Sunday, December 14, 2014

Weekly Commentary, September 19, 2014: Only For Wonks

I appreciate Bill Gross’ August Investment Outlook, “For Wonks Only,” and recommend reading (and pondering) it in its entirety.

From Gross: “A credit-based financial economy (as opposed to pure cash) depends on an ever-expanding outstanding level of credit for its survival. Without additional credit, interest on previously issued liabilities cannot be paid absent the sale of existing assets, which in turn would lead to a vicious cycle of debt deflation, recession and ultimately depression. It is this expansion of private and public market credit which the Fed and the BOE have successfully engineered over the past five years, while their contemporaries (the ECB and BOJ) have until now failed, at least in terms of stimulating economic growth. The unmodeled (for lack of historical example) experiment that all major central banks are now engaged in is to ask and then answer: What growth rate of credit is enough to pay prior bills, and what policy rate/amount of Quantitative Easing (QE) is necessary to generate that growth rate? Assuming that the interest rate on outstanding debt in the U.S. is approximately 4.5% (admittedly a slight stab in the dark because of shadow debt obligations), a Fed governor using this template would want credit to expand by at least 4.5% per year in order to prevent the necessary sale of existing assets (debt and equity) to cover annual interest costs… How are they doing? Chart 1 shows outstanding credit growth for recent quarters and all quarters since January 2004. The chart’s definition of credit includes the standard Fed definition of private non-financial credit (corporations, households, mortgages), public liabilities (government debt), as well as financial credit. The current outstanding total approximates $58 trillion and has been expanding at an average annual rate of 2% for the past five years, and 3.5% for the most recent 12 months. Put simply, if credit needs to expand at 4.5% per year, then the private and public sectors in combination must create approximately $2.5 trillion of additional debt per year to pay for outstanding interesting.

Bill Gross’ number is “approximately $2.5 trillion” to ensure sufficient new system Credit to service existing system debt. I’ve posited the U.S. system needs in the neighborhood of $2.0 TN of annual non-financial debt growth. Gross refers to a “credit-based financial economy.” Fair enough, although I believe it is also crucial to appreciate that the U.S. economy has evolved over time to be dominated by a consumption and services-based economic structure. From my analytical framework, annual $2.0 TN (non-financial) Credit growth is required to generate sufficient system-wide purchasing power to sustain various inflated price levels - certainly including incomes, corporate cash-flows, imports, investment and asset prices. An inflated/maladjusted services and consumption economic structure survives on ever-abundant cheap finance.

From the Fed’s Q2 2014 Z.1 “flow of funds” data, we see that total system Credit expanded at a seasonally-adjusted and annualized (SAAR) rate of $2.321 TN during the quarter to a record $57.529 TN. Non-financial market borrowings increased SAAR $1.542 TN (to $40.435 TN); Financial Sector market borrowings rose SAAR $353bn (to $13.954 TN); and Rest of World (ROW) market borrowings expanded SAAR $426bn.

It’s kind of a love/hate thing for me. I love the subject matter of money and Credit. I’m fascinated by monetary history, and always challenging analysis makes my heart go pitter-patter. Yet I admittedly rather despise contemporary finance – today’s “money” and Credit. The 2008/9 crisis offered another glimpse of its inherent danger to all. I believe strongly that sound money and Credit provide the bedrock for Capitalism, economies and societies. An understanding and appreciation for what constitutes stable finance (money and Credit) are fundamental to financial system, economic and social stability. Most regrettably, finance has become so complex, sophisticated and convoluted that basically no one today can feel comfortable that they really grasp what’s going on with “money.”

Mr. Gross aptly titled his piece “For Wonks Only.” And I actually think he simplified his analysis in an effort for it to at least be assessable to so-called “wonks.” He calculates $2.5 TN of required system Credit growth on total outstanding (non-financial and financial) debt of approximately $58 TN. Out of necessity, my analysis focuses on non-financial debt growth of $2.0 TN on outstanding of debt of $40.4 TN.

Analysis of Financial sector borrowings – or “Credit Market Debt Owed by Financial Sectors” – is fraught with myriad challenges. During lending Bubbles – especially booms in risky Credits – financial sector borrowings can reflect layers of financial/risk intermediation. For example, Financial Sector borrowings surged $1.336 TN (10.3%) in 2006 and another $1.834 TN (12.9%) in 2007, with outstanding GSE debt, MBS and ABS swelling as record mortgage lending was intermediated (“Wall Street alchemy”). Financial Credit then contracted $1.663 TN during the 2009 mortgage Credit dislocation.

