Saturday, December 6, 2014

Weekly Commentary, June 21, 2013: Latent Market Bubble Risks

The hours leading up to Wednesday’s FOMC statement and Bernanke press conference provided good television drama. CNBC’s Rick Santelli offered one of the better rants in a while: “Ben, what are you afraid of?” Mr. Santelli returned minutes later with a provocative back and forth with Wall Street Journal Fed-watcher John Hilsenrath.

After Santelli challenged him to more forcefully hold Bernanke and the Fed accountable, Hilsenrath politely snapped back: “Part of my holding people accountable is holding people like you accountable. People have been saying inflation, inflation, inflation. Show me, show me... How about the dollar? How about the dollar? ...Where are the bad things that you said were going to happen?”

As much as I appreciated the respectful exchange between Santelli and Hilsenrath, I was left disappointed that fundamental aspects of the QE debate remain unexplored. For years now, there’s been this ongoing debate of the costs and benefits of the Fed’s (and others’) aggressive monetary easing. The supposed benefits have been easy to articulate: lower market yields and mortgage rates, higher stock and asset prices and additional stimulus for a weak economic recovery.

The costs of monetary inflation have always been more challenging to explain – only much more so in recent years. Opponents of quantitative easing, in particular, have focused on the threat of inflation and dollar devaluation. It has been difficult for this camp to sway public opinion, especially with securities markets at record levels and CPI relatively contained. The lurking cost of unstable financial markets hasn’t been part of the discourse, although this issue jumped into the limelight this week.

I’ve been arguing that the greatest risks associated with Fed and global central bank inflationary policymaking have been in the realm of asset inflation, dangerous Bubble dynamics and ongoing global financial distortions and economic maladjustment. This type of analysis is so removed from conventional thinking that it resonates with few and basically has no impact on the broader discussion. This is a curious dynamic, especially since I believe strongly in the value of the analysis and analytical framework. 

It was quite a week. I’ve been arguing the “global government finance Bubble” thesis for more than four years now. From my vantage point, a strong case can be made that the Bubble is now in serious jeopardy – if not already bursting. There are a few important aspects to Bubble analysis that may help place current vulnerabilities into context. 

Total U.S. debt ended March at $57.0 Trillion. In spite of so called “de-leveraging,” total debt jumped almost $6.2 Trillion over the past five years. Debt has expanded much more rapidly globally, especially in the booming emerging-market (EM) economies. Total Chinese “social financing” jumped $1.0 Trillion during the first quarter alone, indicative of one history’s most spectacular Credit booms. 

The world is awash in debt – virtually everywhere. The Fed and fellow central bankers have resorted to previously unimaginable measures to “reflate” global Credit and economies. They have manipulated short-term interest-rates to near zero. They have directly purchased Trillions of bonds and other instruments, in the process injecting Trillions into overheated securities markets. Over time, policy measures have come to dominate markets. 

This has ensured the ongoing rapid expansion of global debt, too much of it non-productive. The upshot has been unprecedented price inflation for most securities trading all over the world. Moreover, there has been the ongoing inflation in the already massive pool of speculative finance, derivatives and financial leveraging. Such Bubble Dynamics leave debt, securities market and economic structures acutely vulnerable to any reduction in Credit growth and/or central bank liquidity. 

This continuing Credit expansion has exacerbated latent fragilities – vulnerabilities that have been met with unprecedented central bank market intervention. When the European debt crisis was on the brink of unleashing global crisis last summer, global central bankers responded with incredible measures. Overextended Bubbles – along with attendant fragilities – inflated precariously worldwide. Global speculative excess was spurred to even more dangerous extremes. Bubbles throughout the developing world turned only more unwieldy. The historic Chinese Bubble’s “terminal phase” of excess was pushed into precarious overdrive.

Fundamental to my Bubble thesis is that tens of Trillions of global debt has been mis-priced in the marketplace. Market yields have been forced lower (fixed-income prices higher), which has worked to inflate equities prices as well. Near zero returns on savings have forced Trillions into assorted risk markets, certainly including EM securities and U.S. fixed income and equities. This week’s bout of market instability reflects how quickly distorted Bubble markets can succumb to illiquidity and near-panic. 

In an email to CNBC, David Tepper wrote, “All the concern in the markets is because the Fed sees the economy stronger in the future.” I don’t buy into this line of reasoning. Instead, I believe that key Federal Reserve officials are begrudgingly coming to terms with the reality that the risks of ongoing huge QE outweigh the rewards. This would be consistent with my view: the overall economic impact has been muted at best, while financial markets have become increasingly speculative and generally overheated. As I’ve argued in previous CBBs, there’s been a widening gulf between inflating asset Bubbles and problematic economic fundamentals. The markets’ behavior this week provides important confirmation of inherent fragilities.

There are reasons to fear how things might unfold. Importantly, it appears the “sophisticated” leveraged speculating community has been caught unprepared for the abrupt market reversal. Over the years, those (hedge fund, mutual fund, sovereign wealth fund, etc.) managers most adept at profiting from policymaking outperformed the markets - and in the process attracted incredible amounts of assets under management (AUM). The “sophisticated” speculator market universe became one big “crowded trade.” 

