Sunday, December 14, 2014

Weekly Commentary, May 16, 2014: Nervous Time

I’ll begin with a few of this week’s notable market moves. The euro/yen declined another 82 bps, increasing its two-week decline to 1.94%, to the lowest level since February. Greek 10-year sovereign yields surged 75 bps to the highest level since March. The spread between Portugal and Germany bond yields widened 35 bps. Spreads to German bunds widened 17 bps in Spain and 24 bps in Italy. Italian stocks were hit for 3.5%. Here at home, the Bank stock index (BKX) dropped 1.7% and the Broker/Dealers (XBD) were hit for 2.2%. Let me suggest weakness at the “periphery of the periphery” – out at the “margin” that I look to for subtle market “risk on/risk off” leanings. I’ll take this week’s trading as added confirmation of the incipient risk aversion thesis.

May 14 – Bloomberg (Kelly Bit, Saijel Kishan and Joshua Fineman): “David Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, said he’s nervous about markets as the U.S. economy isn’t growing fast enough amid complacency by the Federal Reserve. ‘We have this term called coordinated complacency to describe the world’s central banks right now,’ Tepper said… ‘The market is kind of dangerous in a way.’ Tepper… said he’s more worried about deflation than inflation and that this is the time to preserve money. The money manager, who is worth $7.9 billion… said that while investors can be optimistic on markets, they should hold some cash. ‘I think its nervous time’ he said…”

Tepper (who made approximately $400,000 per hour more than me in 2013) said markets are “tough.” No disagreement here. But “coordinated complacency” from the world’s central banks? Well, the Fed funds rate is locked at near zero - and the Fed has ballooned its balance sheet an unprecedented $1.463 Trillion in 79 weeks. Not seeing a lot of complacency there. The BOJ has shown no indication of backing away from their desperate $65bn monthly “money” printing operation. The ECB has rates near zero and is about to adopt additional stimulus.

I would contend complacency as the prevailing attitude of market participants – and not central bankers. Unfortunately, central bank monetary inflation and market intervention have been the leading instigators of complacency-inducing asset price Bubbles. Tepper is fearful of “deflation” and for good reason (including $440k/hr) and would prefer that central bank “money” sustains this gilded age of speculative genius. I’ll be the first to argue that there is heightened Bubble fragility in the global financial system and economy that will ensure interminable pressure on central bankers to keep the electronic debits and Credits coming. I also view QE3 and all the monetary stimulus as having made global markets, finance and economies only more distorted and vulnerable.

Unsustainable Credit and asset Bubbles provide the existential threat. So-called “deflation” risk is a consequence of precarious “money,” Credit, securities, asset, economic and speculative Bubbles. At this point having resorted to rank monetary inflation (and with global growth dynamics alarmingly weak), Central banks have no solution. Trying to gauge how much time is left is the pressing issue for market participants.

This week also brought further evidence of a rapidly deteriorating geopolitical backdrop. Anti-China protests erupted in Vietnam that claimed lives and shut down scores of factories and businesses. I was reminded of the horrible Indonesian riots and attacks on ethnic Chinese after the collapse of the “SE Asian Tiger” Bubbles back in 1997. China wasn’t an economic or military power back then.

Heightened social tension is not limited to Vietnam. Thailand’s military warned that they are prepared to use force if necessary if political protests again turn violent. The terrible mining accident in Turkey – and the embattled Prime Minister’s comments that “accidents happen” and its “part of the nature of the business” – sparked protests within a tense political and social backdrop. And with four weeks until the World Cup, strikes and protests returned to Brazil this week. Protests were said to have heated up in Venezuela as well.

On various fronts, it does appear a Summer of Discontent is brewing. The “Ukraine” crisis shows no sign of resolution. Things could easily spiral out of control. The Russians are winning territory – and the West seems powerless. In an interesting Bloomberg interview, Russia’s foreign secretary Sergei Lavrov made it clear that sanctions will only stiffen Russian resolve. Lavrov also warned the U.S. risks sacrificing its reputation as the holder of the “key” to “virtual money” – the “reserve currency.”

There were also various news articles supporting the view of a tightening relationship between Russia and China. And with U.S and Chinese relations on a downward track, it is not lunacy to contemplate Russia and China moving decisively together in the direction of a more bipolar world of competing security, economic and, even, financial systems. Such a development would create great uncertainty – and perhaps might even help to explain the powerful bid to “safe haven” sovereign bonds of late.

May 15 – Fortune (Stephen Gandel): “Larry Summers is worried that the Federal Reserves' efforts to stimulate the economy could end up doing damage. ‘Low interest rates could become a source of instability down the road,’ said Summers… Summers was speaking… to a packed auditorium of hedge fund industry professionals at SALT, the annual industry confab… Summers told the crowd that he shared concerns that low interest rates could be causing new bubbles. That’s why, Summers said, he has long favored government spending on jobs programs rather than stimulus engineered by the Fed. What’s more, Summers said that the Fed's policies are likely making the income inequality problem in the U.S. worse, by helping wealthy Americans who hold the majority of stocks, more than the rest of the country. ‘A policy that works by pumping up asset prices is not going to be egalitarian,’ said Summers.”

From my analytical perspective, Larry Summers’ comments were more notable than even Tepper’s. Summers is stating what has been dismissed for too long – but has become increasingly obvious: Misguided Fed policies have caused Bubbles and exacerbated inequality. And if Fed “money” printing is anathema to the political right and these inequitable Bubbles anathema to the political left, where will Fed doves turn to for support for future QE? Is the bullish market faith that the Fed will always be there with QE on Demand way too complacent?

May 11 – Bloomberg: “Chinese President Xi Jinping said the nation needs to adapt to a ‘new normal’ in the pace of economic growth and remain ‘cool-minded’ amid a slowdown in expansion. China’s growth fundamentals haven’t changed and the country is still in a ‘significant period of strategic opportunity,’ Xi said… At the same time, the government must prevent risks and take ‘timely countermeasures to reduce potential negative effects,’ he said.”