Overall, Z.1 Financial Sector market borrowings of almost $14.0 TN remain $3.0 TN below peak levels from early 2009. This seeming contraction in Financial borrowings helped to improve ratios of total system debt to GDP, in the process providing ammo for the deleveraging thesis crowd. Importantly, Financial Sector market debt excludes the almost $4.5 TN of outstanding Federal Reserve Credit (it also excludes Trillions of bank deposit liabilities). Indeed, the almost $3.6 TN six-year expansion of Fed Credit has played a momentous role in U.S. and global system reflation, while remaining conveniently excluded from tallies of system debt.

It would meaningfully change Credit growth calculations if Federal Reserve Credit was part of the analysis. For one, it would more than reverse the $3.0 TN post-crisis contraction in Financial Sector borrowings. More importantly, it significantly alters annual Credit growth numbers/analysis (and is at the heart of my analysis that system deleveraging is a myth). From my perspective, unprecedented inflation in Federal Reserve Credit has been instrumental in inflating U.S. incomes, corporate cash flows, securities and asset prices, spending, imports and tax receipts in the face of insufficient overall Credit expansion in the real economy.

It’s impossible to quantify the various impacts from Fed Credit expansion (“money” printing), so conventional analysis simply disregards it. Most believe that Fed Credit has been sitting inertly on the banking system balance sheet. In reality this torrent of liquidity has been slushing about global securities markets. There should be no doubt that the effects have been profound – in the markets and real economy, at home and abroad.

The Fed is to wind down its “money” printing in a month or so. Markets remain excessively complacent. It remains difficult for me to envisage ongoing Credit growth sufficient to sustain levitated system price levels without the headwinds provided by massive inflation of Fed Credit. Global financial flows remain The Wildcard.

Examining the most recent Z.1, Total Non-Financial Debt expanded SAAR $1.542 TN (3.8%) during Q2, down from Q1’s SAAR $1.692 TN (4.3%). This was the weakest Credit expansion since Q3 2013. Total Household borrowings jumped to SAAR $471bn, the strongest gain since Q1 ’08. Total Business borrowings of SAAR $722bn (6.3%) were up somewhat from Q1’s SAAR $695bn. Federal borrowings grew SAAR $314bn (2.5%), down from Q1’s $741bn.

Federal Reserve Liabilities ended Q2 at a record $4.430 TN. Fed Credit was up $903bn, or 25.6%, year-on-year. Fed Credit inflated $1.546 TN, or 53.6%, over two years. In six years Fed Credit inflated $3.478 TN, or 365%. It’s my view that this unprecedented inflation in Federal Reserve “money” has unleashed major inflationary dynamics upon securities prices, perceived household wealth and incomes, while also provoking highly unstable global financial flows and market Bubbles. Impacts on securities prices, the household balance sheet and incomes are easiest to illustrate.

First of all, Incomes jumped strongly in Q2, indicative of the modest inflationary bias that has taken hold after six years of extreme monetary measures. National Income expanded at a 7.6% pace during the quarter, with one-year gains of $502bn, or 3.5%. Compensation increased at a 5.2% pace in Q2, increasing one-year gains to $389bn, or 4.4%. Chair Yellen should be pleased.

Indicative of a rather immodest inflationary bias, Household Assets increased nominal $1.552 TN during Q2 to a record $95.44 TN. This boosted one-year gains to $8.0 TN, or 9.2% , and two-year gains to $14.511 TN, or 17.9%. With Household Liabilities little changed, Household Net Worth gained $1.391 TN during Q2. Household Net Worth increased $7.679 TN over the past year to a record $81.493 TN (551% of GDP!). For reference, Household Net Worth ended 2007 at a then record $67.832 TN. Amazingly, Household Net Worth has now inflated $24.295 TN, or 42.5%, since the end of 2008.

