets, explains the difficulty late-comers have had, according to Larry Haverty of Gamco Investors Inc.”

April 23 – New York Times (David Leonhardt and Kevin Quealy): “The American middle class, long the most affluent in the world, has lost that distinction. While the wealthiest Americans are outpacing many of their global peers, a New York Times analysis shows that across the lower- and middle-income tiers, citizens of other advanced countries have received considerably larger raises over the last three decades. After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans. The numbers, based on surveys conducted over the past 35 years, offer some of the most detailed publicly available comparisons for different income groups in different countries over time. They suggest that most American families are paying a steep price for high and rising income inequality."

April 19 – Bloomberg (Chris Wellisz): “To hire 10 to 15 project coordinators this year, Sabre Commercial Inc. has boosted pay 10% and added a 401(k) retirement plan. ‘It is an employee’s market,’ said John Cyrier, co- founder and president of the 48-employee Austin, Texas-based builder. ‘We are definitely seeing a labor shortage in Austin and central Texas. I see it only getting worse.’ Companies across the U.S. from Texas to Virginia and Nebraska are struggling to fill positions with metropolitan jobless rates below the 5.2% to 5.6% level the Federal Reserve regards as full employment nationally. Competition for workers is prompting businesses to raise wages, increase hours for current employees, add benefits and recruit from other regions. ‘There are spot labor shortages’ that probably will ‘broaden out over the next year as the job market steadily improves,’ said Mark Zandi, chief economist at Moody’s Analytics…”

April 21 – Bloomberg (William Selway): “Property-tax collections are rising at the fastest pace since the U.S. housing market crash sent government revenue plunging, helping end an era of local budget cuts. In cities including San Jose, California, Nashville, Tennessee, Houston and Washington, revenue from real-estate levies has set records, or is poised to. Local governments are using the money to hire police, increase salaries and pave roads after the decline in property values and 18-month recession that ended in 2009 forced them to eliminate about 600,000 workers and pushed Detroit, Central Falls, Rhode Island, and three California cities into bankruptcy. ‘The money is flowing back, but it’s not like an open spigot,’ said Rob Hernandez, deputy administrator of Broward County, Florida…”

April 24 – Bloomberg (John Gittelsohn): “Home sales in New York’s Hamptons, the beach retreat for financiers and celebrities, surged in the first quarter as stock-market gains and fatter Wall Street bonuses fueled demand for luxury properties. Sales soared 52% from a year earlier to 528 transactions, according to… appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. The median price rose 19% to $880,000. Thirty-seven homes sold for $5 million or more, up from eight at the start of 2013… Wall Street’s bonus pool rose 15% to $26.7 billion in 2013, the most since the 2008 financial crisis, according to New York’s state comptroller.”

Central Bank Watch:

April 24 – Bloomberg (Tracy Withers): “New Zealand’s central bank raised interest rates for the second time in two months as an economic recovery gathers pace, spurring gains in the local dollar. ‘It is necessary to raise interest rates toward a level at which they are no longer adding to demand,’ Governor Graeme Wheeler said… in Wellington after increasing the official cash rate by a quarter percentage point to 3%... The Reserve Bank of New Zealand will assess the extent to which currency gains curb inflation pressures, he said.”

Ukraine/Russia Watch:

April 23 – Bloomberg (Henry Meyer): “Authorities in Kiev haven’t fulfilled a single clause of April 17 Geneva agreement aimed at de-escalating crisis in Ukraine, Russian Foreign Minister Sergei Lavrov says… U.S. ‘running the show’ in Ukraine: Lavrov… ‘If we are attacked, we would certainly respond. If our interests, our legitimate interests, the interests of Russians have been attacked directly, like they were in South Ossetia for example, I do not see any other way but to respond in accordance with international law… Russian citizens being attacked is an attack against the Russian Federation… Ukraine is just one manifestation of the American unwillingness to yield in the geopolitical fight… Russia, Georgia fought a 2008 war after Georgian army tried to retake breakaway region of South Ossetia, where local residents had Russian citizenship…”