After struggling with challenging macro analysis and unsettled “risk-on, risk off” market dynamics over recent years, Draghi’s “do whatever it takes,” Bernanke’s $85bn QE a month, and Kuroda’s “shock and awe” “Hail Mary” seemed to ensure a breakout “risk on” year in 2013. The enticing backdrop worked to ensure the speculator crowd became fully committed – only to now see global risk markets abruptly reverse course. Anytime the crowd suddenly seeks the exits, risk markets will confront immediate liquidity issues. This dynamic is compounded by the fact that thousands of funds have “weak hands.” It wouldn’t take significant market losses before redemptions and viability become pressing issues. 

Troublingly, today’s market liquidity issues go way beyond hedge funds and myriad sophisticated leveraged speculative bets across the globe. Over recent years, as the Bernanke Federal Reserve pressured savers out of the safety of deposits and money funds, Wall Street has been busy creating instruments to harvest this torrent of return-seeking household finance. Bloomberg used the number $3.9 TN in quantifying the “money” that flowed to global emerging market funds. Apparently, the value of exchange-traded funds (ETFs) has swelled to $2.0 Trillion. 

I’ll leave it to others to discuss the structural weaknesses of ETF products. For my purposes this evening, I’ll focus on ETFs as a focal point in the world of Latent Market Bubble Risks. ETF products have enjoyed incredible flows and growth. Many of the major ETFs are highly liquid, and have been the perfect instrument for speculators playing the Bernanke Bubble, as well as for savers keen to escape the Fed’s “financial repression.” They have provided a most convenient vehicle for playing about any market, theme or sector - anywhere. 

For those wanting to invest like the “sophisticated” players, there’s a bevy of ETF products in which to build your “investment” portfolio. You want exposure to the latest hot emerging economy or simply a basket of the emerging markets? “Bond” funds that always return significantly more than lowly deposits? Dividend-producing equities? How about higher-yielding corporates or mortgage-backed securities? Tax-advantaged municipal debt? Would you prefer put or call options? How much leverage would you like to employ? 

Well, as multi-billions flowed WEEKLY into fixed-income funds and various ETF products – no one seemed the least bit concerned with the possibility of a significant reversal of flows. It hasn’t mattered that many of the most popular ETFs hold huge portfolios of illiquid securities. It didn’t matter because the “money” just kept rolling in. It matters now that serious “money” has been lost and the flows have reversed course. 

As an analyst of Bubbles, I have issues with financial instruments that work to distort perceptions of market risk. Bubbles, after all, always involve important market misperceptions. Over the years, I’ve noted that a Bubble financed by junk bonds wouldn’t get all that far – wouldn’t expand long enough and big enough to equate with major financial and economic structural distortions. On the other hand, a Bubble financed by “money” or “money”-like Credit instruments (“perceived liquid stores of nominal value”) have potential to inflate as long as confidence is retained in the “moneyness” of the underlying Credit.

From a global Bubble perspective, determined central bank market liquidity support has been instrumental in shaping market risk perceptions. On a more micro basis, the perception of liquidity and low-risk throughout the ETF complex has been crucial in funneling household savings into instruments that savers for the most part would have never purchased directly. Never has the U.S. household sector made such a huge bet on the emerging markets. Never have so much savings flowed indirectly into illiquid mortgage securities and municipal debt. I don’t believe many “retail” investors appreciated the myriad risks associated with today’s highly inflated and distorted financial markets. I suspect the vast majority made ETF purchases with the perception that risk was limited. 

From my analytical framework, this was a critical week. I believe the “sophisticated” speculators came to realize they are suddenly on the wrong side of a rapidly changing financial and economic landscape. I suspect that many of these market operators have held the view that this will all end badly – they just thought the Fed, BOJ and other central banks ensured they had more time to build on their vast fortunes. Meanwhile, the less market sophisticated - that had funneled savings directly and indirectly into long-term bonds, corporate debt, MBS, emerging markets, municipal debt and equities – will come to realize there is significantly more risk in these markets than they had perceived (and been led to believe). The perception of endless liquidity now confronts the reality that global central banks and myriad financial products and speculative excesses have worked to foment very serious inherent market liquidity issues.

Yet this week was critical beyond the Fed and risk market dynamics. In a potentially momentous development, an intriguing story seemed to gain some clarity this week in China. Uncharacteristically, the People’s Bank of China waited until short-term and inter-bank lending rates had spiked higher before providing targeted and limited liquidity injections in the Chinese money market (see “China Bubble Watch” above). 

I have chronicled China’s historic Credit Bubble for years now. I have posited that the post-2008 U.S., Chinese and global crisis response propelled the Chinese Bubble to precarious “terminal phase” excess. As a tenet of my Bubble analysis framework, I have often stated that major Bubbles become impervious to “tinkering.” To actually rein in Bubble excess policymakers must inflict pain, alter perceptions and behaviors - and accept the inevitable consequences of bursting Bubbles. 