May 14 – MarketNews International: “Another disappointing set of Chinese data has renewed calls for the government to take action to support the economy. But official sources insist that this time really is different, and that the economic ‘new normal’ really does means slower growth with an emphasis on fundamental reform… The message that ‘this time it’s different’ has been trumpeted since President Xi Jinping said… China needs to adapt to a ‘new normal’ of slower growth. The official People's Daily said… that the West has been overly reliant on China to support the global economy, citing repeated demands at G20 meetings for Beijing to roll out stimulus measures. It's a familiar refrain -- then-Minister of Commerce Chen Deming said in 2009 that China can't play Kung-fu Panda, coming to save the world time and time again… But he was a member of the previous government, whose CNY4 trillion stimulus program enacted in November 2008 is now considered the original sin (a time of ‘crazy stimulus’, the NBS source said). The new leadership… say they are committed to cleaning up the waste created by that stimulus program and engineering a more sustainable -- and slower -- pace of economic development.”

May 11 – Reuters: “China's war chest of foreign currency reserves has become a headache as its continued rise could stoke inflation in the long term, Premier Li Keqiang said… pledging to reduce the country’s trade surplus. China’s foreign exchange reserves, the world’s largest, grew by $130 billion in the first quarter, to a record $3.95 trillion… ‘Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation,’ Phoenix New Media Ltd quoted Li as saying… ‘From China’s perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced.’ China will take steps to reduce its trade surpluses with the rest of the world…”

Are bullish markets way too complacent about China? Data confirm that apartment sales slowed sharply in April (see China Bubble Watch), with prices turning down across many markets (as inventories turn way up!). There is now overwhelming support for the bearish bursting China Bubble thesis. Credit has begun to slow markedly, hence China’s economic downturn is set to accelerate (outside the defense sector). Importantly, top policy officials have made it clear that they remain focused on necessary readjustment rather than major stimulus. Chinese central bankers and bank regulators appear to be hastily preparing for the onset of financial crisis. Increasingly, they’ve pointed blame at the Fed and U.S. and Japanese policies for their predicament. Foreign exchange reserves a “burden?” The world is really changing.

Think of it this way: Going all the way back to the nineties, the Fed has promoted and accommodated a New Age Credit system increasingly dominated by marketable-based Credit (as opposed to traditional bank loans). This new system ensured ever-increasing market risk (growing quantities of securities with market, duration and Credit risk) and a resulting booming derivatives (“insurance”) marketplace. To ensure viability for this ballooning system of securitizations and derivatives, the Federal Reserve pegged short-term rates and essentially guaranteed that securities markets would remain “liquid and continuous.” Basically, the Fed had to promise that Credit would remain in a perpetual “bull market.” And this assurance of financial nirvana nurtured a historic cycle of speculative excess – speculation that I believe is late in the “Terminal Phase.”

Not surprisingly, there have been (going all the way back to the 1994 bond bust) market problems all along the way. To be sure, this system – both domestically and on an international basis – has proven itself highly unstable – a propagator of serial booms and busts. The Fed and global central bankers have had to resort to increasingly radical measures to resuscitate faltering or burst Bubbles. The system came close to meltdown back in 2008/09. Eurozone finance came close to meltdown again in 2011/2012. And since autumn 2012 global central bankers have instigated the greatest monetary inflation in history. Global securities markets have inflated to record highs, as exuberant investors now look back at the “Lehman crisis” as the proverbial “100-year flood.”

From my analytical perspective, this global Bubble in New Age Credit has finally arrived at a critical crossroads. Rates have been held at zero for years. And for years, Fed and global central bank balance sheets have inflated like never before. This “money” printing culminated with the Fed and BOJ combining for $150bn a month. Fledgling asset and securities Bubbles were pushed to dangerous excess everywhere – bigger and more dangerous than ever. Global securities markets speculative excess now dwarfs even 2007. Yet even extreme financial excess equates with only feeble (and highly unbalanced) economic growth. Moreover, the world has seemingly now been fully inundated by Fed Credit and U.S. debt. And, importantly, the Chinese no longer see it in their best interest to do another round of big stimulus and accumulate only more U.S. IOUs and global debt securities. Russia and others see a global system controlled by the West that is working against their interests.

But when it comes to the Summer of Discontent thesis, let me throw this unappetizing morsel out as food for thought: bear market. Bull markets are all about optimism and self-reinforcing speculation and liquidity excess. Bear markets are the creatures of unmet expectations, disappointment and waning liquidity. I have made the case that desperate monetary stimulus from the world’s central bankers has created a dangerous divergence: inflated and highly speculative securities market Bubbles (and the associated distorted “Truman World” view of reality) versus very real deteriorating fundamental prospects and heightened global risk. I’ve tried to make the case that with Fed balance sheet expansion winding down, the markets have become extraordinarily vulnerable to a bout of “risk off” de-risking and de-leveraging.

But let me get a little more specific. With the Fed promising not to raise rates for some time to come, the marketplace is really complacent with regard to the end of QE3. Rates are staying at zero – and the Fed is surely willing to respond to market instability with more “money” printing, so the thinking goes. So the bullish view that financial conditions stay loose indefinitely has solidified. Is this a major misconception that holds potential for a big downside surprise?

I worry that the big negative lurking out there is the reality that the Fed no longer controls “financial conditions.” Especially with the recklessness of QE3, precariously loose finance became the domain of hedge funds leveraging high-yielding instruments and performance-chasing finance flooding into high-yield ETF products. Now, with monetary inflation having levitated price levels all over the place – bonds, stocks, homes, household incomes, spending, corporate earnings and cash flows, global finance, etc. – the system is today extraordinarily susceptible to speculative de-leveraging and the reversal of flows out of the ETF complex. And this week we have confirmation that David Tepper, king of sophisticated market operators, is sensing “Nervous Time.”

