Sunday, December 14, 2014

Weekly Commentary, July 26, 2013: The One Year Anniversary of Do Whatever it Takes

Mario Draghi’s “ad-libbed” comments one year ago (July 26, 2012) altered the course of financial history: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

After trading above 7.50% just over a year ago, Spain’s 10-year sovereign yields traded to as low as 4.04% (May 3) and closed Friday at 4.61%. Italian yields dropped from 6.50% to 3.76% (May 2) and closed Friday at 4.40%. Spanish stocks posted a one-year gain of 31.1%, and Italian stocks were up 24.3%. The French CAC40 and German DAX jumped 23.8% and 25.3%. It’s worth noting that the Eurozone economy has contracted in the face of rapidly rising stock and bond prices. After declining 0.1% during Q3 2012, real GDP dropped 0.6% during Q4 and another 0.3% during Q1 2013. And with the ECB having repressed financial crisis, politicians throughout the Eurozone have relaxed measures to rein in deficits and restructure economies.

European and global investors agree with Mr. Draghi’s claim: “It’s really very hard not to state that OMT has been probably the most successful monetary policy measure undertaken in recent time.” Draghi’s Plan removed what was a very real risk of collapses in confidence in the euro, the Europe’s banking system and European finance more generally. A potentially serious bout of capital flight – out of the Eurozone’s periphery, out of Europe and away from emerging markets (EM) - was reversed. Draghi convinced the speculators to unwind bearish bets – and instead go long European debt and equities. With speculators adding leveraged holdings rather than selling and hedging, the market liquidity backdrop was altered profoundly. “Do whatever it takes” provided a green light for global speculation.

It was about a year ago that San Francisco Fed President John Williams talked openly of the benefits of open-ended QE. Not long afterward chairman Bernanke announced the Fed’s intention to move forward with the largest non-crisis central bank balance sheet expansion in history. And then it wasn’t many months later that the Bank of Japan implemented an even more radical experiment in central bank “money printing”/market liquidity injections. Japan’s monetary base inflated 40% over the past year to 173 Trillion yen. Japan’s Nikkei equities index sports a one-year gain of 67.4%.

Here at home, the S&P500 enjoyed a one-year advance of 26.4%. The broader market has significantly outperformed. The small cap Russell 2000 has inflated 34.9% in 12 months and the S&P400 Mid-caps have jumped 32.1%. The Broker/Dealers were up 64.6% in twelve months, with the Banks up 45.3%. Biotech jumped 44.3% and the Internet stocks rose 37.3%. Speculation - and short squeezes – became only more intense. In the past year, Netflix gained 332%, Green Mountain Coffee 320%, First Solar 240% and Gamestop 187%. After expanding 3.1% during Q3 2012, real GDP growth slowed to 0.4% in Q4 and then recovered somewhat to 1.8% in Q1 2013. GDP is forecast to have expanded at a 1.0% pace during Q2. As the economy slowed, corporate debt issuance jumped to a record pace – sold into a euphoric marketplace at record low yields. Only a few weeks after the Draghi Plan and Fed open-ended QE talk, benchmark MBS yields sank to a record low 1.68%.

I have argued against the conventional view of a favorable QE risk vs. reward calculus. My thesis holds that there are extraordinary (and escalating) risks associated with QE-related “mis-priced finance” – debt that is being over-issued at exceptionally low yields, and stocks prices that are being grossly inflated by policy measures and speculation. Mis-pricing, misperceptions and systemic debt dependencies ensure latent market and economic fragilities.

Throughout its protracted Bubble, I remained analytically fixated on the historic expansion of mortgage finance. There were key facets of the analysis: the nominal expansion in debt, the intermediation process that was transforming risky mortgage debt into perceived “money”-like debt instruments, associated distortions in the pattern of spending and investment, and the problematic systemic dependencies on ever-increasing amounts of (progressively risky) mortgage borrowings. I was convinced a problematic adjustment would inevitably unfold as soon as debt growth slowed. It was the timing that was unclear.

Intermediation risks were critical. Especially late in a Credit Cycle, there becomes a growing divergence between the perceived value of debt and the real underlying economic wealth supporting those inflating quantities of obligations. As they did throughout 2007 and much of 2008, Fed officials today believe expansionary monetary policies can sustain inflated securities prices irrespective of underlying economic fundamentals.

The GSEs were instrumental in the previous Bubble. But late in the Bubble period, so-called “private-label” mortgages were being intermediated through various sophisticated Wall Street instruments. These were categorized as asset-backed securities (ABS) in the Fed’s Z.1 data. This late-cycle mis-priced debt relatively quickly came back to haunt the Credit system.

For this cycle, Federal Reserve (and global central bank) measures have led to unappreciated financial asset mis-pricing. And I would see parallels as well as key differences to previous late-cycle excesses. Federal debt has doubled in four years. Risks associated with this debt Bubble are mounting, yet unprecedented central bank buying has suppressed what should be increasing risk premiums. Meanwhile, massive ongoing fiscal and monetary stimulus has spurred a major increase in corporate borrowings at record low yields. I would further contend that fiscal and monetary stimulus has boosted spending and corporate profits, while unprecedented loose financial conditions have spurred corporate borrowing, stock buybacks, special dividends, mergers & acquisitions, financial engineering and speculative excess that have led to major stock market overvaluation.

