Sunday, December 14, 2014

Weekly Commentary, July 11, 2014: 2014 vs. 2007

The job of an economist, among many other duties, is to put things into perspective. So, because I am an economist, among other duties, here is a little perspective on the recent turmoil in the stock and bond markets. First, when the story of this turbulence is reported, the usual explanation mainly has to do with some new loss in the subprime mortgage world… Here is the first instance in which proportion tells us that something is out of whack: The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13%, or about $1.35 trillion, is subprime — certainly a large sum. Of this, nearly 14% is delinquent, meaning late in payment or in foreclosure. Of this amount, about 5% is actually in foreclosure, or about $67 billion. Of this amount, according to my friends in real estate, at least about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to $34 billion… The total wealth of the United States is about $70 trillion. The value of the stocks listed in the United States is very roughly $15 trillion to $20 trillion. The bond market is even larger… This economy is extremely strong. Profits are superb. The world economy is exploding with growth. To be sure, terrible problems lurk in the future: a slow-motion dollar crisis, huge Medicare deficits and energy shortages. But for now, the sell-off seems extreme, not to say nutty. Some smart, brave people will make a fortune buying in these days, and then we’ll all wonder what the scare was about.” Ben Stein, “Chicken Little’s Brethren, on the Trading Floor,” New York Times, August 12, 2007

I couldn’t help but to recall Ben Stein’s summer 2007 article, as pundits were this week dismissing that tiny little Portugal could have any bearing on the juggernaut U.S. economy and booming financial markets. And thinking back to August ’07, Mr. Stein looked pretty smart for a while, with stocks rallying back from that month’s selloff to post all-time highs in mid-October. On the surface, things did look pretty good – “This economy is extremely strong. Profits are superb. The world economy is exploding with growth.” Unappreciated back then was the acute fragility inherent to massive quantities of mis-priced finance and speculative leverage. So flawed was market faith that Washington would never tolerate a general housing downturn.

From my perspective, 2014 and 2007 share troubling similarities. Both periods feature overheated securities markets, replete with the rapid issuance of securities at inflated valuations. Both are characterized by investor exuberance in the face of deteriorating fundamentals – and in both cases central bank policymaking was fundamental to heavily distorted market risk perceptions. It’s no coincidence that today’s overheated backdrop – record securities issuance and meager risk premiums/record high prices – readily garner statistical comparison to 2007.

This year’s booming M&A market has posted the strongest activity since 2007. Second quarter global M&A volume of $1.06 TN was up 72% from the year ago period. Here at home, M&A more than doubled year-on-year to $473 billion, pushing record first-half volume to $749 billion. The proliferation of deals was fueled by the loosest Credit conditions in years. First-half global corporate bond issuance hit an all-time high $2.29 TN. A record $286 billion of junk bonds were issued globally, as average junk yields traded to the lowest level ever. At $642 billion, first-half U.S. investment-grade company bond sales easily posted an all-time high. The first six months of 2014 also saw record issuance of collateralized loan obligations (CLOs). A record number of global IPOs were sold in the first half, with $90.6 billion of offerings 54% above comparable 2013. Led by technology and biotechnology issues, U.S. IPO sales enjoyed the strongest first-half since the height of the technology bubble back in 2000. According to Dealogic, year-to-date total global sales of corporate stock and equity-linked securities reached an unmatched $510 billion, outpacing 2007’s record pace.

Various measures of market risk perceptions – from corporate risk premiums to the VIX equities volatility index – have this year sunk back to 2007 Credit Bubble heyday lows. Ominously reminiscent of the second-half of 2007, Treasury yields have unexpectedly turned lower in the face of overheated risk markets. I have posited that respective rate “conundrums” can both be at least partially explained by safe haven buying in anticipation of mounting market vulnerability. Recalling 2007, market exuberance is these days fueled by the perceptions of endless cheap liquidity and adroit policymakers with everything under control. Quite simply, it is taken as indisputable fact that global central bankers will not tolerate a return to financial crisis.

The major problem, now midway through 2014, is that global central bankers do not have things under control. Yes, they can continue to aggressively create “money” and stoke runaway global securities booms. But this in no way helps to rectify structural economic impairment. In no way has rampant monetary inflation worked to correct global financial and economic imbalances. As such, central bank liquidity and market intrusion have set the stage for inevitable problematic market adjustments.

I certainly don’t believe Draghi’s “do whatever it takes” market intervention resolved Europe’s deep structural problems. I don’t even think it “bought time.” Loose “money” instead bought another Bubble. The Draghi ECB (in concert with the Bernanke Fed and Kuroda BOJ) forced sweeping short covering of bearish bets throughout Europe – and then incentivized leveraged speculation throughout the euro zone.

The resulting historic collapse in European periphery yields was nothing short of miraculous. Unfortunately, this market moonshot may have enriched the speculator community but it did little to ameliorate structural maladjustment. I suspect that when Bubble ebullience and greed subside, fear for the soundness of the European banking system could hastily reemerge. Indeed, the divergence between bubbling securities markets and poor economic prospects has created acute latent fragilities.

Fragilities erupted this week with issues in the Portuguese banking sector. Troubles at Banco Espirito Santo, one of Portugal’s largest banks, quickly spread throughout European equities and debt markets. Portugal’s PSI All-Share Index was slammed for 9.1%. Fears of a potential bank bailout pressured Portuguese sovereign bonds. Portugal 10-year yields jumped 28 bps this week. Nervousness quickly spread throughout periphery markets. Spanish stocks were hit for 4.3%, with 10-year yields up nine bps. In Italy, stocks were slammed for 4.4%, as yields rose five bps. Greek 10-year yields jumped 33 bps. And with German 10-year bund yields sinking six bps to near 2012 lows, yield spreads (to bunds) widened meaningfully throughout Europe.

It’s also worth noting that the euro vs the yen this week traded to the lowest level since early-February, ending the week down 65 bps. So called “carry trades” – short bunds or the Japanese yen to finance higher-yielding peripheral bonds – suffered a rough week. And perhaps it was only a coincidence that commodities markets got walloped and Treasuries caught a strong bid.