For the Week:

The S&P500 was volatile but unchanged (up 1.6% y-t-d), while the Dow declined 0.6% (down 0.5%). The Utilities slipped 0.7% (up 9.5%). The Banks sank 1.7% (down 3.5%), and the Broker/Dealers fell 2.2% (down 7.2%). The Morgan Stanley Cyclicals were little changed (up 2.4%), while the Transports jumped 1.6% (up 6.0%). The S&P 400 Midcaps were little changed (up 0.7%), while the small cap Russell 2000 slipped 0.4% (down 5.2%). The Nasdaq100 gained 0.9% (down 0.1%), and the Morgan Stanley High Tech index rose 1.1% (up 0.1%). The Semiconductors were unchanged (up 7.7%). The Biotechs slipped 0.1% (up 7.4%). Although bullion gained $5, the HUI gold index lost 1.1% (up 9.8%).

One-month Treasury bill rates ended the week at one basis point and three-month bills closed at two bps. Two-year government yields declined two bps to 0.36% (down 2 bps y-t-d). Five-year T-note yields fell 7 bps to 1.555% (down 19bps). Ten-year Treasury yields were down 10 bps to 2.52% (down 51bps). Long bond yields fell 12 bps to 3.35% (down 62bps). Benchmark Fannie MBS yields were down six bps to 3.22% (down 39bps). The spread between benchmark MBS and 10-year Treasury yields widened four to 70 bps. The implied yield on December 2015 eurodollar futures fell 6 bps to 0.925%. The two-year dollar swap spread increased two to 15 bps, and the 10-year swap spread gained two to 10 bps. Corporate bond spreads widened. An index of investment grade bond risk increased one to 65 bps. An index of junk bond risk gained five to 346 bps. An index of emerging market (EM) debt risk rose six to 284 bps.

Debt issuance was strong. Investment-grade issuers included Pfizer $5.0bn, Volkswagen Group America $2.5bn, GE Capital $2.5bn, Toyota Motor Credit $2.0bn, Continental Resources $1.7bn, Prudential Financial $700 million, Carefusion $1.0bn, L-3 Communications $1.0bn, Pricoa Global Funding $700 million, Florida Power & Light $500 million, Westar Energy $400 million, Corporate Office $300 million, Principal Life $300 million, Tampa Electric $300 million, Lexington Realty $250 million, Wisconsin Electric $250 million and Regency Centers $250 million.

Junk funds saw outflows of $259 million (from Lipper). Junk issuers included First Energy Transmission $1.0bn, AES Corp $775 million, Sabine Pass $2.5bn, Commscope $650 million, Energy XXI Gulf Coast $650 million, Suburban Propane Partners $525 million, Alpha Natural Resources $500 million, Avis Budget Car Finance $400 million, Group One Auto $350 million, Genesis Energy LP $350 million, Teleflex $250 million and Atlas Resource Partners $100 million.

Convertible debt issuers this week included Spirit Realty $300 million and TAL Education Group $200 million

International dollar debt issuers included European Investment Bank $5.0bn, Westpac Banking $4.25bn, Barclays Bank $2.25bn, Neder Waterschapsbank $1.8bn, Perusahaan Gas Negara $1.35bn, Ukraine Aid $1.0bn, Municipality Finance $1.0bn, Dexia Credit $860 million, Country Garden $550 million, KCA Deutag Finance $375 million, BRF $300 million, Signet Finance $400 million, Maoye International $300 million, Kissner Milling $220 million and Diamond Bank $200 million.

Ten-year Portuguese yields jumped 20 bps to 3.74% (down 239bps y-t-d). Italian 10-yr yields rose 11 bps to 3.06% (down 106bps). Spain's 10-year yields increased four bps to 2.95% (down 120bps). German bund yields dropped 13 bps to 1.33% (down 60bps). French yields declined 11 bps to 1.79% (down 77bps). The French to German 10-year bond spread widened two to 46 bps. Greek 10-year yields surged 75 bps to 6.86% (down 156bps). U.K. 10-year gilt yields dropped 12 bps to 2.56% (down 46bps).

Japan's Nikkei equities index declined 0.7% (down 13.5% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.58% (down 16bps). The German DAX equities index added 0.5% (up 0.8%). Spain's IBEX 35 equities index was little changed (up 5.7%). Italy's FTSE MIB index sank 3.5% (up 8.9%). Emerging equities were mostly higher. Brazil's Bovespa index gained 1.7% (up 4.8%). Mexico's Bolsa increased 0.6% (down 1.9%). South Korea's Kospi index jumped 2.9% (up 0.1%). India’s Sensex equities index surged 4.9% to a record high (up 13.9%). China’s Shanghai Exchange increased 0.8% (down 4.2%). Turkey's Borsa Istanbul National 100 index declined 0.7% (up 10.6%). Russia's MICEX equities index gained 1.2% (down 7.4%).

Freddie Mac 30-year fixed mortgage rates slipped a basis point to 4.20% (up 69bps y-o-y). Fifteen-year fixed rates declined three bps to 3.29% (up 60bps). One-year ARM rates were unchanged at 2.43% (down 12bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a notable 24 bps to 4.82% (up 87bps).

Federal Reserve Credit last week expanded $18.0bn to a record $4.274 TN. During the past year, Fed Credit expanded $971bn, or 29.4%. Fed Credit inflated $1.463 TN, or 52%, over the past 79 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt was little changed at $3.284 TN. "Custody holdings" were down $68bn year-to-date, with a one-year decline of $14.8bn, or 0.4%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $784bn y-o-y, or 7.0%, to $11.909 TN. Over two years, reserves were $1.463 TN higher for 14% growth.

M2 (narrow) "money" supply gained $22.6bn to a record $11.265 TN. "Narrow money" expanded $725bn, or 6.9%, over the past year. For the week, Currency declined $0.4bn. Total Checkable Deposits jumped $32.1bn, while Savings Deposits declined $8.6bn. Small Time Deposits slipped $1.2bn. Retail Money Funds increased $0.9bn.

