Saturday, December 6, 2014

Weekly Commentary, July 12, 2013: Bernanke's Comment

I read with keen interest chairman Bernanke’s paper “The First 100 Years of the Federal Reserve: The Policy Record, Lessons Learned, and Prospects for the Future,” presented Wednesday to the National Bureau of Economic Research:

“In the words of one of the authors of the Federal Reserve Act, Robert Latham Owen, the Federal Reserve was established to ‘provide a means by which periodic panics which shake the American Republic and do it enormous injury shall be stopped.’ In short, the original goal of the Great Experiment that was the founding of the Fed was the preservation of financial stability. At the time, the standard view of panics was that they were triggered when the needs of business and agriculture for liquid funds outstripped the available supply--as when seasonal plantings or shipments of crops had to be financed, for example--and that panics were further exacerbated by the incentives of banks and private individuals to hoard liquidity during such times. The new institution was intended to relieve such strains by providing an ‘elastic’ currency--that is, by providing liquidity as needed to individual member banks through the discount window; commercial banks, in turn, would then be able to accommodate their customers.”

Dr. Bernanke is renowned as a preeminent expert on the causes of the Great Depression. We share the view that understanding this historic downturn is indeed “the Holy Grail of economics.” Bernanke’s views of monetary policy “mistakes” made early in the 1930s profoundly shaped the Fed’s monetary policy doctrine following the post-tech Bubble downturn and then even more so during this extended post-mortgage finance Bubble period.

I take strong exception with what has over decades become a distorted revisionist view of the 1920s and 1930s periods. For starters, I’ll take issue with the general context of how Bernanke explains the objectives of the new Federal Reserve back at its inception in 1913. The U.S. economy and banking system had suffered through decades of destabilizing boom and bust cycles. While having a central bank to help manage systemic liquidity issues during crisis periods was advantageous, the critical role for the Federal Reserve was to more effectively regulate Credit – to try to avoid crises. There was a clear appreciation at the time that Credit and speculative excesses were the bane of financial stability.

It is worth noting that Bernanke and others’ historical accounts of the 1920s basically disregard a crucial fact: The Federal Reserve patently failed in its responsibilities to safeguard financial stability during that period. It basically accommodated a runaway boom. By intervening to limit downturns and backstop system liquidity, the Fed nurtured historic financial and economic Bubbles. It failed in regulating Credit and it failed in dealing with historic financial excess. Its policies were instrumental in what evolved into epic economic maladjustment and imbalances on a globalized basis.

Dr. Bernanke and others gloss over these failures, preferring instead their ideological focus on activist central bank post-Bubble “mopping up” stimulus and market interventions. When Milton Friedman in the early-1960s canonized the 1920s as the “Golden Age of Capitalism,” this seemingly brought to an end the critical evaluation of one of the most relevant periods in financial, economic and policy history. The focus shifted to post-Bubble policy activism.

The Friedmanite view holds that the Fed committed a dereliction of duties by not dramatically loosening policy and printing money early in the 1930’s downturn. From Bernanke: ‘The Great Depression was the Federal Reserve's most difficult test. Tragically, the Fed failed to meet its mandate to maintain financial stability.” I would argue that mistakes are indeed commonplace in the fog and confusion associated with bursting Bubbles (look no further than contemporary Europe). Post-Bubble landscapes are fraught with financial, economic, political and social upheaval and discontinuities – and this is a critical reason why central banks should place money, Credit and Bubble analysis prominently in policy doctrines.

I strongly believe that the Fed’s fateful dereliction of responsibilities was committed during the 1920s accommodation of destabilizing Credit and speculative excesses, especially late in the decade. While they may very well remain latent throughout a protracted Bubble period, the reality is that the foundation of financial stability is compromised during the boom. Moreover, the greatest risks to systemic stability manifest during the boom’s late-cycle period, often as authorities move to aggressive interventions in an attempt to stave off the collapse of increasingly vulnerable Credit and speculative Bubbles. This is a most relevant topic, as I believe the Bernanke Fed is now repeating errors similar to those committed by the Benjamin Strong Federal Reserve during the late-twenties period.

Benjamin Strong, first head of the Federal Reserve Bank of New York (1914-1928), is a controversial figure. He was the dominant leader at the Fed during the twenties – the Greenspan or Bernanke of that era. And based on one’s historical/ideological perspective, he was either the central bank genius whose death in 1928 left a fateful leadership void at the Fed - or a dominating activist central banker much too eager to intervene in the marketplace and accommodate a historic Bubble.

From “Benjamin Strong, the Federal Reserve, and the Limits to Interwar American Nationalism…,” Priscilla Roberts, Federal Reserve Bank of Richmond Economic Quarterly, Spring 2000):

“The most notorious episode of monetary ease, however, occurred in July and August 1927, when Strong, though alarmed by the American market’s speculative and inflationary tendencies, nonetheless forced through the Federal Reserve System a decrease in the discount rate from 4 to 3 percent. This move relieved the excessive pressures to which the initial level of American interest rates was subjecting the dangerously shaky [British] pound. In July 1927 the central bankers of Great Britain, the United State, France, and Germany had met on Long Island in the United States to discuss means of strengthening Britain’s gold reserves and the general European currency situation. Strong’s reduction of discount rates… appears to have been the direct result of this conference. Indeed, according to Charles Rist, one of the French central bankers who attended, Strong said that the American authorities would reduce discount rates as “un petit coup de whisky for the stock exchange.’ Strong pushed this reduction through the Federal Reserve System despite strong opposition…”

Throughout the Roaring Twenties, U.S.-based Credit became an increasingly dominant source of finance internationally. Some have criticized Strong for being too close to Wall Street. He was definitely a avid proponent for the U.S. taking an active internationalist approach with policymaking. Strong came to recognize the powerful new tools available for the Fed to lower market yields, bolster system liquidity and backstop the financial markets (at home and abroad). The Fed in general believed the proliferation of productivity-enhancing technologies and low (and falling) inflation provided an opportune backdrop for implementing accommodative monetary policy. There was definitely a New Era/New Paradigm mentality that took root at the Federal Reserve, in Wall Street and throughout segments of the real economy. Enlightened policymaking ensured a “permanent plateau” in U.S. prosperity – or so leading economic thinkers believed heading into 1929.