A brief note on the composition of Household Sector Assets seems appropriate. As a component of total Household Assets, holdings of Equities and Mutual Funds jumped from $9.238 TN at the end of ’08 to $20.995 TN to end Q2 2014. Equities and Mutual Funds have jumped from 20% of total Financial Asset holdings to 31%. For comparison, since the end of ’08 Household holdings of Deposits (bank and money market fund) have increased from $8.172 TN to $9.861 TN.

Federal Reserve monetary inflation has had its most conspicuous impact on securities prices. In past analyses, I’ve combined (Z.1 categories) Treasuries, MBS, Corporate Bonds and Municipal Securities to come to a proxy for total marketable debt, and then added Equities for my proxy of Total Marketable Securities (the Fed made some significant revisions, especially to its tally of Corporate Debt). For the quarter, Total Securities increased $1.590 TN during Q2 to a record $71.184 TN. Total Securities was up $26.349 TN, or 59%, during the past 22 quarters. Total Securities has now inflated to a record 411% of GDP. For comparison, Total Securities ended 2007 at a then record $53.080 TN, or 378% of GDP.

There’s another crucial “balance sheet” especially worthy of contemplation these days. Rest of World (ROW) holdings of U.S. Financial Assets increased another $634bn during Q2 to a record $22.277 TN, with a notable one-year gain of $2.344 TN, or 11.8% (second only to 2006’s $2.49 TN). ROW holdings have jumped over $6.0 TN in four years, with flows almost equaling the levels from the 2004-2007 Bubble period. I view ROW flows as a good proxy for global “hot money” speculative flows.

I believe the Fed and global central bank QE has unleashed Trillions of liquidity into global securities markets. Moreover, extreme monetary measures (zero rates and QE) coupled with assurances of market liquidity backstops has incited unprecedented global leveraged speculation. This speculative leveraging has likely created Trillions additional liquidity that has worked surreptitiously to inflate global securities markets.

This liquidity bonanza has played a crucial if unappreciated economic role. In the U.S., it has been integral in the inflation of securities markets, in the process inflating perceived wealth, spending and general economic activity. In the Emerging Markets (EM), this liquidity was instrumental in inflating domestic Credit and financing financial and economic Bubbles. With faltering economies and fragile Credit systems, EM is now acutely vulnerable to a destabilizing reversal of these investment and speculative (“hot money”) flows.

And here’s where the analysis turns even more challenging. Global QE incited strong inflationary biases throughout global securities markets. Meanwhile, the liquidity bonanza and the powerful magnetism of speculative securities Bubbles worked (perversely) to place further downward pressure on global commodities and manufactured good prices. At the same time, the Fed’s QE3 coupled with global flows ensured a general inflationary bias for both U.S. securities markets and the services/consumption U.S. economy. The inflationary U.S. backdrop in the face of strengthening global disinflationary forces has incited an increasingly self-reinforcing King Dollar Dynamic.

Thus far, King Dollar has bolstered the bullish viewpoint for U.S. economic and stock market prospects. Increasingly, however, the King is fostering instability. Commodity prices were under further pressure this week, while EM fragility becomes a bigger market worry by the day. The Brazilian real’s 1.2% decline this week pushed the currency to within easy striking distance of multi-year lows. The week saw Russian ruble decline 1.8%, the Indonesian rupiah 1.2%, the Philippine peso 1.2% and the Malaysian ringgit 1.1%. The Goldman Sachs Commodities Index declined another 0.5% to the low since the summer of 2012. Venezuela CDS jumped another 178 bps to 1,615. Wheat traded to a new four-year low and corn to a five-year low.

Helping to explain market complacency, this is clearly not the first instance in recent years that EM Bubbles appeared vulnerable. The Fed’s QE2 worked its magic for the EMs back in 2011. The reemergence of acute stress in 2012 was reversed by Draghi’s “do whatever it takes” and open-ended QE from the Fed and BOJ. Bernanke’s “the Fed will push back…” did the trick in mid-2013.

Of late, talk has been that the ECB’s balance sheet would come to the rescue. Count me as deeply skeptical of all the bullish ECB “QE” liquidity propaganda. As such, I see a world of somewhat waning liquidity abundance with an increasingly destabilizing King Dollar bias. There’s risk that escalating EM stress and attendant “hot money” outflows lead to a self-reinforcing de-risking/de-leveraging dynamic. EM companies and countries at this point have way too much dollar-denominated debt. At some point, contagion might negatively impact market expectations for the global economy at large, perhaps leading to a more generalized global “risk off” backdrop.