For a while now Chinese authorities have tinkered with little effect. They’ve implemented various measures to contain house price inflation – yet the Chinese housing (apartment) Bubble has only gathered further momentum. They have watched the economy slow while Credit growth has exploded. They have surely seen enough of the surge in “shadow banking” to appreciate that they have a very serious financial issue to contend with. 

There were indications this week that the new Chinese government may be very serious about reform – economic, financial, political, environmental and social. This is an enormous population that has had expectations inflated throughout the protracted Credit and economic boom. But inflationary consequences include massive debt, deep economic maladjustment, housing Bubbles, inequitable wealth distribution, horrific environmental degradation and widespread corruption. The Chinese people increasingly fear they are being poisoned by toxic air, food and water. They are increasingly fed up with corruption throughout the government and economy 

The conventional market view is that Chinese officials will manage the situation to ensure an ongoing economic expansion – if not 10% growth at least 7-8%. My view is that it will require some tough medicine if Chinese authorities are determined to rein in Bubble excess – especially in a runaway Credit inflation. I believe they’re determined. 

I’ll assume that the new communist government is now ready to get on with it. They have stated their intention to target strategic industries for development. It would appear they have decided to move in the direction of central control over the allocation of Credit. There were indications this week that they have commenced the process of restricting liquidity to segments of their financial system that they don’t see as supporting their view of sound economic growth. And, best I can tell, there is an enormous infrastructure that has evolved to finance all types of assets – apartments, commercial real estate, commodities, commercial ventures and likely all kinds of fraud. 

The increasingly unwieldy Chinese Bubble has to end at some point. The increasingly unwieldy Bernanke Fed-induced global Bubble has to end at some point. It was a bit astonishing to watch such important developments unfold this week in Beijing and Washington. And the emerging markets now face the perfect storm.

The global risk backdrop has quickly become less latent – economic and market backdrops much more uncertain. Powerful de-risking/de-leveraging dynamics are now in play. Global market yields (and risk premiums) are adjusting to new risk and liquidity dynamics. Financial conditions have tightened meaningfully, especially in the now troubled "emerging" economies. Higher yields and risk premiums put a fragile Europe back in the spotlight. Forecasts for global growth must now come down, which implies risk to elevated earnings expectations. I would strongly argue that stock market multiples in the U.S. and elsewhere are much too high considering extraordinary risks and uncertainties. If the global government debt Bubble has begun to succumb, there are very challenging times ahead.

For the Week:

The S&P500 fell 2.1% (up 11.7% y-t-d), and the Dow declined 1.8% (up 12.9%). The Morgan Stanley Consumer index dropped 2.6% (up 17.0%), and the Utilities were hit for 2.8% (up 4.2%). The Banks were unchanged (up 17.3%), while the Broker/Dealers added 0.2% (up 31.7%). The Morgan Stanley Cyclicals were down 3.4% (up 12.0%), and the Transports fell 3.2% (up 15.1%). The S&P 400 MidCaps sank 3.0% (up 11.4%), and the small cap Russell 2000 declined 1.8% (up 13.5%). The Nasdaq100 dropped 2.2% (up 8.2%), and the Morgan Stanley High Tech index declined 1.4% (up 8.5%). The Semiconductors fell 1.0% (up 20.0%). The InteractiveWeek Internet index lost 1.1% (up 14.4%). The Biotechs declined 2.3% (up 20.4%). With bullion down $94, the HUI gold index was slammed for 11.6% (down 48.0%). 

One-month Treasury bill rates ended the week at one basis point and three-month bill rates closed at four bps. Two-year government yields were up 10 bps to 0.37%. Five-year T-note yields ended the week 39.5 bps higher to 1.425%. Ten-year yields surged 40 bps to 2.53%. Long bond yields jumped 28 bps to 3.38%. Benchmark Fannie MBS yields spiked 50 bps higher to 3.44%. The spread between benchmark MBS and 10-year Treasury yields widened a notable 10 to 91 bps. The implied yield on December 2014 eurodollar futures jumped 21.5 bps to 0.785%. The two-year dollar swap spread rose 4 to 20 bps, and the 10-year swap spread jumped 5 to 23 bps. Corporate bond spreads widened meaningfully. An index of investment grade bond risk jumped 10 to 94 bps. An index of junk bond risk surged 51 to 463 bps. An index of emerging market debt risk jumped 31 to 350 bps.

Debt issuance remained slow. Investment grade issuers included Chevron $6.0bn, Ingersoll-Rand $1.55bn, Solar Funding $1.0bn, Georgia Pacific $850 million, Boston Properties $700 million, Mylan $1.15bn, Agilent Technologies $600 million, Met Life $500 million, O'Reilly Automotive $300 million and Osprey Aircraft Leasing $160 million.

Junk bond fund outflows slowed to $333 million (from Lipper). Junk issuers included Laureate Education $1.4bn, Rite Aid $810 million, Atwood Oceanics $650 million, Brookfield Residential Properties $500 million, Service Corp International $425 million, AK Steel $380 million, and Asbury Automotive Group $100 million.

I saw no convertible debt issued.

The short list of international dollar debt issuers included Israel Electric Corp $1.1bn and Carpintero Finance $133 million.