April 25 – Dow Jones (Andrey Ostroukh): “The Russian state-controlled natural gas monopoly Gazprom has billed Ukraine's state-owned energy firm Naftogaz $11.4 billion for not importing the full agreed amount of gas in 2013, Gazprom's Deputy Chief Executive Alexander Medvedev said… The move adds pressure on the already battered economy and finances of Ukraine because its ballooning debt gives Moscow the right to demand an early repayment of a loan--which could theoretically cause a domino effect on about $20 billion of Ukraine sovereign and quasi-sovereign debt. Moscow provided Ukraine with a $3 billion loan in late December when it bought its Eurobonds. The bond prospectus stated that the volume of total state debt and state-guaranteed debt should not at any time exceed 60% of Ukraine's annual nominal gross domestic product.”

April 25 – Bloomberg (Anna Andrianova): “Russia’s sovereign debt rating was cut to the lowest investment grade at Standard & Poor’s, which said further downgrades are possible if economic growth deteriorates and the conflict in Ukraine sparks wider sanctions… ‘The tense geopolitical situation between Russia and Ukraine could see additional significant outflows of both foreign and domestic capital from the Russian economy and hence further undermine already weakening growth prospects,’ S&P said…”

April 21 – Bloomberg (Vladimir Kuznetsov): “Russian companies, facing $115 billion of debt due over the next 12 months, will have the funds even as bond markets shut because of the Ukraine crisis, according to Moody’s… and Fitch… Firms will have about $100 billion in cash and earnings at their disposal during the next 18 months, Moody’s said… ‘The amount of cash on balances of Russian companies, committed credit lines from banks and the operating cash flows they will get is sufficient for the companies to comfortably service their liabilities,’ Denis Perevezentsev, an analyst at Moody’s in Moscow, said… There hasn’t been a single public corporate Eurobond sale since February from Russian firms after President Vladimir Putin annexed Ukraine’s Crimea region and as unrest spread to the country’s east.”

April 23 – Bloomberg (Joe Carroll, Nicole Gaouette and Julianna Goldman): “Ukraine’s best hope for keeping furnaces and factories running through next winter is to store as much natural gas as it can after a U.S. aid pledge fell far short of the nation’s needs. Energy supplies have given Russian leader Vladimir Putin powerful economic leverage in his battle with Ukraine. The former Soviet republic gets half its gas from Russia, and it’s the transit route for 50 to 60% of the gas Russia sells to other European nations. U.S. Vice President Joe Biden told Ukrainian leaders this week that the U.S. would provide help so that ‘Russia can no longer use energy as a weapon.’ Biden announced $50 million in aid… Russia responded yesterday, when Prime Minister Dmitry Medvedev said Ukraine would have to prepay for gas shipments unless it starts paying down the $2.2 billion debt its accumulated through March.”

Global Bubble Watch:

April 22 – Wall Street Journal (Rob Copeland): “Even as performance flickers at some top managers, investors still are taking a shine to hedge funds. During the first quarter of 2014, investors continued to move increasing amounts of money into hedge funds, sending industrywide assets under management to a record, industry tracker HFR Inc. said. The alternative-asset managers… collected a net $26.32 billion of new cash in the first quarter, the most in almost three years. The flows pushed hedge-fund assets overall to a peak—$2.7 trillion, nearly double the total from 2008—and marked the seventh consecutive quarter that the industry has hit a record. ‘Across the spectrum, investors continue to be bullish on hedge funds,’ said Marlin Naidoo… head of Americas capital introduction for Deutsche Bank AG. ‘Even on the back of what was a pretty difficult March, we are definitely seeing people look to increase their hedge-fund allocations.’ In 2013, hedge funds on average returned about 9% after fees… The average hedge fund charged investors a 1.54% management fee and a 18.27% performance fee, according to… HFR data. But 2014 has dismayed some managers, particularly over the past few weeks. Some stock-focused funds are down double-digit percentages for the year through the middle of April…”

