Sunday, December 14, 2014

Weekly Commentary, May 30, 2014: He's Back

May 30 – MarketNews International (Brai Odion-Esene): “Former Bank of England official Adam Posen believes there is undue worry about how the Fed will tighten monetary policy and withdraw stimulus when the time comes, saying the limited powers the Fed now has to deal with credit issues should be of greater concern. ‘If you are talking about uncharted waters, I’d be much more emphasizing the financial stability aspect and the institutional issues for the Fed,’ Posen, now president of the Peterson Institute for International Economics, said… Speaking on the sidelines of a Cleveland Fed conference on monetary policy and inflation, Posen - a former member of the BOE's Monetary Policy Committee - said all the concerns about winding down the Fed's large scale asset purchase program and potential inflation is ‘unnecessary hand-wringing.’ He said he is much more concerned about the ‘institutional limitations’ on the Fed. ‘I'm not worried that there is an imminent financial stability problem for the U.S.,’ Posen added. ‘Once you’ve had a bubble, you are less likely to have one soon afterward.’”

May 29 – CNBC: “Investors should not fear any of the kind of catastrophic ‘Minsky moments’ that fed the recent financial crisis, despite the reappearance of easy credit in the home mortgage markets, [Paul] McCulley said. McCulley is credited with inventing term ‘Minsky moment’ to describe a sudden crash in asset values, usually following a period of extreme speculation using borrowed money… ‘We don't have to be worried about the Big One. We had the Big One, and you don't have another Big One after you have had the Minsky moment,’ he said.”

Paul McCulley, May 29, 2014, appearing on CNBC: “I don’t think the world is upside down. I think the world is pricing in and coming to grips with the fact that post the ‘Minsky Moment’ – which was 2008 – and post five years’ worth of healing in the economy and in the financial markets and in the banking system – that we’re on the cusp of emerging from a liquidity trap. And that the Fed and other central banks around the world are going to be exceedingly low on short-term interest rates. This is a brand new regime. We are calling it here (Pimco) the ‘New Neutral’ and I love the phrase; I’ve been writing about it for ten years. And ultimately we had to get to this point where the marketplace broadly defined – all asset classes are accepting that risk-free cash trades at par – you get it back tomorrow – should not provide a real rate of return. Its preservation of capital - period. If you want to have a real rate of return you have to be in assets. So we’re having a once-in-a-lifetime revaluation of assets. I think it’s kind of cool.”

Bubbles and financial manias are just incredibly fascinating. Unfortunately, they’re also exceedingly dangerous; something that somehow goes unlearned. Having studied past manias, for me it's invariably a case of “how could they have fallen for that.” In hindsight, bouts of financial euphoria always look ridiculous. Having now worked through twenty-five years of serial booms and busts, I have come to appreciate how the “analysis” always follows the direction of the markets. And the crazier the (late-cycle) market excesses the more creative the bullish propaganda. Of late, it’s turned fervently “creative.”

In the nineties there was all the “New Era” and “New Paradigm” hype. There was the so-called “productivity miracle”. Our nation was going to pay down the entire deficit and run surpluses. Our financial system was incredibly effective at allocating our limited amount of savings. The collapse of the Soviet Union and fall of the Berlin wall were to usher in a golden age of Capitalism and global prosperity. Meanwhile, a historic financial Bubble was unleashed that continues to this day. Along the way, there were various serious financial Bubbles and collapses, including Mexico, SE Asia, Russia, LTCM, Argentina and the U.S. “tech” Bubble. Not much talk these days about the heyday of global Capitalism and prosperity – at least outside the securities markets.

The post-tech Bubble reflation inspired additional creative bullish propaganda including “the global savings glut,” “Bretton Woods II,” and “the great moderation.” These notions were largely obliterated by the collapse of the mortgage finance Bubble.

It is a truism that manias spawn sophisticated justification and rationalization. Analysis and theories will inevitably flourish in support of inflating Bubbles. It’s also true that bullish analyses and theories will garner powerful followings. Inflating asset prices will “prove” the genius of the bullish proponents, while the naysayers will be crushed and discredited. This, however, doesn’t change the reality that Bubbles do leave a trail of evidence for those willing to stick diligently with the analysis.

Bubbles are invariably fueled by Credit excess. There will be prevailing market misperceptions, along with resulting mis-priced Credit and asset markets. Major Bubbles invariably are nurtured by government and central bank market interventions/manipulations. As always, Credit excess begets Credit excess – and asset price inflation begets speculation and greater asset price inflation. So long as Credit flows freely – and misperceptions persist – it all will look viable or better.

The views espoused above from (inflationists) Adam Posen and Paul McCulley epitomize today’s bullish thinking. From Posen: “I'm not worried that there is an imminent financial stability problem for the U.S. Once you’ve had a bubble, you are less likely to have one soon afterward.” And from McCulley: “We don't have to be worried about the Big One. We had the Big One, and you don’t have another Big One after you have had the Minsky moment.” “So we’re having a once-in-a-lifetime revaluation of assets. I think it’s kind of cool.”

I generally don’t pull content from previous CBBs. But since He’s Back, I couldn't resist. As background, for years I referred to Paul McCulley as a leading “inflationist” as well as my “analytical nemesis.”

CBB 12/2/2005: “Bill and Paul’s Wild Analytical Adventure.” “Mr. McCulley is an especially clever Fed watcher/proponent. Now plainly in the Bernanke camp, he blends insightful analysis with really creative rationalization for today’s flawed American experiment in central banking… Mr. McCulley remains firmly entrenched in his hypothesis that the Fed has attained the promised land of price stability, and it is this postulate that provides the foundation for his analytical framework. He goes so far as to link the achievement of price stability to the collapse of risk premiums and the propensity for Bubbles. I take very strong exception to this analysis, and there really can be no reconciliation between his “price stability” view and my assertion of the polar opposite, Monetary Disorder – none. It is the foundation of my analysis that the “evolution” to an unrestrained capital markets and asset-based Credit system has, not unpredictably, nurtured a highly unstable monetary environment.”

It’s interesting. I argued against the inflationists (including McCulley) throughout the post-tech Bubble reflation. Having chronicled the mortgage finance Bubble on a weekly basis from 2002 through its 2008 collapse, there was a time when I actually thought my analytical framework had decisively won the debate. But like the irrepressible Credit Bubble, the inflationists have come Back more emboldened than ever. I also believe their frameworks are more flawed and dangerous than ever.