A couple Bloomberg headlines were worth highlighting: “Espirito Santo Rocks Bonds from Sao Paulo to Rio” and “Complacency Disrupted by Portugal to Puerto Rico.” It may be early to get too excited about contagion effects. Yet the colossal global leveraged speculating community is a likely transmission mechanism from Portuguese debt to the world’s risk markets. Europe’s market Bubbles would appears at this point a high-risk proposition.

In the face of unprecedented monetary stimulus and surging securities markets, the continent’s economy will struggle to post positive growth this year. In particular, the second (France) and third (Italy) largest economies might actually contract, while the great German economic machine has begun to sputter. National government debt as a percent of GDP is approaching 100% in France and 135% in Italy. In Portugal, government debt of 130% is dwarfed by corporate debt at 250% of GDP. Portugal’s economy will likely contract again in 2014. It will post another large fiscal deficit, with a stubbornly high 15% unemployment rate. Bubbling securities markets have been masking a lot of economic, social and political angst throughout the continent.

From the perspective of my analytical framework, Portuguese markets reside at “the periphery of the periphery” – a marginal borrower susceptible to inflection points in the market backdrop for risk-taking and liquidity. So I’ll take this week’s developments seriously. There is the possibility that markets might now confront the initial onset of de-risking/de-leveraging dynamics.

Late-stage speculative Bubbles grow into wild animals. There is always a fine line between manic speculative blow-off excess and problematic cracks appearing in the underlying Bubble. As was certainly the case in early-2000 and late-2007, deteriorating fundamental prospects and resulting shorting (and hedging) provide combustible tinder for squeezes and destabilizing market advances. Moreover, upside market dislocations in the face of dimming fundamental prospects create divergences and latent fragilities.

I have argued that (reminiscent of 2007) we’re in the midst of an especially precarious environment. The now full-fledged Global Government Finance Bubble has spurred Bubble markets encompassing virtually all asset classes in markets all around the world. Many markets have succumbed to “blow-off” squeezes and excess – with religious zeal for the power of central bank liquidity. Risk markets have also become highly correlated.

I have argued that the next round of “risk off” will be problematic. The Fed is now only several months from ending liquidity-creating operations. If a bout of market turbulence forces the leveraged players to de-risk, it’s not clear who’s left to buy. Markets should not dismiss the global ramifications from Portuguese bank problems (or Puerto Rico debt issues).

Here at home, corporate debt spreads widened somewhat this week. More interestingly, spreads widened meaningfully for the Credit insurers. MBIA, Radian, Assured Guarantee and MGIC all saw debt spreads widen at least 30 bps. Fundamental issues are at work. There’s mounting nervousness for insurers of Puerto Rico debt, while proposed rules from the Federal Housing Finance Agency to boost the strength of the mortgage insures also weighed on the sector. Operating with extreme leverage to potential systemic Credit issues, I have always viewed the risk insurance industry as the “periphery of the periphery” for the U.S. Credit Bubble.

As an analyst of Bubbles, I appreciate that it is virtually impossible to predict the timing of their implosion. But that doesn’t dissuade me from diligently monitoring for “weak links” and potential catalysts. And like 2007, highly speculative markets fixate on fun and games and instant gratification, while steadfastly refusing to discount mounting systemic risk (in ebullient markets, it’s referred to as “resilient”). Thus far, markets have performed consistent with the “Granddaddy of all Bubbles” thesis.

Compared to 2007, today’s excesses are more extreme. U.S. equities have jumped from 2007’s $25.6 TN to today $34.5 TN. I have in previous CBBs highlighted that total marketable securities (debt & equities) surpassed $72 TN in Q1, up 36% from booming 2007. I would also contend that the global economy was in relatively much better shape in ‘07/'08. Europe is today much weaker and China is much more vulnerable. Emerging market economies and Credit systems, in particular, suffer from six years of unwieldy finance on an unprecedented scale. Today’s geopolitical mess makes 2007 look like outright peace, tranquility and global solidarity. And I would argue that the maladjusted U.S. economy is today more vulnerable to “risk off” securities market tumult than ever.

What really worries me is the huge growth since 2007 in trend-following and performance-chasing finance (i.e. the leveraged speculating community and the ETF industry). It’s this “Moneyness of Risk Assets” issue (see last week’s CBB). The world believes central banks will ensure ample marketplace liquidity – the never-ending bull market. In my eyes, it has all regressed to a precarious confidence game of epic proportions. And so long as speculative leverage increases and funds continue to flow freely into stocks and bonds, bullish perceptions of endless cheap liquidity and unending growth in corporate earnings (adjusted for stock buybacks, of course) endure.

Chair Yellen last week dazzled the bulls with simple dovishness. This week, regional Fed Presidents Esther George, Charles Plosser and James Bullard all suggested rate increases may be closer than the market today anticipates. Which brings to mind an important contrast to 2007: The entire committee was ready to fall in line behind Dr. Bernanke, as the learned professor formulated his (inflationist) response to the unfolding crisis. Today, the Fed has shot its bullets, while deep philosophical differences within the Fed will surely complicate its response to faltering market Bubbles. A lot of market misperceptions and misguided faith will be at risk come the next serious bout of “risk off.” I was almost expecting David Tepper to show up on CNBC this week and warn of another round of Nervous Time.

For the Week:

The S&P500 declined 0.9% (up 6.5% y-t-d), and the Dow lost 0.7% (up 2.2%). The Utilities gained 0.9% (up 11.6%). The Banks were hit for 2.0% (up 2.5%), and the Broker/Dealers sank 4.2% (down 3.1%). The Morgan Stanley Cyclicals were unchanged (up 9.7%), while the Transports dipped 0.5% (up 11.5%). The S&P 400 Midcaps dropped 2.3% (up 5.1%), and the small cap Russell 2000 was pounded for 4.0% (down 0.3%). The Nasdaq100 slipped 0.5% (up 8.7%), and the Morgan Stanley High Tech index declined 1.4% (up 6.6%). The Semiconductors fell 1.0% (up 20.3%). The Biotechs dropped 2.1% (up 19.9%). With bullion jumping $18, the HUI gold index rallied 3.1% (up 25.1%).