From the Z.1 we know that Security Credit was up $161bn year-over-year, or 13.7%, to a record $1.333 TN. Fed Funds and Repurchase Agreements were little changed y-o-y at $3.792 TN. Security Broker/Dealer Assets were actually down about 5% y-o-y to $3.388 TN. Funding Corps were down 3.3% y-o-y to $1.312 TN. Clearly, securities leveraging remains integral to overall U.S. Credit system operations.

At the same time, there are important sources of global leverage outside the purview of Fed monitoring and Z.1 reporting. There are myriad avenues for “carry trades,” securities shorting and “off-shore” securities financing vehicles, not to mention the murky world of (hundreds of Trillions of) derivatives. And it wouldn’t surprise me in the least if this is where the surprise lurks, especially now that currency markets have turned notably unstable. Seth (“Truman Show”) Klarman was said to have written that “we are recreating the markets of 2007.” For me, the world today is a whole lot scarier.

For the Week:

The S&P500 gained 1.3% trading to a new record high (up 8.8% y-t-d), and the Dow jumped 1.7% to a new high (up 4.2%). The Utilities rose 1.4% (up 11.1%). The Banks advanced 1.4% (up 6.4%), and the Broker/Dealers added 0.5% (up 8.7%). Transports gained 1.0% (up 16.7%). The S&P 400 Midcaps slipped 0.2% (up 5.7%), and the small cap Russell 2000 fell 1.2% (down 1.4%). The Nasdaq100 increased 0.8% (up 14.2%), while the Morgan Stanley High Tech index slipped 0.2% (up 9.1%). The Semiconductors jumped 1.5% (up 21.4%). The Biotechs added 0.9% (up 33.4%). With bullion down $14, the HUI gold index sank 4.8% (up 5.5%).

One-month Treasury bill rates closed the week at zero and three-month bills ended at one basis point. Two-year government yields were little changed at 0.57% (up 19bps y-t-d). Five-year T-note yields slipped a basis point to 1.81% (up 7bps). Ten-year Treasury yields fell four bps to 2.58% (down 45bps). Long bond yields declined six bps to 3.28% (down 69bps). Benchmark Fannie MBS yields fell five bps to 3.25% (down 36bps). The spread between benchmark MBS and 10-year Treasury yields narrowed one to 67 bps. The implied yield on December 2015 eurodollar futures was unchanged at 1.085%. The two-year dollar swap spread was unchanged at 24 bps, and the 10-year swap spread was unchanged at 13 bps. Corporate bond spreads narrowed. An index of investment grade bond risk fell four bps to 56 bps. An index of junk bond risk dropped 11 to 323 bps. An index of emerging market (EM) debt risk rose eight to 281 bps.

Ten-year Portuguese yields declined six bps to 3.17% (down 296bps y-t-d). Italian 10-yr yields fell nine bps to 2.37% (down 176bps). Spain's 10-year yields dropped 14 bps to 2.20% (down 195bps). German bund yields declined four bps to 1.04% (down 89bps). French yields were down four bps to 1.39% (down 11bps). The French to German 10-year bond spread was unchanged at 35 bps. Greek 10-year yields rose seven bps to 5.78% (down 264bps). U.K. 10-year gilt yields added two bps to 2.54% (down 48bps).

Japan's Nikkei equities index jumped 2.3% (up 0.2% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.56% (down 18bps). The German DAX equities index rallied 1.5% (up 2.6%). Spain's IBEX 35 equities index gained 1.0% (up 10.9%). Italy's FTSE MIB index slipped 0.5% (up 10.6%). Emerging equities were mixed. Brazil's Bovespa index recovered 1.5% (up 12.2%). Mexico's Bolsa was down slightly (up 7.1%). South Korea's Kospi index gained 0.6% (up 2.1%). India’s bubbly Sensex equities index added 0.1% (up 28%). China’s Shanghai Exchange was little changed (up 10.1%). Turkey's Borsa Istanbul National 100 index fell another 1.2% (up 13.5%). Russia's MICEX equities index sank 1.9% (down 4.8%).