It’s actually rather fitting. In a now heated déjà vu all over again Bubble backdrop, some of the old inflationists propaganda is recycled anew. One of these opposing analytical frameworks is going to be right and the other completely wrong: Central banks have either won the battle against inflation or they’re losing the war against speculative finance and Bubbles. We can either relax with the view that we’ve already had the “Big one” - or we ought to be damned worried that we’re in the midst of history’s biggest Bubble.

All the bullish propaganda during the nineties didn’t change that the GSEs and “Wall Street finance” were distorting Credit and the markets – while fueling major Bubbles. GSE holdings expanded $151bn, or 24%, in tumultuous market year 1994. GSE and Fed liquidity and liquidity backstops ensured flourishing speculation and market Bubbles. The 1998 crisis saw GSE assets increase an unprecedented $305bn, or 27.7%. The GSEs were back for another $317bn in 1999. In all, GSE assets expanded $1.092 TN, or 173%, in the six years ended 1999. New Paradigm, indeed.

It is worth noting that total GSE securities (debt and MBS) expanded $431bn in 2000, $642bn in 2001, and $547bn in 2002. While conventional opinion was fixated on deflation risk, I began warning of the unfolding mortgage finance Bubble back in 2002. In the nine-year period 1994 through 2002, total GSE securities increased $3.63 TN, or 190%.

Why are GSE data from a decade ago relevant to today’s “global government finance Bubble”? The GSEs were integral to a historic distortion in the expansion and pricing of U.S. Credit. The 2008 crisis wasn’t at its core about Lehman or even structured finance. The GSEs were instrumental in fueling a Bubble that would inevitably collapse. There was an enormous amount of problematic debt that only appeared sound so long as Credit was mispriced and issued in enormous quantities (ensuring inflating home and asset prices). Integral to this Bubble was the market assumption of an implicit Federal backing of GSE debt and obligations. This could have been clarified, but Congress, the Fed and several administrations simply looked the other way. Without the implicit federal guarantee, the GSEs would not have been able to operate as the Bubble-fueling liquidity backstop, especially during crisis periods.

My thesis is that the overwhelming reaction to the collapse of the mortgage Bubble – from the Fed, U.S. Treasury, global central banks and governments – unleashed even greater and far-reaching financial and economic Bubbles. 2008 was not the “big one.” Rather, it was the crisis response that was the biggest ever, setting the stage, I fear, for the really problematic crisis. And if our policymakers had learned anything from the terrible mortgage boom and bust experience, they’d be especially careful with these implicit market backstops (and the distortions they promote).

Indeed, the danger of “open-ended” QE goes way beyond the $1.5 TN of market-distorting Fed liquidity. The marketplace took QE3 (and concerted global monetary stimulus) as a signal that the Fed and global bankers were willing to provide boundless market backstops. It is this implicit guarantee of unlimited central bank liquidity – and not “stable prices” – that has led to a dramatic revaluation of asset prices. QE3 was an absolute Bubble game-changer – one a responsible central bank would today be eager to rectify by adopting specific rules to limit future Federal Reserve balance sheet growth.

The “Granddaddy of All Bubbles” thesis rests on the premise of a deeply systemic Bubble throughout debt and equities markets and asset prices more generally, on a globalized basis. In contrast to GSE market distortions that impacted pricing most significantly in mortgage Credit, today’s global central bank distortions impact virtually all asset prices. Market risk distortions now basically permeate all markets – stocks, bonds, Credit and any asset that provides income/yield virtually anywhere in the world. Assets include collectible art, Manhattan apartments, farm property and NBA franchises.

Importantly, it is the character of policy-induced market distortions and speculative excess that dictate the risk of future crises. It’s nothing more than wishful thinking to claim the protracted cycle of booms and busts miraculously ended in 2008/09. Typically, one would not expect another Bubble to begin inflating immediately after a major bursting. But 2008-2014 policy measures have been the most extreme and atypical.

The 1994 GSE backstop and Mexican bailout altered risk perceptions and helped spur destabilizing excess at home and abroad. The 1998 LTCM bailout and Fed reliquefication stoked only more virulent speculative excess. The aggressive post-tech Bubble reflation and Dr. Bernanke’s talk of “helicopter money” and the government printing press unleashed a much larger and dangerous Bubble throughout mortgage Credit. As such, the critical question that should be asked today is whether the unprecedented global response to the 2008 crisis set loose only more pernicious global market distortions, Bubbles and economic maladjustment? Despite all the bullish propaganda, the answer is an emphatic “absolutely.”

As I’ve attempted to explain in the past: 2008 was essentially a private debt crisis. It was resolved through massive deficit spending, central bank Credit, zero interest rates and an assortment of government guarantees and assurances. “Too big to fail” evolved to encompass securities markets around the globe.

Following the Credit Bubble data trail, Treasury debt issuance jumped to $1.239 TN in 2008, $1.444 TN in 2009, $1.579 TN in 2011, $1.067 TN in 20012, and $1.141 TN in 2013. After doubling mortgage Credit in just over six years, outstanding Treasuries jumped 140% ($7.2TN) in six years. Looking at Federal Reserve Credit, the Fed’s balance sheet increased $1.319 TN in 2008, was about unchanged in 2009, increased $186bn in 2010, rose $494 TN in 2011, increased $8.0bn in 2012 and then jumped $1.119 TN in 2013. By the time QE3 runs it course, the Fed’s balance sheet will have grown 400% (about $3.6 TN) in six years.

The “global government finance Bubble” thesis rests on the premise that an unprecedented simultaneous expansion of government debt and central bank Credit has basically distorted risk perceptions, market pricing and resource allocation everywhere. The appearance of "stability" is a huge deception.

Euphoric global markets have certainly been enjoying immunity to negative developments. Global bond markets have been in melt-up, perhaps bolstered by heightened disinflationary pressures and geopolitical risks. After all, in the face of ongoing zero rates, incredible central bank monetization and market inflation – recent data around the world indicates economic vulnerability. Expectations for imminent additional monetary stimulus have pushed European market Bubbles to dangerous extremes. Highly speculative global equities markets have been bolstered by the notion of abundant cheap liquidity as far as the eye can see. General market enthusiasm (and short covering) has stoked a significant rally throughout the emerging markets.