Italian 10-yr yields surged 34 bps to 4.61% (up 11bps y-t-d). Spain's 10-year yields jumped 32 bps to 4.89% (down 38bps). German bund yields were up 21 bps to 1.72% (up 40bps), and French yields rose 23 bps to 2.31% (up 31bps). The French to German 10-year bond spread widened 2 bps to 59 bps. Ten-year Portuguese yields increased 14 bps to 6.33% (down 42bps). Greek 10-year note yields surged 123 bps to 10.94% (up 47bps). U.K. 10-year gilt yields jumped 34 bps to 2.40% (up 58bps).

Japan's unstable Nikkei equities index jumped 4.3% (up 27.3% y-t-d). Japanese 10-year "JGB" yields ended the week up 5 bps to 0.87% (up 9bps). The German DAX equities index sank 4.2% for the week (up 2.3%). Spain's IBEX 35 equities index fell 4.6% (down 5.7%). Italy's FTSE MIB dropped 5.6% (down 6.3%). Emerging markets fell under heavy selling pressure. Brazil's Bovespa index was pounded for 4.6% (down 22.8%), and Mexico's Bolsa dropped 3.1% (down 13.0%). South Korea's Kospi index sank 3.5% (down 8.7%). India’s Sensex equities index fell 2.1% (down 3.4%). China’s Shanghai Exchange was hammered for 4.1% (down 8.6%).

Freddie Mac 30-year fixed mortgage rates slipped 5 bps to 3.93%, with a seven-week gain of 58 bps (up 27bps y-o-y). Fifteen-year fixed rates were down 6 bps to 3.04% (up 9bps). One-year ARM rates were down a basis point to 2.57% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 14 bps to 4.49% (up 20bps).

Federal Reserve Credit surged $54.4bn to a record $3.418 TN. Fed Credit expanded $632bn during the past 37 weeks. Over the past year, Fed Credit surged $569bn, or 20%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $718bn y-o-y, or 6.9%, to $11.130 TN. Over two years, reserves were $1.271 TN higher, for 13% growth. 

M2 (narrow) "money" supply gained $11.1bn to a record $10.590 TN. "Narrow money" expanded 6.4% ($639bn) over the past year. For the week, Currency increased $1.2bn. Demand and Checkable Deposits sank $110.5bn, while Savings Deposits jumped $117.8bn. Small Denominated Deposits declined $3.8bn. Retail Money Funds jumped $6.3bn.

Money market fund assets dropped $25.0bn to $2.587 TN. Money Fund assets were up $52bn from a year ago, or 2.1%.

Total Commercial Paper outstanding increased $3.3bn this week to $1.038 TN. CP has declined $28bn y-t-d, while having expanded $40bn, or 4.0%, over the past year. 

Currency and 'Currency War' Watch: 

June 18 – Bloomberg (Ye Xie and Belinda Cao): “Currency strategists from Barclays Plc to Deutsche Bank AG are advising investors to sell the yuan, this year’s best-performing emerging-market currency, as growth slows in the world’s second-largest economy and inflows wane. Policy makers will widen the yuan’s trading band, damping the one-way bet on yuan gains, Barclays analysts led by Igor Arsenin said in a June 13 report. Deutsche Bank analysts wrote two days earlier that the yuan carry trade will probably unwind as Treasury yields rise.” 

The U.S. dollar index gained 2.0% to 82.32 (up 3.2% y-t-d). For the week on the downside, the Norwegian krone dropped 5.6%, the Mexican peso 4.5%, the Brazilian real 4.0%, the New Zealand dollar 3.7%, the Australian dollar 3.7%, the Japanese yen 3.7%, the Swedish krona 3.5%, the Canadian dollar 2.7%, the South Korean won 2.4%, the South African rand 2.1%, the Singapore dollar 1.9%, the British pound 1.8%, the Danish krone 1.7%, the euro 1.7% the Swiss franc 1.4% and the Taiwanese dollar 0.9%.

Commodities Watch: 

June 18 – Financial Times (Emiko Terazono): “Global fish prices have leapt to all-time highs as China’s growing appetite for high-end species – from tuna to oysters – runs up against lower catches. The UN Food and Agriculture Organization’s global fish price index, an industry benchmark that tracks the cost of wild and farmed seafood, hit a record high in May, up 15% from a year ago and above the peak set in mid 2011. ‘In the coming months, supply constraints for several important species are likely to keep world fish prices on the rise,’ the… FAO has warned.” 

The CRB index dropped 2.8% this week (down 5.7% y-t-d). The Goldman Sachs Commodities Index was hit for 3.4% (down 5.7%). Spot Gold sank 6.8% to $1,296 (down 22.6%). Silver sank 9.1% to $19.96 (down 34%). September Crude fell $4.38 to $93.69 (up 2%). July Gasoline dropped 4.7% (unchanged), while July Natural Gas added 1.0% (up 13%). September Copper sank 3.6% (down 15%). July Wheat rallied 2.5% (down 10%), and July Corn increased 1.0% (down 5%).