One- and three-month Treasury bill rates closed the week at two bps. Two-year government yields declined six bps to 0.45% (up 7bps y-t-d). Five-year T-note yields fell 10 bps to 1.64% (down 10bps). Ten-year Treasury yields dropped 12 bps to 2.52% (down 51bps). Long bond yields sank 13 bps to 3.34% (down 63bps). Benchmark Fannie MBS yields fell 13 bps to 3.19% (down 42bps). The spread between benchmark MBS and 10-year Treasury yields narrowed one to 67 bps. The implied yield on December 2015 eurodollar futures declined three bps to 0.975%. The two-year dollar swap spread jumped four to 17 bps, and the 10-year swap spread gained one to 11 bps. Corporate bond spreads widened. An index of investment grade bond risk increased three to 58 bps. An index of junk bond risk jumped 12 to 304 bps. An index of emerging market (EM) debt risk rose four to 264 bps.

Debt issuance was generally slow. Investment-grade issuers included AIG $2.5bn, Met Life $1.0bn, American Honda Finance $1.0bn, Moody's $750 million and Alexandria Real Estate Equities $700 million.

Junk funds saw inflows slow to $107 million (from Lipper). Junk issuers included Calpine $2.75bn, General Motors Financial $1.5bn, Walter Energy $900 million, Sinclair Television Group $550 million, Magnetation $425 million, Summit Midstream $300 million and Covenant Surgical Partners $130 million.

Convertible debt issuers this week included Energy & Exploration Partners $375 million and MacQuarie Infrastructure $305 million.

International dollar debt issuers included InterAmerican Development Bank $3.0bn, Sumitomo Mitsui Banking $3.0bn, BPCE $1.35bn, Bank of Montreal $1.3bn, DBS Group $1.25bn, Bank of Baroda $1.0bn, Bank Nederlandse Gemeenten $1.0bn, Cimpor Financial Operations $750 million, Corp Financciera de Desarrollo $600 million, Paragon Offshore $1.08bn, Kookmin Bank $500 million, Klabin Finance $500 million, Transelec $375 million, Tupy $350 million, Kommuninvest Sverige $300 million, Seven and Seven $125 million and BTG Investments LP $111 million.

Ten-year Portuguese yields surged 28 bps to 3.87% (down 226bps y-t-d). Italian 10-yr yields rose five bps to 2.89% (down 124bps). Spain's 10-year yields gained nine bps to 2.77% (down 138bps). German bund yields were down six bps to 1.20% (down 73bps). French yields dropped five bps to a record low 1.64% (down 92bps). The French to German 10-year bond spread widened one to 44 bps. Greek 10-year yields surged 33 bps to 6.26% (down 216bps). U.K. 10-year gilt yields dropped 16 bps to 2.60% (down 42bps).

Japan's Nikkei equities index dropped 1.8% (down 6.9% y-t-d). Japanese 10-year "JGB" yields declined three bps to 0.54% (down 20bps). The German DAX equities index sank 3.4% (up 1.2%). Spain's IBEX 35 equities index sank 4.3% (up 6.3%). Italy's FTSE MIB index fell 4.4% (up 8.7%). Emerging equities were mixed to lower. Brazil's Bovespa index gained 1.4% (up 6.4%). Mexico's Bolsa was little changed (up 1.8%). South Korea's Kospi index fell 1.0% (down 1.2%). India’s bubbly Sensex equities index was slammed for 3.6% (up 18.2%). China’s Shanghai Exchange slipped 0.6% (down 3.3%). Turkey's Borsa Istanbul National 100 index rallied 2.4% (up 17.1%). Russia's MICEX equities index fell 0.9% (down 0.3%).

Freddie Mac 30-year fixed mortgage rates rose three bps to 4.15% (down 36bps y-o-y). Fifteen-year fixed rates were up two bps to 3.24% (down 29bps). One-year ARM rates gained two bps to 2.44% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down a basis point to 4.57% (down 58bps).

Federal Reserve Credit last week expanded $6.03bn to a record $4.337 TN. During the past year, Fed Credit inflated $880bn, or 25.5%. Fed Credit inflated $1.265 TN, or 54%, over the past 87 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $5.3bn to $3.309 TN. "Custody holdings" were down $45bn year-to-date, while posting a one-year increase of $24bn.

M2 (narrow) "money" supply declined $3.9bn to $11.356 TN. "Narrow money" expanded $702bn, or 6.6%, over the past year. For the week, Currency increased $0.5bn. Total Checkable Deposits jumped $19.4bn, while Savings Deposits dropped $19.4bn. Small Time Deposits slipped $1.0bn. Retail Money Funds declined $3.2bn.

Money market fund assets rose $5.4bn to $2.575 TN. Money Fund assets were down $143bn y-t-d and dropped $48bn from a year ago, or 1.8%.

Total Commercial Paper dropped $12.1bn to $1.420 TN. CP was down $3.9bn year-to-date, while gaining $51bn over the past year, or 5.2%.

Currency Watch:

The U.S. dollar index was little changed at 80.187 (up 0.2% y-t-d). For the week on the upside, the New Zealand dollar increased 0.8%, the Japanese yen 0.8%, the Swedish krona 0.7%, the South African rand 0.5%, the Singapore dollar 0.4%, the Australian dollar 0.3%, the Swiss franc 0.2%, the Norwegian krone 0.2%, the Danish krone 0.1% and the euro 0.1%. For the week on the downside, the South Korean won declined 1.0%, the Canadian dollar 0.8%, the Brazilian real 0.3%, the British pound 0.3%, the Taiwanese dollar 0.2% and the Mexican peso 0.2%.