The Great Credit Inflation/Bubble that set the stage for the Great Depression generally commenced with the outbreak of World War I. There are myriad disconcerting parallels between that period and today's ongoing Credit Bubble – including extraordinary technological innovation, U.S. dominance of global finance, major destabilizing financial innovations, expanding use of leverage in financial speculation, and expanding domestic and international financial and economic imbalances. In both periods, I would argue, central banking policy doctrine was ill-prepared for the major evolutions in the functioning of economies and financial systems. In the twenties, central bankers were confused by how new technologies and a global Credit boom had altered inflation dynamics, while failing to appreciate the latent financial and economic fragilities associated with a long period of rampant Credit growth and leveraged speculation. They unwittingly accommodated Bubble excess – and then systemically tried to sustain the boom when Bubble fragilities became acute risks to global financial and economic systems.

I’m sticking to my view that chairman Bernanke moved forward last summer with open-ended QE primarily because of worsening global fragilities. Tying “money printing” to the unemployment rate was politically expedient – yet deeply flawed policy for an economy suffering from major structural issues. U.S. stocks are up better than 20% from last August’s lows, in the face of slowing U.S. growth and a rapidly deteriorating global economic backdrop. Dr. Bernanke, similar to Strong, could not resist the (“coup de whisky”) stimulus expedient a surge in securities prices might provide to vulnerable financial and economic systems. Both were willing to accommodate dangerous divergences between deteriorating economic fundamentals and highly speculative financial Bubbles.

Chairman Bernanke committed another major policy blunder this week. The media focused on his “highly accommodative monetary policy for the foreseeable future is what's needed” comment. While important, I would argue the following statement was more impactful: “If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that.” It was this statement, I believe, that had such a dramatic impact on global markets – the dollar, currencies, the emerging markets, bonds and record U.S. stock prices.

The Fed needs to begin extracting itself from the aggressive market backstop and intervention business. Such a role, as should be abundantly clear by now, only feeds speculative excess and serial Bubbles. The Fed’s $85bn monthly QE has been fueling speculation and exacerbating global financial instabilities – with marginal (at best) benefits. To be sure, injecting enormous amounts of liquidity into a highly speculative marketplace and generally unstable backdrop carries huge risks. The Fed needed to begin winding down this program – a process Bernanke signaled several weeks back. Our central bank should not have been surprised by market reactions.

The Bernanke Fed needed to demonstrate some courage and resolve. Instead, it almost immediately signaled its limited tolerance for even moderate market tumult. “If financial conditions were to tighten” are code words for the Fed being there as necessary with open-ended QE to backstop U.S. and global markets. Bernanke’s Comment came with the dollar at multiyear highs, emboldening the view that he’s there to push the dollar lower as necessary to stem global de-risking and de-leveraging. Bernanke’s Comment emboldened the view he’ll backpedal from any move to reduce stimulus at the first sign of market unrest. Bernanke’s Comment emboldened the view that he and global central bankers will punish sellers of risk assets and reward those that disregard risk and accumulate securities. Bernanke’s comment emboldened those leveraging and taking outsized risks with the view that the Fed and global central bankers will ensure robust securities markets. Bernanke’s Comment further distorted perceptions of risk throughout global markets. Bernanke’s Comment bolstered the “QE forever” camp and provided a green light to further speculation, especially in the U.S. stock market.

“If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that” – is one for the history books. At this point, the Fed has been accommodating Credit and market Bubbles for so long that the only way to ensure ongoing loose financial conditions is to perpetuate Bubble excess. I would argue – and I believe recent market behavior supports this view – that various Bubbles have inflated to the point of acute vulnerability. This implies fragility to waning liquidity and episodes of risk aversion, hence – and as the speculator community assumes - unrelenting Fed QE activism.

From Bernanke’s paper: “The financial crisis and the ensuing Great Recession reminded us of a lesson that we learned both in the 19th century and during the Depression but had forgotten to some extent, which is that severe financial instability can do grave damage to the broader economy. The implication is that a central bank must take into account risks to financial stability if it is to help achieve good macroeconomic performance. Today, the Federal Reserve sees its responsibilities for the maintenance of financial stability as coequal with its responsibilities for the management of monetary policy, and we have made substantial institutional changes in recognition of this change in goals. In a sense, we have come full circle, back to the original goal of the Federal Reserve of preventing financial panics.

How should a central bank enhance financial stability? One means is by assuming the lender-of-last-resort function that Bagehot understood and described 140 years ago, under which the central bank uses its power to provide liquidity to ease market conditions during periods of panic or incipient panic. The Fed's many liquidity programs played a central role in containing the crisis of 2008 to 2009. However, putting out the fire is not enough; it is also important to foster a financial system that is sufficiently resilient to withstand large financial shocks.”