Money market fund assets declined $3.1bn to $2.588 TN. Money Fund assets were down $131bn y-t-d, while gaining $6bn from a year ago, or 0.2%.

Total Commercial Paper declined $4.1bn to $1.038 TN. CP was down $21.1bn year-to-date, while increasing $25bn over the past year, or 2.4%.

Currency Watch:

May 10 – MarketNews International (Karen Mracek): “Treasury Secretary Jack Lew said Friday there have been ‘some very negative movement’ in China’s exchange rate in recent months, and he will address the issue on his upcoming trip to Beijing. ‘Exchange rates is an extremely important issue,’ Lew said… ‘They have made some moves that are consistent with moving toward more market-determined rates. They widened their trading band… But we've seen some very negative movement in the exchange rate in recent months,’ Lew said… ‘One of the issues that I'm going to bring to them is if your policy says that the exchange rate can go up and down, you need to have market signals determining whether it's going up or down.’”

The U.S. dollar index added 0.2% to 80.04 (unchanged y-t-d). For the week on the upside, the Japanese yen increased 0.4%, the Mexican peso 0.4%, the Canadian dollar 0.3%, the New Zealand dollar 0.2% and the Swedish krona 0.1%. For the week on the downside, the Swiss franc declined 0.7%, the Danish krone 0.5%, the euro 0.5%, the Norwegian krone 0.4%, the British pound 0.2%, the Singapore dollar 0.2%, the Brazilian real 0.1%, the South African rand 0.1%, and the Taiwanese dollar 0.1%.

Commodities Watch:

The CRB index added 0.4% this week (up 9.2% y-t-d). The Goldman Sachs Commodities Index gained 0.9% (up 3.3%). Spot Gold added 0.4% to $1,293 (up 7.3%). July Silver gained 1.1% to $19.33 (down 0.2%). June Crude jumped $2.03 to $102.02 (up 3.7%). June Gasoline surged 2.7% (up 7%), while June Natural Gas slumped 2.6% (up 4%). July Copper gained 2.1% (down 7%). July Wheat sank 6.7% (up 11%). July Corn fell 4.7% (up 15%).

U.S. Fixed Income Bubble Watch:

May 14 – Bloomberg (Wes Goodman): “U.S. corporate bonds offered the smallest yield versus Treasuries in almost seven years as investors try to increase income following a decline in benchmark borrowing costs. Bonds in an index of investment-grade company debt yielded 113 bps more than Treasuries on average, the smallest spread since July 2007… Demand for riskier assets outside the safety of government debt has also helped push U.S. stock benchmarks to records, after Federal Reserve Chair Janet Yellen indicated she plans to maintain support for the economic expansion.”

May 16 – Bloomberg (Sarika Gangar and Abigail Moses): “Bond buyers have never been paid so little to lend to the riskiest junk-rated companies, yet they’ve been gobbling up their debt at an accelerating pace. Average yields on debt worldwide graded CCC and below fell to a record-low 8.58% this week, a rate investors were getting just three years ago from BB rated companies on the cusp of investment-grade… Sales of the bonds increased to 18% of total junk-bond issuance in April, the most in eight months and above the average of 13% over the past decade… The rush for high-yielding assets in the sixth year of the Federal Reserve’s easy-money policies is leaving debt markets wide open for companies that had been teetering on distress.”

May 13 – Bloomberg (Kelly Bit and Lisa Abramowicz): “Almost six years after Lehman Brothers Holdings Inc. filed for the largest bankruptcy in history, triggering a global market meltdown, hedge funds are still feeding on its remains. A small group of firms that waded into the morass in the aftermath of the financial crisis… have made billions of dollars trading in the debt. As claims are being paid out, often at a multiple of initial estimates, investors that have spent years analyzing the bankruptcy are ploughing money back into newly available loans, such as those between the investment bank’s Hong Kong and U.S. units, fueling a rally unmatched by stocks and high-risk bonds.”

May 15 – Bloomberg (Kasia Klimasinska): “Russia’s holdings of U.S. government securities fell by 20% in March to the lowest level since September 2008 as analysts said Russian banks sought to avoid U.S. sanctions and the nation’s central bank tried to shore up the value of the ruble. Russian holdings declined for a fifth straight month, to $100.4 billion from $126.2 billion in February, according to figures released today by the Treasury Department in Washington.”

Federal Reserve Watch:

May 13 – Wall Street Journal (Ryan Tracy and Gillian Tan): “The Federal Reserve warned it may need to take additional action to rein in banks' funding of corporate takeovers after observing continued deterioration of lending standards this year. The statements by a Fed official in remarks prepared for a regulatory conference were the latest warning that U.S. regulators want banks to end practices they see as risky in so-called leveraged lending markets. The Fed and the Office of the Comptroller of the Currency told banks in March 2013 to avoid funding takeover deals that would leave companies with high levels of debt. Judging from aggregate market data, it appears that many banks have not fully implemented standards set forth’ in the March 2013 guidance, said Todd Vermilyea, senior associate director in the Fed’s Division of Banking Supervision and Regulation… The statement was unusual for the Fed, which has sent private letters telling banks to change their policies but hasn't spoken much about the issue in public. The OCC has been more vocal, telling The Wall Street Journal in March of this year that there would be ‘no exceptions’ to the guidance for newly issued loans. ‘This is a shot across the bow by the Fed, which is saying 'We're going to take some action beyond tongue-lashing' where they find noncompliance,’ said Richard Farley, a partner at Paul Hastings LLP who advises banks on leveraged-finance deals.”

Ukraine & Russia Watch:

May 16 – Bloomberg (Leon Mangasarian): “The Ukraine crisis reverberating across Europe recalls 1914 before the outbreak of World War I as Russia, the U.S. and European governments risk sleepwalking into conflict, said former German Chancellor Helmut Schmidt. ‘I don’t want to encourage a third world war and especially not calls for more money for arms for NATO,’ Schmidt, 95, was cited as saying… ‘But the danger that the situation intensifies as in 1914 is growing day by day.’ Schmidt, who was German chancellor from 1974 to 1982, and fellow Social Democrat Gerhard Schroeder, who held the post from 1998 to 2005, have warned against imposing sanctions on Russia and moves by the European Union and the North Atlantic Treaty Organization to forge closer ties with Ukraine.”