Debt issuance remained strong. Investment-grade issuers included Teachers Insurance & Annuity $2.0bn, Humana $1.75bn, JPMorgan $1.6bn, Alcoa $1.25bn, American Express $1.0bn, PNC Bank $1.0bn, Plains All American Pipeline LP $750 million, A.P. Moeller-Maersk $1.25bn, Ameriprise Financial $550 million, Brown & Brown $500 million, Toyota Motor Credit $350 million, Realty Income $250 million, Piedmont Natural Gas $250 million, Ross Stores $250 million, Zarapito Leasing $160 million and Gulf Power $200 million.

Junk funds saw outflows jump to $1.2 billion (from Lipper). Junk issuers included CBS Outdoor Americas $1.0bn, AECOM Technology $1.6bn, Acosta $800 million, Simmons Foods $415 million, Anixter $400 million, GameStop $350 million, RCN Telecom Services $305 million, York Risk Services $270 million, SFX Entertainment $285 million, PennantPark Investment Corp $250 million, Ply Gem Industries $150 million, Midas $200 million and Jac Products $150 million.

Convertible debt issuers included Tivo $200 million and Violin Memory $105 million.

The long list of international dollar debt issuers included Mizuho Bank $2.5bn, Royal Bank of Canada $1.75bn,Toronto Dominion Bank $1.75bn, Panama $1.25bn, Municipality Finance PLC $1.05bn, Nordea Bank $1.0bn, Pacific Rubiales Energy $750 million, Corpbanca $750 million, WPP $750 million, ANZ New Zealand $500 million, Export Credit Bank of Turkey $500 million, Inter-American Development Bank $500 million, Gol Luxco $325 million, BBVA Banco Continental $300 million, DHT Holdings $250 million and Honghua Group $200 million.

Freddie Mac 30-year fixed mortgage rates jumped 11 bps to a four-month high 4.23% (down 25bps y-o-y). Fifteen-year rates rose 11 bps to 3.37% (down 17bps). One-year ARM rates declined two bps to 2.43% (down 22bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.63% (down 4bps).

Federal Reserve Credit last week expanded $29.9bn to a record $4.408 TN. During the past year, Fed Credit inflated $735bn, or 20.0%. Fed Credit inflated $1.597 TN, or 57%, over the past 97 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $8.8bn last week to a record $3.347 TN. "Custody holdings" were up $8.8bn year-to-date and $68bn from a year ago.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $832bn y-o-y, or 7.4%, to $12.006 TN. Over two years, reserves were $1.396 TN higher for 13% growth.

M2 (narrow) "money" supply jumped $26.9bn to a record $11.498 TN. "Narrow money" expanded $712bn, or 6.6%, over the past year. For the week, Currency increased $0.2bn. Total Checkable Deposits jumped $32.1bn, while Savings Deposits slipped $3.6bn. Small Time Deposits added $1.5bn. Retail Money Funds were little changed.

Money market fund assets dropped $16.7bn to $2.576 TN. Money Fund assets were down $142bn y-t-d and dropped $82bn from a year ago, or 3.1%.

Total Commercial Paper added $0.9bn to a two-month high $1.052 TN. CP was up $6.0bn year-to-date, with a one-year gain of $5bn, or 0.5%.

Currency Watch:

The U.S. dollar index gained 0.6% to 84.735 (up 5.4% y-t-d). For the week on the upside, the Canadian dollar increased 1.2% , the Mexican peso 0.4%, the Norwegian krone 0.1% and the British pound 0.1%. For the week on the downside, the Japanese yen declined 1.6%, the Australian dollar 1.3%, the Brazilian real 1.2%, the Danish krone 1.1%, the euro 1.0%, the South Korean won 0.9%, the Swiss franc 0.8%, the Taiwanese dollar 0.7%, the South African rand 0.5%, the Swedish krona 0.4%, the Singapore dollar 0.3% and the New Zealand dollar 0.3%.

Commodities Watch:

The CRB index declined 0.9% this week (down 0.3% y-t-d). The Goldman Sachs Commodities Index lost 0.5% (down 7.8%). Spot Gold fell 1.1% to $1,216 (up 0.8%). September Silver sank 4.1% to $17.844 (down 8%). October Crude increased 14 cents to $92.41 (down 6%). October Gasoline rallied 3.7% (down 6%), while October Natural Gas declined 0.5% (down 9%). December Copper slipped 0.5% (down 9%). December Wheat sank 5.6% to a four-year low (down 22%). December Corn lost 2.1% to a five-year low (down 21%).