Well, allow me to suggest a few things the Fed shouldn’t do if it endeavors to enhance financial stability. It shouldn’t peg short-term interest rates; it shouldn’t seek to manipulate long-term market yields (bond prices); it shouldn’t seek to promote the stock market or risk assets more generally – as all such interventions work to distort market behavior, mis-price securities and risk, and incentivize destabilizing speculation. Its policy doctrine should not incentivize the issuance of potentially destabilizing marketable debt, at the expense of more stable traditional bank finance. The Fed should not pre-commit to a future policy course – or provide policymaking “transparency” that works to promote risk-taking and speculation. The Fed should only resort to backstopping market liquidity in the event of dire systemic vulnerability.

Significant Fed balance sheet expansions should be temporary and then reversed as soon as possible. The Fed should refrain from non-crisis asset purchases/liquidity injections – and should limit its open-market activity to Treasury bills. The Fed should not accommodate a doubling of mortgage debt in six years. It shouldn’t then accommodate a doubling of federal debt in four. Fed policymaking should not unduly impact system Credit and resource allocation – albeit to housing or, more recently, the federal government.

The Fed should avoid the slippery slope of intervening in the markets in the name of promoting economic growth. Its policies shouldn’t distort market risk perceptions or the pricing of finance. This will only fuel asset inflation, Credit Bubbles and the misallocation of real and financial resources. The Fed should not accommodate persistently large current account deficits. These only promote liquidity excesses and global financial and economic imbalances. The Fed must never set off on an experimental path, but should instead strive toward a stable and conservative rules-based policy regime.

Generally, in what direction should the Fed be going? When it comes to financial stability, the Fed must be disciplined and preemptive. In this World of Unanchored Global Finance, the Fed finds itself full-circle back to where it began 100 years ago: It’s imperative that some type of policy regime or mechanism is constructed to help regulate U.S. and global Credit. The Fed must develop a framework for recognizing Bubble dynamics and nipping them in the bud before they become too powerful to address. And, importantly, the Fed will need to scrap this inflationist doctrine and dangerous notion that our central bank can print its away out of problems. It can’t. As we’ve been witnessing, the Fed can only “print” more and inflate bigger Bubbles. Clearly, there’s too much left unlearned from the Fed’s checkered 100-year history.

For the Week:

The S&P500 jumped 3.0% to a record closing high (up 17.8% y-t-d), and the Dow rose 2.2% (up 18.0%). The broader market spiked to all-time highs. The S&P 400 MidCaps surged 3.0% (up 19.7%), and the small cap Russell 2000 rose 3.1% (up 22.0%). The Morgan Stanley Consumer index surged 3.7% (up 23.5%), and the Utilities rallied 4.5% (up 10.0%). The Banks gained 0.9% (up 25.8%), and the Broker/Dealers rose 1.8% (up 41.0%). The Morgan Stanley Cyclicals were up 3.5% (up 18.9%), and the Transports gained 2.3% (up 21.3%). The Nasdaq100 surged 3.9% (up 15.7%), and the Morgan Stanley High Tech index jumped 4.0% (up 14.8%). The Semiconductors advanced 2.8% (up 27.5%). The InteractiveWeek Internet index jumped 5.1% (up 23.3%). The Biotechs surged 7.0% (up 40.8%). With bullion gaining $63, the HUI gold index rallied 4.2% (down 49.3%).

One-month Treasury bill rates ended the week at two bps and three-month bill rates closed at three bps. Two-year government yields declined 6 bps to 0.34%. Five-year T-note yields ended the week down 19 bps to 1.42%. Ten-year yields sank 16 bps to 2.58%. Long bond yields dropped 9 bps to 3.63%. Benchmark Fannie MBS yields fell 22 bps to 3.47%. The spread between benchmark MBS and 10-year Treasury yields narrowed six to 89 bps. The implied yield on December 2014 eurodollar futures declined 9.5 bps to 0.695%. The two-year dollar swap spread was little changed at 19 bps, while the 10-year swap spread declined 3 to 22 bps. Corporate bond spreads narrowed sharply. An index of investment grade bond risk declined 9 bps to 78 bps. An index of junk bond risk sank 57 to 375 bps. An index of emerging market debt risk increased 11 to 331 bps.

Debt issuance picked up. Investment grade issues included GE Capital $3.5bn, Oracle $3.0bn, Toyota Motor Credit $2.05bn, Realty Income $750 million, American Honda Finance $500 million, Private Export Funding $500 million, Allegheny Technologies $500 million, Duke Energy $500 million, PPL Electric Utilities $350 million, Met Life $300 million and Southern Power $300 million.

Outflows from junk bond funds and ETFs remained quite high at $3.28bn (from Lipper). Junk issuers this week included Cyrusone $525 million, Quicksilver $500 million, Best Buy $500 million, American Equity Investment $400 million, Post Holdings $350 million and Monitronics $175 million.

Convertible debt issuers included Merrimack Pharmaceutical $125 million, Ascent Capital Group $90 and Vantage Drilling $85 million.

International dollar debt issuers included Bank of Nova Scotia $2.0bn, Sumitomo Mitsui Banking $2.0bn, Bank of Montreal $2.0bn, Expro Finance $1.1bn, Indonesia $1.0bn, Petroleos Mexicanos $1.5bn, and International Bank of Reconstruction & Development $1.0bn.