U.S. Bubble Economy Watch: 

June 18 – Bloomberg (Chris Christoff and Steven Church): “A plan to cut pension benefits previously thought sacrosanct for 30,000 workers and retirees may tip Detroit into bankruptcy as Emergency Manager Kevyn Orr negotiates over $17 billion in debt and obligations. Getting dispassionate bondholders to take partial payment will be easier than wresting retirement cuts from unions, said Ken Schneider, a Detroit bankruptcy lawyer… Orr’s plan will test retirees’ contention that Michigan’s constitution protects vested pension benefits.”

June 17 – Bloomberg (Kasia Klimasinska): “Lauren O’Shaughnessy has boosted prices for her wedding-planning services by about 25% since 2009 as the economic expansion puts Americans in the mood for bigger parties and fancier locations. Spending on the average wedding in the U.S. climbed 5.2% to $28,427 in 2012 from a year earlier, according to XO Group… ‘People do feel more comfortable spending their money than they used to,’ said O’Shaughnessy, a 29-year-old partner at Bellafare LLC, an event and wedding-planning company… ‘We’re busier, the stuff we’re getting is much more grand, and we’ve had to hire more people to help us out with everything.’”

Federal Reserve Watch:

June 21 – Bloomberg (Simon Kennedy and Steve Matthews): “Federal Reserve Bank of St. Louis President James Bullard said the Fed “inappropriately timed” a plan to trim $85 billion in monthly bond purchases amid slowing inflation. ‘A more prudent approach would be to wait for tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement,’ Bullard said… Bullard this week dissented from a statement by Fed policy makers not to change their current pace of monthly asset purchases.”

June 21 – Bloomberg (Simon Kennedy and Steve Matthews): “Federal Reserve Bank of St. Louis President James Bullard said the Fed ‘inappropriately timed’ a plan to trim $85 billion in monthly bond purchases amid slowing inflation. ‘A more prudent approach would be to wait for tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement,’ Bullard said… Bullard this week dissented from a statement by Fed policy makers not to change their current pace of monthly asset purchases.”

EM Bubble Watch:

June 20 – Bloomberg (Ye Xie and Michael Patterson): “Investors are pulling money from emerging markets at the fastest pace in two years… More than $19 billion left funds investing in developing- nation assets in the three weeks to June 12, the most since 2011, according to EPFR Global. Foreign investors dumped an unprecedented $5.6 billion of Brazilian stocks and $3.2 billion of Indian bonds this month, exchange data show… ‘These are pre-quake tremors: something big is coming,’ Stephen Jen, the co-founder of hedge fund SLJ Macro Partners LLP, said… ‘There’s tremendous deceleration in emerging markets. You may see crisis- like price actions without having a crisis.’” 

June 18 – Bloomberg (David Biller and Maria Luiza Rabello): “President Dilma Rousseff wants to meet her budget goal by selling bonds that she says won’t boost Brazil’s indebtedness, underscoring concern her administration is imperiling the nation’s creditworthiness as it tries to arrest an economic slowdown. The cost to protect Brazil’s debt against default for five years has increased… twice as much as China and more than Russia, as Standard & Poor’s cited such ‘off-budget measures’ and growth that has missed estimates in five quarters for lowering its outlook on Brazil’s BBB rating to negative. The move came less than three weeks after Rousseff issued a decree letting the Treasury sell bonds worth 29% of her budget target that are backed by revenue from Itaipu, Latin America’s largest hydroelectric dam. The Itaipu-backed bond sale for as much as $14.8 billion is emblematic of the nation’s worsening standing in debt markets… ‘They’re trying to do quick fixes at the cost of future revenue,’ Marcelo Salomon, co-head for Latin America economics at Barclays, said… ‘The government is going in the wrong direction on the fiscal side.’”

June 18 – Bloomberg (Raymond Colitt): “Francisco Soares, a 32-year-old Brasilia electrician, felt good about life two years ago when he started commuting in his first car, blasting the music and passing packed buses. Since then, bills started piling up, the cost of living jumped and last week he had to sell his wheels. After a decade that saw 40 million people rise from poverty, Brazil’s middle class finds itself squeezed by faster inflation, rising debt and a weaker currency… The emerging middle class was the engine of economic growth and made the developing nation one of the world’s top five markets for cars and mobile phones… ‘The golden days are over, the feel-good factor is lost,’ said Renato Fragelli, economics professor at the Fundacao Getulio Vargas, a business think tank in Rio de Janeiro. ‘It’s not that the middle class is disappearing but there’s been a setback, people feel they’re getting less for their money.”

June 19 – Bloomberg (Firat Kayakiran): “As Turkey’s government seeks to rally support by identifying culprits behind the unprecedented explosion of anger that erupted in recent weeks, one group has featured on almost every list: bankers. Prime Minister Recep Tayyip Erdogan began blaming a so- called ‘interest-rates lobby’ in the first week after anti- government protests spread nationwide on May 31. Economy Minister Zafer Caglayan said ‘blood-sucking’ financiers, seeking to push Turkey’s interest rates back up, helped provoke the movement that ignited over a police crackdown against people opposed to development plans in Istanbul’s Taksim Square.”

