Sunday, December 14, 2014

Weekly Commentary, July 18, 2014: Druckenmiller the Statesman

Hedge fund manager Stanley Druckenmiller rightfully attained “legendary” stature after achieving a phenomenal 30-year track record. Throughout his career, he has successfully implemented a “top down” macro approach to investing/speculating across global markets, including a highly successful stint partnering with George Soros. Druckenmiller provided cogent remarks Wednesday at the Delivering Alpha conference covered live by CNBC:

Druckenmiller: “As a macro investor, my job for 30 years was to anticipate changes in the economic trends that were not expected by others – and therefore not yet reflected in securities prices. I certainly made my share of mistakes over the years, but I was fortunate enough to make outsized gains a number of times when we had different views from various central banks. Since most investors like betting with the central bank, these occasions provided our most outsized returns - and the subsequent price adjustments were quite extreme. Today’s Fed policy is as puzzling to me as during any of those periods and, frankly, rivals 2003 in the late-stages to early-2004, as the most baffling of a number of instances I have in mind. We at Duquesne [Capital Management] were mystified back at that time why the funds rate was one percent with the ‘considerable period’ attached to it, given the vigorous economic growth statistics available at the time. I recall walking in one day and showing my partners a bunch of charts of economic statistics of that day and asking them to take the following quiz: Suppose you had been on Mars the last five years and had just come back to planet Earth. I showed them five charts and I said, ‘If you had to guess, where would you guess the Federal funds rate was?’ Without exception, everyone guessed way north of one percent, as opposed to the policy at the time which was a verbal guarantee that they would stay at one percent for a ‘considerable period of time.’ So we were confident the Fed was making a mistake, but we were much less confident in how it would manifest itself. However, our assessment by mid-2005 that the Fed was fueling an unsustainable housing Bubble, with dire repercussions for the greater economy, allowed our investors to profit handsomely as the financial crisis unfolded. Maybe we got lucky. But the leadership of the Federal Reserve did not foresee the coming consequences as late as mid-2007. And, surprisingly, many Fed officials still do not acknowledge any connection between loose monetary policy and subsequent events. That is why I am personally experiencing a sense of Deja vu.”

I hope we can all agree that these once-in-a-century emergency measures are no longer necessary five years into an economic and balance sheet recovery. There is a heated debate as to what a ‘neutral’ Fed funds rate would be. We should be debating why we haven’t moved more meaningfully towards a neutral funds rate. If for no other reason, so the Fed will have additional weapons available if the outlook darkens again. Many Fed officials and other economists defend their current policies by claiming the economy is better than it would have been without their ongoing stimulus. No one knows for sure, but I believe that is logical and correct. However, I also believe if you’d asked the same question in 2006 – that the economy was better in 2004 to 2006 than it would have been without the monetary stimulus that preceded it. But was the economy better in total from 2003 to 2010 – without the monetary stimulus that preceded it? The same applies today. To economists and Fed officials who continually cite that we are better off than we would have been without zero rate policies for long, I ask ‘Why is that the relevant policy time frame?’ Five years after the crisis, and with growing signs of economic normalization, it seems time to let go of myopic goals. Given the charts I just showed and looking at economic history, today’s Fed policy seems not only unnecessary but fraught with unappreciated risk. When Ben Bernanke and his colleagues instituted QE1 in 2009, financial conditions in the real economy were in a dysfunctional meltdown. The policy was brilliantly conceived and a no-brainer from a risk/reward perspective. But the current policy makes no sense from a risk/reward perspective. Five years into an economic and balance sheet recovery, extraordinary money measures are likely running into sharply diminishing returns. On the other hand, history shows potential long-term costs can be quite severe. I don’t know whether we’re going to end with a mal-investment bust due to a misallocation of resources; whether it’s inflation; or whether the outcome will actually be benign. I really don’t. Neither does the Fed.

I really appreciate Mr. Druckenmiller’s statesman-like comments. As a seasoned trader and hedge fund manager, his thought processes are conditioned to analyze things in terms of probabilities and a risk versus reward calculus. He has generated incredible investment returns and accumulated stunning wealth through a profound understanding of shifting macro backdrops, while implementing disciplined trading strategies. Basically, success depends upon intense objectivity and focus, pressing the winning bets and slashing the losers – the old “You gotta know when to hold ‘em, know when to fold ‘em, when to walk away and when to run.”