Ten-year Portuguese yields surged 30 bps to 7.21% (up 46bps y-t-d). Italian 10-yr yields rose 6 bps to 4.48% (down 2bps). Spain's 10-year yields jumped 12 bps to 4.76% (down 51bps). German bund yields dropped 16 bps to 1.56% (up 24bps), and French yields fell 11 bps to 2.19% (up 19bps). The French to German 10-year bond spread widened five to 63 bps. Greek 10-year note yields dropped 48 bps to 10.46% (down one basis point). U.K. 10-year gilt yields fell 16 bps to 2.33% (up 51bps).

Japan's Nikkei equities index gained 1.4% (up 39.6% y-t-d). Japanese 10-year "JGB" yields ended the week down four bps to 0.81% (up 3bps). The German DAX equities index jumped 5.2% for the week (up 7.9%). Spain's IBEX 35 equities index slipped 0.3% (down 4.0%). Italy's FTSE MIB was down 0.7% (down 5.2%). Emerging markets were mostly higher. Brazil's Bovespa index recovered 0.7% (down 2%), while Mexico's Bolsa declined 0.7% (down 7.7%). South Korea's Kospi index rallied 2.0% (down 6.4%). India’s Sensex equities index jumped 2.4% (up 2.7%). China’s Shanghai Exchange rose 1.6% (down 10.1%).

Freddie Mac 30-year fixed mortgage rates jumped 22 bps to an almost two-year high 4.51%, with a 10-week gain of 116 bps (up 95bps y-o-y). Fifteen-year fixed rates were up 14 bps to 3.53% (up 67bps). One-year ARM rates were unchanged again at 2.66% (down 3bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates surging a notable 47 bps to 5.15% (up 95bps).

Federal Reserve Credit jumped $11.4bn to a record $3.456 TN. Fed Credit expanded $659bn during the past 40 weeks. Over the past year, Fed Credit surged $607bn, or 21.3%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $733bn y-o-y, or 7.0%, to a record $11.168 TN. Over two years, reserves were $1.128 TN higher, for 11% growth.

M2 (narrow) "money" supply surged $81.1bn to a record $10.654 TN. "Narrow money" expanded 6.6% ($616bn) over the past year. For the week, Currency increased $1.4bn. Total Checkable deposits jumped $26.6bn, and Savings Deposits rose $46.6bn. Small Time Deposits declined $2.9bn. Retail Money Funds gained $9.4bn.

Money market fund assets jumped $24bn to $2.620 TN. Money Fund assets were up $69bn from a year ago, or 2.7%.

Total Commercial Paper outstanding sank $45.2bn this week to an eight-month low $990.5bn. CP has declined $75bn y-t-d, while having expanded $9bn, or 0.9%, over the past year.

Currency and 'Currency War' Watch:

July 10 – Bloomberg (Lukanyo Mnyanda): “Europe’s lowest money-market rates since 2007 relative to the U.S. are pointing to a weaker euro after Mario Draghi waded into the currency wars to fight the region’s longest recession on record. Two-year interest-rate swaps denominated in euros slid relative to those priced in dollars after the European Central Bank president took the unprecedented step last week of pledging to keep borrowing costs at the current record low, or even lower, for an ‘extended period.’”

The U.S. dollar index dropped 1.7% to 82.99 (up 4.0% y-t-d). For the week on the upside, the Norwegian krone increased 3.1%, the South African rand 2.2%, the Swedish krona 2.1%, the Mexican peso 2.0%, the Japanese yen 2.0%, the Danish krone 1.9%, the euro 1.9%, the Swiss franc 1.9%, the Canadian dollar 1.8%, the South Korean won 1.6%, the Singapore dollar 1.5%, the British pound 1.5%, the New Zealand dollar 0.9% and the Taiwanese dollar 0.4%. For the week on the downside, the Brazilian real declined 0.7% and the Australian dollar dipped 0.2%.

Commodities Watch:

The CRB index jumped 2.1% this week (down 2.8% y-t-d). The Goldman Sachs Commodities Index rose 1.7% (down 0.3%). Spot Gold rallied 5.1% to $1,286 (down 23.3%). Silver recovered 5.6% to $19.79 (down 35%). September Crude gained another $2.73 to $105.95. (up 15%). September Gasoline surged 7.6% (up 12%), and September Natural Gas added 0.7% (up 9%). September Copper was up 2.9% (down 14%). July Wheat gained 3.0% (down 13%), and July Corn rose 2.4% (unchanged).

U.S. Bubble Economy Watch:

July 8 – Bloomberg (Roger Runningen): “The Obama administration projects the federal budget deficit will shrink to $759 billion for the year ending Sept. 30, the smallest gap in five years… The Office of Management and Budget said in an update of its forecasts that the economy may grow 2% this year on an annual basis. That’s down from the 2.3% growth rate predicted three months ago… In the budget review, the forecast for a deficit of $759 billion translates to 4.7% of the gross domestic product.”

July 10 – Bloomberg (Sridhar Natarajan): “Bank lending to U.S. companies is rising at a pace that will by year-end push the total above the record high of $1.61 trillion reached in 2008. Commercial and industrial loans outstanding climbed to $1.56 trillion in the week ended June 26, an increase of 4.1% this year… The amount surged about $18 billion last month, the most this year. Lenders awash in $9.5 trillion of deposits are extending credit lines to companies needing cash to help finance projects and expand businesses as delinquency rates fall and evidence mounts that the economic recovery is more sustainable.”