Global Bubble Watch: 

June 17 – Bloomberg (Matthew Leising) “The probe of Libor manipulation is proving to be the tip of the iceberg as inquiries into assets from derivatives to foreign exchange show that if there’s a chance to rig benchmark rates in world markets, someone is usually willing to try. Singapore’s monetary authority last week censured 20 banks for attempting to fix interest rate levels in the island state and ordered them to set aside as much as $9.6 billion. Britain’s markets regulator is looking into the $4.7 trillion-a-day currency market after Bloomberg News reported that traders have manipulated key rates for more than a decade, citing five dealers. ‘It’s happened time and again: all of these markets have been influenced by major market-makers, which is a polite way of saying they’ve been rigged,’ Charles Geisst, a finance professor at Manhattan College… said…” 

June 20 – Bloomberg (Ye Xie, Lilian Karunungan and David Yong): “Developing nations around the world are scaling back or canceling billions of dollars of bond sales as borrowing costs climb the most since 2008, just as spending needs increase amid slowing economic growth… Romania’s Finance Ministry rejected all bids at a seven- year bond sale yesterday because of market volatility, while South Korea raised less than 10% of the amount planned in an auction of inflation-linked bonds. Russia scrapped a sale of 15-year ruble-denominated bonds June 19, the second time it canceled an auction this month, and Colombia pared an offering of 20-year peso debt by 40%. A cash shortage led to failures last week of China Ministry of Finance debt sales.”

June 20 – Bloomberg (Jody Shenn): “Mortgage rates in the U.S., already increasing at the fastest pace in a decade, are poised to rise even further after Federal Reserve Chairman Ben S. Bernanke said the central bank is ready to slow its purchases of Treasuries and bonds backed by housing loans. Yields on Fannie Mae’s 3.5%, 30-year securities soared 0.3 percentage point yesterday to a 14-month high of 3% as their price tumbled 1.3 cents to 102 cents on the dollar, the most since 2010… The tone of Bernanke’s comments was ‘very assuring and soothing, but that’s like a mother telling her baby that she will be leaving in a very gentle voice,’ said Tae Park, a money manager in New York at Societe Generale… ‘The baby will still have a fit.’” 

June 21 – Financial Times (Arash Massoudi, Tom Braithwaite and Stephen Foley): “A wave of selling caused many exchange traded funds to tumble below the value of their underlying assets as a bond market sell-off caused stress in the $2tn ETF industry. ETFs track baskets of underlying assets, such as emerging-market stocks or municipal bonds, but discounts widened sharply on Thursday as dealers struggled to keep up with the sell orders. Emerging-markets ETFs were among the worst affected, as investors took fright that the end of Federal Reserve monetary policy would lead to outflows from developing countries. For example, the share price of the iShares MSCI Emerging Markets Index fell to a 6.5% discount to the underlying asset value. The selling also caused disruptions in the plumbing behind several ETFs. Citigroup stopped accepting orders to redeem underlying assets from ETF issuers, after one trading desk reached its allocated risk limits… The selling also caused disruptions in the plumbing behind several ETFs. Citigroup stopped accepting orders to redeem underlying assets from ETF issuers, after one trading desk reached its allocated risk limits… Market participants described the heavy volumes and losses on Thursday as a rare occurrence and said that it could translate into further selling on Friday or early next week. ‘The losses for ETFs today were far beyond what the most sophisticated financial risk models could have predicated for worst-case scenarios,’ said Bryce James, president of Smart Portfolio, which provides ETF asset allocation models.’” 

June 20 – Bloomberg (Michelle Kaske): “The largest exchange-traded fund tracking the U.S. municipal-bond market fell to the lowest price in almost two years and the week’s two biggest sales were delayed as the Federal Reserve said it may stop buying debt. The $3.6 billion iShares S&P National AMT-Free Municipal Bond Fund, known as MUB, fell to… the lowest since August 2011 and the biggest one-day price drop since February 2012… The price decline mirrored changes in the $3.7 trillion municipal market, where tax-exempt yields rose along with those on Treasuries, said David Manges, muni trading manager at BNY Mellon Capital Markets… ‘The muni market is in a free-fall today,’ Manges said. ‘It’s tough to get a sense of value or benchmark spreads because prices are so fluid.”

June 20 – Dow Jones (Kelly Nolan): “Benchmark municipal bond prices saw their sharpest one-day decline since the financial crisis Thursday… Yields on Thomson Reuters Municipal Market Data's benchmark scale increased as much as 0.20 percentage point Thursday… munis maturing around 10 to 30 years saw the biggest yield increase on MMD's scale... It is rare for the typically sleepy muni market to show such drastic price moves: The last time MMD’s benchmark scale showed a similar one-day yield jump was in October 2008, said strategist Dan Berger. ‘It's getting disastrous out there,’ said MMD senior market analyst Randy Smolik. ‘Our adjustments yesterday paled to Treasurys, and today, with more [Treasury] selling, it’s giving the green light for guys to unload positions.’ Gary Pollack, managing director at Deutsche Asset & Wealth Management, agreed that several market participants were trying to sell bonds. ‘It's raining bid wanteds out there,’ said Mr. Pollack… Kathy Bramlage, director at Treasury Partners, a unit of financial-advisory firm HighTower Advisors, which oversees about $9 billion in fixed-income assets, said the market tone was anxious. ‘Traders will not put a number on anything this afternoon,’ she said. ‘Everyone is skittish.’ Thursday's slide in muni prices adds on to what has already been a brutal month and a half for the asset class.”