I agree completely with Druckenmiller’s comment: “The current policy makes no sense from a risk/reward perspective.” And the critical issue of risk vs. reward gets right to the heart of the failure of contemporary central banking. As a masterful professional speculator, it was imperative for Druckenmiller to move quickly to recognize mistakes and mitigate losses. Discretionary central banking, in contrast, ensures that policy errors will be followed by only greater ones. You can toss accountability and objectivity right out the window. Poor performance will see hedge fund managers lose their investors and businesses. Poor policy has led to previously unthinkable policymaker discretion and power at the Federal Reserve (and why there’s an appropriate push for a more rules-based policy approach). And when it comes to pure analytical prowess, the academic central banker is no match for the well-schooled hedge fund titan.

Druckenmiller highlights the 2003-2004 period as an example of “puzzling” monetary policy. I remember my frustration with the Fed during that time. Fed funds were held at one percent until June 2004, despite an acceleration of already breakneck mortgage Credit expansion. In fact, 2004 saw annual mortgage Credit growth jump to 13.5%, marking the fourth straight year of double-digit mortgage Credit growth (and fifth of six).

Monetary policy was recklessly loose, though it was expounded in terms of an adroit “risk management” approach for minimizing the probability of a very bad economic outcome. Stated differently, the Greenspan/Bernanke Fed believed aggressive monetary policies reduced the likelihood of a highly undesirable deflationary spiral. The Fed explicitly adopted the Bernanke doctrine of ignoring Bubbles and instead placed emphasis on post-Bubble “mopping up” (reflationary) measures. As Druckenmiller noted, the Fed was oblivious to the risks its policies were fomenting.

I wasn’t particularly puzzled by Fed policy back in 2003/04; I simply believed our central bank was following terribly misguided doctrine. Clearly, there was a complete lack of understanding as to the myriad financial and economic risks associated with asset inflation and Bubbles. Moreover, there was overconfidence with respect to the Fed’s capacity to reflate system Credit in the event of a major securities market crisis of confidence.

With the Fed apparently having learned nothing from past experience, I find current policy somewhat more baffling. At this point, risks associated with loose monetary policy should be readily appreciated. It doesn’t make any sense that the Fed remains so dismissive of securities market excesses. And with Fed funds stuck at zero and the Fed’s balance sheet rapidly approaching $4.5 TN, our central bankers should recognize that the risks of stoking asset Bubbles are actually even greater today. After almost six years of post-crisis stimulus, Bernanke’s “mopping up” maxim has understandably disappeared from Fed discourse.

From Druckenmiller: “There is a heated debate as to what a ‘neutral’ Fed funds rate would be. We should be debating why we haven’t moved more meaningfully towards a neutral funds rate.”

We’re inundated these days with rationalizations and justification for ongoing reckless monetary management. There are variations of this “new neutral” mantra that an extraordinary backdrop dictates that the Fed sticks with exceptionally low targeted rates for much longer. Apparently, it’s logical that the dire consequences from a period of loose monetary policy stipulate another period of ultra-aggressive monetary stimulus.

Interestingly, leading “Keynesian” (inflationist) Paul Krugman has focused a bit recently on the “Wicksellian natural rate” (esteemed Swedish economist Knut Wicksell, 1851-1926):

Krugman (NYT, July 7, 2014): “The Keynesian view of monetary policy is that the central bank should, if it can, set interest rates at a level that produces full employment. Sometimes it can’t: even at a zero rate the economy remains depressed, so you need fiscal policy. But in normal times the Fed and its counterparts should be aiming at the full-employment interest rate. Wicksellian analysis is an older tradition; it argues that there is at any given time a ‘natural’ rate of interest in the sense that keeping rates below that level leads to inflation, keeping them above it leads to deflation. I have always considered these approaches essentially equivalent: the Wicksellian natural rate is the rate that would lead to full employment in a Keynesian model. I have, in fact, treated them as equivalent on a number of occasions, e.g. here. Now, what about the BIS [Bank of International Settlements]? It is arguing that central banks have consistently kept rates too low for the past couple of decades. But this is not a statement about the Wicksellian natural rate. After all, inflation is lower now than it was 20 years ago.