July 12 – Bloomberg (Oshrat Carmiel): “Home prices in Brooklyn, New York’s most populous borough, surged to a record as low interest rates and rising rents across the city swelled demand for homeownership amid a dwindling supply of properties for sale. The median price of condominiums, co-ops and one- to three- family homes that sold in the second quarter was $550,000, up 15% from a year earlier and the highest in more than a decade of record keeping… Miller Samuel Inc. and brokerage Douglas Elliman Real Estate said…”

July 11 – Bloomberg (Mark John Gittelsohn): “Loan applications for purchases of new U.S. homes tumbled last month, a sign rising mortgage rates may have damped demand for builders, according an index released today by the Mortgage Bankers Association. The Builder Application Survey showed a 15% decline in loan submissions in June from the previous month…”

Federal Reserve Watch:

July 11 – Bloomberg (Joshua Zumbrun, Craig Torres and Steve Matthews): “Federal Reserve Chairman Ben S. Bernanke called for maintaining accommodation even as the minutes of policy makers’ June meeting showed them debating whether to stop bond buying by the Fed in 2013. ‘Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,’ Bernanke said…”

July 10 – UK Telegraph (Katherine Rushton): “US markets were volatile on Wednesday as investors weighed signs that the Federal Reserve could suddenly taper its fiscal stimulus package, against the news that many of its members want to see a sustainable improvement in jobs first. Around half of Fed policymakers wanted to bring its massive fiscal stimulus package to a relatively rapid halt this year, instead of phasing it out slowly by the middle of 2014, according to the minutes of its June meeting… ‘About half’ of the 19-member Federal Open Market Committee said ‘it likely would be appropriate to end asset purchases late this year’, the minutes read. ‘A few’ wanted to slow or stop the purchases at the June meeting. The revelation will heighten expectations on Wall Street that the Fed is eager to start winding down the $85bn-a-month bond buying programme as soon as it thinks it can do so.”

July 12 – MarketNews International (Brai Odion-Esene): “Philadelphia Federal Reserve Bank President Charles Plosser Friday revealed himself as one of those Fed officials that want the central bank to begin scaling back and then conclude its current bond-buying program by the end of this year… ‘My view is that the time has come for us to exit our current asset purchase program and commit to a way forward that seeks to normalize monetary policy,’ Plosser said. ‘I favor starting to reduce the pace of purchases and ending the asset purchase program by year-end,’ he added… Plosser warned that the Fed faces some significant challenges going forward when time comes to unwind it’s massive balance sheet. ‘Failing to execute a graceful exit and falling behind the curve could risk significant inflation or a rapid increase in interest rates that may be counterproductive… The recent volatility in interest rates may be a taste of things to come.’”

Central Bank Watch:

July 11 – Bloomberg (Mark Deen and Caroline Connan): “European Central Bank Executive Board member Benoit Coeure said policy makers will use each monthly meeting to revisit their unprecedented commitment to keep interest rates low for an extended period. ‘It will be reassessed Governing Council after Governing Council,’ Coeure said... Executive Board member Joerg Asmussen sowed confusion on July 9 when he said that the new policy held for a period beyond 12 months, only for the ECB later to issue a statement saying he didn’t mean to outline any time horizon. ‘Forward guidance is not a shift in our strategy,’ Coeure said. ‘It’s a way to clarify our communication and provide more stability to financial markets. The mandate of the ECB is the same: it’s intact, it’s a price-stability mandate.’”

U.S. Fixed Income Bubble Watch:

July 12 – Bloomberg (Laura Kaster): “Morningstar says investors withdrew $43.8b from taxable-bond funds, $16.4b from muni-bond funds in June, the worst month on record for bond fund total outflows.”

July 8 – Bloomberg (Candice Zachariahs): “U.S. Treasury sales by Japanese investors exceeded purchases by a record in May amid the biggest monthly drop for the securities in more than three years. Money managers in the Asian nation unloaded a net 3 trillion yen ($30bn) of U.S. government bonds in a fifth straight month of overall sales that was the largest in data from 2005… In June, Japanese investors were net sellers of overseas debt valued at a record 2.96 trillion yen, taking the total to 10.6 trillion yen this year… That’s on track for the first net annual sales ever.”

July 10 – Financial Times (Stephen Foley): “Structured finance vehicles that have pumped $42bn into the US loan market so far this year are employing increasing amounts of leverage to do so, as issuers battle to keep their complex deals profitable. The amount of debt finance used by collateralized loan obligations (CLOs) jumped in the second quarter of 2013, according to… RBS. CLOs are highly-levered vehicles which themselves invest in leveraged loans of the kind typically used to fund private equity buyouts. In the three months to the end of June, the debt financing raised for new CLOs was 9.3 times the value of the underlying equity. That leverage figure is up from 8.2 times in the average deal in 2012, and from 8.7% in the first quarter of 2013.”

July 11 – Bloomberg (Sarika Gangar): “Corporate bonds that can convert into stock are being offered at the fastest pace since 2008, luring investors with the biggest relative returns in 14 years. Volkswagen AG and Starwood Property Trust Inc. led companies worldwide selling $8.6 billion of convertible bonds last month, bringing offerings this year to $48.3 billion… That’s 77% more than was sold by this time last year and is the most for the period since $69 billion in 2008…”

Bursting EM Bubble Watch:

July 10 – Bloomberg (Ye Xie, Maria Levitov and Ksenia Galouchko): “Capital flight from the BRICs, Brazil, Russia, India and China, is sending their stocks, bonds and currencies down in tandem for the first time since 2006 as the 10-year love affair with the largest emerging markets ends. ‘Every decade, there’s a theme that captures investors’ imagination -- the 1970s was about gold, 1980s was all about Japan and 1990s was about technology companies,’ Ruchir Sharma, the… head of emerging markets at Morgan Stanley Investment Management, which oversees $341 billion, said… ‘Last decade it was about the BRICs. That theme has basically run its course.’”

