Sunday, December 14, 2014

Weekly Commentary, June 27, 2014: No Bubble?

Earlier in the week BlackRock’s Larry Fink commented on CNBC: “A Bubble is predicated on leverage.” Fink was implying that he didn’t see the type of leverage that had fueled the previous Bubble.

As part of my Bubble analysis framework, I have posited that the more conspicuous a Bubble the less likely it is to be systemic. The “tech” Bubble was conspicuous, though gross excesses impacted only a relatively narrow segment of asset prices and a subsection of the real economy.

I received a lot of pushback to my mortgage finance Bubble thesis during that Bubble period. The conventional view held that excesses were not a major issue, especially when compared to the Internet stocks and all the nonsense illuminated with the technology Bubble collapse. The Fed’s unwillingness to move beyond baby-step rate increases (to aggressively tighten Credit) played prominently in Bubble Dynamics. Today, conventional thinking sees a system that has been working successfully through a multi-year deleveraging process. Leverage and speculative excess are believed to be nothing on the order of those that gave rise to the (“100-year flood”) “Lehman crisis.”

As an analyst of Bubbles, I’ve definitely got my work cut out for me. I have seen overwhelming evidence in support of my “Granddaddy of all Bubbles” – global government finance Bubble – thesis. Yet the Bubble is so comprehensive – so systemic – that the greatest financial Bubble in human history somehow goes largely unappreciated – hence unchecked.

Understanding this era’s Credit Bubble (as opposed to the causes of the Great Depression) will prove the ultimate “Holy Grail of Economics.” The past 25 years have been unique in financial history. Indeed, the world is trapped in a perilous experiment with unfettered finance - with no limits on either the quantity or quality of Credit created. Closely associated with this trial in unchecked electronic finance (“money” and Credit) has been runaway experimentations in “activist” monetary management. Just as crucial is the experiment in unconventional economic structure – including the deindustrialization of the U.S. economy, with the corresponding unprecedented expansion of industrial capacity throughout China and Asia. This has engendered a period of unmatched global economic and financial imbalances – best illustrated by the massive and unrelenting U.S. Current Account Deficits and the accumulation of U.S. IOU’s around the globe.

The amazing thing to me is that the world has been subjected to more than 25 years of brutal serial boom and bust cycles (going back to 1987 – although there’s a strong case to start at 1971) – yet there has been no effort to reform either a patently flawed global financial “system” or a reckless policymaking doctrine. Instead, global central bankers have turned only more “activist,” drifting further into the bizarre (that passes for “enlightened”). The world’s leading central banks have resorted to rank inflationism, massive “money” printing operations specifically to inflate global securities markets. And the resulting raging “bull” markets ensure bullishness and a positive spin on just about everything. The sophisticated market operators play the speculative Bubble for all its worth, while the unsuspecting plow their savings into stock and bond Bubbles.

Credit is inherently unstable. Marketable debt instruments exacerbate instability. A financial system where Credit expansion is dominated by marketable debt (in contrast to “staid” bank loans) is highly unstable - I would argue unwieldy, whimsical and prone to manipulation. And a monetary policy regime that specifically nurtures and backstops a system dominated by marketable securities and associated speculation is playing with fire. Importantly, the more deeply central bankers intervene and manipulate such a system and the longer it is allowed to inflate – the more impossible for these central planners to extricate themselves from the financial scheme.

I’m fond of a relatively straightforward analysis that does a decent job of illuminating the state of ongoing U.S. (marketable securities) Bubbles. From the Fed’s Z.1 “flow of funds” data, I tally Total Marketable Debt Securities (TMDS) that includes outstanding Treasury securities (not the larger Federal liabilities number), outstanding Agency Securities (MBS & debt), corporate bonds and municipal debt securities.

My calculation of TMDS began the 1990’s at $6.28 TN, or an already elevated 114% of GDP. Led by explosive growth in GSE and corporate borrowings, TMDS ended the nineties at $13.59 TN, for almost 120% growth. Over this period, GSE securities increased $2.65 TN, or 209%, to 3.916 TN. Corporate bonds jumped 185% to $4.564 TN. It is worth noting that total Business borrowings expanded 9.2% in 1997, 11.5% in 1998 and 10.4% in 1999, excess that set the stage for the inevitable bursting of the “tech” Bubble.

The Fed’s aggressive post-tech Bubble reflation ensured already dangerous excess was inflated to incredible new extremes. On the back of a doubling of mortgage borrowings, TMDS expanded 102% in the period 2000 through 2007 to $27.50 TN. Over the mortgage finance Bubble period, Agency Securities jumped 89% to $7.40 TN. Corporate bonds surged 154% to $11.577 TN. Municipal bonds rose 135% to $3.425 TN.

This unprecedented Credit expansion fueled various inflationary manifestations, including surging asset prices, spending, corporate profits, investment, GDP and trade/Current Account Deficits. After beginning the nineties at $6.227 TN, the value of the U.S. equities market surged 409% to end the decade at $19.401 TN. As a percentage of GDP, the nineties saw TMDS jump from 114% to 147%. Spurred by crazy technology stock speculation, Total Securities – TMDS plus Equities – jumped from 183% of GDP to end 1999 at 356%. Although Total Securities to GDP retreated to 284% by 2002, mortgage finance Bubble excesses quickly reflated the Bubble. Total Securities ended 2007 at a then record 378% of GDP.