May 16 – Bloomberg (Olga Tanas and Elena Mazneva): “When Russian President Vladimir Putin travels to China next week chasing a long-term natural-gas supply deal, he’ll be joined by at least two businessmen sanctioned by the U.S. amid tensions over Ukraine. OAO Rosneft Chief Executive Officer Igor Sechin and billionaire Gennady Timchenko will take part in Putin’s talks with Chinese President Xi Jinping… Russia is turning to China to bolster its economy as relations sour with the U.S. and European Union, pushing capital flight to $50.6 billion in the first quarter and setting it on the brink of recession.”

May 15 – Bloomberg (Daryna Krasnolutska, Daria Marchak and Ryan Chilcote): “Russia’s foreign minister said Ukraine is sliding into a civil war that could make it impossible to hold legitimate elections, as Ukrainian leaders and their international allies blamed Russia for the violence. When Ukrainians kill Ukrainians, I believe it’s as close to civil war as you can get,’ Sergei Lavrov told Bloomberg… ‘In the east and south of Ukraine, there is a war, a real war, with heavy weaponry used, and if this is something that is conducive to free and fair elections, then I don’t understand something about freedom.’”

May 14 – Bloomberg (Zoltan Simon): “Hungarian Prime Minister Viktor Orban mentioned ‘self-governance’ for the ethnic Hungarian community living there, not autonomy, Foreign Minister Janos Martonyi says… Orban also referred to dual citizenship request and community rights for ethnic Hungarians in Ukraine…”

May 12 – Dow Jones (Ben Edwards): “Ukraine's bondholders could face losses if the country's southeastern regions break away from Kiev, according to Bank of America Merrill Lynch. Separatists in Donetsk and Luhansk held referendums at the weekend, which Ukraine said were illegal, where organizers said roughly 9 out of every 10 voters called for independence from Ukraine amid the ongoing tensions with Russia. Should those two regions and neighboring Kharkiv succeed in splitting from Ukraine, the International Monetary Fund--which last month approved a $17 billion aid program for the country--could call for some form of debt restructuring, said Vadim Khramov, an economist at Bank of America Merrill Lynch. In a more extreme scenario where all eight southeastern 'Novorossiya' regions were to break away (including Dnipropetrovsk, Zaporizhya, Mykolayiv, Kherson and Odessa,) Ukraine's debt load would become unsustainable and the IMF, which has said it would need to re-design Ukraine's aid program if the country loses control over its eastern regions, could demand debt restructuring with bondholders taking a sizeable hit, Mr. Khramov said.”

Geopolitical Watch:

May 15 – Reuters: “A top Chinese general on Thursday defended China's deployment of an oil rig in the disputed South China Sea that has triggered deadly protests in Vietnam, saying Beijing can’t afford to ‘lose an inch’ of territory. Anti-China riots broke out this week in Vietnam, killing up to 21 people and setting fire to factories perceived to have been Chinese-owned, after China towed a giant oil rig into waters claimed by both nations. General Fang Fenghui, chief of the general staff of the Chinese People's Liberation Army, said in Washington that the drilling rig was operating in China's territorial waters, activity he vowed to protect. He also pointed blame at U.S. President Barack Obama's so-called pivot to Asia, saying some countries in the region seized upon it as an opportunity to create trouble in the South and East China Seas. At different points, he singled out disputes with U.S. allies the Philippines and Japan. … Fang said Vietnam was at fault for stirring up trouble by dispatching ships in an attempt to ‘disrupt’ Chinese drilling activity. ‘I think it's quite clear ... who is conducting normal activity and who is disrupting it,’ Fang told a Pentagon news conference… Speaking broadly about regional tensions, Fang said Beijing did not create trouble, but was also unafraid of it and suggested China was ready to defend its territorial integrity.”

May 14 – Xinhua: “The Chinese and Russian foreign ministers held a telephone conversation on Wednesday over Russian President Vladimir Putin's upcoming visit to China. Putin will pay a state visit to China and attend a summit of the Conference on Interaction and Confidence Building Measures… The visit bears great significance to the present and future development of the China-Russia relationship, said Chinese Foreign Minister Wang Yi. Hailing the full-scale preparatory work by both China and Russia, Wang called on continued efforts from both sides to guarantee a complete success of the visit, and to deepen strategic mutual trust, boost practical cooperation, strengthen coordination and cooperation within… and push for fresh developments of the China-Russia comprehensive relations of strategic cooperation and partnership. Russian Foreign Minister Sergei Lavrov said his country attaches great importance to Putin’s upcoming visit to China, and will join efforts with China to greatly promote achievement of positive results of the visit.”

May 14 – Bloomberg (Elena Mazneva): “OAO Gazprom, the largest natural-gas producer, seeks to boost exports to China rather than bringing partners from the Asian nation into Russian drilling projects. ‘We’re talking about gas supply with Chinese companies,’ Deputy Chief Executive Officer Vitaly Markelov said… Russian President Vladimir Putin is turning toward Asia as capital flows from the country surge and the U.S. and European Union restrict access to funds due to a conflict over Ukraine. China, Russia’s largest trading partner with $94.5 billion of business last year, was the only country in the United Nations Security Council not to censure Putin’s annexation of Crimea.”