July 11 – Bloomberg (Novrida Manurung): “Bank Indonesia raised its key interest rate more than economists forecast to bolster a weakening currency and ease inflation pressures after the government increased fuel prices last month. The central bank boosted the reference rate by 50 bps to 6.5%... Indonesia in June became the region’s first major economy to boost rates this year…”

July 11 – Bloomberg (Matthew Malinowski and Arnaldo Galvao): “Brazil’s central bank raised the benchmark interest rate a third consecutive time and said it was giving continuity to the world’s biggest tightening cycle, signaling increases may be extended through year-end as policy makers battle inflation. The bank’s board… raised the benchmark Selic rate by 50 bps to 8.50%... In Brazil, quickening inflation is sapping economic growth and further driving away investors.”

July 11 – Bloomberg (Blake Schmidt): “The biggest street protests in two decades are adding to speculation Brazilian President Dilma Rousseff won’t come to the rescue of beleaguered billionaire Eike Batista. Bonds due in 2018 from OGX Petroleo & Gas Participacoes SA, Batista’s flagship oil producer, have tumbled 35 cents in the past month…, to 22 cents… The securities have lost 76% of their value this year while OGX shares have tumbled 87%... The plunge has deepened as demonstrators rail against more than $13 billion of spending on World Cup projects and demand better education and health services, diminishing the chances Rousseff will risk further angering protesters by bailing out Batista, according to Credit Agricole SA.”

July 11 – Bloomberg (Siddhartha Singh and Kartik Goyal): “India’s government plans to meet as many as eight bankers as it weighs selling debt abroad to raise dollars and help steady the rupee, according to two Finance Ministry officials… Any issuance of Indian sovereign dollar bonds for overseas investors would be the first in the nation’s history…”

July 12 – Bloomberg (Yudith Ho): “Indonesian bonds declined for a ninth week, the longest losing streak in five years, after the central bank boosted its benchmark rate by the most since 2005 to slow inflation. The rupiah fell to the lowest since 2009… The yield on the government’s 5.625% notes due May 2023 surged 67 bps this week to 8.07%..., the highest level since March 2011…”

July 12 – Bloomberg (Kevin Crowley): “Eskom Holdings SOC Ltd. is facing a $25 billion funding gap over the next five years that the South African power utility may be unable to fill with bond sales, jeopardizing timetables for building plants to avoid blackouts. Yields on the power utility’s dollar bonds due January 2021 rose for the seventh straight day…”

Global Bubble Watch:

July 9 – Financial Times (Robin Harding): “In an update to April’s World Economic Outlook, the IMF cut its global growth forecasts by 0.2 percentage points for both years, to 3.1% for 2013 and 3.8% for 2014. The downgrades highlight the gathering clouds around the world economy as big developing countries – such as China and Brazil – start to weaken before the developed markets have fully recovered. For 2014, the IMF cut its growth forecast for Russia by 0.5 percentage points to 3.3%, for China by 0.6 percentage points to 7.7% and for Brazil by 0.8 percentage points to 3.2%.”

July 9 – Bloomberg (Jeanna Smialek): “World economic growth will struggle to accelerate this year as a U.S. expansion weakens, China’s economy levels off and Europe’s recession deepens, the International Monetary Fund said. Global growth will be 3.1% this year, unchanged from the 2012 rate, and less than the 3.3% forecast in April…, trimming its prediction for this year a fifth consecutive time. The IMF reduced its 2013 projection for the U.S. to 1.7% growth from 1.9% in April, while next year’s outlook was trimmed to 2.7% from 3% initially reported in April. ‘Downside risks to global growth prospects still dominate,’ the IMF said… It cited ‘the possibility of a longer growth slowdown in emerging market economies, especially given risks of lower potential growth, slowing credit, and possibly tighter financial conditions if the anticipated unwinding of monetary policy stimulus in the U.S. leads to sustained capital flow reversals.’”

July 10 – Reuters (Simon Jessop): “Investors seeking to predict the magnitude of share price moves at times of market flux may get a faulty steer from a closely watched "fear gauge", one of investment banking's top equity traders has warned. Citi's Mike Pringle, global head of equity trading at the third-biggest U.S. bank, told Reuters that the VIX volatility index , is now as much a traded asset as it is a guide to investors seeking protection from losses. The VIX reflects Standard & Poor's 500 options prices and, therefore, expectations of future market moves. The idea is that as people become fearful of losing their money, they are more willing to buy a put option as protection. At the moment, it remains at very low levels. ‘A big mistake the market makes is looking at the VIX as an indicator of stock market risk. Why? Because it's an asset class and it's more traded for yield than protection,’ Pringle said. ‘The growth of structured products around VIX drove that move. In most cases, the VIX is sold to generate yield but during some stress periods, the weakness in the spot level triggers significant computer-generated technical buying from these products,’ he said.”

Global Credit Watch:

July 9 – Financial Times (Christopher Thompson): “Lending to European financial institutions has dropped to its lowest level in a decade as banks shrink their balance sheets and investors grow wary of regulatory risks. Total issuance of financial institutions’ debt dropped 7 per cent year-on-year to $230.3bn for the six months to the end of June, the lowest since 2003, according to figures from Dealogic… The International Monetary Fund has slashed its growth forecasts for 2013 and 2014 as it warned of a slowdown in key emerging markets and a more protracted recession in the euro area.”