Similar to so many traditional metrics, axioms and concepts, Wicksell’s “natural rate” is not so easily applied to the current environment. I have always been fascinated by Wicksell’s notion of a hypothetical (“natural”) rate that equates with general price and economic stability. The “Austrian” school has argued persuasively that central banks have for years fostered precarious boom and bust dynamics by pushing market yields below the “natural rate.” It makes for a provocative discussion.

From my perspective, Wicksell’s conceptual “natural rate” was derived from the interplay between the supply of and demand for a limited quantity of capital. And this gets right to the major problem I have with both contemporary finance and monetary management: There is today, on a globalized basis, no limits to either the quantity or quality of Credit. To that end, I avoid using the term “capital.” Capital connotes something of real value – or a financial claim backed by real economic wealth. Yet too much of today’s (debit and Credit entry electronic) finance is backed by nothing. So then, what does a global regime of unfettered electronic finance imply for a “natural” or “neutral” interest rate?

Brief thoughts on Wicksell’s “natural rate”: I completely disagree with Krugman’s contention that modest consumer price inflation is evidence that current central bank-dictated market rates have been consistent with a Wicksellian equilibrium rate (which Krugman states appropriately supports today’s asset prices). One should instead think more in terms of general stability in various price levels throughout the system, certainly including real and financial asset prices. And one would have to be delusional to believe that asset prices have been in anyway consistent with a stable “equilibrium”. Moreover, it is disingenuous to claim that asset prices have not been profoundly impacted by the almost six-year $3.5 TN increase in Federal Reserve securities holdings (Fed Credit). Simply overlay a five-year chart of Federal Reserve holdings with a chart of the U.S. stock market.

And while on the subject of a “natural rate,” I think it’s worth pondering this concept in terms of today’s extraordinarily low Treasury and corporate yields. I believe central bank policies – especially “open-ended” QE3 – have comprehensively distorted asset markets. First, the unprecedented purchases of Treasuries and MBS created liquidity/purchasing power that inflated securities prices generally. Secondly, this liquidity onslaught incited dangerous self-reinforcing excess throughout corporate debt and equities markets. And a runaway corporate securities Bubble has of late boosted the safe haven appeal of Treasuries, with sinking yields further stoking the historic Bubble throughout virtually all asset markets.

Importantly, the willingness to adopt an open-ended approach to the third round of QE has been viewed throughout the marketplace as the Fed (in concert with the global central bank community) having adopted a regime of boundless securities market support. This has profoundly affected market perceptions, hence securities pricing, with the greatest impact upon the traditionally higher-risk segments of the corporate and “structured finance” securities markets.

Stated somewhat differently, the collapse in risk premiums – risk asset price inflation – is this inflationary cycle’s greatest market distortion. Indeed, I would strongly argue that unprecedented liquidity injections coupled with implied (ok, explicit) central bank market backstops has inflated the biggest Bubble yet. Any semblance of a “neutral rate” – or a stable securities market “equilibrium” – would require that central banks extricate themselves from the securities market liquidity and backstopping business. Good luck with that.

For the Week:

The S&P500 gained 0.5% (up 7.0% y-t-d), and the Dow rose 0.9% (up 3.2%). The Utilities slipped 0.2% (up 11.4%). The Banks declined 0.3% (up 2.2%), while the Broker/Dealers gained 1.1% (down 2.1%). The Transports jumped 1.6% (up 13.3%). The S&P 400 Midcaps were little changed (up 5.2%), while the small cap Russell 2000 declined 0.8% (down 1.1%). The Nasdaq100 added 0.9% (up 9.7%), and the Morgan Stanley High Tech index rose 0.9% (up 7.6%). The Semiconductors were about unchanged (up 20.3%). The Biotechs sank 2.5% (up 16.9%). With bullion down $28, the HUI gold index fell 1.7% (up 22.9%).