June 18 – Bloomberg (Sarah Mulholland): “Rising interest rates may trim issuance of commercial-mortgage bonds by $15 billion this year, according to Standard & Poor’s. An increase of 55 bps on 10-year Treasury yields coupled with a rise of 30 bps on relative yields on top-ranked securities linked to property loans will put a damper on the resurgent market, S&P analysts led by Howard Esaki said…”

Global Credit Watch: 

June 20 – Financial Times (Peter Spiegel): “The International Monetary Fund is preparing to suspend aid payments to Greece by the end of next month unless eurozone leaders plug a €3bn-€4bn shortfall that has opened up in Greece’s €172bn rescue programme, according to officials involved in management of the bailout. The gap emerged after eurozone central banks refused to roll over Greek bonds they hold, and comes amid signs that even the scaled-back privatization plan Athens agreed to last year is falling behind schedule.”

June 16 – Financial Times (Peter Wise in Lisbon and Jamie Smyth): “Less than a year before European leaders hope to chalk up success for their handling of the sovereign debt crises in Ireland and Portugal, rising bond yields and long-term interest rates are causing concern over how the two countries will exit their bailout programmes. Amid expectations that central banks in the US, Japan and elsewhere will tighten monetary policy, yields on Portugal’s benchmark 10-year bonds surged to 6.6% last week from a low of 5.2% in late May.”

June 19 – Bloomberg (Boris Groendahl): “Austria is racing against the clock to keep 15 billion euros ($20bn) borrowed by nationalized Hypo Alpe-Adria-Bank International AG off its books. The Alpine republic has until the end of the month to tell the European Union how it will break up and shut down Hypo Alpe, a plan that will add to the price of one of the most costly bank failures for its taxpayers since 2008… ‘The market isn’t particularly paying attention right now because the focus in the last few weeks was the concern that central banks are removing liquidity,’ said Michael Leister… at Commerzbank… ‘But that can change…” 

June 14 – Reuters (Emily Stephenson and Douwe Miedema): “A top U.S. banking regulator called Deutsche Bank’s capital levels ‘horrible’ and said it is the worst on a list of global banks based on one measurement of leverage ratios. ‘It's horrible, I mean they’re horribly undercapitalized,’ said Federal Deposit Insurance Corp Vice Chairman Thomas Hoenig… ‘They have no margin of error.’ Hoenig, who is second-in-command at the regulator, said global capital rules, known as the Basel III accord, allow lenders to appear well-capitalized when they are not. That is because the rules allow the banks to use complicated measurements of how risky their loans are to determine the capital they must hold, he said… Other banks with a low ratio, according to Hoenig, are UBS at 2.52%, Morgan Stanley at 2.55%, Credit Agricole at 2.72% and Societe Generale at 2.84%.”

China Bubble Watch: 

June 20 – Financial Times (Kathrin Hille): “China’s Communist party has unleashed a rectification campaign of a scale and tone not seen in more than a decade as the leadership seeks to address frustration over corrupt officials while avoiding bold political reforms. As investors wait for party chief Xi Jinping to initiate long-delayed economic reforms and liberals in China push for political change, Mr Xi is taking a page out of the playbook of Mao Zedong, the charismatic but dictatorial politician who led China through a sequence of mass campaigns. Mr Xi, in a speech on Tuesday, exhorted the party that it must embrace the ‘mass line’ to avoid its extinction. Every cadre, demanded Mr Xi, must ‘look in the mirror, tidy your attire, take a bath and seek remedies’ to clean the party from formalism, bureaucratism, hedonism and extravagance. All cadres from county level upwards have to attend study and criticism sessions during the year-long campaign.” 

June 19 – Financial Times (Simon Rabinovitch): “China’s cash crunch deepened on Wednesday after the central bank withheld funding from the financial system, putting pressure on overextended lenders. Short-term interbank rates jumped more than 200 basis points, setting a record high at nearly 8% for loans of one month or less, the latest indication of how credit has suddenly become very tight in China. The main reason for the tightness has been the central bank’s reluctance to pump liquidity in to the money market, wrong-footing banks that had expected Beijing would support them with large cash injections, as it had regularly done before. Signaling that the cash crunch could persist for a while, the China Securities Journal, a major state-run newspaper, ran a front-page commentary saying China was at a turning point in monetary policy. ‘We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth,’ the newspaper said. ‘This means that authorities must control the pace of money supply growth...’ ‘The only explanation is that the central bank wants to send a warning signal to commercial banks and other credit issuers that unchecked credit expansion, particularly through the shadow banking system, will not be accommodated,’ said Na Liu with CNC Asset Management. Overall credit growth in China has reached about 22-23% this year, up from 20% in 2012, after surge in ‘shadow’ lending by trust companies and banks through off-balance-sheet vehicles..."