A “funny” thing happened during the post-mortgage Bubble’s so-called “deleveraging” period. Since the end of 2008, total TMDS has jumped $8.348 TN, or 29%, to a record $37.542 TN. As a percentage of GDP, TMDS ended Q1 2014 at a record 220%. Even more importantly from a Bubble analysis perspective, in 21 quarters Total Securities (debt & equities) inflated $27.2 TN, or 61%, to end March 2014 at a record $72.039 TN. To put this in context, Total Securities began 1990 at $10.0 TN, ended 1999 at $33.0 TN and closed 2007 at a then record $53.01 TN. Amazingly, Total Securities as a percent of GDP ended Q1 at 421%. For comparison, Total Securities to GDP began the nineties at 183%, ended Bubbly 1999 at 356% before peaking at 378% in a more Bubbly 2007. No Bubble today? “Valuations in historical range”?

Let’s return to “A Bubble is predicated on leverage.” Yes, Total Household Liabilities declined $715bn from the 2008 high-water mark (much of this from defaults). Yet over this period federal liabilities increased almost $10.0 TN. Corporate borrowings were up more than $2.3 TN. On a system-wide basis, our system is inarguably more leveraged today than ever.

Many contend there is significantly less speculative leverage these days compared to the heyday (“still dancing”) 2007 period. I’m not convinced. Perhaps there’s less leverage concentrated in high-yielding asset- and mortgage-backed securities. However, from today’s vantage point, there appears to be unprecedented “carry trade” leverage on a globalized basis. I’ve conjectured that the “yen carry trade” – using the proceeds from selling (or borrowing in) a devaluing yen to speculate in higher-yielding securities elsewhere – could be one of history’s biggest leveraged bets. Various comments also suggest that there is enormous leverage employed in myriad Treasury/Agency yield curve trades. I suspect as well that the amount of embedded leverage in various securities and derivative trades in higher-yielding corporate debt is likely unprecedented.

When it comes to leverage, the Federal Reserve’s balance sheet is conspicuous. Fed Assets will end the year near $4.5TN, with Federal Reserve Credit having expanded about $3.6 TN, or 400%, in six years. Few, however, appreciate the ramifications from this historic monetary inflation from the guardian of the world’s reserve currency. I find it astonishing that conventional thinking dismisses the market impact from this unprecedented inflation of central bank Credit.

Over the years, I have argued that “money” is integral to major Bubbles. A Bubble financed by junk debt won’t inflate too far before the holders of this debt begin to question the rationale for holding rapidly expanding debt of suspect quality. In contrast, a Bubble fueled by “money” – a perceived safe and liquid store of nominal value – can inflate for years. The insatiable demand enjoyed by issuers of “money” allows protracted excesses and maladjustment to impart deep structural impairment (financial and economic).

I’m convinced history will look back and view 2012 as a seminal year in global finance. Draghi’s “do whatever it takes,” the Fed’s open-ended QE, and the Bank of Japan’s Hail Mary quantitative easing will be seen as a fiasco in concerted global monetary management. The Fed’s QE3 will be viewed as an absolute debacle. After all, QE3 incited an unwieldy “Terminal Phase” of speculative Bubble excesses throughout U.S. equities and corporate debt securities, along with global securities markets more generally.  It unleashed major distortions throughout all markets, including sovereign debt.

A quick one-word refresher on “Terminal Phases:” Precarious. Their inherent danger arises from egregious late-cycle speculative excess and attendant maladjustment coupled with timid policymakers. Over recent years I have repeatedly invoked “Terminal Phase” in my analyses of a progressively riskier Chinese Bubble backdrop impervious to hesitant policy “tinkering.”

Here at home, we’re beginning to hear the apt phrase “The Fed is behind the curve.” Traditionally, falling “behind the curve” indicated that the central bank had been too slow to tighten policy in the face of mounting inflationary pressures. “Behind the curve” dictated that more aggressive tightening measures were required to rein in excesses. These days, “behind the curve” is applicable to an inflationary Bubble that has taken deep root in stock and bond markets. With the Yellen Fed seen essentially promising to avoid even a little baby-step 25 bps rate bump for another year, highly speculative Bubble markets can blithely disregard poor economic performance, a rapidly deteriorating geopolitical backdrop and the approaching end to QE. Worse yet, market participants are emboldened that “behind the curve” and the resulting dangerous market Bubbles preclude the Fed from anything but the most timid policy responses. A dangerous market view holds that, after instigating inflating securities markets as a direct monetary policy tool to stimulate the economy, the Fed would not in any way tolerate a problematic market downturn.

June 26 – Bloomberg (Steve Matthews and Jeff Kearns): “Federal Reserve Bank of St. Louis President James Bullard predicted the central bank will raise interest rates starting in the first quarter of 2015, sooner than most of his colleagues think, as unemployment falls and inflation quickens. Asked about his forecast for the timing of the first interest-rate increase since 2006, he said: ‘I’ve left mine at the end of the first quarter of next year.’ ‘The Fed is closer to its goal than many people appreciate,’ Bullard said… ‘We’re really pretty close to normal…’ If his forecasts bear out, ‘you’re basically going to be right at target on both dimensions possibly later this year… That’s shocking, and I don’t think markets, and I’m not sure policy makers, have really digested that that’s where we are.’”