May 13 – Reuters (Ho Binh Minh and Manuel Mogato): “Thousands of Vietnamese set fire to foreign factories and rampaged in industrial zones in the south of the country in an angry reaction to Chinese oil drilling in a part of the South China Sea claimed by Vietnam, officials said… The brunt of Tuesday's violence, one of the worst breakdowns in Sino-Vietnamese relations since the neighbors fought a brief border war in 1979, appears to have been borne by Taiwanese firms in the zones in Binh Duong and Dong Nai provinces that were mistaken for Chinese-owned companies… The row over the South China Sea and anti-China violence in tightly-controlled Vietnam have raised fears of an escalation in tensions between the Communist neighbors. ‘I fear a dark chapter in Sino-Vietnamese relations is now being written,’ said Ian Storey, a South China Sea expert at Singapore’s Institute of Southeast Asian Studies.”

May 13 – Sydney Morning Herald: ‘China has said US Secretary of State John Kerry did not refer to ‘provocative’ action by Beijing in the South China Sea while holding a telephone conversation with Chinese Foreign Minister Wang Yi. In fact, US Secretary of State Kerry made no such comments during the phone conversation,’ China Foreign Ministry spokesman Hua Chunying told the official Xinhua news agency… Mr Kerry’s message during the phone talks was that the United States does not take sides in the South China Sea dispute, and has no intention to make any judgment on the issue of territorial sovereignty, Xinhua said… ‘He (Kerry) said China’s introduction of an oil rig and numerous government vessels in waters disputed with Vietnam was provocative,’ US State Department spokeswoman Jen Psaki told reporters…”

May 11 - Financial Times (Michael Peel): “Thailand’s political crisis was moving closer to violent conflict on Sunday, after the opposition urged judges and senators to appoint a new premier and the embattled government called on people to stay away from anti-government demonstration sites to avoid confrontations. Thousands of pro-government ‘red shirts’, angered by last week’s court-ordered removal of Yingluck Shinawatra as prime minister, rallied on the outskirts of Bangkok and warned they would fight what they see as an intensifying elite-orchestrated campaign to sweep away democracy and appoint an unelected ruling council.”

May 16 – Reuters: “A senior U.S. official expressed concern… about a current lack of progress in negotiations between six world powers and Iran over Tehran's disputed nuclear program, speaking on the expected last day of a May 13-16 meeting. ‘Talks have been slow and difficult,’ the official said… ‘Significant gaps remain. Iran still has some hard decisions to make. We’re concerned that progress is not being made and that time is short."

China Bubble Watch:

May 13 – Bloomberg (Elena Mazneva): “China’s home sales fell 18% in April, amid tighter credit, adding to signs of a slowdown in the world’s second-largest economy. The value of homes sold declined to 418 billion yuan ($67bn) from 509 billion yuan in March… The value of sales from January to April fell 9.9% to 1.53 trillion yuan from a year earlier… China’s broadest measure of new credit fell last month as authorities extended their campaign to tame a debt boom. New- home sales in 54 cities during the May 1-3 Labor Day holiday dropped 47% from a year earlier to 236,000 square meters, a four-year low… Slowing property data ‘are testing the tolerance of the government on the economic slowdown,’ said Dai Fang, a Shanghai-based property analyst at Zheshang Securities Co.”

May 13 – Bloomberg (Elena Mazneva): “China’s broadest measure of new credit fell last month as authorities extended their campaign to tame financial dangers even as construction and manufacturing data point to risks that the economy’s slowdown will worsen. Aggregate financing was 1.55 trillion yuan ($249 billion) in April…, compared with 2.07 trillion yuan in March. New local-currency bank loans were 774.7 billion yuan, down from 1.05 trillion yuan the previous month. The figures add to signs that officials are reluctant to heed calls for monetary stimulus… ‘In the face of calls for stimulus, China’s government appears comfortable with a continued slowdown in credit growth,’ Mark Williams, chief Asia economist at Capital Economics… said… ‘The government’s composure so far is an encouraging sign that policy makers are still giving priority to bringing credit risks under control,’ said Williams, a former U.K. Treasury adviser on China… M2, the broadest gauge of money supply, rose 13.2% from a year earlier, after record-low growth of 12.1% in March.”

May 13 – Bloomberg (Elena Mazneva): “China’s economic slowdown deepened with unexpected decelerations in industrial-output and investment growth and a decline in home sales, testing policy makers’ reluctance to step up monetary stimulus. Factory production rose 8.7% in April from a year earlier…, compared with the 8.9% median estimate… Fixed-asset investment increased 17.3% in the first four months of the year, the slowest for the period since 2001, and home sales fell 9.9%.”

May 10 – MarketNews International: “A senior central bank official warned over the weekend of the need to clear up wealth management and interbank businesses which have pushed up financial costs for the real economy and fueled a ‘gambling mentality’ in Chinese lending. Liu Shiyu, vice governor of the People's Bank of China, made his sharp criticism of current practices in a forum at Tsinghua University over the weekend… ‘I think we should make the decision to clean up interbank business and various wealth management businesses, otherwise investors, including the public, would be very easily directed to seek short-term high yield, ignoring long-term return, which would generate huge spillover effect on the development of the capital market.’ He cited an example that the interest rate of a loan which reaches the real economy could be as high as 14% compared with the 8% return paid to the public from whom banks first raise the money via wealth management products. Liu said this kind of practice, which he described as ‘adding water layer by layer, raising prices at each link,’ directly raises costs for the real economy and makes no contribution to improving labor productivity. ‘And also, it would push a nation and the country's financial system into short-term behavior with an extreme gambling mentality.’”

May 16 – MarketNews International: “The People’s Bank of China, along with the country's bank, insurance, securities and foreign exchange regulators, issued a set of regulations Friday governing how institutions are to lend and borrow in the interbank market. The 18 regulations will ‘help guide more funds to flow into the real economy, lower corporate financing costs, and raise the ability of financial institutions to support the real economy,’ the PBOC said. The co-ordinated approach to regulation follows a move by the State Council at the end of last year to assume oversight of shadow banking regulation. The cabinet body moved to replace the earlier piecemeal, and largely unsuccessful, approach to managing the rapidly-growing part of the financial system.”