Commodities Watch:

The CRB index sank 3.2% this week (up 6.0% y-t-d). The Goldman Sachs Commodities Index was hit for 3.5% (down 0.2%). Spot Gold gained 1.4% to $1,339 (up 11%). September Silver rose 1.5% to $21.46 (up 11%). August Crude fell $3.23 to $100.83 (up 2%). August Gasoline sank 3.7% (up 4%), and August Natural Gas dropped 5.9% (up 2.0%). July Copper slipped 0.3% (down 4%). July Wheat was hammered for 9.4% (down 15%). July Corn sank 4.1% (down 5%).

U.S. Fixed Income Bubble Watch:

July 10 – Wall Street Journal (Aaron Kuriloff): “Puerto Rico remains committed to honoring its financial obligations and creating economic growth, according to a statement by the commonwealth's Government Development Bank and Treasury… The recent legislation allowing some public agencies to restructure their debts is a last resort that protects both essential services and stakeholders, creating a forum for where ‘the fair and equitable allocation of the value of a public corporation can be negotiated,’ the statement says.”

July 11 – Wall Street Journal (Aaron Kuriloff): “The Puerto Rico Electric Power Authority tapped reserve funds to pay investors last week in the latest sign the cash-strapped utility may soon restructure its debt. A trustee for the power authority withdrew about $41.6 million from a reserve fund to make payments… Investors were concerned that the authority, which has almost $9 billion in total debt, wouldn't make scheduled bond payments last week after Puerto Rico passed legislation allowing some public agencies to restructure their finances.”

July 11 – Bloomberg (Abigail Moses, John Glover and Matt Robinson): “Credit investors lulled into complacency by the largesse of central banks are getting a reminder about risk. Portugal’s Banco Espirito Santo SA jolted global markets when a parent company missed short-term debt payments. Puerto Rico’s governor signed a law giving some government entities the right to restructure debt, potentially hurting creditors. Then there’s the Middle East, where Israel is mobilizing 20,000 soldiers for a possible ground invasion of the Gaza Strip. The events are triggering turmoil in debt markets from London to New York, renewing concern the financial system remains vulnerable six years after central banks began flooding their economies with cheap cash to break free from the global credit crisis… ‘This is a stark reminder that things can go wrong,’ said Graham Neilson, the… chief investment strategist at Cairn Capital… ‘Any sign that things under the bonnet aren’t really that great causes a repricing.’”

July 11 – Bloomberg (Zachary Tracer and Clea Benson): “Radian Group Inc. and MGIC Investment Corp. are among mortgage insurers that would need to fill a financial gap under new financial-strength rules proposed by the Federal Housing Finance Agency… Radian said it would need about $850 million to meet the standard now and expects to be able to comply within a two-year transition period allowed under the rules... …MGIC didn’t provide a figure and said it faced a ‘material shortfall.’ Genworth Financial Inc. said yesterday that it may need as much as $550 million… U.S. regulators are seeking to stiffen standards for mortgage insurers that back loans sold to Fannie Mae and Freddie Mac to prevent a repeat of the losses the government-backed firms faced in the 2008 financial crisis.”

July 11 – Bloomberg (Brian Chappatta): “Municipal bonds are the cheapest in four months relative to Treasuries as speculation that debt from Puerto Rico will default spurs the biggest exodus from local- debt mutual funds since January… Individuals yanked $790 million from muni mutual funds in the week through July 9, with the highest outflows from funds focused on long-dated and high-yield debt, Lipper US Fund Flows data show.”

July 10 – Bloomberg (Kristen Haunss): “Deals packaging junk-rated corporate loans into securities with ratings as high as AAA are being done at a record pace, fueling a boom in the underlying debt that the Federal Reserve says is showing signs of froth. Led by Leon Black’s Apollo Global Management LLC, $13.8 billion of collateralized loan obligations were raised in the U.S. last month, an all-time high… Julian Black, a Cayman Islands-based lawyer who helped raise more than $25 billion in CLOs in 2013, predicts as much as $120 billion will be sold this year, a record… The flurry of CLOs underscores the length investors are going to in order to generate returns with the Fed forecast to hold interest rates near zero until at least mid-2015. As the biggest buyers of leveraged loans, CLOs are helping to make it easier for speculative-grade borrowers to obtain credit…”

July 9 – Bloomberg (Kristen Haunss): “Efforts under way since 2007 to automate the $750 billion market for junk-rated corporate loans may soon pay dividends just as Moody’s… warns managers may not be able to refund investors trying to flee… Modernization can’t come soon enough for loans, which have been identified by regulators as a source of concern due to deteriorating underwriting practices. After receiving a record $61.3 billion last year, loan mutual funds have seen eight consecutive week of outflows, with Moody’s now saying that managers may struggle to raise cash to meet investor redemptions if too many try to exit at once.”

July 7 – Bloomberg (Lisa Abramowicz): “Investors are tired of analysts predicting the bottom will fall out of the bond market. Those who heeded Wall Street analysts’ warnings last year that interest rates would rise and yanked money ended up missing 2014’s 3.9% return on a broad index of debt globally. That was the market’s best performance in four years, and many investors aren’t inclined to lose out again. So individuals are piling back into the debt they’d abandoned even as prices surge and yields plunge once again toward record lows. They funneled $65.4 billion into bond funds in the three months ended June 30, the most since the start of 2013, EPFR Global data show.”

July 8 – Bloomberg (Brian Chappatta): “Texas and its localities are taking on more debt this year than any other U.S. state, outpacing New York and California for the first time in at least a decade… Municipalities in the state, home to seven of the 15 fastest-growing U.S. cities, issued about $19 billion of bonds in the first half of 2014, up 24% from the same period last year… The state has never toppled California’s bond lead for a full year. In 2009, issuers in the Lone Star State borrowed $32 billion to the Golden State’s $67.6 billion.”