A quick look at some Z.1 data might be helpful. On a seasonally-adjusted and annualized basis (SAAR), Q4 Total Non-Financial Debt (TNFD) expanded at a $2.585 TN pace, more than double Q3 to the strongest Credit expansion since Q3 2007. Total Business debt growth jumped to SAAR $1.157 TN. This was followed by SAAR Q1 2013 Total Non-Financial Debt growth of $1.851 TN.

Total Credit Market Borrowings surged to SAAR $2.524 TN during Q4, up from Q3’s $870bn and Q2’s $1.212 TN, and then remained at an elevated SAAR $2.392 TN during Q1. Over this six month period, the federal government borrowed at about a $1.2 TN annual pace, and corporate borrowings came in at about $850bn annualized, the strongest since 2007. In a replay of late-cycle mortgage finance Bubble dynamics, we’re in the midst of a boom in marketable debt issued at highly inflated prices – in a marketplace distorted by major policy-induced misperceptions.

It is worth noting that Mutual Fund holdings of Corporate debt jumped 22% in four quarters (Q1 through Q1) to a record $1.819 TN. Mutual Fund Corporate debt holdings closed 2007 at $887bn. After ending 2007 at $13.8bn, Exchange-Traded Funds (ETF) holdings of Corporate bonds ended Q1 2013 at $162bn. ETF Corporate bond holdings surged $39bn, or 32%, in the four quarters ended March 31, 2013.

During the three quarters Q3 2012 to Q1 2013, outstanding Corporate debt increased a notably large $645bn. Who purchased this mispriced debt? During this period, Rest of World (ROW) holdings rose $137bn. U.S. Life Insurers boosted holdings $61bn, and Broker/Dealers increased Corporate debt holdings $10bn. Meanwhile, Household sector holdings surged $229bn, Mutual Fund holdings $269bn and ETF holdings $27bn. As a proxy of total U.S. household exposure to Corporate debt, combined Household, Mutual Fund and ETF holdings jumped $524bn in nine months, accounting for 81% of the net issuance over that period. An indicator of an important market top?

Driving household savings into the risk markets has been integral to the Fed’s monetary experiment. And, sure enough, surging asset prices inflated Household Net Worth and no doubt spurred spending. The upshot has been an unprecedented expansion in household exposure to U.S. and international stocks and bonds – securities prices that have been inflated to historic extremes throughout global markets.

Especially over the past year, unprecedented policy measures have goaded frustrated savers into unstable risk markets. This has accommodated a debt issuance bonanza, while the hedge funds have been incentivized into aggressive leveraged speculation. With China faltering, EM unraveling and the Fed talking tapering, global Bubbles were looking increasingly vulnerable in June. The Fed and Chinese officials both moved quickly to calm markets. U.S. stocks rallied to record highs and Japanese equities to five-year highs – further inflating powerful speculative Bubbles. But what about the issues of mis-pricing and Bubbles in fixed-income?

After trading at 2.28% in early May and as high as 3.68% on July 5, benchmark MBS yields ended Friday not far off highs at 3.40%. With the Detroit bankruptcy further weighing on confidence, municipal bonds have recovered little of the steep price declines suffered in May and June. Corporate debt has performed better. It is worth noting that many of the darling – and quite large – chiefly fixed-income “total return” mutual funds have struggled to recoup losses. And with investors hit with surprisingly quick losses throughout the fixed-income ETF complex, perhaps the bloom is off the rose in “bond” investing more generally.

The conventional bullish view holds that rising bond yields are a confirmation of a strengthening U.S. economy. And there is this “great rotation” dynamic that sees waning enthusiasm for bonds drive strong fund flows into equities. For now – with QE at $85bn a month – there may be adequate liquidity to both stabilize bond markets and fuel an inflating equities Bubble. Yet I can’t help but to think that the marketplace remains too complacent with respect to what might be unfolding throughout global fixed-income. After years of Bubble excess, more recent developments have had elements of “terminal phase” mis-pricing, misperceptions and speculation.

The yen rallied 2.6% this week. The big “macro” players are short the yen and long Japanese equities. The Nikkei was hit for 3.0% Friday. Yen strength seemed to play an important role in what was at the cusp of developing into a bout of global market de-risking/de-leveraging back in June. Markets reversed sharply on assurances from the Fed, along with support from global central Banks and Chinese officials. Short covering and the reversal of hedges helped fuel a speculative run in stocks, especially U.S. and Japanese markets so favored by the global speculators.

As a whole, the global hedge fund community continues to struggle for performance. The volatile and policy-dominated “risk on, risk off” dynamic is tough on many trading strategies. Global risk markets – currencies, commodities, EM, bonds and equities – remain minefields, particularly for multi-asset class approaches. I believe enormous leverage has been employed by myriad strategies, certainly including global “carry trade,” corporate, MBS and municipal debt. I’ll assume there’s no egregious LTCM-like leveraging, but I still worry a lot about global derivatives markets. I believe the world of speculative finance is full of problematic “crowded trades.”

A few weeks back the markets were again indicating fragility – and the Fed once again demonstrated its market-pleasing low tolerance for market weakness. The flaw in aggressive QE is the notion that the Fed will be able to back away from market intervention without major consequences. Fed stimulus can spur debt issuance, market risk embracement and speculation. But if that debt is mis-priced and predominantly non-productive, the system faces unavoidable debt problems. If speculative leverage is playing a prominent role in inflating securities and asset markets, the system face unavoidable de-leveraging issues. If the already vulnerable household sector continues to load up on mis-priced stocks and bonds, there will be negative consequences.