April 23 – Bloomberg (Katya Kazakina): “Major works by Francis Bacon, Andy Warhol and Mark Rothko are set to fuel Christie’s auction of postwar and contemporary art in New York next month with a target of $500 million. The 72-lot evening sale on May 13 has at least 10 works estimated at $20 million or more… Christie’s sale last May tallied a then-record $495 million… Global annual sales of postwar and contemporary art increased by 11% in 2013, with a highest-ever auction tally of 4.9 billion euros ($6.8bn)…”

EM Bubble Watch:

April 22 – Bloomberg (Isobel Finkel, Onur Ant and Ali Berat Meric): “Turkey’s pledge to guarantee the debt of contractors on public-works projects threatens to balloon government spending, a headwind for foreign buyers of the nation’s bonds. The Treasury will insure 85% of the price of projects costing over 1 billion liras ($470 million) should an agreement fall through because of the contractor’s fault… It will guarantee the entire amount for causes unrelated to the firm, according to the notice. While Turkey’s two-year note yields have fallen… since the ruling party of Prime Minister Recep Tayyip Erdogan won municipal elections last month, gains may be harder to achieve on longer-term debt, Murat Ucer, an economist at GlobalSource Partners in Istanbul, said… ‘This is a quantum leap in the wrong direction,’ Ucer, who co-authored a book about Turkey’s 2001 banking crisis, said… ‘This constitutes a significant threat to the good public-sector balance sheet story.’”

China Bubble Watch:

April 22 – Reuters (Megha Rajagopalan): “China will not ‘swallow the bitter pill’ of ceding its sovereign rights to others, a senior military official told foreign naval leaders on Wednesday, as the country takes an increasingly assertive approach to guarding its maritime territory. ‘No country should expect China to swallow the bitter pill of our sovereignty, national security or development interests being compromised,’ said Fan Changlong, vice chairman of the powerful Central Military Commission. The commission is China's top military council, chaired by President Xi Jinping.”

April 23 – Bloomberg (David J. Lynch): “President Barack Obama’s trip to Asia this week will be dominated by a country he’s not even visiting: China. Each of the four nations on the president’s itinerary is involved in territorial disputes with an increasingly assertive China. And years of military spending gains have boosted the capabilities of the People’s Liberation Army faster than many defense analysts expected, casting a shadow over relations between China and its neighbors and sparking doubts about long- term prospects for the U.S. presence in the Pacific. ‘There are growing concerns about what China is up to in the maritime space,’ said Bonnie Glaser, a China expert at the Center for Strategic and International Studies. ‘There’s a widely held view in the region that the U.S.-China relationship is tipping toward being much more confrontational.’”

April 21 – Bloomberg: “A Shanghai court ordered the seizure of a Japanese ship owned by Mitsui OSK Lines Ltd. as compensation for the loss of two ships leased from a Chinese company before the two countries went to war in 1937. The 226,434-ton Baosteel Emotion was impounded on April 19…as part of a legal dispute that began in 1964...The holding of the ship reflects strained ties between China and Japan amid a territorial dispute over an island chain and visits by Japanese politicians to a Tokyo shrine honoring that country’s war dead. The move is the first time a Chinese court has ordered the seizure of Japanese assets connected to World War II, and could cast a pall over the countries’ trade, according to Shogo Suzuki, a senior lecturer at the University of Manchester… ‘Many of the major Japanese companies like Mitsubishi or Mitsui have existed through back to the pre-war era and could all be implicated in one way or another,’ Suzuki said. ‘Japanese companies can’t extract themselves easily at this stage so I think they’ll be quite worried.’ Disputes have increasingly shifted to the courts, with a Chinese judge accepting a lawsuit last month against two Japanese companies, including Mitsubishi Materials Corp. accused of using forced labor during the war.”

April 25 – Wall Street Journal (Richard Silk): “China's broadest measure of trade with the world posted its smallest quarterly surplus in three years… China's first-quarter current-account surplus, the difference between exports and imports in goods and services as well as one-time transfers of funds, shrank to $7.2 billion… That is down from a $44 billion surplus in the final quarter of 2013, and reflects an unusually poor export performance in the first three months of the year.”