Federal Reserve Watch:

July 11 – Reuters (Jonathan Spicer): “A top U.S. central banker said… the Federal Reserve may be ‘closer than a lot of people think’ to raising interest rates given the firmer recent inflation and labor data. Charles Plosser, president of the Philadelphia Fed, told Bloomberg TV the Fed is now closer than it has been to reaching its objectives, no matter how they are measured, adding: ‘We should not be keeping interest rates at zero until we reach all our objectives.’ Many monetary policy rules and guidelines are now suggesting the Fed should start to tighten policy after years of accommodation in the post-crisis era, Plosser said. ‘For us to deviate from what these guidelines and benchmark rules tell us, we’d have to have pretty good reason to want to deviate from them and explain why,’ he said. ‘So I think we're closer than a lot of people might think.’”

July 10 – Bloomberg (Mark Gilbert): “The Federal Reserve is concerned investors are too complacent and may be taking on too much risk, echoing recent comments from the European Central Bank and the Bank of England. The thing is, not only are central banks the perpetrators of the death of volatility, they are the knowing architects of the accompanying surge in asset prices. Andrew Haldane, the chief economist at the Bank of England and one of the most eloquent policy makers around, described the environment… ‘Lower rates and QE were an exercise in trying to stimulate risk taking. We’re seeing risk change shape. That will mean, on average, that volatility in financial-market asset prices will be somewhat greater than in the past.’”

July 10 – Dow Jones (Pedro Dacosta): “With October looking like the end date of the Fed's bond-buying program, economists are again opining on the effectiveness of the central bank's policies. Count John Taylor, Stanford University professor and former Treasury official, among the skeptics. …Taylor notes the latest round of bond buys, intended to keep long-term rates down, were actually accompanied by a sharp rise in 10-year Treasury rates. He also says the Fed's policies may be to blame for some of the very uncertainties central bank officials say investors are underpricing. ‘The interference with price discovery in the markets has caused uncertainty which when added to confusion over forward guidance and the zero rate has been counterproductive for the US and other countries,’ Taylor says.”

July 8 – Bloomberg (Craig Torres and Jeff Kearns): “House Republicans proposed legislation to limit how the Federal Reserve makes monetary policy, a week before Chair Janet Yellen is scheduled to deliver her semiannual testimony to lawmakers. The draft bill… would require the policy-setting Federal Open Market Committee to describe a strategy or rule for how it would adjust interest rates. Currently, the Fed doesn’t bind itself to a formula, preferring flexibility in an economy that continues to elude their forecasts of where it is headed. ‘It’s broadly consistent with Republicans’ continued anger with the Fed and seems to reflect a continuing concern that it’s time for the Fed to get further down the exit path and start raising rates,’ said Sarah Binder, a senior fellow in governance studies at the Brookings Institution…”

July 10 – Bloomberg (Steve Matthews): “Federal Reserve Bank of St. Louis President James Bullard said a rapid drop in joblessness will fuel inflation, bolstering his case for an interest-rate increase early next year. ‘I think we are going to overshoot here on inflation,’ Bullard said… He predicted inflation of 2.4% at the end of 2015, ‘well above’ the Fed’s 2% target. ‘That is a break from where most of the committee seems to be, which is a very slow convergence of inflation to target,’ he said… A drop in unemployment to 6.1% in June, the lowest level in almost six years, increases pressure on the Fed to raise the main interest rate sooner than most officials have estimated, Bullard said.’”

July 7 – Bloomberg (Rich Miller): “Federal Reserve Chair Janet Yellen faces an economy that is starting to look more like Arthur Burns’s in the 1970s than Alan Greenspan’s in the 1990s. Productivity growth is slowing, just as it was when Burns headed the central bank, not accelerating as it did under Greenspan’s watch. Business output per hour excluding agriculture has risen at a 1.4% average annual rate since the recession ended in June 2009… That result is in line with the 1.5% rate from 1973 to 1977 and less half of the 3% pace from 1996 to 2000… The post World War II average is 2.3%.”

July 7 – Wall Street Journal (Ben Leubsdorf and Jon Hilsenrath): “U.S. food prices are on the rise, raising a sensitive question: When the cost of a hamburger patty soars, does it count as inflation? It does to everyone who eats and especially poorer Americans, whose food costs absorb a larger portion of their income. But central bankers take a more nuanced view. They sometimes look past food-price increases that appear temporary or isolated while trying to control broad and long-term inflation trends, not blips that might soon reverse. The Federal Reserve faces an especially important challenge now as it mulls the long-standing dilemma of what to make of the price of a pork chop. As Fed officials debate when to start raising short-term interest rates to prevent the economy from overheating and causing inflation, Fed Chairwoman Janet Yellen has signaled she wants to take her time.”

U.S. Bubble Watch:

July 9 – Los Angeles Times (Tim Logan): “A record amount of foreign money is flowing into the U.S. housing market… Overseas buyers and new immigrants accounted for $92 billion worth of home purchases in the U.S. in the 12 months ended in March, according to… the National Assn. of Realtors. That’s up 35% from the year before, and the most ever. Nearly one-fourth of those purchases came from Chinese buyers. And the place they're looking most is Southern California… The report highlights the growing effect of global capital on some local housing markets. The $92 billion amounts to 7% of all money spent on homes in the U.S. during those 12 months, and nearly half of it was concentrated in a handful of cities, including Los Angeles.”

July 9 – Bloomberg (John Gittelsohn): “Henry Nunez, a real estate agent in Arcadia, California, met with so many homebuyers from China that he bought a Mandarin-English translation app for his phone. The $1.99 purchase paid off last month, when he sold a five-bedroom home with crystal chandeliers, marble floors and two kitchens, one designed for smoky wok cooking. The buyers were a Chinese couple who paid $3.5 million in cash. ‘Last year, it would’ve been $2.8 million,’ said Nunez, a property broker for 27 years… ‘The biggest driver is a lot of people wanting to invest their money here.’ Buyers from Greater China, including people from Hong Kong and Taiwan, spent $22 billion on U.S. homes in the year through March, up 72% from the same period in 2013… Chinese purchases of U.S. homes are likely to continue increasing as the country’s swelling ranks of affluent consumers seek refuge from pollution and political and economic uncertainty, according to Thilo Hanemann, who tracks cross- border investment for… Rhodium Group. ‘A lot of people are trying to hedge against a generally bearish outlook for the Chinese economy,’ Hanemann said… ‘Buying real estate overseas has been in the past limited to a relatively small group of wealthy individuals and sometimes government officials. But it’s become a much bigger trend, involving affluent middle-class people.’ Chinese buyers paid a median of $523,148 per transaction, compared with a U.S. median price of $199,575 for existing-home sales.”