If there are major risk misperceptions endemic in the global marketplace – including with ETFs, the hedge funds, derivatives and perceived low-risk strategies – then there is latent market fragility that is only exacerbated by central bank liquidity injections and backstop assurances. I fully expect history to look back at the past year’s Draghi Plan, Fed open-ended QE, and Bank of Japan “Hail Mary” monetary inflation as misguided market interventions that set loose historic market Bubble excess. I will posit that global systemic risk is significantly higher today than it was a year ago. And if the current trajectory of global central bank market intervention continues, systemic risk will be even more problematic one year from now.

For the Week:

The S&P500 was unchanged (up 18.6% y-t-d), while the Dow added 0.1% (up 18.7%). The Morgan Stanley Consumer index slipped 0.4% (up 24.2%), and the Utilities declined 0.6% (up %). The Banks dipped 0.1% (up 28.7%), and the Broker/Dealers declined 0.3% (up 42%). The Morgan Stanley Cyclicals were down 0.7% (up 20.0%), and the Transports fell 1.7% (up 22.0%). The S&P 400 MidCaps declined 0.5% (up 20.4%), and the small cap Russell 2000 slipped 0.2% (up 23.5%). The Nasdaq100 gained 1.0% (up 15.6%), and the Morgan Stanley High Tech index added 0.8% (up 14.2%). The Semiconductors sank 2.7% (up 23.2%). The InteractiveWeek Internet index added 0.1% (up 23.8%). The Biotechs fell 1.1% (up 38.6%). With bullion up $37, the HUI gold index rallied 6.4% (down 42.4%).

One-month Treasury bill rates ended the week at one basis point and three-month bill rates closed at two bps. Two-year government yields gained 1.5 bps to 0.315%. Five-year T-note yields ended the week up 7 bps to 1.37%. Ten-year yields jumped 8 bps to 2.56%. Long bond yields rose 6 bps to 3.62%. Benchmark Fannie MBS yields rose 6 bps to 3.40%. The spread between benchmark MBS and 10-year Treasury yields narrowed 2 to 84 bps. The implied yield on December 2014 eurodollar futures declined 1.5 bps to 0.595%. The two-year dollar swap spread declined one to 16 bps, and the 10-year swap spread declined one to 20 bps. Corporate bond spreads widened somewhat. An index of investment grade bond risk increased 2 bps to 74.5 bps. An index of junk bond risk jumped 14 to 365 bps. An index of emerging market debt risk rose 4 to 315 bps.

Debt issuance was strong. Investment grade issues included Daimler Finance USA $3.0bn, American Airlines $1.4bn, Citigroup $1.25bn, American Express $1.2bn, Bank of New York Mellon $1.1bn, Nucor $1.0bn, Pepsico $1.7bn, Mass Mutual $600 million, Renaissance $575 million, Travelers $500 million, NYU Hospitals Center $350 million, Osprey Aircraft Leasing $160 million, GE Capital $250 million, and Gibson Brands $225 million.

Junk bond funds enjoyed inflows of $3.2bn (from Lipper). Junk issuers this week included Alliance One $735 million, Michaels Finco $800 million, CIT Group $750 million, Gannett $600 million, Brightstar $250 million, Atlas Resources $250 million, Parker Drilling $225 million, Woodside Homes $220 million and Northern Group $200 million.

Convertible debt issuers included American Realty Capital Properties $300 million.

International dollar debt issuers included Royal Bank of Canada $2.0bn, Bahrain $1.5bn, Westpac Banking $1.4bn, Anglogold $1.25bn, European Bank of Reconstruction & Development $1.0bn, Ruwais Power $825 million, Ghana $750 million and Brazil Loan Trust $660 million.

Ten-year Portuguese yields dropped 32 bps to 6.30% (down 45bps y-t-d). Italian 10-yr yields were unchanged at 4.40% (down 11bps). Spain's 10-year yields declined 5 bps to 4.61% (down 66bps). German bund yields jumped 15 bps to 1.66% (up 34bps), and French yields gained 9 bps to 2.27% (up 27bps). The French to German 10-year bond spread narrowed 6 to 61 bps. Greek 10-year note yields added 2 bps to 9.80% (67bps). U.K. 10-year gilt yields increased 5 bps to 2.33% (up 51bps).

Japan's Nikkei equities index dropped 3.2% (up 35.9% y-t-d). Japanese 10-year "JGB" yields ended the week down 3 bps to 0.78% (unchanged). The German DAX equities index fell 1.0% for the week (up 8.3%). Spain's IBEX 35 equities index surged 5.2% (up 2.3%). Italy's FTSE MIB jumped 1.8% (up 0.9%). Emerging markets were mixed to higher. Brazil's Bovespa index rallied 4.3% (down 18.9%), and Mexico's Bolsa rose 2.9% (down 6.0%). South Korea's Kospi index rallied 2.1% (down 4.3%). India’s Sensex equities index dropped 2.0% (up 1.7%). China’s Shanghai Exchange gained 0.9% (down 11.4%).

Freddie Mac 30-year fixed mortgage rates declined 6 bps to 4.31%, with a 12-week gain of 96 bps (up 82bps y-o-y). Fifteen-year fixed rates were down 2 bps to 3.39% (up 59bps). One-year ARM rates dipped a basis point to 2.65% (down 6bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 2 bps to 4.68% (up 47bps).