One-month Treasury bill rates closed the week at two bps and three-month bills ended at one basis point. Two-year government yields added three bps to 0.48% (up 10bps y-t-d). Five-year T-note yields rose three bps to 1.67% (down 7bps). Ten-year Treasury yields declined four bps to 2.48% (down 55bps). Long bond yields fell five bps to 3.29% (down 68bps). Benchmark Fannie MBS yields were unchanged at 3.18% (down 43bps). The spread between benchmark MBS and 10-year Treasury yields widened four to a three-month high 70 bps. The implied yield on December 2015 eurodollar futures jumped seven bps to 1.045%. The two-year dollar swap spread increased two to 19 bps, and the 10-year swap spread added one to 12 bps. Corporate bond spreads were mostly wider. An index of investment grade bond risk was up slightly to 59 bps. An index of junk bond risk jumped eight to 312 bps. An index of emerging market (EM) debt risk gained nine to 273 bps.

Debt issuance was steady. Investment-grade issuers included Morgan Stanley $3.0bn, Bed Bath & Beyond $1.5bn, Toyota Motor Credit $1.25bn, CSX $1.0bn, Wells Fargo $350 million, Mutual of Omaha $300 million, Stifel Financial $300 million and Comerica $250 million.

Junk funds saw outflows surge to $1.7bn (from Lipper). Junk issuers included American Energy $1.6bn, Memorial Production Partners LP $500 million, Triangle USA Petroleum $450 million, Light Tower Rentals $330 million, REX Energy $325 million, Hardwoods $300 million, Cardtronics $250 million, Bonanza Creek Energy $300 million and Infinity $185 million.

I saw no convertible debt issues this week.

International dollar debt issuers included Bank of Nova Scotia $1.75bn, Toronto Dominion Bank $1.25bn, South Africa $1.0bn, Empresa Nacional de Telecommunications $800 million, Ivory Coast $750 million, Celulosa Arauco $500 million, Unifin Financiera $400 million and Caixa Economica Federal $350 million.

Ten-year Portuguese yields sank 20 bps to 3.67% (down 247bps y-t-d). Italian 10-yr yields fell 11 bps to 2.78% (down 135bps). Spain's 10-year yields dropped 17 bps to 2.60% (down 155bps). German bund yields were down five bps to 1.16% (down 77bps). French yields declined 11 bps to a record low 1.57% (down 98bps). The French to German 10-year bond spread narrowed six to 41 bps. Greek 10-year yields dipped three bps to 6.23% (down 219bps). U.K. 10-year gilt yields declined three bps to 2.57% (down 45bps).

Japan's Nikkei equities index recovered 0.3% (down 6.6% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.55% (down 20bps). The German DAX equities index gained 0.6% (up 1.8%). Spain's IBEX 35 equities index slipped 0.1% (up 6.2%). Italy's FTSE MIB index increased 0.6% (up 9.3%). Emerging equities were mostly higher. Brazil's Bovespa index surged 4.1% (up 10.7%). Mexico's Bolsa gained 1.8% (up 3.6%). South Korea's Kospi index jumped 1.5% (up 0.4%). India’s bubbly Sensex equities index was up another 2.5% (up 21.1%). China’s Shanghai Exchange gained 0.6% (down 2.7%). Turkey's Borsa Istanbul National 100 index surged 3.7% (up 21.4%). Russia's MICEX equities index was slammed for 4.1% (down 5.4%).

Freddie Mac 30-year fixed mortgage rates slipped two bps to 4.13% (down 24bps y-o-y). Fifteen-year fixed rates were down a basis point to 3.23% (down 20bps). One-year ARM rates dipped one basis point to 2.39% (down 27bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.57% (down 6bps).

Federal Reserve Credit last week expanded $12.3bn to a record $4.349 TN. During the past year, Fed Credit inflated $880bn, or 25.5%. Fed Credit inflated $1.538 TN, or 55%, over the past 88 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $2.7bn to $3.312 TN. "Custody holdings" were down $42bn year-to-date, while posting a one-year increase of $24bn.

M2 (narrow) "money" supply declined $12.4bn to $11.361 TN. "Narrow money" expanded $717bn, or 6.7%, over the past year. For the week, Currency increased $0.6bn. Total Checkable Deposits sank $38.6bn, while Savings Deposits jumped $27.2bn. Small Time Deposits were little changed. Retail Money Funds fell $1.7bn.

Money market fund assets fell $10.2bn to $2.565 TN. Money Fund assets were down $153bn y-t-d and dropped $66bn from a year ago, or 2.5%.

Total Commercial Paper dropped $13.5bn to $1.028 TN. CP was down $17.4bn year-to-date, while gaining $51bn over the past year, or 5.2%.