July 8 – Bloomberg (Brian Louis): “Office buildings in top U.S. markets are getting so expensive that landlords are choosing to build rather than buy, spurring the most development by real estate investment trusts in at least a decade. Office REITs… are planning to plow almost $11 billion into new projects, triple the amount just two years ago and the most in data going back to 2004, according to… Green Street Advisors Inc. Much of that is focused on the coasts, including San Francisco and New York, the areas with the most demand from both tenants and investors. Prices for office buildings in major markets have surged past peak levels, lifted in part by sovereign-wealth funds and pensions willing to accept lower yields than other investors because they are seeking safe investments. For REITs, which have to answer to shareholders seeking higher returns, building is often a better option than competing with institutional buyers.”

Central Banker Watch:

July 8 – Bloomberg (Simon Kennedy): “Central bankers’ experiment with zero interest rates is falling short on the supply side of their economies. Productivity and labor-force growth are failing to accelerate despite policies Bank of England Governor Mark Carney said should deliver the economic growth needed to generate ‘supply-side improvement.’ ‘Weaker supply-side performance may dampen the enthusiasm of developed-market central banks to experiment with their growth/inflation trade-off to elicit strong supply,’ JPMorgan… economists led by Bruce Kasman said… The argument of policy makers was that a by-product of promoting demand would be an expansion in their economies’ capacity. The theory went that if low interest rates boosted growth then that would encourage the corporate investment needed to lift productivity or the hiring necessary to draw disgruntled jobless back into labor markets or turn part-time positions into full-time ones.”

Europe Watch:

July 11 – Financial Times (Peter Wise): “The Espírito Santos are no strangers to trouble. In the wake of Portugal’s 1974 revolution, several members of the banking dynasty were imprisoned for months by the radical leftwing military. After their release, they fled in disguise across the Spanish border to escape probable rearrest. Forty years later, Portugal’s most influential business family again finds itself at the centre of a storm. Fears over the health of Banco Espírito Santo, one of the country’s biggest banks, have triggered a European stock market sell-off and raised questions over Lisbon’s capacity to fend for itself after withdrawing from an international rescue programme. Ricardo Espírito Santo Salgado, 70, head of a business dynasty that goes back almost 150 years, is being forced to step down early after 22 years as BES’s executive chairman as regulators detach the management of the bank from a family riven by rivalries and facing deep financial difficulties.”

July 11 – Financial Times (Elaine Moore): “Trouble in Portugal’s banking dynasty trickled across the border to countries in southern Europe on Thursday, pushing up government borrowing costs and curbing investor appetite for a new sale of Greek government debt. Athens had been expecting strong demand for its new three-year bond after a debt sale in April attracted €20bn in orders, more than six times the amount sold. Analysts had predicted that Greece would use the new bond to raise €3bn. However, volatility in capital markets, attributed to the suspension of shares in Portugal’s Banco Espírito Santo, led to a sell-off in peripheral Europe’s bond markets. Investors placed orders of €3bn for Greece’s sovereign bond, which was sold at a yield of 3.50% and raised €1.5bn.”

July 10 – Dow Jones (Andrea Thomas): “Germany warned… that its economic growth rate slowed in the second quarter because of the Ukraine-Russia conflict and an unusually weak seasonal pick-up this spring, but it stressed that the economy's overall upward trend was intact. The warning from the country's economics ministry shows that the stand-off between western countries and Russia over the future of Ukraine has already hurt German companies, the biggest of which are highly exposed to the Russian market. The European Union and the U.S. have threatened economic sanctions against Russia should Moscow not cooperate in helping to stabilize the situation in Ukraine. ‘A weak pick-up in spring was expected following a mild winter. This was accompanied by new geo-political uncertainties,’ the ministry said… ‘The Ukraine conflict has led to a certain degree of uncertainty and contributed to restrained business decisions.’”

July 5 – Financial Times (Peter Spiegel and James Fontanella-Khan): “A simmering battle between Italy and Germany over Rome’s push to ease EU’s budget rules burst into public… when the Italian prime minister lashed out at the head of Germany’s powerful central bank, accusing him of improperly intervening in Italian politics. Italy’s Matteo Renzi, who has spearheaded an effort by centre-left European leaders to gain more flexibility in the rules, said it was not the role of central bankers to weigh in on budget matters. Mr Renzi’s remarks come less than 24 hours after the Bundesbank’s president, Jens Weidmann, singled out Mr Renzi in a speech and criticized countries seeking to loosen the rules. ‘The Bundesbank does not have among its tasks to take part in the Italian political debate,’ Mr Renzi said. ‘Europe belongs to European citizens, not to bankers, neither Italian nor German bankers.”

July 10 – Bloomberg (Mark Deen and Helene Fouquet): “French Industry Minister Arnaud Montebourg hit out at the European Central Bank, calling on it to buy bonds and weaken the euro in order to boost growth. ‘We have the most depressed region in the world with a currency that has appreciated the most globally and a European Central Bank that has not respected its mandate,’ Montebourg told an audience of executives in Paris, citing the risk of deflation. ‘No one should leave the economy in the hands of moralists and accountants.’ The remarks were made against the backdrop of a screen reading ‘economic patriotism’ and ‘fight for growth’…”

July 7 – Bloomberg (Elisa Martinuzzi): “Europe’s banks face a further $50 billion of legal costs as they catch up with their U.S. counterparts, according to analysts at Morgan Stanley. European firms, which have set aside or paid out more than $80 billion since 2009, face about $130 billion of litigation and settlement costs in total, analysts led by Huw van Steenis wrote… U.S. firms, which have so far made provisions for or paid out $125 billion, may have only to set aside a further $25 billion, the analysts said.”