U.S. Fixed Income Bubble Watch:

September 18 – Bloomberg (Lisa Abramowicz): “Imagine a trillion-dollar market that runs on faxes and phone calls while routinely tying up investors’ money for months before they get any return. That’s not fiction: It’s the unregulated market for leveraged corporate loans. In a financial system that is increasingly automated, the origination and trading of loans is in the relative dark ages while money pours in from mainstream investors such as Kansas and New York pension plans and mutual funds catering to individuals seeking high yields in an era of near-zero interest rates. The antiquated structure of a market that’s ballooned from a mere $35 billion in 1997 poses a growing threat, raising the odds of gridlock in a downturn when investors expect to get their money back with a click of a button. As of yet, no regulators have taken responsibility for fixing the deficiency.”

September 16 – MarketNews International (John Shaw): “Doug Elemendorf, the director of the Congressional Budget Office, in two recent briefings on U.S. fiscal policy, has argued the nation is moving toward ‘strikingly different’ budget policies that will shape the U.S. in profound ways. In two presentations last week, Elmendorf argued that the U.S.'s federal budget is changing in two deeply consequential ways. First, federal debt will become much larger relative to the size of the economy than it has been in almost all of American history. Second, a much larger share of federal spending will go to benefits for older Americans and for health care and a much smaller share will go for all other federal programs and activities… ‘Such large and growing federal debt would have serious negative consequences,’ Elmendorf said, adding it would boost debt service costs, slow economic growth, restrict future fiscal policy options, and increase the risk of a future ‘fiscal crisis.’”

September 19 – Financial times (Michael MacKenzie): “Investors are shunning US inflation bonds as a stronger dollar and lower commodity costs negate the need for owning insurance against the risk of rising consumer prices. Expectations for inflation over the next 10 years, as measured by comparing yields on Treasury inflation protected securities and those of nominal Treasury bonds, have dropped to their lowest level in 14 months. A drop in the so-called breakeven rate to 2.04% from 2.27% earlier this summer, reflects the influence of a stronger dollar and lower commodity prices that have reduced inflationary pressure across the US economy in recent months.”

Federal Reserve Watch:

September 19 – Bloomberg (Rich Miller): “Federal Reserve policy makers signaled they won’t be raising interest rates anytime soon while suggesting they would tighten credit at a faster pace once the liftoff has begun. Fed Chair Janet Yellen and her colleagues… stuck with a pledge to hold interest rates near zero for a ‘considerable time’ after they end asset purchases, probably next month. Even so, policy makers projected a steeper increase in borrowing costs next year, raising the median forecast for the benchmark rate at the end of 2015 to 1.375% from June’s estimate of 1.125%... ‘There is a tension between the committee’s statement keeping the considerable period language versus the rate forecasts,’ said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi… ‘It is quite a balancing act of the high-wire kind that still leaves the market guessing about the Fed’s intentions.’”

September 15 – Wall Street Journal (Victoria McGrane and Pedro Nicolaci da Costa): “The Federal Reserve is elevating its postcrisis efforts to monitor potential threats to financial stability, creating a high-level committee led by the central bank's No. 2 official. The committee, which includes Fed Vice Chairman Stanley Fischer and governors Daniel Tarullo and Lael Brainard, will play a role monitoring the financial system for emerging problems such as asset bubbles and analyzing how the central bank should respond… The committee's makeup, which was confirmed by the Fed, suggests it could be a powerful voice within the Fed on financial stability issues… Among the many postcrisis criticisms was that regulators didn't spot or respond to problems quickly enough, failing to address deteriorating underwriting standards and missing the exposure of big banks to the asset-backed commercial-paper market, which collapsed under the weight of investments in troubled mortgage debt.”

September 13 – Bloomberg (Alister Bull): “The Federal Reserve has created a committee led by Vice Chairman Stanley Fischer to monitor financial stability, reinforcing its efforts to avoid the emergence of asset-price bubbles. Joining Fischer on the Committee on Financial Stability are Governors Daniel Tarullo and Lael Brainard… Fed officials want to ensure that six years of near-zero interest rates don’t lead to a repeat of the excessive risk- taking that fanned the U.S. housing boom and subsequent financial crisis. ‘They’re putting the varsity team on it, but whether or not they’re going to be able to call bubbles better than anyone else is really is an open question,’ Drew Matus, deputy U.S. chief economist at UBS…, said… Sharpening the issue, measures of volatility across stocks, bonds and currencies worldwide have declined to record or multi- year lows this year, in a potential sign of investor complacency.”