China Bubble Watch:

July 10 – Bloomberg: “China’s exports and imports unexpectedly declined in June, underscoring the severity of the slowdown in the world’s second-biggest economy as Premier Li Keqiang reins in credit growth. Overseas shipments fell 3.1% from a year earlier, the most since the global financial crisis…, compared with the median estimate of a 3.7% gain… Imports dropped 0.7%, while the median projection was for a 6% increase.”

July 12 – Bloomberg: “Chinese Finance Minister Lou Jiwei signaled the world’s second-biggest economy may expand less than the government’s target this year and that growth as low as 6.5% may be tolerable in the future. While the government in March set a 2013 growth goal of 7.5%, Lou said he’s confident in achieving a 7% rate this year… His comments suggest China is prepared to allow a further slowdown from a rate that’s already at risk of falling to a 23-year low this year as Premier Li Keqiang focuses on policy changes to create more-sustainable expansion.”

July 12 – Bloomberg: “China made progress in curbing shadow banking in June and slowed money-supply growth, as Premier Li Keqiang seeks to rein in the credit boom that poses risks for the nation’s financial system. Data for aggregate financing, the broadest measure of credit, showed new yuan loans played the biggest role since September 2011, with non-traditional sources of finance less prominent. M2 money supply rose 14%, down from 15.8% the previous month… A central bank-engineered cash crunch last month helped squeeze speculative lending and rein in what Vice Finance Minister Zhu Guangyao… termed ‘prominent’ shadow- banking risks… ‘The impact of the PBOC’s liquidity crunch operation is very clear: targeting shadow banking but maintaining regular bank lending,’ said Shen Jianguang, chief Asia economist at Mizuho Securities… The surge in the share of bank loans in aggregate financing reflects ‘a severe decline in shadow-banking activities,’ he said.”

July 12 – Bloomberg: “China’s money-supply growth trailed estimates in June while new local-currency loans were more than forecast after a cash squeeze that sent interbank borrowing costs to record highs. M2 money supply rose 14.0%... That compared with the median… estimate of 15.2% and a 15.8% pace in May. New yuan loans were 860.5 billion yuan ($140bn) compared with the 800 billion yuan median analyst estimate and 919.8 billion yuan a year ago. Aggregate financing, the government’s broadest measure of credit, was 1.04 trillion yuan, down from 1.78 trillion yuan in June 2012.”

July 11 – Reuters: “New local currency yuan loans extended by China's big four state-owned banks stood at an unusually large 170 billion yuan ($27.7bn) in the first week of July…, a move that may alarm regulators trying to strangle distorted credit growth. Traders said similarly aggressive lending by Chinese banks in early June caused the central bank to set off an acute liquidity squeeze in the country's interbank market.”

July 11 – Bloomberg (David Yong and Andrea Wong): “The risk of a hard landing in China’s economy has caused the longest drought in dollar-denominated junk bond sales in a year and encouraged Morgan Stanley to recommend buying credit-default protection. Amid the nation’s worst cash crunch on record, no Chinese speculative-grade companies have marketed dollar notes since… May 22… That’s the longest stretch since the market went quiet for 95 days through July 24 last year…”

July 8 – Bloomberg: “China’s money-market cash squeeze is likely to reduce credit growth this year by 750 billion yuan ($122bnn), an amount equivalent to the size of Vietnam’s economy, according to a Bloomberg News survey. The number is the median estimate of 15 analysts…”

July 10 – Bloomberg: “China’s cash crunch is spreading to the nation’s auto dealerships as they become increasingly reluctant to ship their vehicles to neighborhood car lots without upfront payment. ‘With the cash squeeze, authorized dealers are no longer willing to hand over their cars on good faith,’ Chi Yifeng, general manager of Beijing Asian Games Village Automobile Exchange… said… ‘They’re holding tighter to their capital and are more cautious about their business plans.’ …‘The cash crunch has led to psychological panic among dealers over access to financing,’ Luo Lei, deputy secretary- general of the China Automobile Dealers Association, said…”

July 9 – Bloomberg: “China’s inflation stayed subdued in June while a decline in factory-gate prices extended its longest streak in a decade, underscoring weaker demand in an economy that probably decelerated for a second quarter. The consumer price index rose 2.7% from a year earlier …compared with a median estimate of 2.5%... and a 2.1% gain in May. Producer prices fell 2.7%. The lowest first-half inflation since the financial crisis in 2009 and prolonged factory-gate deflation reflect a slowdown and overcapacity that leave the government at risk of missing its annual growth target for the first time since 1998.”

July 10 – Bloomberg: “China Rongsheng Heavy Industries Group Holdings Ltd. is in talks with two coastal cities and government departments to secure financial assistance, as the nation’s shipowners association forecast a slump in vessel orders will run through next year.”

Japan Bubble Watch:

July 12 – Bloomberg (Satoshi Kawano and Tom Redmond): “The popularity of Japanese exchange-traded funds has risen to record levels, led by an ETF that doubles the returns of the Nikkei 225 Stock Average. The… value of transactions to buy or sell the Next Funds Nikkei 225 Leveraged Index ETF soared more than 1,159% starting from Jan. 4, compared with a 17% increase in overall trading value for the Tokyo Stock Exchange first section.”

India Watch:

July 9 – Bloomberg (Jeanette Rodrigues and Yumi Teso): “India’s rupee rebounded from a record low after regulators took measures to curb speculation in currency derivatives. The Reserve Bank of India barred banks from proprietary trading in currency futures and exchange-traded options, it said on its website yesterday. The Securities and Exchange Board of India said separately it will raise margin requirements and cap open positions in such contracts.”