Federal Reserve Credit jumped $39.0bn to a record $3.517 TN. Fed Credit expanded $731bn during the past 42 weeks. Over the past year, Fed Credit jumped $672bn, or 23.6%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $717bn y-o-y, or 6.9%, to a record $11.167 TN. Over two years, reserves were $1.104 TN higher, for 11% growth.

M2 (narrow) "money" supply surged $54.1bn to a record $10.699 TN. "Narrow money" expanded 6.8% ($680bn) over the past year. For the week, Currency increased $2.7bn. Total Checkable deposits jumped $30.2bn, and Savings Deposits rose $24.3bn. Small Time Deposits slipped $1.8bn. Retail Money Funds declined $1.1bn.

Money market fund assets fell $9.8bn to $2.622 TN. Money Fund assets were up $67bn from a year ago, or 2.7%.

Total Commercial Paper outstanding declined $3.1bn this week to $996.1bn. CP has declined $70bn y-t-d and $7.0bn, or 0.7%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index declined 1.2% to 81.66 (up 2.4% y-t-d). For the week on the upside, the Japanese yen increased 2.5%, the New Zealand dollar 2.1%, the Swiss franc 1.1%, the Danish krone 1.1%, the South African rand 1.1%, the euro 1.0%, the Australian dollar 1.0%, the South Korean won 0.9%. the Canadian dollar 0.9%, the Swedish krona 0.8%, the British pound 0.8%, the Norwegian krone 0.7%, the Singapore dollar 0.2% and the Taiwanese dollar 0.2%. For the week on the downside, the Mexican peso declined 1.1% and the Brazilian real 0.4%.

Commodities Watch:

The CRB index dropped 2.2% this week (down 3.6% y-t-d). The Goldman Sachs Commodities Index fell 2.1% (down 1.5%). Spot Gold jumped 2.9% to $1,333 (down 20.4%). Silver rallied 1.6% to $19.77 (down 35%). September Crude fell $3.17 to $104.70 (up 14%). September Gasoline dropped 2.5% (up 10%), and September Natural Gas sank 6.2% (up 6%). September Copper declined 1.1% (down 15%). September Wheat declined 2.1% (down 16%), and July Corn sank 9.6% (down 29%).

U.S. Bubble Economy Watch:

July 24 – Bloomberg (William Selway and Darrell Preston): “The bankruptcy of Detroit, which may cut retirement benefits of 30,000 current and former city workers, is causing investors to scrutinize billion-dollar shortfalls in government pensions in other parts of the country. Chicago, Philadelphia, New York, Phoenix and Jacksonville, Florida, are among large cities that had 60% or less of what they need in their retirement systems to cover promised benefits… At least 29 public plans in 16 states are less than two-thirds funded, according to Boston College’s Center for Retirement Research… Detroit ‘brings that concern to the forefront again,’ said Matt Dalton, who helps manage $1.6 billion of munis at Belle Haven Investments… Pension obligations are among ‘the most stressful situation for the state and cities.’”

July 23 – Bloomberg (Martin Z. Braun and Chris Christoff): “In 2006, businessman Robert Shumake asked trustees of Detroit’s two pensions to hand him $27 million to invest in real estate. George Orzech, a fire battalion chief who still represents uniformed workers on their fund’s board, found one thing odd: ‘Anybody who knows the first names of trustees in a first meeting has already had meetings with people,’ said Orzech, who unsuccessfully opposed the plan. ‘It was a political deal.’ Shumake, whose real-estate broker’s license had expired four years earlier, became embroiled in a federal case that led to indictments of a former city treasurer and pension officials on charges of bribery, extortion and kickbacks that cost the systems more than $84 million, the U.S. Justice Department said. A litany of such deals gone wrong shows how a municipal retirement system for 30,000 employees and retirees -- propped up by $1.4 billion in borrowed money -- became a cash cow for a select few. Now, these bad investments are coming back to haunt workers and pensioners as the city proposed slashing their benefits in its filing last week of the biggest municipal bankruptcy in U.S. history.”

July 23 – Bloomberg (Alexandria Baca): “The U.S. economic expansion is ‘two-speed,’ favoring those who are already well-off financially, said Vincent Reinhart, the chief U.S. economist at Morgan Stanley. ‘Income inequality is increasing,’ Reinhart said… ‘Real wages, except at the very highest incomes, are actually stagnant to going down.’ The weekly Bloomberg Consumer Comfort index has shown optimism among lower-income Americans has deteriorated. The index for households earning less than $15,000 fell in the period ended July 14 to minus 69.2, its worst since January… For households earning more than $100,000, the index eased to 14.9 after 21 in the prior week, which matched the highest level since November 2007. ‘It’s been a two-speed recovery,’ Reinhart said. ‘The upper’s done better than lower.’”