May 16 – Bloomberg: “The Chinese government ordered lenders to curb interbank borrowing in the latest effort to check growth in the informal shadow-banking industry that threatens to undermine the nation’s financial system. A commercial bank should limit its interbank borrowing to less than a third of its liabilities, while its lending to another financial firm shouldn’t exceed 50% of its Tier 1 capital… Borrowing between financial institutions on the interbank market more than tripled in the past five years as part of a web of underground finance that evolved to sidestep government lending restrictions. Estimated by JPMorgan… to be worth $7.5 trillion as of September, shadow banking has made it harder for the government to curtail debt and shield state banks from rising defaults as the economy cools. Interbank assets surged to 21.5 trillion yuan ($3.4 trillion) by the end of last year from 6.2 trillion yuan at the beginning of 2009…”

May 11 – Bloomberg: “A Chinese central banker today urged tougher rules to rein in shadow banking as its unchecked growth has helped drive up borrowing costs and threatens to undermine the financial system... Financial innovation in the interbank market and wealth management products has often been aimed at evading regulations on issues such as risk provisioning and capital adequacy, Liu Shi-yu, deputy governor of the People’s Bank of China, said… China’s authorities have stepped up efforts to curb the more lightly regulated shadow banking industry as they seek to rein in the country’s total debt that’s surged to more than double gross domestic product. Shadow financing, estimated at 46.7 trillion yuan ($7.5 trillion) by JPMorgan Chase & Co., has made it harder for the government to curtail credit and shield state-controlled banks from rising defaults as the economy cools. ‘If everyone in society is trying to get into the financing business, we may have entered a phase where a fever has started to affect our ability to think,’ Liu said…”

May 10 – MarketNews International: “China's Premier Li Ke-qiang said China does not seek a trade surplus and warned of the impact of massive forex reserves on domestic inflation. Li made the comments when responding to questions… Li said the trade imbalance will add pressure to China's macro controls. ‘The relatively big forex reserves have been a very big burden for us as they will become domestic base money, which will affect inflation.’”

May 11 - South China Morning Post: “Industry needs reform as it drives up lending cost and invites gambling, deputy governor says. The wealth-management industry should be reorganized because it is unduly raising funding costs and encouraging savers to behave like gamblers by chasing after lucrative short-term returns, a deputy governor of the People's Bank of China (PBOC) said… In an unusually sharp criticism of the rapidly growing wealth-management business, Liu Shiyu said the sector had pushed up funding costs for companies, making credit unpalatably expensive and distorting the mainland economy. ‘This type of practice, where water is added at every layer and prices are raised in an exploitative way at every link, directly increases costs in the real economy,’ Liu told a forum… ‘There is no contribution to labour productivity and it will lead a nation, it will lead a country's financial system, into a short-term behavior that is extreme in its gambling mentality.’ He said wealth managers were lending money to companies at rates of around 14%, but often offering rates of only around 8% to individuals investing in their funds. Fueled by savers' and companies' thirst for higher returns, the mainland's wealth-management sector has exploded in recent years. Liu warned non-financial companies were increasingly becoming involved in the wealth-management industry, lured by the attractive returns on offer.”

May 13 – Financial Times (Jamil Anderlini): “China’s economy slowed further in April as sales and investment in the country’s crucial real estate sector fell sharply. Analysts and even normally tight-lipped Communist party officials are now asking whether the country’s real estate bubble is deflating or bursting after nationwide sales in the first four months fell 7.8%... from the same period a year earlier… Trouble in Chinese property also has implications for the country’s financial system, in particular the shadow banking sector, which has lent huge amounts to developers and relies on highly-priced land for collateral… In an indication of just how exposed China’s economy is to a property downturn, Moody’s… estimates that the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product in 2013. ‘Self-fulfilling expectations of falling house prices, financial difficulties among developers on the back of a highly leveraged economy with huge local government debt, and a fragile financial system with a large shadow banking sector, suggest the risks of a disorderly adjustment [in the Chinese economy] are real and rising,’ said Jian Chang, Barclays’ chief China economist… Electricity production, a closely watched proxy for economic activity in China, grew at its slowest pace in nearly a year in April, up 4.4% from 12 months earlier, compared with 6.2% growth in March.”

May 15 – MarketNews International: “A global conversation about the possibility of a Chinese property market meltdown has been interrupted by a call to arms from the People’s Bank of China to the country's mortgage loan officers. It remains to be seen if the bank's intervention will shore up sentiment in an overstretched real estate sector… The PBOC told banks in a meeting this week they should ‘approve and grant mortgages to qualified individuals in a timely manner,’ according to a central bank statement…”

May 12 – Bloomberg (Elena Mazneva): “China’s government is drafting rules to help manage the fallout of any bank failure, two people with knowledge of the matter said, as lenders in the country face rising loan defaults and increased competition. The People’s Bank of China and the China Banking Regulatory Commission are working on a plan to ensure the safety of deposits and an orderly repayment of financial firms’ liabilities during a crisis, the people said… Under the rules, financial institutions deemed to have failed will be allowed to cease operations rather than be propped up.”

May 15 – Bloomberg (Elena Mazneva): “Chinese banks’ bad loans rose for the 10th straight quarter to the highest level in more than five years as the nation’s economic slowdown takes its toll on lenders’ asset quality. Nonperforming loans rose by 54 billion yuan ($8.7 billion) in the three months through March to 646.1 billion yuan, the highest level since September 2008… Bad loans accounted for 1.04% of total lending, up from 1% three months earlier. The increase in defaults adds to concern bank profitability may slip as they build buffers to cover loan losses, while policy makers crack down on financing to weaker borrowers. Sour debts are rising as China’s slowing economy makes it more difficult for borrowers to make repayments.”