Currency Watch:

The U.S. dollar index increased 0.4% to 80.503 (up 0.6% y-t-d). For the week on the upside, the South African rand increased 0.5% and the Mexican peso gained 0.4%. For the week on the downside, the New Zealand dollar declined 1.4%, the South Korean won 1.0%, the Swiss franc 0.7%, the Swedish krona 0.7%, the Danish krone 0.6%, the euro 0.6%, the Brazilian real 0.2%, the Taiwanese dollar 0.2%, the British pound 0.2% and the Norwegian krone 0.2%. The Canadian dollar, Australian dollar and Japanese yen were little changed.

Commodities Watch:

The CRB index was little changed this week (up 6.2% y-t-d). The Goldman Sachs Commodities Index gained 0.5% (up 0.2%). Spot Gold fell 2.1% to $1,311 (up 8.7%). September Silver sank 2.7% to $20.89 (up 8%). August Crude rallied $2.30 to $103.13 (up 5%). August Gasoline fell 1.7% (up 3%), and August Natural Gas sank 4.7% to a six-month low (down 7%). September Copper dropped 2.6% (down 6%). September Wheat recovered 1.2% (down 12%). September Corn fell another 1.9% to an almost four-year low (down 12%).

U.S. Fixed Income Bubble Watch:

July 17 – Bloomberg (Brian Chappatta): “The municipal market’s strongest start since 2009 may be in jeopardy as developments in Puerto Rico bonds increase price swings, Citigroup Inc. said. The Caribbean commonwealth and its agencies, which have about $73 billion in debt, sustained credit cuts from the three biggest rating companies this month. The downgrades deeper into junk and ensuing price declines prompted investors to yank $790 million from muni mutual funds in the week through July 9, the most since January… Losses in Puerto Rico bonds ‘have the perceived potential to roil the entire municipal market and thus negate the positive returns generated by municipals year-to-date,’ Citigroup strategists George Friedlander, Mikhail Foux and Vikram Rai wrote…”

July 14 – Bloomberg (Michelle Kaske): “The Puerto Rico Electric Power Authority, which supplies most of the commonwealth’s electricity, won’t make a January interest payment to investors, according to Municipal Market Advisors. The agency, called Prepa, used $41.6 million of reserve funds to help pay bondholders $417.6 million on July 1. With the reserve containing only one year of scheduled interest expense, now depleted by about 10%, ‘we expect the bond trustee is unlikely to make any more distributions to bondholders, reserving cash for likely litigation expenses,’ Matt Fabian, a managing director at… MMA wrote… The next payment is due Jan. 1… Prepa has $8.6 billion of debt, 70% of which doesn’t have bond insurance…”

Federal Reserve Watch:

July 14 – Reuters (Jonathan Spicer): “The Federal Reserve will still need to deliver ‘unusually accommodative’ monetary policy even once the U.S. economy returns to ‘where we want it to be,’ Fed Chair Janet Yellen was quoted as saying in a magazine article. The New Yorker, which interviewed Yellen three times in the last few months, in its July 21 issue quoted her as saying the economy still faced headwinds. ‘And so even when the headwinds have diminished to the point where the economy is finally back on track and it's where we want it to be, it’s still going to require an unusually accommodative monetary policy,’ she is quoted as saying… ‘I come from an intellectual tradition where public policy is important, it can make a positive contribution, it’s our social obligation to do this,’ she says… ‘We can help to make the world a better place.’”

July 14 – Reuters (Howard Schneider): “Federal Reserve officials are cautiously nearing completion of a new plan for managing interest rates, concerned that some of the new tools they are likely to rely on could pose unintended risks in a crisis. The central bank has devoted extensive debate to the matter over the past two months and officials ‘have made a lot of progress’ on a strategy to return monetary policy to a more normal footing after years of coping with crisis, Chicago Federal Reserve Bank President Charles Evans said… However, the sheer magnitude of the amounts of money used to combat the crisis - $2.6 trillion sitting at the Fed as bank reserves and $4.2 trillion held by the Fed in various securities - may complicate the U.S. central bank's ability to control its target interest rate once the decision is made that it should be raised… In recent weeks, the Fed has neared consensus that its workhorse tool will be the interest it pays banks on excess reserves on deposit at the Fed - giving the central bank a direct way to encourage banks to either take money out of circulation and leave it at the Fed, or lend it elsewhere.”