July 9 – Bloomberg (Anurag Joshi, Abhishek Shanker and George Smith Alexander): “A plunge in the rupee threatens to boost costs for Indian companies facing at least $20 billion in overseas debt repayments in the coming year, potentially wiping out the benefits of seeking lower interest rates. Local borrowers… are due to redeem $18.7 billion of loans by mid-2014 and $1.1 billion in bonds… The rupee slid 9.6% since March 31… Businesses hedging dollar exposure and investors betting on further rupee declines spurred a 47% surge in Mumbai’s trading of currency derivatives in June, prompting the nation’s market regulator to tighten rules on futures and options transactions this week… ‘Everyone is nervous,’ Seshagiri Rao, chief financial officer at JSW Steel Ltd., India’s no. 3 maker of the alloy, said… ‘Such a sharp fall in the rupee will hit companies in the form of foreign-exchange losses. This will bring volatility in earnings of all corporates with foreign liabilities even though operationally they may be doing well.’”

Latin America Watch:

July 10 – Bloomberg (Boris Korby): “Law firms Cleary Gottlieb Steen & Hamilton LLP and Bingham McCutchen LLP are arranging separate meetings with bondholders of billionaire Eike Batista’s OGX Petroleo & Gas Participacoes SA and OSX Brasil SA to discuss Brazilian insolvency law.”

July 8 – Bloomberg (Lucia Kassai): “Marfrig Alimentos SA, Latin America’s second-largest beef producer, expects Brazil’s development bank to approve a four-month delay on interest payments for its domestic bonds without levying any penalty. The company has already discussed the deferral with the lender, known as BNDES, and has pledged to pay interest that will accrue until the new date…”

Europe Crisis Watch:

July 9 – Reuters: “Greece’s inability or unwillingness to collect taxes threatens to create a new financing shortfall, its lenders said in a report seen by Reuters that signals a new low in relations. After months of relative calm, concerns over the bloc's first bailout recipient as well as a teetering government in Portugal have reignited the threat that the euro zone crisis may return. Athens is far from financial independence and even as Greece received a fresh lifeline from the European Union and the International Monetary Fund on Monday, the report underscores the sense of alarm over Greece's willingness to change. If Greece's long-term funding looks no longer secured, there is a risk the IMF may have to pull out of the rescue. In private, European officials have struck an increasingly damning tone on Athens in recent weeks, with some saying the government was doing just the bare minimum and the country’s economic outlook was dimming.”

Portugal Watch:

July 11 – Reuters (Axel Bugge): “Portugal's president threw the bailed-out euro zone country into disarray on Thursday after rejecting a plan to heal a government rift, igniting what critics called a ‘time bomb’ by calling for early elections next year. President Anibal Cavaco Silva proposed a cross-party agreement between the ruling coalition and opposition Socialists to guarantee wide support for austerity measures needed for Portugal to exit its bailout next year, followed by elections. The surprise move came just when conservative Prime Minister Paolo Passos Coelho thought he had overcome a cabinet crisis by reaching a deal to keep his center-right coalition together. The decision was a warning shot to all mainstream parties indicating the conservative president does not think any of them is capable of ruling effectively until the EU-IMF bailout is due to expire in June 2014.”

Germany Watch:

July 8 – Bloomberg (Stefan Riecher): “German industrial production dropped more than economists predicted in May, adding to signs that Europe’s sovereign debt crisis is weakening a recovery in the region’s largest economy. Production fell 1% from April, when it gained a revised 2%... From a year earlier, production decreased 1% when adjusted for working days.”

July 8 – Bloomberg (Stefan Riecher): “German exports unexpectedly fell in May, indicating the euro area’s sovereign debt crisis is disrupting a recovery in the region’s largest economy. Exports… dropped 2.4% from April, when they rose a revised 1.4%... Imports increased 1.7% from April. Germany’s factory orders unexpectedly dropped for a second month in May…”

France Watch:

July 12 – Bloomberg (Mark Deen): “France lost its top credit rating at Fitch Ratings, which highlighted concern about lack of growth and the buildup of debt in Europe’s second-largest economy. France was cut by one step to AA+ from AAA, Fitch said today, joining Moody’s… and Standard & Poor’s in removing France from the shrinking club of top-rated governments… Budget risks ‘lie mainly to the downside, owing to the uncertain growth outlook and the ongoing euro zone crisis, even assuming no wavering in commitment to fiscal consolidation,’ Fitch said… “

Spain Watch:

July 9 – UK Telegraph (Fiona Govan): “Spain’s prime minister Mariano Rajoy is under increasing pressure after the publication of original documents purporting to show illegal cash payments were paid to him while he was a minister. Excerpts from an accounts ledger of a secret slush fund were published by Spain'sEl Mundo newspaper, apparently implicating Mr Rajoy and other senior members of the ruling Popular Party. The documents have reignited a scandal that outraged Spaniards suffering its fifth year of economic crisis and led to street protests earlier this year calling for the prime minister to resign.”

Italy Watch:

July 9 – Bloomberg (Dave Liedtka): “Italy’s credit rating was lowered to BBB, or two levels above junk, by Standard & Poor’s because of expectations for a further weakening of economic prospects and the nation’s impaired financial system. The outlook on the rating, reduced from BBB+, remains negative, the… ratings company said… Italy’s economic output in the first quarter of 2013 was 8% lower than in the last quarter of 2007 and continues to fall, S&P said. The company lowered its growth forecast for 2013 to minus 1.9%, from minus 1.4%...”