April 22 – Bloomberg (Henry Meyer): “China plans to give the developers of its military planes, ships and weapons access to the nation’s capital markets by folding them into listed state-owned companies, according to people familiar with the matter. The plan would allow military research institutes to be incorporated into the state-owned companies… The policies, being drafted by the Ministry of Finance and other agencies, could be released as soon as next month… The changes fit with the ruling Communist Party’s pledge to give markets a ‘decisive’ role in the allocation of resources. They may also promote the formation of higher-quality defense companies, according to James Hardy, Asia Pacific editor of IHS Jane’s Defence Weekly. ‘There has been a trend to streamline originally fully-state owned enterprises and make them a lot more competitive internationally,’ Hardy said. ‘Generally these research institutes are where a lot of the high end, high-tech stuff like missiles tend to get designed and road-tested.’”

April 22 – Bloomberg: “China’s bad-loan ratio rose ‘significantly’ in the first quarter, increasing risks for the nation’s banking industry, according to the nation’s largest manager of soured debt. The business environment this year has been ‘grim and complicated’ as lenders face pressures on asset quality, liquidity and lending margins, China Huarong Asset Management Co. Chairman Lai Xiaomin said… China’s slowing economy has made it tougher for borrowers to repay debt, driving up banks’ sour loans for a ninth straight quarter as of December to the highest level since 2008… New nonperforming loans amounted to more than 60 billion yuan ($9.6bn) in the first two months of this year, compared with 100 billion yuan for all of 2013, China Business News reported… ‘The economic indicators we’ve seen so far are quite disappointing and repayment risks are rising across sectors from property to small businesses due to weak demand,’ Rainy Yuan, a Shanghai-based analyst at Masterlink Securities… ‘Banks will be hit in such an operating environment but managers of bad assets like Huarong and China Cinda Asset Management Co. stand to benefit’ because they can accumulate more sour loans, she said.”

April 21 – Bloomberg (Henry Meyer): “Chinese Premier Li Keqiang’s plan to introduce deposit insurance is meant to comfort the nation’s savers as bad loans mount. In the bond market, it’s fueling speculation he’s preparing to let some banks collapse. Authorities may tolerate failures of smaller banks once depositor safeguards are in place, Kwong Li, chief executive officer of China Lianhe Credit Rating Co. said… ‘With the deposit insurance coming online, the government is signaling they may be willing to let some of the smaller banks default or be consolidated,’ Li said… Bank defaults ‘probably won’t happen until deposit insurance is in place.’ Lianhe Credit is Fitch Ratings Ltd.’s China joint venture.”

April 22 – Bloomberg: “In front of construction-site billboards depicting Tiffany and Louis Vuitton shops, Liu Cuiying squats on the bank of the Han river, washing orange bedsheets. ‘What do I have? I have nothing!’ she says repeatedly as she beats the sheets on the bank with a wooden bat. ‘My land is gone. What are we going to do?’ Liu lives in a run-down house in the village of Luying on the outskirts of the city of Laohekou in central China. She says her land was bought by the local government as part of a plan to expand the city to more than twice its size, but she hasn’t been relocated to a new home. In other villages nearby, farmers say the government promised to buy their houses and then didn’t have the money to pay. They are caught between a local government that wants to extend China’s three-decade investment spree and President Xi Jinping’s determination to rein in lending and real-estate development that caused debt to soar. With Xi’s cash squeeze, inland cities that are trying to urbanize to reduce poverty are relying on private developers who can tap the estimated $7.7 trillion in the nation’s shadow-banking industry. ‘This is a litmus test for whether Xi Jinping’s reforms are working,’ said Tom Miller, managing editor of the China Economic Quarterly… and the author of ‘China’s Urban Billion: The Story Behind the Biggest Migration in Human History.’ ‘Cities in the interior are trying to grow along the same model as the cities in the east did 10-20 years ago that made them rich. If they start building and then it gets stopped that’s a disaster because it will end up a white elephant.’”