July 15 – Reuters (Howard Schneider): “A strengthening U.S. economy and job market means the Federal Reserve should begin raising interest rates ‘relatively soon,’ Kansas City Federal Reserve Bank President Esther George said… George said that by many measures, including a recent rise in rent and food prices, and strong hiring reports, the Fed should have already lifted interest rates from the zero level. Not moving soon risked creating problems, George said, adding the Fed's continued low interest rates may already be encouraging ‘excess’ in financial markets. ‘These patches of potential excess paint a picture of financial markets that have become overly conditioned on high degrees of monetary accommodation,’ George said. ‘Getting interest rates off zero relatively soon is not only appropriate in terms of current economic conditions, but also will allow the Fed room to maneuver in the future should economic activity slow,’ she added.”

July 16 – Reuters (Ann Saphir): “The Federal Reserve should allow its massive balance sheet to begin to shrink in October, a move that would signal a start to interest-rate hikes early next year, if not before, a top Fed official said… Many Fed officials, wary of any move that could send market rates higher before the economy is ready, want to continue to top up the U.S. central bank's $4.3-trillion balance sheet by reinvesting the proceeds of maturing bonds until or even after rate hikes begin. But in the view of Dallas Fed President Richard Fisher… the Fed risks stoking future inflation by keeping monetary policy too loose for too long… ‘Reducing our reinvestment of proceeds from maturing securities would be a good first step for the markets to more gently begin discounting the inevitable second step: that early next year, or potentially sooner depending on the pace of economic improvement, the (Fed) may well begin to raise interest rates in gradual increments, finally beginning the process of policy normalization,’ Fisher said…”

U.S. Bubble Watch:

July 18 – Wall Street Journal (Kathleen Madigan): “Forget about escape velocity. The U.S. economy in 2014 is likely to record another disappointing year of growth, according to the latest Wall Street Journal survey of economists… The July consensus view calls for inflation-adjusted gross domestic product to grow just 1.6% this year… That would represent a steep drop from the 2.2% expected just a month ago, and is off more than a percentage point from the 2.7% and 2.8% estimates made in the first five months of 2014. Real GDP grew 2.6% during the four quarters of 2013.”

Central Banker Watch:

July 14 – New York Times (Jack Ewing): “Mario Draghi, president of the European Central Bank, said… he did not see a risk of widespread asset bubbles in the eurozone, even if some markets were ‘frothy.’ Answering questions from members of the European Parliament…, Mr. Draghi acknowledged that investors had driven down the premium they demand for riskier assets. But he said the demand for high-yield investments had not been accompanied by a surge in debt of the kind that preceded the financial crisis. ‘We don’t have the general conditions that accompany the creation of systemic bubbles,’ Mr. Draghi said… The central bank is attentive to the risk of bubbles, he said. If any arose, he said, the solution would be to tighten regulation of banks rather than raise official interest rates. ‘We don’t see a bubble yet,’ Mr. Draghi said, adding, ‘I think the word is ‘frothy’ market conditions.’”

July 18 – Dow Jones (Todd Buell): “European Central Bank Governing Council member Jens Weidmann put euro-zone countries on notice, saying the ECB won’t let considerations about public finances keep it from raising interest rates when this becomes necessary. The comments reflect concerns that euro-zone countries will use record low interest rates as an excuse to finance new spending, rather than reinforce budget discipline. ‘There is a danger that the low interest rates will be used not to consolidate budgets, but to finance additional spending,’ said Mr. Weidmann… ‘This is why the Governing Council so insistently calls for sound public finances as a prerequisite for a stability-oriented monetary policy.’ Mr. Weidmann said it is therefore ‘particularly important to make it quite clear now that the Eurosystem will not put off a necessary increase in central bank interest rates out of consideration for public finances.’”