The same day Bullard was talking hawk-like, Federal Reserve Bank of Richmond President Jeffrey Lacker was also making comments that should have the markets on edge. Countering uber-dove Yellen, Lacker stated that the recent jump in inflation was not entirely “noise.” Interestingly, he suggested that the Fed follow closely the FOMC’s 2011 exit strategy. “It’s not obvious to me a larger balance sheet should change any of our exit principles. I still think we should, as our exit principles say, be exiting from mortgage backed securities as soon as we can...” And following the lead of Kansas City Fed head Esther George, Lacker believes the Fed should allow its balance sheet to begin shrinking by ending the reinvestment of interest and maturity proceeds. Bullard also said the Fed should consider ending reinvestment.

Market ambivalence notwithstanding, I’m sticking with my analysis that the Fed can’t inflate its balance sheet from $900bn to $4.5 TN – and then end this massive monetary inflation without consequences. Things get even more interesting when talk returns to the Fed’s 2011 “exit strategy” road map. Regrettably, instead of exiting the Fed doubled-down – literally. And Dr. Bernanke may now say (while earning $250k) that the Fed’s balance sheet doesn’t have to shrink even “a dime.” Yellen and Dudley likely agree. But there’s now a more hawkish contingent that has other things in mind, and I don’t believe they will be willing to simply fall in line behind Yellen as officials did behind Greenspan and Bernanke.

Actually, I believe the so-called “hawks” (i.e. responsible central bankers) are gearing up to try to accomplish something that might these days appear radical: normalize monetary policy. Read “Systematic Monetary Policy and Communication” presented this week by Charles Plosser. Read Esther George’s “The Path to Normalization.” Re-read Richard Fisher. While you’re at it, read John Taylor’s op-ed from Friday’s WSJ: “The Fed Needs to Return to Monetary Rules.” I’m with Taylor (and Plosser!) on having and following rules. I’m also with Bullard: “I don’t think markets… have really digested… where we’re at.”

For the Week:

The S&P500 slipped 0.1% (up 6.1% y-t-d), and the Dow declined 0.6% (up 1.7%). The Utilities gained 0.9% (up 14.4%). The Banks dipped 0.4% (up 3.0%), and the Broker/Dealers fell 1.1% (down 0.9%). The Morgan Stanley Cyclicals were little changed (up 7.6%), while the Transports slipped 0.4% (up 10.5%). The S&P 400 Midcaps were up slightly (up 6.3%), and the small cap Russell 2000 added 0.1% (up 2.2%). The Nasdaq100 gained 1.1% (up 7.0%), and the Morgan Stanley High Tech index added 0.3% (up 6.0%). The Semiconductors fell 1.0% (up 17.6%). The Biotechs gained 0.6% (up 18.6%). With bullion up a buck, the HUI gold index increased 0.1% (up 19.7%).

One-month Treasury bill rates ended the week at one basis point and three-month rates closed at two bps. Two-year government yields added a basis point to 0.46% (up 8bps y-t-d). Five-year T-note yields fell four bps to 1.64% (down 10bps). Ten-year Treasury yields dropped seven bps to 2.54% (down 49bps). Long bond yields declined four bps to 3.37% (down 60bps). Benchmark Fannie MBS yields fell four bps to 3.18% (down 43bps). The spread between benchmark MBS and 10-year Treasury yields widened three to 64 bps. The implied yield on December 2015 eurodollar futures sank eight bps to 0.955%. The two-year dollar swap spread declined two to 13 bps, while the 10-year swap spread increased two to 11 bps. Corporate bond spreads widened somewhat. An index of investment grade bond risk increased one to 58 bps. An index of junk bond risk rose four to 299 bps. An index of emerging market (EM) debt risk added one to 266 bps.

Debt issuance slowed somewhat. Investment-grade issuers included Monsanto $4.0bn,Williams Partners LP $1.25bn, Legg Mason $1.05bn, Met Life Global Funding $800 million, Martin Marietta Material $700 million, Peoples United Bank $400 million, DTE Electric $350 million, Healthcare Trust of America $300 million, Kansas City Gas & Electric $250 million, Ameren Illinois $250 million, Entergy Louisiana $190 million and Entergy Gulf States $110 million.

Junk funds saw inflows of $619 million (from Lipper). The long list of junk issuers included Nielsen Finance $1.55bn, Memorial Resource Development $600 million, Endo Finance $500 million, Hilcorp Energy LP $500 million, CNH Capital $500 million, Rose Rock Midstream $400 million, C&S Group $400 million, NGL Energy LP $400 million, Carlson Travel $360 million, Conn's $250 million, AV Homes $200 million, Belden $200 million, SAExploration $150 million and APX Group $100 million.

Convertible debt issuers this week included Palo Alto Networks $500 million, Restoration Hardware $350 million, Scorpio Tankers $360 million and Mercadolibre $225 million.

International dollar debt issuers included National Australia Bank $2.1bn, Intesa Sanpaolo $2.0bn, Wind Acquisition Finance $1.9bn, Grupo Bimbo $1.3bn, Jordan $1.0bn, Ziraat Bankasi $750 million, Yamana Gold $500 million, Korea Gas $500 million, Popular $450 million, Toronto Dominion Bank $350 million, Mastellone Hermanos $200 million and Investec Property Fund $150 million.