April 23 – Bloomberg: “China’s economy has yet to respond to policy makers’ stimulus efforts, an April manufacturing gauge indicated today, helping send the yuan to a 16-month low. The preliminary Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics was 48.3 in April… The reading rose from March’s final figure of 48 while remaining below the expansion-contraction dividing line of 50.”

April 23 – Bloomberg: “China’s trust assets expanded almost 8% in the first quarter to a record, signaling that a government crackdown on shadow banking and a rise in defaults haven’t curbed demand for the high-yield investments. The nation’s 68 trust companies ended March with 11.7 trillion yuan ($1.9 trillion) after attracting 820 billion yuan in assets, or the most in four quarters… The average yield of the trust products fell to 6.44% in the quarter from 6.62% a year earlier. The expansion undermines authorities’ efforts to curtail credit growth, especially outside the state-controlled banking system, as Premier Li Keqiang grapples with risks from shadow banking amid an economic slowdown.”

April 23 – Wall Street Journal (Esther Fung): “For years, Chinese property has been a sure bet for savvy investors looking to ride the country’s economic surge. Now, some of the best-known names in Chinese investing are cutting back… Since September, Hong Kong tycoon Li Ka-shing, widely considered Asia's richest man, has sold office and shopping-mall projects in the cities of Shanghai and Guangzhou. His son, businessman Richard Li, sold a prime piece of real estate, a mixed-use complex in Beijing's Sanlitun shopping district, for US$928 million in early April. Soho China Ltd. , which develops property only in Beijing and Shanghai, sold two office projects in Shanghai in February for 5.23 billion yuan (US$837 million) in total. The move to sell real-estate projects ‘is looking like a really smart call right now,’ said Colin Bogar, managing director of real-estate private-equity firm MGI Pacific.”

April 20 – Bloomberg: “In recent months, Chinese leaders have pledged drastic steps to clear their nation’s smog-choked air. The bigger question, though, may be how far they’re willing to go to clean up its water. Say one thing for the lung-burning pollution that regularly blankets Beijing and other cities: At least everyone can see the problem. In contrast, a recent benzene spill that poisoned the water supply of Lanzhou -- a city of more than 2 million people -- was terrifyingly odorless and colorless. If anything, polluted water poses a more insidious threat to Chinese people than dirty air does. Seventy percent of the groundwater in the heavily populated north China plain has become unfit for human touch, let alone drinking or irrigation. Because the area encompasses several of the country’s largest farming provinces, crops and livestock are exposed to dangerous contaminants as well. The 9 in 10 Chinese who say they’re ‘highly concerned’ about the safety of their food and water have reason to be alarmed.”

April 23 – Bloomberg (Henry Meyer): “Almost 60% of the groundwater at 4,778 sites monitored across China has been found to be of poor or extremely poor quality, contaminated with pollutants that exceed acceptable standards. About 16% of the sites saw water quality worsen from the previous year, the Ministry of Land and Resources said in the 2013 annual report… Excesses were found of manganese and fluoride, with some monitored sites showing high lead, chromium or arsenic levels. China has become more vocal about trying to curb water, air and soil contamination in the nation of 1.3 billion people.”

Japan Watch:

April 21 – Bloomberg (Masaaki Iwamoto and Chris Shimamoto): “Japan’s weakest export growth in a year spurred a wider-than-forecast trade deficit in March, adding to challenges for Prime Minister Shinzo Abe… The 1.8% rise in the value of shipments overseas from a year earlier, reported today by the Ministry of Finance, compared with a 6.5% median estimate… An 18.1% jump in imports helped widen the deficit to the biggest ever for the month. Exports by volume fell the most since June last year, suggesting external demand may fail to provide much support for an economy set to contract this quarter. A spending spree ahead of the tax increase boosted imports, already swollen by a surge in energy costs due to the yen’s slide and nuclear shutdowns.”