July 7 – Bloomberg (Nikos Chrysoloras and Rebecca Christie): “Greece fought off calls to consider a third bailout as European Central Bank President Mario Draghi warned that the pace of economic fixes is slowing, officials said after euro-area finance ministers met… Greece has ruled out further aid -- which would come with another raft of conditions -- after its current rescue ends… According to the so- called troika of International Monetary Fund, ECB and euro-area authorities, Greece may need one anyway, an EU official said. Further emergency aid will probably be needed as the government still faces a funding shortfall, can’t count on financial-market support and is slipping further behind on its commitments to overhaul the economy, the EU official said.”

July 8 – Bloomberg (Scott Hamilton): “U.K. manufacturing unexpectedly slumped the most in 16 months in May, indicating the economy may have struggled to maintain momentum in the second quarter. Factory output plunged 1.3% from April…”

Global Bubble Watch:

July 7 – New York Times (Neil Irwin): “In Spain, where there was a debt crisis just two years ago, investors are so eager to buy the government’s bonds that they recently accepted the lowest interest rates since 1789. In New York, the Art Deco office tower at One Wall Street sold in May for $585 million, only three months after the going wisdom in the real estate industry was that it would sell for more like $466 million, the estimate in one industry tip sheet. In France, a cable-television company called Numericable was recently able to borrow $11 billion, the largest junk bond deal on record — and despite the risk usually associated with junk bonds, the interest rate was a low 4.875 percent. Welcome to the Everything Boom — and, quite possibly, the Everything Bubble. Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors.”

July 11 – Financial Times (Vivianne Rodrigues): “Global companies have turned to international debt markets in the first half of 2014 to meet their funding needs, seizing on low borrowing costs and strong investor demand to push sales of corporate bonds to the highest level in five years. Some of the world’s largest companies… as well as banks including Wells Fargo, Bank of America and BNP Paribas have together sold more than $1.8tn in new bonds in the six months to the end of June, according to Standard & Poor’s data. That is the highest total for the first half of a year since 2009. Investors have flocked to the securities, leaving aside for now concerns about credit quality and the sensitivity of bond prices to changes in interest rates as the US Federal Reserve tapers it asset purchases.”

July 10 – Wall Street Journal (Matt Jarzemsky): “Companies world-wide are selling stocks at a record pace, capitalizing on investors' appetite for riskier assets at a time of low returns on safer bets. Offerings of stock and stock-linked securities have raised $510.1 billion in 2014 through Tuesday, according to… Dealogic. That beats out the previous record for that time period, $498.9 billion in 2007. While many deals still originate with growing companies looking to fund expansion plans, much of the volume this year has come from private-equity firms looking to cash out on investments made before the financial crisis…”

July 8 – Bloomberg (Bob Ivry): “These are boom times for complacency. To gauge just how comfortable the world of debt has gotten, consider: Bond buyers handed $2 billion last month to Ecuador, whose socialist president forced a default during the financial crisis while calling creditors ‘true monsters.’ So many investors piled into a May bond sale by Clear Channel Communications Inc. that the radio broadcaster, with a credit rating that implies default is almost a certainty, more than doubled the offering to $850 million. China’s Logan Property Holdings Co. defied predictions of a slowdown in the nation’s real estate market by selling $300 million of bonds in May. The developer has negative cash flow and total debt almost twice its cash and cash equivalents. Hellenic Petroleum SA in Greece, where the government has needed two bailouts in the past four years, borrowed the equivalent of $444 million last month. Lenders were so enthusiastic that they put in orders exceeding $1.37 billion. Florida’s Orange County Industrial Development Authority issued $64 million of unrated debt last month to fund facilities near Orlando that convert sewage into fertilizer. ‘It definitely feels like investors are getting overexuberant, and you can stay in overexuberant conditions for a while,’ said Fred H. Senft Jr., director of fixed income and equity research for Key Private Bank… ‘But when it turns it will turn quickly and it will turn very ugly.’”

July 9 – Financial Times (Miles Johnson): “Hedge funds have sharply scaled back their bearish bets that the value of stocks is about to fall, with the proportion of shares earmarked for short selling at its lowest level since before the financial crisis despite warnings of renewed market exuberance. The percentage of stocks that have been borrowed by short sellers… has dropped to the lowest level in the US, UK and the rest of Europe since the years before the collapse of Lehman Brothers… The fall in short selling comes as Wall Street and markets in Europe trade at near record and multiyear highs, indicating that while some high profile hedge fund managers have warned of excessive market euphoria the industry is still unwilling to bet against the rally.”

July 9 – Bloomberg (Esteban Duarte): “Companies in Spain are having to pay three times more to borrow than their German peers, potentially stifling an economic recovery needed to provide jobs for the one in four people in the country looking for work. Adjusted for expected inflation, Spanish banks charged 4.2% for loans of more than one year in May, just below a euro-era record of 4.39% in April… The stock of loans to non-financial companies and households in Spain is declining at twice the pace of 2011, when Mario Draghi took over at the ECB. ‘Lenders in the periphery still see a significant credit risk,’ said Stefano Loreti, a partner at Hayfin Capital Management… ‘It’s a bit too early to say that we’ve left the credit crisis behind.’”

Geopolitical Watch:

July 10 – Washington Post (Stephanie Kirchner): “The German government has asked the CIA station chief at the U.S. Embassy in Berlin to leave the country, an unusual action between allies that represents a public expression of anger over reported cases of U.S. spying in Germany… A day earlier, federal prosecutors in Germany said police had searched the office and apartment of an individual with ties to the German military who is suspected of working for U.S. intelligence. Those raids followed the arrest of an employee of Germany’s foreign intelligence service who was accused of selling secrets to the CIA.”

July 11 – Bloomberg (Cornelius Rahn and Amy Thomson): “Germany’s Interior Ministry is reviewing rules for awarding government contracts for computer and communications equipment and services as a political rift with the U.S. widens… The ministry will probably issue new purchasing guidelines in the coming weeks to replace its ‘no-spy-order’ dated April 30, said the people, who asked not to be named… Details are being worked out, and may require suppliers of components of a bidder’s goods or services to guarantee they don’t hand over confidential data.”