Ten-year Portuguese yields increased three bps to 3.57% (down 256bps y-t-d). Italian 10-yr yields sank 11 bps to 2.83% (down 129bps). Spain's 10-year yields fell eight bps to 2.64% (down 151bps). German bund yields dropped eight bps to 1.26% (down 67bps). French yields fell nine bps to 1.71% (down 85bps). The French to German 10-year bond spread narrowed one to 45 bps. Greek 10-year yields declined seven bps to 5.92% (down 250bps). U.K. 10-year gilt yields sank 12 bps to 2.64% (down 38bps).

Japan's Nikkei equities index dropped 1.7% (down 7.3% y-t-d). Japanese 10-year "JGB" yields were down two bps to 0.56% (down 18bps). The German DAX equities index fell 1.7% (up 2.8%). Spain's IBEX 35 equities index dropped 1.8% (up 10.5%). Italy's FTSE MIB index sank 3.0% (up 12.4%). Emerging equities were mixed. Brazil's Bovespa index dropped 2.7% (up 3.2%). Mexico's Bolsa declined 0.9% (down 0.6%). South Korea's Kospi index gained 1.0% (down 1.1%). India’s Sensex equities index was unchanged (up 18.6%). China’s Shanghai Exchange increased 0.5% (down 3.8%). Turkey's Borsa Istanbul National 100 index was little changed (up 15.7%). Russia's MICEX equities index declined 0.6% (down 1.8%).

Freddie Mac 30-year fixed mortgage rates declined three bps to 4.14% (down 32bps y-o-y). Fifteen-year fixed rates sank eight bps to 3.22% (down 28bps). One-year ARM rates declined a basis point to 2.40% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 22 bps to 4.53% (down 14bps).

Federal Reserve Credit last week expanded $9.7bn to a record $4.332 TN. During the past year, Fed Credit expanded $890bn, or 25.8%. Fed Credit inflated $1.521 TN, or 54%, over the past 85 weeks. Elsewhere, Fed holdings for Foreign owners of Treasury, Agency Debt increased $8.5bn to $3.315 TN. "Custody holdings" were down $38bn year-to-date, with a one-year increase of $24.6bn.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $795bn y-o-y, or 7.1%, to $11.933 TN. Over two years, reserves were $1.520 TN higher for 15% growth.

M2 (narrow) "money" supply expanded $4.3bn to $11.317 TN. "Narrow money" expanded $723bn, or 6.8%, over the past year. For the week, Currency increased $2.0bn. Total Checkable Deposits declined $5.1bn, while Savings Deposits rose $12.7bn. Small Time Deposits were little changed. Retail Money Funds fell $4.1bn.

Money market fund assets increased $5.1bn to $2.556 TN. Money Fund assets were down $162bn y-t-d and dropped $38bn from a year ago, or 1.5%.

Total Commercial Paper jumped $12.4bn to $1.055 TN. CP was up $9.1bn year-to-date and $15bn over the past year, or 1.4%.

Currency Watch:

The U.S. dollar index slipped 0.4% to 80.04 (unchanged y-t-d). For the week on the upside, the Brazilian real increased 1.7%, the New Zealand dollar 0.9%, the Canadian dollar 0.9%, the South Korean won 0.7%, the Japanese yen 0.6%, the South African rand 0.6%, the Swiss franc 0.5%, the Australian dollar 0.4%, the Danish krone 0.4%, the euro 0.4%, the Taiwanese dollar 0.3%, the Mexican peso 0.1% and the British pound 0.1%. For the week on the downside, the Swedish krona declined 0.3%, the Norwegian krone 0.2% and the Singapore dollar 0.1%.

Commodities Watch:

The CRB index declined 0.7% this week (up 10.9% y-t-d). The Goldman Sachs Commodities Index fell 0.8% (up 4.9%). Spot Gold was little changed at $1,316 (up 9.2%). September Silver added another 0.7% to $21.13 (up 9%). August Crude declined $1.09 to $105.74 (up 7%). August Gasoline fell 0.9% (up 11%), and August Natural Gas sank 3.1% (up 4%). July Copper rallied 1.8% (down 7%). July Wheat was unchanged (down 3%). July Corn dropped 2.3% (up 5%).

U.S. Fixed Income Bubble Watch:

June 23 – Bloomberg (Lisa Abramowicz): “It’s never been easier for individuals to enter some of the most esoteric debt markets. Wall Street’s biggest firms are worried that it’ll be just as simple for them to leave. Investors have piled more than $900 billion into taxable bond funds since the 2008 financial crisis, buying stock-like shares of mutual and exchange-traded funds to gain access to infrequently-traded markets. This flood of cash has helped cause prices to surge and yields to plunge. Now, as the Federal Reserve discusses ending its easy-money policies, concern is mounting that the withdrawal of stimulus will lead to an exodus that’ll cause credit markets to freeze up. While new regulations have forced banks to reduce their balance-sheet risk, analysts at JPMorgan Chase & Co. are focusing on the problems that individual investors could cause by yanking money from funds. There’s a bigger risk ‘that when the the Fed starts hiking in earnest, outflows from high-yielding and less-liquid debt will lead to a free fall in prices,’ JPMorgan strategists led by Jan Loeys wrote… ‘In extremis, this could force a closing of the primary market and have serious economic impact.’”