U.S. Bubble Watch:

September 19 – Bloomberg (Naomi Christie and Shruti Date Singh): “Shipping companies probably will miss out on exports from the record U.S. grain harvest because the shale-oil boom is clogging up rail lines to ports. While the U.S. will reap the most crops ever, fourth-quarter export cargoes will be 15% lower than last year, according to RS Platou Markets AS, a Norwegian bank specialized in shipping. Rates for Panamaxes, the most commonly used vessels for grains, averaged $7,574 a day this year, headed for the lowest level since at least 1999… The U.S. shale-oil boom means energy shipments are dominating rail networks at the expense of grains. The Association of American Railroads says crude moved by rail almost doubled last year. The bottlenecks may persist because the Energy Department is predicting the most oil output in 45 years in 2015.”

September 15 – Wall Street Journal (Alexandra Scaggs and Steven Russolillo): “The U.S. stock market's bears have gone into hibernation. With no end in sight to a market rally now in its fifth year, once-pessimistic Wall Street forecasters are espousing rosier views. For some investors, the disappearance of negative views is cause for concern. They worry that with bulls so dominant, whenever any shocks do hit, the damage could be much worse than if there were more skeptical investors around. But a healthier U.S. economy, solid corporate profits and low interest rates have persuaded many bearish analysts that a major pullback for stocks isn't in the cards at least well into next year.”

September 16 – Bloomberg (Chris Christoff): “A $450 million bond sale to finance a Detroit hockey arena neared final approval with consent of the city taxing authority that will help pay for it. The Detroit Downtown Development Authority approved terms that may be considered tomorrow by the Michigan Strategic Fund, which would issue the bonds. The 18,000-seat arena is the anchor for a 250-acre (101-hectare) redevelopment to be financed by Olympia Development… The new venue will replace Joe Louis Arena, where the Red Wings have won four Stanley Cup championships since it opened in 1979.”

September 18 – Bloomberg (Nick Baker): “It hasn’t been high-frequency trader Vincent Viola’s best year. His trading firm, Virtu Financial Inc., shelved plans for an initial public offering amid the furor stirred up by author Michael Lewis’s ‘Flash Boys,’ a critique of the industry… His hockey team, the Florida Panthers, won only a third of its games last season. Now he’s cut the offering price for his six-floor, 19-room Manhattan townhouse, nine months after putting it on the market. The home, described in a real estate listing as exuding the ‘ultimate in sophistication and grandeur,’ was reduced last week to $98 million from $114 million…”

Central Bank Watch:

September 17 – Bloomberg: “China’s central bank joined its European counterpart in boosting liquidity to address weakening growth, underscoring a divergence in direction among the world’s biggest economies as the U.S. reduces stimulus. The People’s Bank of China is injecting 500 billion yuan ($81bn) into the nation’s largest banks… China’s credit expansion builds on targeted measures to shore up growth while stopping short of broad-based stimulus seen in the U.S. in the wake of the global financial crisis and still being pushed in Europe and Japan. By attaching a three- month term to its injection, China is taking a step down that path while maintaining control of a process designed to fuel demand for credit in an already debt-laden economy.”

September 18 – Financial times (Claire Jones, Sam Fleming and Christopher Thompson): “Mario Draghi’s latest attempt to stave off economic stagnation in the eurozone had a faltering start on Thursday when demand for the European Central Bank’s first offer of cheap four-year loans fell far short of expectations. The low take-up of the loans piles pressure on the ECB to consider more radical measures such as quantitative easing, though the idea continues to face resistance in Germany, Europe’s largest economy. Europe’s banks borrowed €82.6bn through the first of the ECB’s Targeted Longer-Term Refinancing Operations, or TLTROs, out of a possible €400bn, much less than analysts had forecast.”