July 26 – Bloomberg (Oshrat Carmiel): “Home sales in New York’s Hamptons, Wall Street’s favored beach retreat, jumped to a seven-year high as buyers rushed to secure deals before expected increases in prices and mortgage rates. Purchases in the three months through June totaled 675, up 25% from a year earlier and the most since the second quarter of 2006, when home values were climbing toward their peak, according to… Miller Samuel Inc. and… Douglas Elliman Real Estate. Buyer competition for a small inventory of listings pushed the median price up 8.2% to $920,000. ‘People are saying, ‘If there’s a time, now’s the time,’’ Paul Brennan, Douglas Elliman’s regional manager in the Hamptons, said…”

July 24 – Bloomberg (Kathleen M. Howley and Prashant Gopal): “Jung Lim plans to offset the cost of rising mortgage rates by using an adjustable-rate loan to buy a home for his expanding family. For the Californian endodontist, the money he’ll save makes up for the ARM’s risky reputation. Lim… is leaving a two-bedroom condo in Los Angeles’s Hancock Park to buy a four-bedroom house in the city’s Sherman Oaks neighborhood for $1.12 million. His lender offered him a rate for an adjustable mortgage that is about a percentage point cheaper than a fixed loan. ‘If I could have gotten a 30-year fixed at the interest rate I’m getting the ARM for, I would have felt a lot more comfortable,’ said Lim… ‘But I’m hoping to refinance in five years or less. And we’ll be in the house for about 10 years so we could also sell. Hopefully prices have bottomed so we won’t be underwater then…’ ‘We’ve seen a shift in the way people look at adjustable- rate mortgages,’ said Cameron Findlay, chief economist of Discover Financial Service’s home-loan unit. ‘They’re still skeptical about using ARMs, given the role they played in the financial crisis, but the sticker shock of what fixed rates have done is making them look for alternatives.”

July 26 – Bloomberg: “Shanghai Greenland Group Co., the developer building one of China’s tallest towers, is investing $1 billion in a downtown Los Angeles project, the latest Chinese builder to venture overseas.”

Federal Reserve Watch:

July 26 – Wall Street Journal (Jon Hilsenrath): “The Federal Reserve is on track to keep its $85 billion-a-month bond-buying program in place at its policy meeting next week, but officials likely will debate changes to the way the central bank describes its plans for the program and for short-term interest rates. Fed Chairman Ben Bernanke has been saying since May that the central bank expects to begin winding down its bond-buying program later this year, if the economy strengthens as the Fed forecasts. At their July 30-31 meeting, Fed officials are likely to discuss whether to refine or revise ‘forward guidance,’ the words they use to describe their intentions for the next few years.”

U.S. Fixed Income Bubble Watch:

July 26 – Reuters: “The municipal bond market’s self-regulator on Friday said the Detroit emergency manager’s proposed treatment of general obligation bonds in the city's bankruptcy case risks changing how investors view what has long been considered the safest class of municipal debt. Kevyn Orr, Detroit's state-appointed manager, has said that general obligation bondholders will remain unsecured creditors in the $18.5 billion bankruptcy filing. ‘You have a long history of ... what everyone thought a GO bond was or what it meant to have a GO bond,’ said Jay Goldstone, chairman of the Municipal Securities Rule-making Board. ‘That whole landscape could change.’”

July 25 – Bloomberg (Sarah Mulholland): “Commercial-mortgage bonds, which tumbled the most in more than four years in June, are struggling to keep up with a rebound in credit markets as Wall Street banks prepare to issue as much as $5 billion of the debt. Securities linked to skyscrapers, shopping malls, hotels and apartment buildings have gained 0.54% this month, following a 1.51% loss in June… Corporate notes from the riskiest to the most creditworthy borrowers have returned 1.48% after declining 2.73%.”

July 24 – Bloomberg (Christine Idzelis): “Money managers are creating fewer collateralized loan obligations in the U.S. than any time since last July as concern the Federal Reserve may scale back its stimulus efforts pushes yields to a six-month high. About$ 2.3 billion of CLOs have been sold this month, plummeting from $7.2 billion in June… Spreads on the top-rated portion of the funds have risen to 130 bps more than lending benchmarks, from 113 bps in May… The slowdown may be a sign than banks are pulling back from buying CLOs, making it harder for money managers who create the funds to sell them after issuance quadrupled to $55 billion last year.“

Global Bubble Watch:

July 26 – Bloomberg (Benjamin Purvis): “U.S. equity funds attracted investments for a fourth-straight week while money-market and municipal bond funds suffered outflows, according to… Lipper. Stock funds gained $5.4 billion in net new money in the week ended July 24, while fixed-income funds added $4.6 billion… Those investing in municipal debt had to hand back $1.2 billion in the same week as Detroit became the most populous U.S. city to file for bankruptcy protection. Money- market funds saw net redemptions of $12.7 billion following four weeks of positive flows.”

July 26 – Bloomberg (Mary Childs): “Traders are finding a haven from surging yields in credit derivatives that are beating returns on junk bonds by the most in at least four years. Traders offering credit-default swaps protection on the Markit CDX North American High Yield Index, tied to the debt of 100 speculative-grade companies from J.C. Penney Co. to Caesars Entertainment Corp., have realized returns that reached 4.46 percentage points more than high-yield, high-risk debt last week, according to Barclays Plc data. Default swaps that were blamed by the Financial Crisis Inquiry Commission for contributing to the worst credit meltdown since the Great Depression are now seen as a refuge after speculative-grade bonds suffered their biggest losses since 2011 in May and June.”

July 23 – Bloomberg (Joe Richter and Lynn Doan): “Banks such as JPMorgan Chase & Co. may have adopted the model for commodity trading used by Enron Corp., adding ‘more and more risk’ to the financial system, U.S. Senator Elizabeth Warren said. JPMorgan, Morgan Stanley and Goldman Sachs Group Inc. are among lenders whose commodity trading is in jeopardy as the Federal Reserve reconsiders letting banks ship crude oil and run warehouses for industrial metals. Warren… spoke… at a Senate subcommittee hearing on bank ownership of metal and energy assets. Enron, once the world’s biggest trader of power and natural gas, collapsed in 2001. Moves by banks at the start of the last decade into broader areas of physical commodity trading and assets ‘suggests this movie won’t end well,’ Warren said during a question-and-answer session at the hearing.”