June 27 – Bloomberg (Lisa Abramowicz): “Companies are on a borrowing binge that’s only accelerating, with investment-grade bond sales poised for a new record year. No one seems to be too concerned because leverage levels -- debt to a measure of profitability -- are in check, and central banks across the globe are working hard to keep suppressing borrowing costs. Companies have sold $668.4 billion of high-grade notes in the U.S. this year, 11% more than the same period last year and on pace for the biggest annual volume ever… Buyers still can’t get enough. Investors are now demanding about the smallest premium over benchmark rates to own the debt since 2007, according to Bank of America Merrill Lynch index data.”

June 16 – Financial Times (Tom Braithwaite, Tracy Alloway, Michael Mackenzie and Gina Chon): “Federal Reserve officials have discussed imposing exit fees on bond funds to avert a potential run by investors, underlining regulators’ concern about the vulnerability of the $10tn corporate bond market. Officials are concerned that bond-fund investors, as with bank depositors, can withdraw their money on demand even though the assets held by their funds are long-term debt and can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter. ‘So much activity in open-end corporate bond and loan funds is a little bit bank like,’ Jeremy Stein, a Fed governor from 2012-2014 told the Financial Times last month… ‘It may be the essence of shadow banking is ... giving people a liquid claim on illiquid assets.’”

June 27 – Bloomberg (Michael B. Marois and Michelle Kaske): “Puerto Rico may see its credit rating, already in the speculative range, lowered even more because of legislation to allow some public corporations to restructure their debt, Standard & Poor’s said. The company said it put the commonwealth’s general- obligation bond rating on CreditWatch with negative implications, meaning it could be lowered within 60 to 90 days if Governor Alejandro Garcia Padilla signs the bill into law.”

Federal Reserve Watch:

June 24 – Reuters (Howard Schneider): “The U.S. economy is approaching the Fed's economic targets faster than expected and might push the central bank to accelerate plans to increase interest rates, Philadelphia Federal Reserve Bank President Charles Plosser said… Plosser said he had increasing confidence in economic growth, and added that inflation was trending higher and unemployment likely to fall faster than many of his central bank colleagues project. ‘The current data suggest economic strength is fairly broad-based,’ Plosser, who is a voting member of the Fed's policy-setting committee this year, said… While he supported the Fed's most recent policy statement… Plosser said he had ‘growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive.’”

June 27 – MarketNews International (Karen Mracek): “Richmond Federal Reserve Bank President Jeffrey Lacker said… he thinks the U.S. central bank should follow the exit strategy outlined back in 2011 and there is not a compelling enough case to deviate from it. ‘It's not obvious to me a larger balance sheet should change any of our exit principles,’ Lacker told reporters… ‘I still think we should, as our exit principles say, be exiting from mortgage backed securities as soon as we can, to reduce the extent to which we are allocating credit and distorting credit markets,’ he said. Also as outlined in the 2011 exit principles, Lacker said the Fed should start by ending reinvestments, ‘letting our portfolio run off.’ ‘I don’t see any tremendous benefit to not doing what we said we would do,’ he said, adding that it is a credibility issue.”

U.S. Bubble Watch:

June 27 – Bloomberg (Jeanna Smialek): “The U.S. economy contracted in the first quarter by the most since the depths of the last recession as consumer spending cooled… Gross domestic product fell at a 2.9% annualized rate, more than forecast and the worst reading since the same three months in 2009… It marked the biggest downward revision from the agency's second GDP estimate since records began in 1976. The revision reflected a slowdown in health care spending.”

June 18 – Dow Jones (Steven Russolillo ): “U.S. companies returned a record amount of cash to shareholders through stock buybacks and dividend payouts in the first quarter, continuing a trend that has helped drive the stock market's record-setting rally. Stock buybacks and cash dividends reached $241.2 billion during the first three months of the year, exceeding the previous record of $233.2 billion set in the fourth quarter of 2007, according to S&P… The new high is more than three times the $71.8 billion total in the second quarter of 2009, when the economy was in the early stages of recovering from the financial crisis. The large payouts have played a prominent role in the market's record-breaking rally… ‘I expect this trend of greater shareholder return to continue throughout 2014, as activists remain strong, interest rates low, and companies awash in cash,’ said Howard Silverblatt, senior earnings analyst at S&P Dow Jones Indices. Companies particularly splurged on buybacks during the first quarter. They bought back $159.3 billion worth of stock during the first three months of 2014, up 59% from a year ago and a 23% increase from the fourth quarter.”

June 16 – Bloomberg (Sandrine Rastello and Nina Glinski): “The International Monetary Fund cut its growth forecast for the U.S. economy this year and said the Federal Reserve may have scope to keep interest rates at zero for longer than investors expect. The Washington-based IMF now sees the world’s largest economy growing 2% this year, down from an April estimate of 2.8%.”

Central Banker Watch:

June 27 – Bloomberg (Jennifer Ryan): “Bank of England Governor Mark Carney may need a bigger weapon to subdue risks from Britain’s booming property market. Faced with house-price increases of almost 20% in London and calls to prevent a bubble from threatening financial stability, Carney said yesterday the bank would impose a cap on loan-to-income ratios and other limits on mortgages… Carney’s approach, while marking an unprecedented step into the housing market for U.K. authorities, was less severe than analysts had anticipated.”