Global Bubble Watch:

May 14 – Bloomberg (Kelly Bit, Saijel Kishan and Joshua Fineman): “David Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, said he’s nervous about markets as the U.S. economy isn’t growing fast enough amid complacency by the Federal Reserve. ‘We have this term called coordinated complacency to describe the world’s central banks right now,’ Tepper said… ‘The market is kind of dangerous in a way.’ Tepper… said he’s more worried about deflation than inflation and that this is the time to preserve money. The money manager, who is worth $7.9 billion… said that while investors can be optimistic on markets, they should hold some cash. ‘I think its nervous time’ he said…”

May 16 – Financial Times (Demetri Sevastopulo, Julie Zhu and Michael Peel): “Factories in Vietnam that make products for global retailers including Walmart and Nike on Thursday halted production for a second day as violent anti-China protests spread across the country. Local mobs have been ransacking factories near Ho Chi Minh City since Tuesday in protest over China drilling for oil in disputed waters in the South China Sea. Li & Fung, the world’s biggest sourcing company which supplies goods for retailers such as Target and Walmart, said factories in south Vietnam had halted operations as a precaution, causing possible shipment delays. Yue Yuen, the sports shoe manufacturer that supplies Nike and Adidas, also suspended production for a second day.

EM Bubble Watch:

May 13 – Bloomberg (Anna Edgerton and Arnaldo Galvao): “Elected officials, rather than the appointed central banker, should have the final say in determining monetary policy, Rui Falcao, the coordinator of President Dilma Rousseff’s re-election campaign, said… ‘The central bank has operational autonomy, and we think the economy -- and the monetary issue is part of the economy as a whole -- needs to be directed by those who are elected,’ he said… ‘I’m against the formal autonomy of the central bank.’ Rousseff’s government has struggled to keep inflation within two percentage points of the 4.5% target, while economic growth during her term has been the lowest in two decades.”

May 13 – Bloomberg (David Yong): “Asia’s junk bond returns are lagging behind investment-grade debt like never before as China’s weakest projected growth since 1990 and escalating leverage expose cracks across the region’s economies. Speculative-grade notes denominated in dollars have gained 2.76% this year through May 9, 1.95 percentage points less than high-grade bonds… The underperformance is the worst over the same period since at least 2005. Globally, returns were about even at 4.1%, Bloomberg indexes show.”

May 16 – Bloomberg (Matthew Malinowski): “Brazil’s economic activity contracted in March for the first time this year as above target inflation curbs demand.”

May 14 – Bloomberg (Blake Schmidt): “Brazil’s shopping malls are proving to be the latest bond-market casualties of the nation’s economic malaise. General Shopping, the owner of 18 malls, had its rating cut by Moody’s… on May 9 on concern a building boom in shopping centers will end up harming creditors as consumers stung by surging interest rates curtail spending.”

May 13 – Bloomberg (Kartik Goyal): “India’s retail inflation accelerated by the fastest pace in three months while factory output declined, adding pressure on the central bank to keep rates elevated after national elections finish. The consumer-price index rose 8.59% from a year earlier, compared with 8.31% in March… Industrial production shrank 0.5 percent in March, a separate report showed…”

Japan Watch:

May 16 – Wall Street Journal (Rob Copeland): “Jim Chanos has long had a target fixed on China. Now he’s moving his scope across the East China Sea to Japan.  The hedge-fund manager, famed for his bearish bets against companies like Enron, said at a conference Friday the biggest threat to the Asian economy was Japanese Prime Minister Shinzo Abe.  ‘The most dangerous figure in Asia is not in China; it’s in Japan. Abe, with our backing, is an ultranationalist,’ said Mr. Chanos… ‘He [will begin] to destabilize the area from a political and military point of view more than any Chinese leader.’”

India Watch:

May 16 –  Bloomberg (Andrew MacAskill and Unni Krishnan): “Narendra Modi declared a new era in India after his opposition bloc secured the biggest election win in 30 years, with voters tired of sluggish economic growth and corruption handing the Gandhi dynasty a historic defeat.  The Bharatiya Janata Party and its allies won or were leading in about 340 of 543 seats up for grabs, more than the 272 needed for a majority… ‘The era of divisive politics is over and it is time for unification,’ Modi, 63, told a rally yesterday in Gujarat, the western state he’s run since 2001. ‘I see the dawn of a new era for our country.’”

May 12 – Bloomberg (Kartik Goyal): “India’s consumer-price inflation quickened in April while factory output declined, adding pressure on the central bank to keep rates elevated as a new government takes power. The consumer-price index rose 8.59% from a year earlier, compared with 8.31% in March… Industrial production shrank 0.5% in March, a separate report showed…”

Europe Watch:

May 15 – Bloomberg (Stefan Riecher): “The euro-area recovery failed to gather momentum last quarter, as France unexpectedly stalled and economies from Italy to the Netherlands shrank. Growth of just 0.2% for the currency bloc, half as much as economists had forecast, adds pressure on the European Central Bank to deliver stimulus… While German expansion doubled to 0.8%, that wasn’t enough to offset renewed weakness across the region, including a 0.7% drop in Portugal.”

May 15 – Bloomberg (Lorenzo Totaro): “Italy’s economy unexpectedly contracted last quarter, signaling the country’s failure to sustain a pullout from its longest recession on record. Gross domestic product in the three months through March decreased 0.1% from the fourth quarter… From a year earlier, output shrank 0.5%. ‘Italy GDP surprised on the downside,’ said Annalisa Piazza, a fixed-income strategist at Newedge Group… ‘Italian activity continues to contract and the already ample output gap keeps widening.’ An unexpected decline in Italy’s industrial production in March prompted concerns about the recovery’s sustainability in the months ahead. Earlier today in Paris, national statistics office INSEE said French GDP was unchanged in the three months through March…”

May 11 – Bloomberg (Brian Parkin and Rainer Buergin): “The French government’s efforts to persuade the European Central Bank to bring down the euro exchange rate are riling lawmakers in Germany, according to two lower-house members from Chancellor Angela Merkel’s party. France is using complaints about the currency as a distraction as it stalls on measures to free up its economy, said the lawmaker… German lawmakers, for whom central bank independence is sacrosanct, are also upset at France’s attempts to interfere in policy making, they said.”