July 26 – Reuters (David Sheppard): “JP Morgan Chase & Co is exiting physical commodities trading, the bank said in a surprise statement on Friday, as Wall Street's role in the trading of oil tankers, coffee beans and metals comes under intense political and regulatory pressure. Wall Street's biggest bank said an ‘internal review’ had concluded it should pursue ‘strategic alternatives’ for its physical commodities operations, which includes assets like its Henry Bath metals warehousing subsidiary and a team of physical power and oil traders in Houston and New York. The firm will explore ‘a sale, spinoff or strategic partnership’ for its physical arm…, adding the bank remained ‘fully committed’ to its traditional financial commodity business, including trading derivatives and its activities in precious metals.”

July 23 – Bloomberg (Neil Callanan and Patrick Gower): “The average value of luxury homes in central London surpassed 2 million pounds ($3 million) for the first time in the second quarter as more purchasers competed for a smaller number of properties on the market, Marsh & Parsons Ltd. said. Home values in prime locations from Chelsea to Kensington rose 9.3% in the 12 months through June… ‘The imbalance of supply and demand is pushing property prices higher in prime London areas,’ Chief Executive Officer Peter Rollings said… ‘Property is changing hands in record time and for close to the asking price.’”

July 26 – Bloomberg (Katie Linsell and Verity Ratcliffe): “High-yield debt issuance is surging to the busiest July on record as Europe’s economy shows signs of recovery a year after European Central Bank President Mario Draghi promised to do ‘whatever it takes’ to save the euro. Italian automaker Fiat SpA led 6.2 billion euros ($8.2bn) of speculative-grade sales, up 55% from June…”

Bursting EM Bubble Watch:

July 23 – Bloomberg (Joshua Goodman and Matthew Malinowski): “Stretched budgets and sluggish growth are putting emerging-market governments on a collision course with rising pressures from recently empowered middle classes for more spending and better services. From Jakarta to Brasilia, policy makers face the end to an era of abundant global liquidity that helped fuel the fastest expansion in three decades. In the eight weeks through July 17, investors pulled $40.3 billion from emerging-market bond and equity funds amid signs the Federal Reserve may begin reducing stimulus later this year. In 2012, $111 billion poured into these asset classes… The Fed’s plans didn’t trigger the slump -- after a decade of prosperity, the BRIC economies of Brazil, Russia, India and China have been slowing since 2010. Developing nations are punished more during downturns than their European counterparts because they depend on growth to mitigate social tensions, said Angel Gurria, secretary-general of the Organization for Economic Cooperation and Development. ‘The needs are much more elementary and brutal,’ said Gurria, a former Mexican finance secretary… Families live with ‘vermin because they don’t have cement on the floor, and when there’s a big wind it blows off the roof. This isn’t the problem the middle class in the Netherlands face.’”

July 24 – Bloomberg (Alan Wong): “China’s manufacturing weakened by more than estimated in July, according to a preliminary survey of purchasing managers that casts further doubt on the government’s ability to meet its annual economic growth target. The reading of 47.7 for an index released today by HSBC Holdings Plc and Markit Economics… would be the lowest in 11 months… ‘The key thing now is confidence,’ Qu Hongbin, HSBC’s chief China economist in Hong Kong, said… ‘The confidence now is pretty weak both in the financial market and the corporate sector.’”

July 24 – Bloomberg: “China paid the highest yield at a five-year bond auction since August 2011 on speculation demand waned as the supply of cash tightened. The Ministry of Finance sold at least 30 billion yuan ($4.9bn) of notes at an average yield of 3.7%... The seven-day repurchase rate, a gauge of interbank funding availability, climbed six bps to a three-week high of 4.2%... ‘Liquidity has been tightened for most banks, and only the big guys were lending out in the money market,’ said Becky Liu, a senior rates strategist at Standard Chartered Plc in Hong Kong. ‘The primary market has been weak recently.’”

July 26 – Bloomberg (Scott Rose): “Russia’s financial industry faces risks from surging demand for domestic ruble bonds as investors plow into the securities, competing with local banks for the assets used as refinancing collateral, the central bank said. Non-resident holdings of ruble-denominated sovereign notes, known as OFZs, are now approaching the emerging-market average of 30%, compared with 21% on Feb. 1 and 7% on July 1, 2012…”

Global Credit Watch:

July 24 – Bloomberg (Nicholas Comfort and Elisa Martinuzzi): “Europe’s biggest banks, which more than doubled their highest-quality capital to $1 trillion since 2007 to meet tougher rules, may have further to go as regulators scrutinize how lenders judge the riskiness of their assets. Deutsche Bank AG, Barclays Plc and Societe Generale SA are among European banks that issued stock, sold units or hoarded earnings to bring capital, as a proportion of assets weighted by risk, into line with new global rules. Now some regulators are questioning the weightings, typically set by the banks’ own models, and embracing a broader measure of equity to total assets known as the leverage ratio that ignores risk. ‘Europe’s banks are far from done on efforts to raise capital,’ Lutz Roehmeyer, who helps manage more than 11 billion euros ($14.5 billion) at Landesbank Berlin Investment, said… ‘We have to take out the arbitrary method by which banks assign the risk of their assets.’”