June 25 – Bloomberg (Jeff Black): “European Central Bank Governing Council member Jens Weidmann says even though inflation rates will remain ‘significantly below 2%’ until the end of 2016, ‘the euro area is not in a deflationary spiral.’ With the introduction of a negative deposit rate and targeted loans, ‘we have entered uncharted territory…’ ‘I’m taking a stand for not keeping interest rates low for longer than absolutely necessary.’ ‘High vigilance is needed on Germany’s property market,’ because high price increases in some German cities could be the first sign for a bubble.’”

Geopolitical Watch:

June 25 – Financial Times (Jamil Anderlini): “China is aggressively expanding plans to establish a global financial institution to rival the World Bank and the Asian Development Bank, which Beijing fears are too influenced by the US and its allies. In meetings with other countries in recent weeks, Beijing has proposed doubling the size of registered capital for the proposed bank to $100bn… So far, 22 countries across the region, including several wealthy states in the Middle East – which China refers to as ‘West Asia’ – have shown interest in the multilateral lender… China’s push for a regional institution that it would control reflects Beijing’s frustration at western dominance of the multilateral bodies… ‘China feels it can’t get anything done in the World Bank or the IMF so it wants to set up its own World Bank that it can control itself,’ said one person directly involved in discussions… ‘There is a lot of interest from across Asia but China is going to go ahead with this even if nobody else joins it.”

June 25 – Dow Jones: “A new map that gives extra attention to China's territorial claims in the South China Sea is drawing a mixed response from social-media users, with some calling it ‘unnecessary.’ The map, made by mapmakers affiliated with Hunan Map Press and the Hubei Bureau of Surveying, Mapping and Geo-Information, stretches from the northern tip of China to the southern tip of Borneo. It's the first map of China from an official organization to be stretched vertically to include all of the islands it claims in the South China Sea, the state-run Xinhua news agency said. ‘[This map] will give the reader a comprehensive and intuitive awareness of China's entire map," Xinhua said, citing Lei Yixun, the editor in chief of Hunan Map Press. 'Readers won't ever think again that China's territory has primary and secondary claims."

June 27 – Wall Street Journal (Anton Troianovski and Danny Yadronmowicz): “The German government… said it would end a contract with Verizon Communications Inc. because of concerns about network security, one of the most concrete signs yet that disclosures about U.S. spying were hurting American technology companies overseas… The German government's move underscores the continuing political headaches for U.S. technology businesses operating abroad, more than a year after former National Security Agency contractor Edward Snowden started revealing the reach of America's electronic surveillance programs and the alleged cooperation with some U.S. firms.”

China Bubble Watch:

June 27 - Reuters (Xiaoyi Shao): “Sales of new homes in China dropped 23% in the first six months of 2014 from a year ago, a private survey showed…, underlining a sustained downturn in the housing market after a weak start to the year… After a strong performance in 2013, China's real estate market has softened as banks become increasingly cautious about issuing mortgages and lending to developers, and as home buyers turn pessimistic. The CRIC data showed average sales in China's wealthiest cities including Beijing, Shanghai, Guangzhou and Shenzhen slumped 37% in the first-half of this year. Beijing experienced the deepest fall at 49%.

June 25 – Reuters (Fayen Wong): “Chinese gold processing firms have since 2012 used falsified gold transactions to borrow 94.4 billion yuan ($15.2bn) from banks, the country’s chief auditor said. Commodities such as copper, rubber, soybeans and bullion have commonly been used in China for financing, where traders or investors borrow against the commodity with the aim of investing the money in high-return areas such as real estate or shadow banking. Most such deals are legitimate, but revelations of borrowing based on fake transactions in the gold market by the national auditor, which comes on the heels of alleged metals financing fraud at Qingdao Port, may prompt authorities to launch another crackdown on commodity financing. Spot checks on 25 companies that process bullion, such as jewellers, showed they made a combined profit of more than 900 million yuan by using the bank loans to take advantage of the difference between onshore and offshore interest rates, as well the appreciation of the Chinese currency, according to a report published this week on the National Audit Office's website. Chinese firms could have locked up as much as 1,000 tonnes of gold in financing deals by the end of 2013, the World Gold Council said in April, indicating a big slice of imports has been used to raise funds due to tight credit conditions… At current prices, that would be worth about $42 billion."

June 18 – Bloomberg: “Citic Resources Holdings Ltd., the commodities trader controlled by China’s largest state-owned investment company, said it’s missing more than half its alumina stored at Qingdao Port amid a probe into lending. A Qingdao court was unable to locate alumina worth about $49 million… Qingdao Port is counting industrial metals held in some of its bonded warehouses to determine if they match the amount in documents pledged to banks as collateral for loans, three people with knowledge of the probe said on June 5. The port is concerned that there has been multiple counting of some batches of metals including copper and aluminum, said the people. ‘Citic Resources’ loss is just the tip of the iceberg,’ said Helen Lau… analyst with UOB Kay Hian Ltd.. ‘There will be many more companies found to be victims as the investigation over multi-counting of metals evolves.’ …Foreign and local banks are examining lending linked to metals at Qingdao amid concern that risks are more widespread in China, where traders use commodities from iron ore to rubber to get funding.”