April 24 – Bloomberg (Masahiro Hidaka and Toru Fujioka): “Bank of Japan officials are increasingly concerned the nation’s bond market is failing to reflect emerging inflation, raising the risk of a sudden surge in yields, according to people familiar with the matter. Japan’s benchmark 10-year government bonds yield 0.615%, little changed from March 2013, even after a jump in the consumer-price inflation rate of almost 2.5 percentage points since then.”

April 23 – Bloomberg (Masahiro Hidaka and Toru Fujioka): “Governor Haruhiko Kuroda said the Bank of Japan won’t buy bonds just to keep down government debt- servicing costs after it achieves stable 2% inflation. ‘If we reach our target and prices are stable, we have no intention of moving away from our goal and implementing policy to reduce debt servicing costs,’ Kuroda said in parliament… in response to a question from opposition lawmaker and former Economy Minister Seiji Maehara, who said “the BOJ could be smacked around and told to do something” if yields rise. Unprecedented easing has helped suppress yields on 10-year government debt to the lowest in the world even as inflation has accelerated to the fastest pace since 2008.”

April 22 – Bloomberg (Shigeki Nozawa and Mariko Ishikawa): “The Japanese government should prioritize expanding its recent sales tax increase or risk an eventual collapse of sovereign bonds, former Ministry of Finance official Eisuke Sakakibara said. A failure to raise the consumption levy ‘could trigger massive dumping’ of the nation’s debt, Sakakibara said… ‘We must not derail from boosting the levy to 10%. The bond market’s collapse would be more dire than a tax increase.’”

India Watch:

April 25 – Bloomberg (Shikhar Balwani): “India’s one-year interest-rate swaps capped their first weekly advance in three on concern a slide in the nation’s currency will stoke inflation. The rupee… slid 0.6% this week, the most since January and a fourth straight week of declines. That threatens to push up costs in a nation that imports about 80% of its oil. Foreigners pulled a net $1.54 billion from local debt this month through April 23 after pumping in a record $6.2 billion in the January-March quarter.”

Europe Watch:

April 24 – Bloomberg (Jeff Black and Corina Ruhe): “European Central Bank President Mario Draghi said any worsening of the medium-term outlook for inflation in the euro area could be the trigger for broad-based asset purchases. ‘The objective here would not be to defend the current stance, but rather to increase meaningfully the degree of monetary accommodation,’ Draghi said… ‘In order to fulfil its mandate, the Governing Council is committed –- unanimously –- to using both unconventional and conventional instruments to deal effectively with the risks of a too-prolonged period of low inflation.’”

April 23 – Financial Times (Tobias Buck): “Catalonia’s president has vowed to press ahead with a fiercely contentious referendum on independence from Spain, warning that he now saw little chance of a negotiated settlement with Madrid that could tackle the region’s economic and political grievances. Artur Mas said he was ‘100 per cent’ committed to calling a regional vote on Catalonia’s future status in November – just two months after Scotland’s independence referendum. ‘We will not halt this process. If we halt this process and there is no alternative the frustration here will be absolute,’ he told a group of foreign journalists… ‘We will never give up on the option of reaching an agreement with Madrid. But at the moment such an agreement is very unlikely. They are saying no to almost everything [we have asked for],’ Mr Mas said. His comments followed a series of equally uncompromising statements from the central government in Madrid, suggesting that a head-on constitutional clash later this year is increasingly likely.”

April 22 – Reuters (Nicholas Vinocur and Alexandria Sage): “France’s government is to set out its roadmap to deficit reduction on Wednesday using optimistic growth forecasts considered risky by its own fiscal watchdog to show how it will meet European budget standards by the end of next year. Europe's second-biggest economy is a laggard where recovery and public finances are concerned. It has already been granted a two-year extension on the original deadline to bring its deficit below the EU's treaty limit of 3% of gross domestic product (GDP). Its partners fear it may miss the deadline again next year, and meanwhile its unpopular Socialist government is struggling to sell painful cuts to rebellious rank and file lawmakers… The government will raise the official deficit forecast for this year and next to 3.8% and 3.0% of gross domestic product (GDP) respectively, business daily Les Echos reported…”