As I often quip, “Bubbles go to unimaginable extremes – then double!” These days I have to remind myself that markets are in the midst of the greatest Bubble in history. And we today see what I believe is a dangerous synchronization of global risk markets. Most markets demonstrate similar dynamics – it’s basically become one big global “risk on” trade. And as fundamental prospects darken, some players begin to position for a transition to more of a “risk off” backdrop. This shorting and buying of derivative hedges then provide the fodder for another round of squeeze-induced market rally. And in an environment with unprecedented scope for performance-chasing and trend-following trading, these rallies have a tendency to take on a (speculative) life of their own. Bubbles just turn more unwieldy.  

The consensus view holds that market risk is currently extremely low. I would counter that the VIX index (at multi-year lows) is low – not risk. These days the VIX (measure of equity market volatility) is a better barometer of market complacency. Below the surface – where folks work diligently to pick the right stocks and sectors – the marketplace is really tough. As a Goldman official stated this week, markets are “abnormal.” And I would suggest that this abnormality just keeps forcing more players into (“closet indexing”) the S&P 500 index – in the process fueling the “market” melt-up. It all seems rather late-cycle dysfunction to me.

With market Bubbles inflating all over, analysis will focus on relative performance and stability. Which Bubble will falter first? Where are excesses the most egregious? Where are securities prices most disconnected from fundamental prospects/reality? Well, bullish propaganda proliferates these days. But the bullish view of the “brics” in the face of fragile underpinnings strikes me as particularly susceptible. Brazil, Russia, India, China and South Africa (and throw in Turkey) all suffer from faltering economies in the face of ongoing rapid Credit growth. It’s worth noting that the South African rand dropped 2.6% this week. Russia’s ruble fell 2.1%, the Indian rupee 1.0% and the Brazilian real 0.8%. The Thai baht declined 0.9% and the Turkish lira lost 0.7%.

For the Week:

The S&P500 gained 1.2% (up 4.1% y-t-d), and the Dow added 0.7% (up 0.9%). The Utilities jumped 2.3% (up 10.7%). The Banks rose 1.2% (down 0.5%), while the Broker/Dealers were unchanged (down 4.7%). The Morgan Stanley Cyclicals were up 1.1% (up 4.8%), and the Transports gained 1.5% (up 9.5%). The S&P 400 Midcaps increased 0.6% (up 2.6%), and the small cap Russell 2000 gained 0.7% (down 2.5%). The Nasdaq100 advanced 1.6% (up 4.3%), and the Morgan Stanley High Tech index rose 1.2% (up 3.7%). The Semiconductors jumped 1.6% (up 12.1%). The Biotechs rose 1.5% (up 11.0%). With bullion down $43, the HUI gold index sank 4.6% (up 4.3%).

One-month Treasury bill rates ended the week at four bps and three-month rates closed at three bps. Two-year government yields increased three bps to 0.375% (down one bp y-t-d). Five-year T-note yields rose two bps to 1.54% (down 20bps). Ten-year Treasury yields dropped six bps to 2.48% (down 55bps). Long bond yields fell seven bps to 3.33% (down 64bps). Benchmark Fannie MBS yields were down five bps to 3.16% (down 45bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 68 bps. The implied yield on December 2015 eurodollar futures slipped a basis point to 0.875%. The two-year dollar swap spread declined two to 14 bps, while the 10-year swap spread increased two to 11 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined one to 62 bps. An index of junk bond risk fell eight to 313 bps. An index of emerging market (EM) debt risk dropped six to 273 bps.

Debt issuance slowed somewhat. Investment-grade issuers included Wells Fargo $4.5bn, Walt Disney $2.0bn, Audatex North America $1.5bn, Enbridge $1.5bn, 3M $1.0bn, Fidelity National $1.0bn, Marsh & McLennan $1.0bn, Public Service Electric $500 million, ITC Holdings $400 million, Goldman Sachs $400 million, Apollo Management $500 million and Citigroup $225 million.

Junk funds saw inflows of $600 million (from Lipper). Junk issuers included Cedar Fair LP $450 million and Interface Master Holdings $115 million.

Convertible debt issuers this week included Spectranetics $200 million, Renewable Energy Group I $125 million, and New Mountain Finance $100 million.

International dollar debt issuers included Banco Inbursa $1.0bn, ICICI Bank $1.0bn, Bank of Nova Scotia $1.0bn, Bharti Airtel International $1.0bn, Turkiye Halk Bankasi $500 million, Baytex Energy $400 million, Precision Drilling $400 million, Transalta $400 million, Barclays $200 million and Financiera Independencia $200 million.

Ten-year Portuguese yields sank 14 bps to 3.62% (down 251bps y-t-d). Italian 10-yr yields fell 19 bps to 2.96% (down 116bps). Spain's 10-year yields dropped 13 bps to 2.85% (down 130bps). German bund yields declined five bps to 1.36% (down 57bps). French yields fell five bps to 1.77% (down 79bps). The French to German 10-year bond spread was little changed at 41 bps. Greek 10-year yields sank 23 bps to 6.27% (down 215bps). U.K. 10-year gilt yields fell six bps to 2.57% (down 45bps).

Japan's Nikkei equities index gained 1.2% (down 10.2% y-t-d). Japanese 10-year "JGB" yields declined a basis point to 0.58% (down 16bps). The German DAX equities index jumped 1.8% (up 4.1%). Spain's IBEX 35 equities index was up 2.3% (up 8.9%). Italy's FTSE MIB index surged 4.3% (up 14%). Emerging equities were mostly lower. Brazil's Bovespa index sank 2.6% (down 0.5%). Mexico's Bolsa fell 1.3% (down 3.2%). South Korea's Kospi index lost 1.1% (down 0.8%). India’s Sensex equities index dropped 1.9% (up 14.4%). China’s Shanghai Exchange increased 0.2% (down 3.6%). Turkey's Borsa Istanbul National 100 index gained 1.6% (up 16.9%). Russia's MICEX equities index fell 1.2% (down 4.8%).