Europe Watch:

July 18 – Bloomberg (Anabela Reis): “Espirito Santo International SA, a holding company that’s part of Grupo Espirito Santo, asked for protection from creditors under Luxembourg law as it’s unable to meet obligations due to a significant part of its debt maturing. ‘The controlled management regime will allow the company to defend the interests of its creditors in a transparent and orderly way under the control of the courts and nominated officials, particularly allowing a process of managing the value of the assets for creditors that is more adequate than a rapid and massive liquidation,’ the company said…”

July 18 – Bloomberg (Marcus Bensasson and Andre Tartar): “Greece’s return to bond markets after a four-year exile hasn’t convinced economists it can avoid a third bailout. Six out of 10 economists in a Bloomberg News survey said Greece will need to top up the 240 billion euros ($325bn) of loans received from Europe and the International Monetary Fund since 2010… The IMF forecasts Greece will have a 12.6 billion-euro financing gap next year. ‘Greece’s ability to generate sufficient funds to cover that is not sufficient,’ said Gianluca Ziglio, executive director of fixed-income research at Sunrise Brokers LLP in London… ‘Eventually the European partners will have to come up with something to basically bridge the funding needs that Greece has from now to the time in which it can establish a regular and sizable market access.”

Global Bubble Watch:

July 14 – Financial Times (Tracy Alloway): “Ultra-low interest rates and a tidal wave of liquidity unleashed by central banks are masking dangers in the market for corporate loans as investors willingly give up protections to lend to riskier companies, Standard & Poor’s has warned. The warning from one of the world’s biggest credit rating agencies is set to revive debate over the riskiness of loans, known as ‘cov-lite,’ that offer higher returns but come with fewer protections for investors or lenders. Sales of first-lien cov-lite loans reached a record $260bn last year, up from $97bn in 2012, according to S&P Capital IQ. The strong issuance means that cov-lite loans are now the norm rather than the exception in the US market, at 66% of the total in 2013, compared with less than a third in 2007.”

Geopolitical Watch:

July 14 – Wall Street Journal (Jay Solomon and Carol E. Lee): “A convergence of security crises is playing out around the globe, from the Palestinian territories and Iraq to Ukraine and the South China Sea, posing a serious challenge to President Barack Obama's foreign policy and reflecting a world in which U.S. global power seems increasingly tenuous. The breadth of global instability now unfolding hasn't been seen since the late 1970s, U.S. security strategists say, when the Soviet Union invaded Afghanistan, revolutionary Islamists took power in Iran, and Southeast Asia was reeling in the wake of the U.S. exit from Vietnam. In the past month alone, the U.S. has faced twin civil wars in Iraq and Syria, renewed fighting between Israel and the Palestinians, an electoral crisis in Afghanistan and ethnic strife on the edge of Russia, in Ukraine.”

July 15 – Reuters (Ben Blanchard): “China will dedicate itself to ‘perfecting’ the role developing countries play in international affairs to give them better representation and a greater say, President Xi Jinping said ahead of a summit of BRICS nations in Brazil. China has already started doing this by promoting international development banks which will either be led by China or will have a very strong Chinese role, as opposed to Western-dominated institutions like the World Bank. Brazil, China, India, Russia and South Africa are due on Tuesday to sign off on a new development bank being launched by the BRICS emerging market nations… China is also planning an Asian Infrastructure Investment Bank. Xi, in an interview… said China would try to better play the role of a responsible major power and promote the rights of the developing world. ‘We will ... dedicate ourselves to perfecting the international system of governance and proactively push for expanding the representation and right to speak for developing countries in international affairs,’ he said. ‘We will come up with more Chinese proposals and contribute China’s wisdom,’ Xi added…”

China Bubble Watch:

July 17 – Bloomberg: “China’s leaders are having trouble breaking their addiction to debt-fueled investment… Outstanding credit rose to 206.3% of gross domestic product last quarter from 202.1% in January-to-March… Investment in fixed assets, a typical outlet for loans, accelerated in June for the first time since August… ‘There are reasons to continue wondering how this is going to end,’ said Louis Kuijs, Royal Bank of Scotland Group Plc’s chief Greater China economist… ‘Clearly they have made the decision that growth is still so important and we notice that they cannot meet their growth target at the moment without adding on more credit.’”