July 11 – Financial Times (Daniel Thomas): “Apple has been dragged into an escalating confrontation over cyber security and US spying in China after its iPhone was branded a threat to national security by state media. The move comes just months after the US technology group struck a deal to supply iPhones to China Mobile, the world’s largest phone company… It also comes in the week that the US and China concluded high-level trade talks in which little progress was made to update an 18-year-old agreement that governed the $2tn annual trade in high-tech products between the two countries.”

July 9 – Bloomberg (Helene Fouquet): “French Finance Minister Michel Sapin called on companies to use the euro more in their international deals… ‘The dollar’s preeminence creates a certain of number of currency risks for our companies that could be avoided,’ he said, adding that Europe ‘must mobilize to increase the use of the euro as a foreign trading currency’…”

July 7 – Financial Times (Michael Stothard): “France’s political and business establishment has hit out against the hegemony of the dollar in international transactions after US authorities fined BNP Paribas $9bn for helping countries avoid sanctions. Michel Sapin, the French finance minister, called for a ‘rebalancing’ of the currencies used for global payments, saying the BNP Paribas case should ‘make us realise the necessity of using a variety of currencies’. As part of the $8.97bn settlement that the US justice department announced on Monday evening, parts of BNP Paribas’s operations will be barred for a year from conducting US dollar transactions – the first large international bank to suffer such a penalty for evading sanctions. The punishment goes to the heart of why US sanctions have become so controversial among banks, because they allow the authorities to police business arrangements that do not involve Americans.”

July 11 – Financial Times (Benedict Mander): “After Argentina’s defeat in the US courts in its decade-long dispute with hedge funds, President Cristina Fernández will turn to the leaders of China and Russia for support when they visit Buenos Aires this month. Argentina is hoping for more than just political backing for its battle against so-called ‘holdouts’ when Russia’s Vladimir Putin arrives on Saturday ahead of a Brics summit in Brazil next week, with China’s Xi Jinping following a week later.”

July 7 – Bloomberg (Ting Shi and Isabel Reynolds): “Chinese President Xi Jinping criticized Japan’s wartime aggression as he risked escalating tensions between the countries by becoming the first leader to attend the official commemoration of the start of the Sino- Japanese war. Xi addressed a crowd that included a small number of veteran troops in a nationally televised address this morning at Lugou Bridge, the location of the Japanese invasion 77 years ago. He warned that China and the world will not accept efforts by a ‘minority’ to distort history and facts. The high-powered government team that attended the ceremony, in front of the Museum of the War of Chinese People’s Resistance Against Japanese Aggression, included Yu Zhengsheng, a member of the elite seven-person Politburo Standing Committee, and vice premier Liu Yandong.”

China Bubble Watch:

July 8 – Financial Times (Gabriel Wildau): “China’s securities regulator has stepped up its probe into insider trading, taking on ‘rat traders’ in an attempt to restore confidence in the country’s stock market, which is widely viewed as being rife with corruption. Rat trading is a form of front-running in which fund managers use personal accounts to buy shares cheaply, then sell them at a profit after purchases from the funds they manage have boosted their value. The investigation is part of Beijing’s sweeping anti-graft campaign, most publicly involving the arrests of senior politicians and military officers. While this enforcement campaign against fund managers has by contrast remained below the radar, it has sent shockwaves through the industry since it got under way this year.”

July 7 – Bloomberg: “Jiamusi New Era Infrastructure Construction Investment Group Co., a local government financing vehicle in northeastern China, used fabricated documents to illegally obtain funds, Beijing News reported… The LGFV, based in the city of Jiamusi near the Russian border in Heilongjiang province, used fabricated urban planning documents to boost the area of land for which it owns the usage rights… The financing unit used the land as collateral to sell bonds, according to the report… Pressure to refinance old borrowings is forcing China’s LGFVs to issue a record amount of bonds this year. They sold 907.8 billion yuan ($146bn) of notes in 2014, the most in the same period since at least 2002...”

July 8 – Bloomberg (Michelle Yun and Moxy Ying): “Chinese developers, hit by tighter liquidity and a widespread anti-graft campaign, are delaying paying fees to realtors who help them sell new projects, according to the nation’s biggest real estate brokerage. Centaline Group… has about 1 billion yuan ($161 million) of uncollected receivables due, group founder Shih Wing Ching said… Developers pay the fees only after they they get the sales proceeds, he said. ‘It used to be easy for buyers to obtain mortgages, then the developers will pay commissions,’ Shih said…”

India Watch:

July 11 – Bloomberg (Rajhkumar K Shaaw): “Indian stocks declined for a fourth day, with the benchmark index posting its steepest weekly loss since December 2011, amid concern the rally that drove the market to a record has outpaced the outlook for earnings.”

EM Bubble Watch:

July 11 – Bloomberg (Julia Leite and Filipe Pacheco): “A missed debt payment by Portugal’s Espirito Santo International SA is wreaking havoc in Brazil. Bonds from the Brazilian unit of Banco Espirito Santo SA fell a record 8.6% in the past two days on speculation its funding costs will soar. Oi SA notes are down 3.4% since June 30, when merger partner Portugal Telecom SGPS SA first said it held $1.2 billion of commercial paper from a unit of Espirito Santo International… The crisis so far is being felt in Brazil, which has cultural and economic ties to its former colonial ruler Portugal, more than in other Latin American countries.”

July 8 – Bloomberg (Matthew Malinowski): “Brazilian President Dilma Rousseff has been fighting inflation by holding down government-regulated prices. The bill will come due next year. The winner of this October’s presidential election will suffer the consequences of policies that have repressed electricity prices by 30%, urban bus fares by 20% and gasoline prices by 15% since 2011, according to data from Rio de Janeiro-based firm Modal Asset Management. Lifting controls will unleash pressures that will keep inflation above the mid-point of the target for a sixth straight year.”