Freddie Mac 30-year fixed mortgage rates declined two bps to a six-month low 4.12% (up 31bps y-o-y). Fifteen-year fixed rates fell four bps to 3.21% (up 23bps). One-year ARM rates were down two bps to 2.41% (down 13bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.51% (up 31bps).

Federal Reserve Credit last week rose $7.7bn to a record $4.285 TN. During the past year, Fed Credit expanded $932bn, or 27.8%. Fed Credit inflated $1.474 TN, or 52%, over the past 81 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt increased $6.7bn to $3.279 TN. "Custody holdings" were down $75bn year-to-date, with a one-year decline of $36bn, or 1.1%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $778bn y-o-y, or 7.0%, to $11.923 TN. Over two years, reserves were $1.450 TN higher for 14% growth.

M2 (narrow) "money" supply increased $5.0bn to a record $11.275 TN. "Narrow money" expanded $733bn, or 7.0%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits fell $13.3bn, while Savings Deposits jumped $18.3bn. Small Time Deposits added $1.4bn. Retail Money Funds slipped $3.7bn.

Money market fund assets increased $3.3bn to $2.587 TN. Money Fund assets were down $132bn y-t-d and dropped $26.2bn from a year ago, or 1.0%.

Total Commercial Paper fell $8.9bn to $1.028 TN. CP was down $18bn year-to-date, and was down $20bn over the past year, or 1.9%.

Currency Watch:

May 28 – Bloomberg (Fion Li): “China’s yuan dropped by the most since March as the central bank set the currency’s daily fixing near the weakest level since September amid concern growth in the world’s second-largest economy is slowing… The economy is in a rare, complicated situation, central bank Governor Zhou Xiaochuan said during a visit to a PBOC branch in Jiaxing city… ‘It’s clear China is helping exports by weakening the currency, and there’s also more dollar buying onshore by oil companies as it’s the end of the month,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. ‘The word ‘rare’ by Zhou highlights the unusual challenges that China is facing. It wants to deleverage, but at the same time, it needs the leverage to support growth.’”

The U.S. dollar index was unchanged at 80.37 (up 0.4% y-t-d). For the week on the upside, the Australian dollar increased 0.9%, the South Korean won 0.5%, the Taiwanese dollar 0.4%, the Japanese yen 0.2%, the Canadian dollar 0.1%, and the Swiss franc 0.1%. For the week on the downside, the South African rand declined 2.6%, the Brazilian real 0.8%, the Swedish krona 0.7%, the New Zealand dollar 0.6%, the British pound 0.5%, the Norwegian krone 0.2% and the Singapore dollar 0.1%.

Commodities Watch:

May 29 – Financial Times (Emiko Terazono): “Continuing dry weather in the key wheat-growing regions of Russia and Kazakhstan is putting commodities traders on high alert about possible production declines. Thomson Reuters Lanworth, an agricultural forecaster, has warned of drought conditions across the countries’ wheat belts, with soil moisture reserves falling to near or below record lows. ‘We are approaching low soil moisture levels that we saw in 2012 and 2010,’ said Corey Cherr, head of the forecasting group’s agriculture and weather research… The Black Sea region, covering Russia, Kazakhstan and Ukraine, supplies northern Africa and the Middle East. Crop failures in the region in the past have had a significant impact internationally.

The CRB index fell 0.9% this week (up 9.0% y-t-d). The Goldman Sachs Commodities Index declined 1.3% (up 2.7%). Spot Gold was down 3.3% to $1,250 (up 3.7%). July Silver fell 3.8% to $18.68 (down 3.6%). July Crude declined $1.64 to $102.71 (up 4%). July Gasoline dropped 1.2% (up 7%), while July Natural Gas jumped 3.1% (up 7.4%). July Copper fell 1.4% (down 8%). July Wheat sank 3.9% (up 4%). July Corn dropped 2.6% (up 10%).

U.S. Fixed Income Bubble Watch:

May 30 – Bloomberg (Liz Capo McCormick): “Betting on higher U.S. Treasury yields has proven to be painful for bond traders. The… hedge funds and other large speculators reduced net short positions by about half on the benchmark 10-year note since the end of last year, according to Commodity Futures Trading Commission data. Traders bailed out of bets that note prices would fall as yields tumbled even as the Federal Reserve was scaling back its bond-buying program… ‘Trying to understand the evolution of macro themes as expressed across and within asset markets has been a challenge,’ Goldman Sachs Group Inc. economists… wrote… ‘The incremental relaxation in yields, taking U.S. 10-year yields down well below 2.5%, is similarly hard to square with some of the recent data prints.’”

May 28 – Bloomberg (Christine Idzelis and Kristen Haunss): “Lenders are increasingly allowing junk-rated borrowers to adjust their earnings to make them look more creditworthy as U.S. regulators increase pressure on banks to refrain from underwriting too-risky deals. Such tweaks, which are permissible under more and more credit agreements, can help companies stay in compliance with their loan terms or to raise debt. More than half of loans this year for issuers backed by private-equity firms allow them to boost earnings by an unlimited amount through projected cost savings from acquisitions and ‘any other action contemplated by the borrower,’ said Vince Pisano, an analyst at Xtract Research LLC…”

May 27 – Bloomberg (Lisa Abramowicz): “Forget complicated total-return swaps and collateralized loan obligations. A proposed exchange-traded fund will make it much easier for anyone to use borrowed money to double down on junk-rated loans. The AdvisorShares Pacific Asset Enhanced Floating Rate ETF will use derivatives to boost gains on high-yield loans, allowing retirees and pensioners to magnify bets on debt that promises higher yields when interest rates rise, according to a U.S. regulatory filing.”

Federal Reserve Watch:

May 30 – Wall Street Journal (Pedro Nicolaci da Costa): “The Federal Reserve should begin raising interest rates soon after it winds down its bond-buying program in order to rein in budding risks in the financial system, Kansas City Fed President Esther George said… Ms. George’s proposal runs counter to the Fed’s prevailing message…”

May 29 – Bloomberg (Aki Ito): “Federal Reserve Bank of Kansas City President Esther George, referring to the Federal Open Market Committee, says ‘it will likely be appropriate to raise the federal funds rate at a somewhat faster pace than the median of committee members’ projections.’ ‘Low rates into late 2016 will likely continue to provide incentives for financial markets and investors to reach for yield,’ George says… Banks are responding to record-low interest rates by ‘engaging in riskier activities,’ George says, citing record volume in leveraged loans last year. ‘I would like to see short-term interest rates move higher in response to improving economic conditions shortly after completion of the ‘taper’ in monthly bond purchases… Policy makers must ‘maintain a careful eye on the financial system and how interest rate policy affects incentives for financial markets and institutions.’”