July 15 - Bloomberg Businessweek (Dexter Roberts): “On the eve of the release of China’s second-quarter gross domestic product figure, which is expected to rise 7.4%, credit figures show a policy shift toward supporting growth in lieu of controlling a surge in debt and shadow banking. China’s new loans in June reached 1.08 trillion yuan ($174bn), compared to 860.5 billion a year ago… Aggregate financing, also known as total social financing, reached 1.97 trillion yuan, well above the highest analyst estimate—1.55 trillion yuan—compared to 1.4 trillion yuan in May. ‘The government has been concerned more about stabilizing growth recently,’ and the credit numbers are a ‘confirmation of credit easing,’ Shen Jianguang, chief Asia economist at Mizuho Securities Asia… told Bloomberg… ‘It’s offsetting the tightening from previous months.’ In order to encourage more lending without moving to a full-scale easing policy, banking authorities have cut bank reserve requirements and loosened loans to small enterprises and to projects in agriculture and affordable housing. Meanwhile, China’s 30-some provinces have been pursuing stimulus programs, too.”

July 18 – Bloomberg (Todd Buell): “China’s new-home prices fell in a record number of cities tracked by the government as developers cut prices to boost sales volume, signaling curbs will be relaxed in more cities. Prices fell in 55 of the 70 cities last month from May… Prices in Shanghai and the southern city of Guangzhou fell 0.6% each from May, the biggest drop since January 2011, while they declined 0.4% in Shenzhen. Prices fell 1.7% in the eastern city of Hangzhou… ‘The current biggest problem of China’s property industry is that the housing inventories are too high,’ said Liu Li- Gang, chief Greater China economist at Australia & New Zealand Banking Group…”

July 18 – Bloomberg (Justina Lee): “China’s one-year interest-rate swaps climbed for a fifth day, the longest rising streak since January… The finance ministry sold 23.4 billion yuan ($3.8bn) of two-year bonds today, less than the 26 billion yuan target. At least four companies announced yesterday they were scrapping fixed- income sales after a builder warned it may miss a debt payment due July 23, which would be China’s second onshore bond default.”

July 18 – Bloomberg (Todd Buell): “China’s corporate bond market is facing its second default after a builder said it may fail to make a payment next week, fueling speculation the government is stepping back from its practice of bailing out borrowers. The average yield on one-year interbank notes rated AAA jumped 10 bps, the most in eight months, to 4.88% yesterday after Huatong Road & Bridge Group Co. said it may miss payment on a 400 million yuan ($64.4 million) note due July 23. One-year swaps have jumped 38 bps this week, the biggest increase in more than a year, to 4.11%...”

July 16 – Bloomberg: “China’s home sales rose 33% in June from the previous month as price cuts by developers lured buyers. The value of homes sold climbed to 591.2 billion yuan ($95bn) last month from 446.1 billion yuan in May… That was the biggest monthly gain this year. The value of sales in the first six months fell 9.2% to 2.56 trillion yuan from a year earlier... Developers… have cut property prices since March to boost sales. The central bank in May called on the nation’s biggest lenders to accelerate the granting of mortgages and urged them to give priority to first-home buyers… Investment in homes, office buildings, malls and other real estate gained 14% to 4.2 trillion yuan in the first half, compared with a 20% gain a year earlier… New property construction dropped 16.4% to 801.3 million square meters (8.6 billion square feet) over the same period.”

July 16 – Bloomberg: “China’s economic growth accelerated for the first time in three quarters after the government sped up spending and freed up more money for loans to counter a property slump. Gross domestic product rose 7.5% in the April-June period from a year earlier… June industrial production and first-half fixed-asset investment exceeded projections. Premier Li Keqiang’s government has brought forward railway spending, reduced reserve requirements for some lenders and cut taxes to protect an annual growth goal of about 7.5% that’s under threat from a plunge in property construction and weaker home-price gains.”

July 16 – Bloomberg: “Chinese banks’ sales of bonds backed by loans have surged 22-fold this year as the government seeks to curb shadow banking, while still allowing lenders to make room on their balance sheets for new financing. Banks have issued 78.7 billion yuan ($12.7 billion) of such securities, compared with 3.6 billion yuan in the same period last year and 15.8 billion yuan for all of 2013… Premier Li Keqiang is seeking to shift financing to official channels after shadow-banking assets jumped 32 percent in 2013 to 38.8 trillion yuan, according to Barclays Plc estimates… ‘Regulators are closing one door, but opening a window,’ said Liu Dongliang, a senior analyst in Shanghai at China Merchants Bank… ‘To Chinese regulators, asset-backed securities, which are standardized products, are safer and more transparent than the shadow-banking products that are hard to monitor.’”