June 19 – Bloomberg: “China’s government said the nation’s financial system must ‘better’ serve economic growth under a prudent monetary-policy framework as the cost of borrowing on the interbank market surged. Authorities will boost credit support for industries the government has defined as strategic and those that are labor- intensive, the State Council, or Cabinet, said… The nation must more firmly guard against financial risks… The comments follow a jump in the seven-day repurchase rate, a gauge of interbank funding availability, to the highest level since June 2011. Slowing economic growth combined with a crackdown on illegal capital inflows, efforts to rein in shadow banking and a campaign to control home prices have contributed to increased borrowing costs… ‘Beijing’s new approach is to focus on reform, rather than stimulus,’ said Qu Hongbin, HSBC Holdings Plc’s… chief China economist… ‘In the last three months, we have seen enough evidence that the current generation of leadership is really determined to push forward reform.’ …Bank lending for projects in industries with overcapacity must be banned, the State Council said. The financing system must ‘support economic transformation and upgrading in a more forceful way, serve real economy development in a better way, promote domestic demand in a more targeted way and prevent financial risks in a more concrete way,’ the government said… China must also uphold prudent monetary policy and ‘use it well,’ and keep a reasonable scale of monetary aggregates, the State Council said.” 

June 18 – Bloomberg: “China’s worst cash crunch in at least seven years is an indicator of shadow lending gone awry and a banking crisis may appear earlier than expected if liquidity remains tight, according to Fitch Ratings. ‘We are starting to see some issues emerging’ in liquidity, Charlene Chu, Fitch’s head of China financial institutions, said… ‘It will be very important over the next month or so to see how that plays out. If that doesn’t go away, some of this may be moving ahead faster and earlier than we thought.’ …Chinese finance companies are calling for the central bank to resume capital injections as the nation’s slowing growth… The tightening is ‘emblematic of some of the shadow banking issues coming to the fore as well as some of the tight liquidity associated with wealth management product issuance, and the crackdown on some shadow channels,’ Chu said. She earlier estimated China’s total credit, including off- balance-sheet loans, swelled to 198% of gross domestic product in 2012 from 125% four years earlier, exceeding increases in the ratio before banking crises in Japan and South Korea. In Japan, the measure surged 45 percentage points from 1985 to 1990, and in South Korea, it gained 47 percentage points from 1994 to 1998… Triggers and timing is the biggest question related to China,’ Chu said. ‘We are going to have banking sector problems. Those can manifest either in a crisis or they can manifest in slow growth.’” 

June 21 – Bloomberg: “China’s interbank rates, which rose to a record yesterday, will be under upward pressure as more than 1.5 trillion yuan ($245bn) of wealth management products mature this month, according to Fitch Ratings. Mid-tier banks, with an average of 20% to 30% of their deposits in such products, face the most difficulty as tight liquidity constrains their ability to meet repayment obligations, Fitch said… Issuance of new products and borrowing from the interbank market are among the most common sources of repayment for maturing products, according to the ratings company.”

June 18 – Dow Jones (Esther Fung): “Housing prices in China's biggest cities last month posted their highest annual growth rate in more than two years, supported by stronger-than-expected sales and expectations of rising prices. The rise is the latest in a strong year for the property market despite Beijing's effort to control prices.”

June 20 – Bloomberg: “China’s manufacturing is shrinking at a faster pace this month, adding to stresses in the economy and financial system as a cash crunch drives benchmark money- market rates to records. The preliminary reading of 48.3 for a Purchasing Managers’ Index… by HSBC Holdings Plc and Markit Economics compares with the 49.1 median estimate…”

June 19 – Bloomberg (Simon Kennedy): “HSBC Holdings Plc economists cut its forecast for Chinese economic growth to 7.4% this year and next. They previously anticipated expansion of 8.2% in 2013 and 8.4% in 2014.”

Japan Bubble Watch:

June 19 – Bloomberg (Mio Coxon): “Japan’s exports rose more than forecast in May as a weaker yen boosted the value of overseas sales… The value of shipments abroad increased 10% in May from a year earlier… At the same time, export volume dropped 4.8%.”

Latin America Watch: 

June 19 – Bloomberg (Julia Leite and Denyse Godoy): “Brazil’s bear-market collapse, the worst among major global equity indexes, is starting to cool off a record boom in initial public offerings. Votorantim Cimentos SA, the Sao Paulo-based cement maker, suspended its sale of as much as $3.7 billion of shares planned for this week because of the market selloff…”

Europe Watch: 

June 21 – Bloomberg (Marcus Bensasson, Tom Stoukas and Maria Petrakis): “Greek Prime Minister Antonis Samaras may lose a coalition partner over his closure of the country’s state broadcaster ERT, heightening concern about his government’s stability. Democratic Left leader Fotis Kouvelis met with his lawmakers this morning in Athens to decide whether to withdraw from the government. He condemned Samaras yesterday for defying a court ruling to reopen ERT, which Samaras shut down without consultation on June 11.” 

June 18 – Bloomberg (Mathieu Rosemain): “European car sales fell to a 20-year low in May as rising joblessness caused by a recession in the euro region reduced demand at PSA Peugeot Citroen, Renault SA, Fiat SpA and General Motors Co.”