U.S. Bubble Watch:

May 28 – Bloomberg (Mary Childs): “BlackRock Inc.’s Laurence D. Fink, who oversees the world’s biggest exchange-traded fund lineup, said leveraged ETFs are a structural problem and have the potential to ‘blow up’ the industry. ‘BlackRock would never do a leveraged ETF,’ Fink said… Fink said he doesn’t understand why the U.S. Securities and Exchange Commission allows them to operate. ETFs, which have turned into one of the most popular investing vehicles over the past decade, have become increasingly complex as firms try to appeal to a more diverse base of investors. While the majority of ETFs mimic indexes, leveraged versions use swaps or derivatives to try to amplify daily index returns.”

May 27 – Bloomberg (Asjylyn Loder): “The U.S. shale patch is facing a shakeout as drillers struggle to keep pace with the relentless spending needed to get oil and gas out of the ground. Shale debt has almost doubled over the last four years while revenue has gained just 5.6%, according to a Bloomberg News analysis… A dozen of those wildcatters are spending at least 10% of their sales on interest compared with Exxon Mobil Corp.’s 0.1%. ‘The list of companies that are financially stressed is considerable,’ said Benjamin Dell, managing partner of Kimmeridge Energy, a… alternative asset manager focused on energy. ‘Not everyone is going to survive. We’ve seen it before.’”

May 30 – Wall Street Journal (Joe Light and AnnaMaria Andriotis): “A rebound in house prices and near-record-low interest rates are prompting homeowners to borrow against their properties, marking the return of a practice that was all the rage before the financial crisis. Home-equity lines of credit, or Helocs, and home-equity loans jumped 8% in the first quarter from a year earlier… The $13 billion extended was the most for the start of a year since 2009… While that is still far below the peak of $113 billion during the third quarter of 2006, this year's gains are the latest evidence that the tight credit conditions that have defined mortgage lending in recent years are starting to loosen. Some lenders are even reviving old loan products that haven't been seen in years in an attempt to gain market share.”

May 30 – Bloomberg (Scott Soshnick, Mason Levinson and David Welch): “Former Microsoft Corp. Chief Executive Officer Steve Ballmer bought the Los Angeles Clippers for a record $2 billion… Ballmer, 58, outbid at least four other suitors. Each of the bids shattered the previous record sale price for an NBA team of $550 million paid in April for the Milwaukee Bucks. ‘Ballmer made a tremendous, tremendous buy, he got a bargain,’ former Sacramento Kings owner Joe Maloof said… ‘There’s nothing like sports franchises in the big cities. Steve did the right thing, even if he overpaid in the short term. Long term, it’s a smart play.’”

Central Bank Watch:

May 26 – Bloomberg (Jeff Black and Alessandro Speciale): “European Central Bank President Mario Draghi signaled policy makers are ready to take action in June should they see low inflation becoming entrenched. ‘What we need to be particularly watchful for at the moment is, in my view, the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit, in particular in stressed countries,’ Draghi said… ‘The key issue today, however, is timing.’”

May 27 – Bloomberg (Jeff Black and Alessandro Speciale): “Mario Draghi’s plans for credit easing may not turn out to be all that easy. In seeking to unblock the supply of loans to the economy by reviving the European market for asset-backed securities, the European Central Bank president risks an unprecedented reach into the functioning of the financial system that could backfire, according to academics including former Bank of England Deputy Governor Paul Tucker. Just over a week before the ECB’s next policy meeting, where it is predicted to cut interest rates to stoke inflation, central-bank officials and researchers are meeting in Sintra, Portugal, to discuss current monetary thinking. Draghi, who has shown support for measures from negative rates to liquidity injections and large-scale asset purchases, said yesterday that buying packaged loans could reduce the ‘drag’ on the economy.”

May 27 – Bloomberg (Rainer Buergin): “German Finance Minister Wolfgang Schaeuble says euro-area governments mustn’t ‘hide behind monetary policy,’ reliance on which risks weakening the resolve of policy makers to pursue economic reforms. Schaeuble rejects notion that euro is too strong as nobody knows ‘what the correct exchange rate should be,’ in remarks at an event in Berlin. Schaeuble says would be ‘disastrous to think’ that Europe is out of the woods. Schaeuble says reforms in some important countries insufficient…”

May 27 – Bloomberg (John Fraher and Jeff Black): “Paul Krugman thinks Mario Draghi’s biggest thinkers have got it all wrong. Speaking to a gathering of the European Central Bank's top researchers and policy makers, the Nobel Laureate said the ECB and other banks around the world need to raise the inflation targets they have clung to since the 1990s. At 2%, those goals are too low and increase the risk that central banks will run out of room to cut interest rates -- the so-called zero lower bound. ‘The intense resistance of central bankers to regime change even after more than five years at the zero lower bound shows that the kind of policy stasis that afflicted Japan for almost two decades is a more or less universal phenomenon,’ Krugman said in a paper delivered to Draghi and other officials in Sintra, Portugal.”

Ukraine & Russia Watch:

May 30 – Bloomberg (Elena Mazneva, Brian Parkin and Ewa Krukowska): “Russia and Ukraine moved closer to a deal that may avoid disrupting gas supplies as the government in Kiev made the first payment in months… While there was no breakthrough, progress was made, giving hope that an agreement can be reached early next week, EU Energy Commissioner Guenther Oettinger said… Ukraine’s state energy company transfered $786 million to pay for gas deliveries in February and March… Gazprom has threatened to cut Ukraine’s gas deliveries as its debt mounts. Ukraine depends on Russia for half of its gas and carries about 15% of Europe’s annual demand through its Soviet-era pipelines, making energy a battleground in the wider political struggle.”