China Bubble Watch:

July 23 – Bloomberg (Jennifer Ryan and Scott Hamilton): “China’s economy may be facing a period of instability and imbalance as it transitions from high- speed growth, a state researcher said. ‘Growth inertia should not be underestimated, as new growth engines and patterns have not been formed,” researcher Yu Bin said in a report… ‘Market expectations are unstable, downward pressure has increased, and existing and new structural mismatches exist. The economy has become unstable and uncertain like never before.’ China’s growth slowed for a second straight quarter to 7.5% in the April-June period, increasing the risk that Premier Li Keqiang will miss a full-year target for the same pace.”

July 23 – Bloomberg: “Premier Li Keqiang’s government sees 7% growth as the bottom line for tolerance of an economic slowdown, Chinese news organizations reported, signaling the nation will act to support expansion if needed. Expansion below 7% won’t be accepted because China needs to achieve a moderately prosperous society by 2020… Li said at a recent meeting with economists that 7% is the ‘bottom line’ and the nation can’t allow growth below that, the Beijing News reported…”

July 25 – Bloomberg: “Chinese Premier Li Keqiang said the nation will speed railway construction, especially in central and western regions, adding support for an economy that’s set to expand at the slowest pace in 23 years. The State Council also yesterday approved tax breaks for small companies and reduced fees for exporters as it pledged to keep the yuan’s exchange rate ‘basically stable at a reasonable and balanced level,’ according to a statement… China plans a railway development fund, the government said.”

July 23 – Bloomberg: “China banned government and Communist Party agencies from constructing new buildings for five years and told them to suspend projects that have already won approval as the country seeks to cut wasteful spending. The ban includes construction for purposes of training, meetings and accommodation, the government said in a statement on its website yesterday, calling for resources to be spent instead on developing the economy and improving public welfare… President Xi Jinping, appointed as the ruling Communist Party’s general secretary in November, last month pledged a ‘thorough cleanup’ of the party amid a yearlong campaign aimed at ridding its ranks of bureaucracy and extravagance… ‘The main purpose of the call for a ban on new government buildings is largely symbolic in that these are a highly visible sign of government officials misusing public monies,’ Andrew Wedeman, a political science professor at Georgia State University and author of ‘Double Paradox: Rapid Growth and Rising Corruption in China,’ wrote… ‘A real assault on corruption, however, requires a much less visible, long-term effort to attack the causes of corruption, not just those involved and the visible symbols of corruption.’”

July 26 – Bloomberg: “China ordered more than 1,400 companies in 19 industries to cut excess production capacity this year, part of efforts to shift toward slower, more- sustainable economic growth. Steel, ferroalloys, electrolytic aluminum, copper smelting, cement and paper are among areas affected, the Ministry of Industry and Information Technology said… Excess capacity must be idled by September and eliminated by year-end, the ministry said… ‘This is a real move and is very specific compared with previous high-level conceptual framework for economic restructuring,’ said Raymond Yeung, a Hong Kong-based economist at ANZ Banking Group Ltd. ‘They maintain the overall tone that they’re not focusing on the quantity of growth but the quality of growth.’”

July 24 – Bloomberg: “At first glance, Daliuta in northern China appears to have a river running through it. A closer look reveals the stretch of water in the center is a pond, dammed at both ends. Beyond the barriers, the Wulanmulun’s bed is dry. Daliuta in Shaanxi province sits on top of the world’s biggest underground coal mine, which requires millions of liters of water a day for extracting, washing and processing the fuel. The town is the epicenter of a looming collision between China’s increasingly scarce supplies of water and its plan to power economic growth with coal. ‘Water shortages will severely limit thermal power capacity additions,’ said Charles Yonts, head of sustainable research at… CLSA Asia-Pacific Markets… ‘You can’t reconcile targets for coal production in, say, Shanxi province and Inner Mongolia with their water targets.’ Coal industries and power stations use as much as 17% of China’s water, and almost all of the collieries are in the vast energy basin in the north that is also one of the country’s driest regions. By 2020 the government plans to boost coal-fired power by twice the total generating capacity of India. About half of China’s rivers have dried up since 1990 and those that remain are mostly contaminated. Without enough water, coal can’t be mined, new power stations can’t run and the economy can’t grow. At least 80% of the nation’s coal comes from regions where the United Nations says water supplies are either ‘stressed’ or in ‘absolute scarcity.’”

July 25 – Fitch Ratings: "Assets under management (AUM) for Chinese open-ended money market funds (MMFs) dropped nearly 40% during the second quarter of 2013 as both retail and institutional funds faced heavy redemptions, according to Fitch… The outflows, unprecedented in the market's relatively short history, were driven by volatile interbank market conditions and tight liquidity during June. Total AUM fell to CNY304bn at the end of Q213. Most notably, assets in institutional offerings fell by nearly 50% to CNY136bn. Around 70% of all institutional funds reported outflows, with 25% of MMFs in this segment losing more than half of their asset base.”