June 27 – New York Times (Neil Gough): “China’s commodities fraud scandal continues to widen, with more companies reporting losses on bogus aluminum and copper financing deals, while Chinese authorities now say gold contracts have also been faked to secure more than $15 billion in loans. On Thursday, a coal producer in the northeastern city of Taiyuan, in Shanxi Province, said it had launched a lawsuit to reclaim about $170 million it said it was owed. The producer named among the defendants the Chinese company at the center of an investigation into aluminum and copper financing fraud at Qingdao Port, in northeastern Shandong Province.”

June 25 – Bloomberg: “China’s chief auditor said growth in local government debt slowed, a sign that tighter scrutiny on borrowing and an economic slowdown have curbed credit. Outstanding debt for nine provinces and nine cities grew 3.79% from the end of June last year through March, 7 percentage points slower than the pace in the first half of 2013… A slower pace of debt growth would help ease financial risks in local borrowings that surged 67% to 17.9 trillion yuan ($2.9 trillion) as of June 2013 from the end of 2010.”

June 23 – Bloomberg (Abigail Moses and Jennifer Joan Lee): “China’s economic slowdown deepened this quarter, as capital spending showed weakness and fewer companies applied for credit, a private survey showed. Half of businesses reported higher investment, the smallest proportion and the sharpest drop since the survey began 10 quarters ago, according to the China Beige Book… The slowdown hurt hiring and wages, and interest rates offered by shadow lenders fell below levels offered by banks, it said. ‘Since investment has been the engine of the economy for the past seven years, this weakness has sweeping effects on sectors, regions and gauges of firm performance,’ Leland Miller, president of China Beige Book International, said… ‘Overinvestment has been an addiction and withdrawal symptoms will not be pretty.’”

June 25 – Bloomberg (Abigail Moses and Jennifer Joan Lee): “China Ting Group Holdings Ltd., a garment maker, said two borrowers defaulted on entrusted loans it made through Ningbo Bank Corp. and Bank of Communications Ltd… Entrusted loans, advances between companies arranged through banks, are part of China’s shadow banking system that regulators are seeking to rein in. Some of the entrusted funds, which totaled 8.2 trillion yuan as of the end of 2013, were being directed to industries that face lending curbs from the government, according to the People’s Bank of China… China’s 10 largest lenders reported overdue loans reached 588 billion yuan at the end of 2013, a 21% increase from a year earlier to the highest level since at least 2009… The number of entrusted loans made by publicly traded companies rose 43% from 2012 to 397 cases in 2013, the central bank said…”

June 27 – Bloomberg (Lisa Abramowicz): “China’s project to build a replica Manhattan is taking shape against a backdrop of vacant office towers and unfinished hotels, underscoring the risks to a slowing economy from the nation’s unprecedented investment boom. The skyscraper-filled skyline of the Conch Bay district in the northern port city of Tianjin has none of a metropolis’s bustle up close, with dirt-covered glass doors and construction on some edifices halted. The area’s failure to attract tenants since the first building was finished in 2010 bodes ill across the Hai River for the separate Yujiapu development, which is modeled on New York’s Manhattan and remains in progress. ‘Investing here won’t be better than throwing money into the water,’ Zhang Zhihe, 60, said during a visit to the area last week from neighboring Hebei province to look at potential commercial-property investments. ‘There will be no way out -- it will be very difficult to find the next buyer.’”

Japan Watch:

June 27 – Bloomberg (Toru Fujioka and Chikako Mogi): “Japan’s consumer prices climbed at the fastest pace in 32 years, boosted by higher utility charges and a sales-tax increase that contributed to the biggest slide in household spending since the March 2011 earthquake. Consumer prices excluding fresh food rose 3.4% in May from a year earlier…”

Global Bubble Watch:

June 16 – Bloomberg (Anchalee Worrachate and Liz Capo McCormick): “The boom in fixed-income derivatives trading is exposing a hidden risk in debt markets around the world: the inability of investors to buy and sell bonds. While futures trading of 10-year Treasuries is close to an all-time high, bond-market volume for some maturities has fallen a third in the past year. In Japan’s $9.6 trillion debt market, the benchmark note didn’t trade until midday on two days last week. As a lack of liquidity in Italy caused transaction costs in the world’s third-largest sovereign bond market to jump last month, Lombard Odier Asset Management helped propel an eightfold surge in Italian futures by relying more on derivatives. The shift reflects an unintended consequence wrought by central banks, which have dropped interest rates close to zero and implemented policies such as buying debt to restore demand in economies crippled by the financial crisis. Inefficiencies in the $100 trillion market for bonds may make investors more vulnerable to losses when yields rise from historical lows. ‘Liquidity is becoming a serious issue,’ Grant Peterkin, a money manager at Lombard Odier, which oversees $48 billion, said… The worry is that when investors try to exit their positions, ‘there may be some kind of squeeze.’ That concern has caused investors to pour into derivatives, which are contracts based on underlying assets that can provide the same exposure without tying up as much capital.”