Geopolitical Watch:

May 25 – Financial Times (Jamil Anderlini): “China has ordered state-owned enterprises to cut ties with US consulting companies such as McKinsey and Boston Consulting Group because of fears they are providing secret commercial information to the US government, according to people close to senior Chinese leaders. The instruction comes days after the US Justice Department indicted five People’s Liberation Army officers on charges of cyber-espionage and stealing trade secrets from US corporations… Beijing’s public response to the indictments was swift and vicious, with a co-ordinated propaganda campaign in Chinese state media describing the US as a ‘mincing rascal’ and a ‘high-level hooligan’. China’s leaders added concrete action to their rhetoric by announcing… a new security screening process for all foreign IT products and services sold in China.”

May 27 – Bloomberg: “The Chinese government is pushing domestic banks to remove high-end servers made by International Business Machines Corp. and replace them with a local brand, according to people familiar with the matter, in an escalation of the dispute with the U.S. over spying claims. Government agencies, including the People’s Bank of China and the Ministry of Finance, are reviewing whether Chinese commercial banks’ reliance on IBM servers compromises the country’s financial security, said the four people, who asked not to be identified because the review hasn’t been made public.”

May 26 – Reuters: “China described Vietnam’s claim to disputed South China Sea islands as ‘ridiculous’ on Monday, as tension rises over competing claims of sovereignty in waters believed to be rich in oil and natural gas. China claims almost the entire South China Sea, rejecting rival claims to parts of it from Vietnam, the Philippines, Taiwan, Malaysia and Brunei in one of Asia’s most intractable disputes and a possible flashpoint. It also has a separate maritime dispute with Japan over islands in the East Sea… Vietnam's Foreign Ministry held a press conference on Friday when officials stressed the country's historical claim to the Paracels. ‘Historical and legal evidence shows that Vietnam has absolute sovereignty in the Paracel and Spratly archipelagos,’ said Tran Duy Hai, deputy head of Vietnam’s National Border Committee. Chinese Foreign Ministry spokesman Qin Gang disagreed. ‘Seeing that the Vietnamese Foreign Ministry held a press conference last Friday on the subject, I felt it was extremely ridiculous,’ he said… ‘The Paracels are the indisputable territory of the Chinese people.’ Qin said the Paracels had been part of Chinese territory since the Han dynasty, and that Chinese explorers had first discovered the islands.”

May 27 – Bloomberg: “Vietnam and China traded barbs over the sinking of a Vietnamese fishing boat, their most serious bilateral standoff since 2007 as China asserts its claims in the disputed South China Sea. ‘It was rammed by a Chinese boat,’ Vietnamese Foreign Ministry spokesman Le Hai Binh said by phone of the Vietnamese vessel, with the crew of 10 rescued after the scrap. The incident occurred after some 40 Chinese fishing vessels encircled a group of Vietnamese boats in Vietnam’s exclusive economic zone, the government in Hanoi said… China said the Vietnamese vessel capsized after it rammed a Chinese fishing boat, having intruded into a ‘precautionary area’ around an oil rig that China has located near islands claimed by both Vietnam and China. ‘We once again urge the Vietnamese side to stop immediately all kinds of disruptive and damaging activities and avoid in particular dangerous actions on the sea,’ Chinese Foreign Ministry spokesman Qin Gang told reporters…”

May 29 – Bloomberg (Berni Moestafa and Sharon Chen): “China’s intensifying move to assert claims over the South China Sea has given fresh impetus to a military buildup in Indonesia that will see its forces deployed with greater focus on external risks. After years of concentrating on separatist threats across an archipelago long enough to stretch from New York to Alaska, Indonesia plans to deploy attack helicopters to its islands at the southern end of the South China Sea and expand its naval power… The strategy shift comes as China escalates disputes with the Philippines and Vietnam, fellow members of the Association of Southeast Asean Nations. China’s standoff with Vietnam over an oil rig this month followed its 2012 success in taking control of the Scarborough Shoal from the Philippines.”

May 30 – Bloomberg (Ting Shi and Sharon Chen): “President Barack Obama’s emphasis this week on restricting the use of the military abroad risks an unintended consequence: deepening concern about fading U.S. engagement among Asian nations locked in disputes with China. Obama’s defense chief, Chuck Hagel, leads the U.S. delegation to an annual security conference in Singapore that starts today, two days after Obama said the armed forces can’t be the ‘primary component of our leadership.’ The gathering concludes a week that’s seen China’s fighter jets challenging Japanese planes and the sinking of a Vietnamese fishing boat after a collision with a Chinese vessel. The incidents underscored China’s determination under President Xi Jinping to press territorial claims against Japan and the Philippines -- two U.S. allies -- and Vietnam, a former American foe that now welcomes U.S. military visits.”

China Bubble Watch:

May 30 – Bloomberg: “China state council reiterates prudent monetary policy, according to a statement on State Council meeting on central govt’s website. China will cut reserve requirement ratio ‘properly’ for some banks which granted a certain amount of loans to agricultural borrowers and smaller companies in support of the real economy, without giving more details. China to reduce social financing costs. China faces ‘relatively large’ downward economic pressure. China to keep reasonable growth in credit and social financing…”

May 28 – Wall Street Journal (Esther Fung and Lingling Wei): “China’s property slump is deepening despite growing government efforts to give home sales a lift, adding to concerns over the health of the world's No. 2 economy… Authorities hope to reverse a downturn that has led to a 9.9% nationwide drop in housing sales by value in the first four months of the year, compared with a year earlier… Property developers face a view among consumers that Chinese real-estate prices have peaked. Potential buyers are holding off on purchases… Experts say that in addition to consumer sentiment, longer-term factors are in play. They cite overbuilding in a number of markets outside the richest cities… Some property developers have expressed concerns about the market. Earlier this week, Chinese media quoted property tycoon Pan Shiyi's remarks at a forum, where he compared the nation's property market to the Titanic. Mr. Pan, chairman of Beijing’s Soho China Ltd. , said on his Weibo social-media account that he wasn’t aware reporters were present.”

May 28 – Bloomberg: “The ‘golden era’ for China’s property market has passed, according to China Vanke Co., the nation’s biggest developer, which is shifting its focus to homes for owner occupiers rather than investors. ‘The period in which everybody makes money out of property is gone,’ President Yu Liang told reporters… ‘Vanke will take a cautiously optimistic approach to face the slowdown and target those buyers who need homes for self-use.’”