July 26 – Bloomberg (Kyoungwha Kim and Yanping Li): “Local-government financing vehicles need to repay a record amount of debt this year, prompting Moody’s… to warn Premier Li Keqiang may set an example by allowing China’s first onshore bond default. Some 127 billion yuan ($21bn) of so-called LGFV notes expire in the second half, according to Everbright Securities Co., the most in its data going back to 2000 and more than double the 62.7 billion yuan that matured in the first six months. The yield premium over top-rated notes for one-year AA debt, the most common rating for LGFVs, widened to 67 bps yesterday, the highest level since Jan. 16…” ‘With bonds approaching maturity, the weaker ones will have some problems as cash flows that they generate are very weak,’ said Christine Kuo, a Moody’s analyst in Hong Kong. ‘I wouldn’t rule out the possibility of the government showcasing some companies to go under.”

July 23 – Bloomberg (Jasmine Wang and Kyunghee Park): “During the 2007 shipping boom, China’s shipyards charged down payments of as much as 60% of a vessel’s value. Now, shipbuilders are cutting those payments to as little as 2%, giving an advantage to state-owned companies that can tap the government’s cash. With flagging demand pushing shipyards to compete by cutting down payments and China taking measures to rein in lending, the nation’s privately owned yards are getting squeezed by state-owned rivals that enjoy greater access to financing. China Rongsheng Heavy Industries Group Holdings Ltd., the largest shipbuilder outside state control by order book, said this month it’s seeking government support after failing to win any new vessel orders this year.”

July 25 – Bloomberg: “Beijing sold a high-end residential land parcel for a record price as developers sought to tap rising demand for luxury homes even as the government maintains its property curbs. The 75,360 square-meter (811,168 square-foot) Sunhe plot, in a northeastern part of the city known as the ‘central villa district’ near the airport, was sold for 2.36 billion yuan ($385 million)… That implies about 46,000 yuan a square meter of buildable area, beating a record set July 3 by a site in southwest Beijing… The number of apartments sold for more than 10 million yuan in the Chinese capital jumped 81% to 1,388 in the first half from a year earlier, as wealthy buyers favored bigger properties under the government’s purchase restrictions…”

Latin America Watch:

July 24 – Bloomberg (Raymond Colitt): “The return to power of Luiz Inacio Lula da Silva, the mentor and predecessor of Brazil President Dilma Rousseff, is gaining traction among her supporters as her party faces a 2014 election having delivered the slowest average growth in 24 years. Rousseff’s poll approval ratings have plummeted to the lowest of her term… More than 1 million Brazilians took to the streets as the cost of living soars and economic growth forecasts drop. Protests escalated from anger over bus fare increases to discontent over corruption, the quality of public services and government spending priorities. Annual economic growth during Rousseff’s term is forecast by analysts to average 2.12%, the slowest during a presidency since that of Fernando Collor, who was forced to resign over corruption charges in 1992.”

July 24 – Bloomberg (Raymond Colitt): “Brazil’s unemployment rate rose in June to the highest since April 2012, signaling a weakening labor market after five quarters of below-forecast economic growth in Latin America’s biggest economy. The jobless rate jumped to 6% last month from 5.8% in May…”

July 25 – Bloomberg (Alex Cuadros): “Eike Batista, the Brazilian tycoon who ranked as the world’s eighth-richest person last year, is no longer a billionaire. Batista, 56, owes $1.5 billion to Abu Dhabi’s Mubadala Development Co. sovereign-wealth fund… He had already amassed at least $2 billion in personal liabilities, meaning that the 56-year-old entrepreneur now has a net worth of about $200 million, according to the Bloomberg Billionaires Index. After peaking at $34.5 billion in March last year, Batista’s fortune has evaporated as his six publicly traded startups repeatedly fell short of his promises, sinking his plan to create an integrated commodity and logistics empire.”

Europe Crisis Watch:

July 25 – Bloomberg (Mathieu Rosemain): “Marie-Estelle Cevatheean dreams of a new car that would be better suited to her growing family after having a baby late last year. Instead, with no work, the 31- year-old Parisian can’t afford to replace her seven-year-old Citroen C3 subcompact. ‘We don’t have the money yet to buy a new car,’ Cevatheean said. ‘I need to find a job first.’ With unemployment in France rising and consumer confidence at a record low, auto sales in the country have tumbled more than any other major European market this year.”

Germany Watch:

July 25 – Bloomberg (Emma Charlton and Joseph Ciolli): “German companies, basking in a manufacturing rebound, are the most pessimistic in more than a year on the euro. A survey by Commerzbank AG, Germany’s biggest lender after Deutsche Bank AG, found that 51% of companies in Europe’s largest economy expect the currency to weaken against the dollar in the next three months, up from 26% in June. That’s the most bearish since May 2012…”

Portugal Watch:

July 24 – Bloomberg (Joao Lima): “Portugal’s Finance Ministry said the government posted a wider deficit in the six months through June after spending rose and revenue fell. The deficit of the central administration and social security agency was 4.02 billion euros ($5.3bn) compared with a deficit of 1.7 billion euros in the same period of 2012… Spending rose 3.8% as subsidy payments increased, and revenue fell 3.1%.”

Italy Watch:

July 24 – Reuters: “Ratings agency Standard & Poor’s cut its long-term counter-party credit ratings by one notch on 18 medium-sized Italian banks… ‘Italian banks are operating in an environment with higher economic risks, leaving them more exposed to a deeper and longer recession in Italy than we had previously anticipated,’ S&P said… ‘Banks face tough operating conditions, which we believe could further weaken their financial profiles, notably in terms of asset quality and capital and earnings.’”