June 16 – Reuters: “The Chinese corporate bond market has overtaken the United States as the world's biggest and is set to soak up a third of global company debt needs over the next five years, according to… Standard & Poor's, underscoring the growing risk China's debt market is imposing on the global financial system. Chinese corporate borrowers owed $14.2 trillion at the end of 2013 versus $13.1 trillion owed by U.S. corporations… The Asia-Pacific region, led by China, is seen accounting for half of global corporate debt financing needs of $60 trillion over the five-year period to 2018 when the region will account for more than half the projected total debt outstanding of $72 trillion. China, the world's second-largest economy is currently financing a quarter to a third of its corporate debt through its shadow banking sector and this had global implications, S&P said. ‘This means that as much as 10% of global corporate debt is exposed to the risk of a contraction in China's informal banking sector,’ the agency said, estimating this at $4 trillion to $5 trillion… Cash flows and leverage at Chinese corporations are the worst among global peers, having deteriorated from being the best in 2009, according to a corporate financial risk trend measure used by Standard & Poor's.”

June 16 – Financial Times (Ralph Atkins): “Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions. ‘A cluster of central banking investors has become major players on world equity markets,’ says a report to be published this week by the Official Monetary and Financial Institutions Forum (Omfif), a central bank research and advisory group. The trend ‘could potentially contribute to overheated asset prices’, it warns. Central banks are traditionally conservative and secretive managers of official reserves… The report, seen by the Financial Times, identifies $29.1tn in market investments, including gold, held by 400 public sector institutions in 162 countries. Central banks’ actions aimed at stimulating economies, including quantitative easing, have deliberately sought to push investors into riskier assets, and share prices have risen sharply since 2009 – leading to fears of stock market corrections if economic growth disappoints.”

June 23 – CNBC (Antonia Matthews and Catherine Boyle): “A bubble currently brewing in sovereign debt will likely burst in the next couple of years, U.S. billionaire Wilbur Ross warned… ‘I've felt for some time that the ultimate bubble, when we look back a few years from now, is going to be sovereign debt, both U.S. and other, because it's way below any sort of reversion to the mean of interest rates… If you look at where the U.S. 10-year had averaged over the 10 preceding years, it's around 4%. If it reverts back to that level at some point there will be terrible losses in the long-term Treasury market and those will probably be accentuated in other areas of fixed income.’”

June 27 – Bloomberg (Lorenzo Totaro): “As Italy’s borrowing costs fall to new lows, its debt is rising to the most ever. The country owed 5% more in April compared with a year earlier, with debt reaching 2.15 trillion euros ($2.9 trillion)… That matches the outstanding borrowing of Germany, the largest economy in Europe and the most of any country on the continent… While Germany is scheduled to grow 2% this year, Italy will expand 0.3% in 2014… This year, Italy foresees increasing its debt ratio to 134.9% of gross domestic product from 132.6% in 2013…”

June 23 – Financial Times (Andrew Bolger): “European companies that raise finance are taking on levels of debt not seen since the financial crisis as they adjust to the prospect of low interest rates for the foreseeable future. The ratio of debt to company earnings, or ‘leverage multiples’, for all European transactions were 5.1 times earnings in the first quarter of 2014, above the 10-year average (4.8 times) for the first time since 2008. The European Central Bank’s decision to cut a key interest rate this month has exacerbated a mismatch in supply and demand for yield from investors. It had resulted in ever-tighter pricing for new issuance of loans and bonds, said Standard & Poor’s… ‘Supply-demand imbalance could continue to lead to excessively borrower-friendly lending standards and more highly leveraged transactions, something we are already starting to observe,’ said Taron Wade, an S&P analyst. ‘Indeed, leverage multiples on transactions in Europe have been steadily increasing since 2009.’”

June 25 – Bloomberg (Abigail Moses and Jennifer Joan Lee): “Companies are debuting a record amount of bonds in Europe as investors demanding higher yields show greater tolerance for untested borrowers who are seeking to diversify funding as banks curtail lending. Finnish insulation maker Paroc Group Oy and French car parts distributor Autodis SA are among 54 first-time issuers that sold 20 billion euros ($27bn) of notes this year, compared with 40 companies selling 14 billion euros in the same period last year… More than 75% were either unrated or below investment grade, with more than half of those ranked B or lower. ‘Issuers can sell anything they want and it’s getting bought,’ said David Newman, the… head of global high yield at Rogge Global Partners, which manages $55 billion. ‘Worse and worse credits are coming to market.’

EM Bubble Watch:

June 17 – Associated Press (Michael Warren): “President Cristina Fernandez says Argentina won't submit to what she calls extortion or allow its economy to be ruined after losing an appeal to the U.S. Supreme Court on defaulted debt. She says there's no way Argentina can comply with the U.S. court rulings to pay off the disputed bonds in full. Fernandez says her government is willing to negotiate but insists it won't pay cash to the winners of the court battle, even if refusing to comply with the court rulings closes the doors of the U.S. financial system to Argentina. Delivering a national address Monday night, Fernandez said: ‘What I cannot do as president is submit the country to such extortion.’”

June 25 – Wall Street Journal (Paulo Trevisani): “Total credit in the Brazilian economy reached 2.8 trillion Brazilian reais ($1.26 trillion) in May… The figure represents a 12.7% increase over the previous 12 months, and a 1% increase over April…”

Europe Watch:

June 24 – Bloomberg (Alessandro Speciale): “German business confidence fell to the weakest level this year amid signs of slower growth in Europe’s largest economy.”