May 28 – Bloomberg: “China’s biggest banks are poised to report the highest proportion of bad debts since 2009 after late payments on loans surged to a five-year high, indicating borrowers are struggling amid an economic slowdown. The nation’s 10 largest lenders reported overdue loans reached 588 billion yuan ($94bn) at the end of 2013, a 21% increase from a year earlier… ‘Overdue loans are a leading indicator of asset-quality deterioration and show the rising liquidity constraints among borrowers,’ said Liao Qiang, a Beijing-based director at Standard & Poor’s. ‘While we believe Chinese banks’ credit woes will unfold gradually, the disturbing thing is that the end is nowhere in sight.’ Overdue loans, those late by at least a day, were 31% greater for the banks as of Dec. 31 than nonperforming ones, which are debts they don’t expect to recoup in full.”

Global Bubble Watch:

May 29 – Financial Times (Michael Mackenzie and Tracy Alloway): “‘Keep calm and carry on’ is a British motivational poster from the second world war that has been co-opted by a generation of design-crazy hipsters and now global investors desperate for higher returns. This year’s extended run of low yields and meagre risk premiums in the bond market leaves investors with a tough choice; they can either accept a very low return or rely on borrowing money to enhance their income. Investors are increasingly seeking the latter option as they engage in ‘carry trades’, which involve borrowing money at cheap rates to invest in higher-yielding assets. ‘The Japanification of rates and the death of volatility means investors have no option but to participate in carry trades,’ says Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch… Anecdotally, for instance, some investors are beginning to employ leverage to pump up returns on the senior slices of CLOs that currently offer the lowest yields. ‘The carry demand is not just purely based on a reach for yield, it’s also based on low volatility,’ says Marc Ostwald at Monument Securities. ‘The people who have been selling volatility have to get more and more aggressive about it. If they get more aggressive that means they have to get more leverage.’”

May 29 – Bloomberg (David Goodman): “Italy auctioned 10-year bonds at the lowest yield on record amid a rally in fixed-income assets that has reduced borrowing costs for governments around the world. Austrian, Belgian and French yields slid to records amid speculation the European Central Bank will introduce further stimulus next week. A worldwide bond market surge pushed the yield on a composite index of bonds to the lowest in a year…”

May 27 – Bloomberg (Hugh Son): “JPMorgan Chase & Co., the world’s biggest investment bank by revenue, said a pair of wrong-way bets made by clients at the start of the year is partly to blame for Wall Street’s trading slowdown. Some of the biggest wagers included shorting Japan’s currency and betting that U.S. interest rates would rise more steeply than those in Europe, according to Daniel Pinto, head of the… firm’s corporate and investment bank. ‘Neither of those trades paid,’ Pinto, 51, said… ‘Essentially you start the year with the wrong momentum, where you lose money at the very beginning, and you ended up with probably a lower risk appetite than you would have otherwise.’”

May 28 – Bloomberg (Michael J. Moore): “Goldman Sachs… President Gary Cohn said low volatility and interest rates that are holding in tight ranges have resulted in an ‘abnormal’ trading market. ‘The environment for all the firms is quite difficult right now,” Cohn, 53, said… ‘What drives activity in our business is volatility. If markets never move or don’t move, our clients really don’t need to transact.’ Citigroup Inc. Chief Financial Officer John Gerspach said yesterday that second-quarter trading revenue could fall as much as 25% from year-earlier levels, and JPMorgan Chase & Co. estimated a 20% drop earlier this month… ‘We think, at the end of the day, it’s economic in nature,’ Cohn said of the cause of lower client volume. ‘We don’t have clear vision of economic growth or lack of growth.’”

May 27 – Bloomberg (Dakin Campbell): “Citigroup Inc. Chief Financial Officer John Gerspach said second-quarter trading revenue could be down 20% to 25% from year-earlier levels in a market he described as ‘becalmed.’ The decline might curtail overall institutional revenue for the period, Gerspach, 60, told analysts and investors… The market feels like participants are ‘sitting on the sidelines,’ Gerspach said, referring to both fixed-income and equity trading. ‘There isn’t a lot of direction.’”

EM Bubble Watch:

May 26 – Bloomberg (Onur Ant and Selcan Hacaoglu): “Turkish Prime Minister Recep Tayyip Erdogan said the central bank’s decision to cut the key interest rate by a half percentage point last week is a joke and told policy makers to ‘shape up.’ The… central bank, led by Governor Erdem Basci, on May 22 lowered Turkey’s benchmark rate by 50 bps to 9.5%, after more than doubling it to 10% in January. ‘When you’re increasing the rates, you do it by 5 percentage points,’ Erdogan told reporters… ‘Now you’re reducing them by half of a percentage point. Are you kidding me?’”

May 30 – Bloomberg (David Biller): “Brazil’s economic growth slowed in the first quarter as President Dilma Rousseff, who is up for re- election in October, struggles to rebuild confidence that led to the biggest decline in investment in two years. Gross domestic product increased 0.2% in the first quarter…, down from a revised 0.4% in the last three months of 2013… Investment fell 2.1% in the quarter.”

May 26 – Bloomberg (Kyoungwha Kim and Yumi Teso): “Thailand’s two debt auctions since the military took power in a May 22 coup have both raised less than targeted amid cooling demand for the nation’s assets. The finance ministry sold 18.157 billion baht ($557 million) of 28-day bills today, less than the 20 billion baht target…”

Japan Watch:

May 30 – Bloomberg (Toru Fujioka): “Japan’s industrial production and household spending fell more than forecast and inflation surged to a 23-year high on a tax rise that is pinching consumers who have seen limited wage gains. Production fell 2.5% in April from the prior month… Household spending declined 4.6% from a year earlier…, while core consumer prices rose 3.2%. The data show the challenge facing Prime Minister Shinzo Abe as he tries to cap the world’s biggest debt burden while the Bank of Japan carries out record easing to drive inflation.”

May 30 – Bloomberg (Isabel Reynolds): “Prime Minister Shinzo Abe said Japan would spare no effort in helping Southeast Asian nations secure the seas and pledged strong support for the Philippines and Vietnam in their maritime disputes with China. ‘Japan will offer its utmost support for the efforts of the countries of Asean as they work to ensure the security of the seas and the skies, and thoroughly maintain freedom of navigation and freedom of overflight,’ Abe said… Abe’s speech to defense officials at the Shangri-La security forum comes at a time of rising tensions over China’s assertiveness in the East and South China Sea… Abe has moved to toughen Japan’s defense posture in the face of the country’s own territorial spat with China and emerging doubts over whether the U.S. would be willing to use its military clout to defend allies in the region. Abe has repeatedly accused China of trying to change the status quo by force and yesterday reiterated offers to Asian allies of military equipment and training.”

May 29 – Bloomberg (Isabel Reynolds and Takashi Hirokawa): “Japanese Prime Minister Shinzo Abe expressed fresh determination to loosen constraints on his nation’s military and reduce economic regulation… Abe cited China’s ballooning defense spending and ‘extremely dangerous’ actions in the East China Sea to justify plans for a more active role for Japan’s Self-Defense Forces in remarks to the Diet yesterday. He followed with a pledge to business leaders to adopt a flexible and merit-based employment system… Abe plans to make his case for Japan broadening the scope of its military at a gathering of Asian, U.S. and European defense officials in Singapore… ‘I want to tell the world about Japan’s plans for proactive contributions to peace based on international cooperation,’ he said… ‘Tensions are now rising in Southeast Asia. I want to show Japan’s basic thinking, which is about cooperating with Southeast Asia in the protection of international norms, not allowing a change in the status quo by force and respecting the rule of law.’”

India Watch:

May 30 – Bloomberg (Unni Krishnan): “India’s economy grew less than 5% for a second quarter, adding pressure on Prime Minister Narendra Modi to spur investment after winning the strongest electoral mandate in 30 years. Gross domestic product rose 4.6% in the three months ended March from a year earlier, unchanged from the previous quarter…”

May 28 – Bloomberg (Shikhar Balwani): “India’s move to rein in rupee gains and rebuild foreign-exchange reserves is flooding the financial system with cash, driving bank funding costs to a 10-month low. The three-month interbank lending rate fell 87 bps this quarter to 8.90% on May 26… The currency stockpile jumped $40 billion from a three-year low in September to $315 billion, and Nomura Holdings Inc. estimates the central bank’s dollar purchases pumped about 800 billion rupees ($13.6bn) into markets in the four months through April.”

Europe Watch:

May 29 – Financial Times (Stefan Wagstyl): “The victory of the far-right National Front (FN) in the French elections for the European Parliament is almost as much of a shock in Berlin as it is in Paris. Even though the result was in line with projections, Germans can scarcely believe what is happening across the Rhine. For decades Paris and Berlin have worked together in running the EU – and for decades they have coped with mutual stresses and strains. But now the French half of the relationship is in trouble – and the German partner is both sharing the pain and wondering what dangers the populist surge in France poses for the rest of the EU. Finance minister Wolfgang Schäuble was passionate in his condemnation of the FN, which came first in Sunday’s poll with 25% of the vote… And he warned that its success was a challenge not just for France – but for the rest of Europe, including Germany. ‘It is a problem not only for our friends in France. We have to think what mistakes we have made that a quarter of the electorate [in France] voted not for a rightwing party but for a fascist extremist party,’ he said. ‘That is a disaster.’”

May 26 – Bloomberg (James G. Neuger): “Protest parties racked up gains across the 28-nation European Union in elections to the bloc’s Parliament, turning the assembly designed to unite Europe into an echo chamber for politicians who want to tear it apart. The wave hit hardest in France, Greece and the U.K., undermining the leaders of those countries and making it more difficult to steer the EU as a whole. In all, protest parties won 30% of the Europe-wide vote, up from 20% in the current Parliament… Political forces suspicious of the U.S. made inroads across the continent, threatening to snag trans-Atlantic trade talks the EU hopes will spur an economy struggling with the after-effects of the euro debt crisis. The U.K. Independence Party, which wants to yank Britain out of the EU, won the election in Britain, beating Prime Minister David Cameron’s Conservatives into third place. The protest vote ‘will have a huge impact on the parties and policies back home,’ said Pieter Cleppe, head of the Brussels office of U.K.-based think tank Open Europe. ‘They will make it harder to centralize powers in the EU, especially when it comes to managing the euro crisis.’”

May 26 – Financial Times (George Parker, Kiran Stacey, Hugh Carnegy and James Fontanella-Khan): “The UK Independence party and France’s far-right Front National stormed to victory in European elections on Sunday night, as populist and nationalist parties across the continent dealt a heavy blow to the push for closer integration. Nigel Farage, Ukip leader, said the result – the first time a party other than Labour or the Conservatives had won a UK national election since 1910 – represented an ‘earthquake’. Marine Le Pen, the FN leader, said that there had been a ‘massive rejection of the EU’, while mainstream politicians struggled to come to terms with what had happened. Manuel Valls, the French socialist prime minister, called the FN victory ‘a shock, an earthquake that all responsible leaders must respond to’, as President François Hollande brought together his key ministers for an emergency inner cabinet meeting on Monday morning to discuss the election results.”

May 26 – Financial Times (Tobias Buck): “Three months ago, Podemos did not even exist. Yet on Sunday night, the new Spanish leftwing party was able to celebrate a famous victory – stunning analysts and pollsters alike by winning five seats and capturing 8% of the vote in the European elections. In some regions – including in Madrid – Podemos (‘We Can’) emerged as the third-biggest political force behind the ruling Popular party… and the opposition Socialists… The new shooting star of Spanish pollsters is 35-year-old Pablo Iglesias… The five Podemos deputies say they will join the leftwing bloc in the European Parliament led by Alexis Tsipras, the leader of Greece’s Syriza party. ‘From tomorrow, we will work together with other partners from southern Europe to say that we don’t want to be a colony of Germany and the troika,’ Mr Iglesias told supporters… Echoing widespread discontent in these countries, Mr Iglesias says on his personal website that the troika’s main objective is ‘securing the profits of the banks, the big companies and speculators’. He adds: ‘Europe cannot be an instrument to asphyxiate the countries of the south, and Spain cannot be a country for the corrupt, the fraudulent and for urban speculators.’”

May 28 – Bloomberg (Jana Randow and Alexander Kell): “German unemployment unexpectedly increased for the first time in six months amid signs of a slowdown in Europe’s largest economy. The number of people out of work rose a seasonally adjusted 23,937 to 2.905 million in May… Economists forecast a decline of 15,000…”