September 18 – Bloomberg (Stefan Riecher): “The European Central Bank’s first targeted-loan program came in below estimates in a sign that President Mario Draghi has a way to go to meet his stimulus target. The… central bank said it allotted 82.6 billion euros ($106.5bn) at a fixed interest rate of 0.15% in its targeted longer-term refinancing operations today. Estimates in a Bloomberg News survey of economists ranged from 100 billion euros to 300 billion euros, with a median of 150 billion euros. The lending program is part of a range of ECB measures to stave off deflation in the euro area that Draghi says will boost the institution’s balance sheet to as much as 3 trillion euros from 2 trillion euros.”

Europe Watch:

September 14 – Bloomberg (Katie Linsell): “Catalan President Artur Mas must deliver a referendum on independence despite Prime Minister Mariano Rajoy’s claims it’s unconstitutional, Oriol Junqueras, leader of separatist party Esquerra Republicana de Catalunya tells El Mundo in an interview. The time has come to break Spanish law, view referendum under law of independent Catalonia, Junqueras tells Mundo…”

September 15 – Bloomberg (Roxana Zega and Charles Daly): “Asset quality of South Europe’s biggest banks diverged in the first half of 2014, as Spanish lenders showed improving non-performing loans and provisions, a Bloomberg First Word analysis of earnings reports shows. Italian banks’ ratios are higher than elsewhere in Europe, reflecting slow bankruptcy procedures in Italy, ECM Asset Management analyst Robert Montague says… The impaired loan ratio for the 5 largest banks in Italy increased by an average of 86 bps over 1H 2014 to 19.5% at end-June.”

September 15 – Bloomberg (Mark Deen): “Francois Hollande is finding out that the European Central Bank is about the only friend he has left. A majority of the French said in a poll last week that they’d like their president to step down before his term ends in 2017; his ex-girlfriend Valerie Trierweiler has written a scathing tell-all book that paints him as cold and calculating; and Prime Minister Manuel Valls faces a confidence vote in parliament tomorrow with mounting opposition in the governing party to his business-friendly policies. To top that, the French economy is barely growing, joblessness is at a record high and rising, and the country’s budget deficit is widening for the first time in five years. Yet investors have not lost their enthusiasm for French bonds.”

September 15 – Bloomberg (Johan Carlstrom and Niklas Magnusson): “Sweden’s election threw the nation’s political establishment into turmoil as backing for the anti-immigration Sweden Democrats more than doubled, leaving the largest Nordic economy facing a hung parliament. The three-party Social Democratic opposition led by Stefan Loefven won 43.7%, versus 39.3% for the four-party government of Prime Minister Fredrik Reinfeldt, with all the votes counted. The Sweden Democrats garnered 12.9% to become the third largest party.”

September 16 – Bloomberg (Stefan Riecher): “German investor confidence dropped to the weakest in 21 months amid increasing political tension in Europe, even as the European Central Bank steps up its stimulus.”

Germany Watch:

September 15 – Bloomberg (Patrick Donahue and Arne Delfs): “Germany’s anti-euro party swept into two eastern state parliaments, expanding its challenge to Chancellor Angela Merkel in a region mostly dominated by her Christian Democrats since the Berlin Wall fell 25 years ago… Alternative for Germany, whose positions range from breaking up the euro area to promoting three-children families and fighting crime on Germany’s eastern border, took 12.2% in Brandenburg and 10.6% in Thuringia. The party, known as AfD, won its first state parliament seats in Saxony last month.”

September 15 – Wall Street Journal (Gabriele Steinhauser): “The head of Germany's central bank said… he is against public guarantees for asset-backed securities as part of the European Central Bank's ABS purchase program, contradicting comments a day earlier from ECB President Mario Draghi. The ABS program, which is expected to kick off in October, forms part of ECB efforts to improve the supply of credit in the eurozone… Mr. Draghi said Friday that the ECB's asset purchase program would be more effective if it was extended to the mezzanine tranche of ABS, which is riskier than the senior tranche that the program is targeting for now. However, Mr. Draghi said that for such an extension, the ECB would require public guarantees for these tranches, effectively moving the risk of such purchases off the ECB's balance sheet. Deutsche Bundesbank President Jens Weidmann warned… that he was concerned about any purchases of ABS that resulted in a big transfer of risk from banks to taxpayers. ‘One has to be aware of this transfer of risk when the Eurosystem [of eurozone central banks] buys risky papers or when… the European Investment Bank issues public guarantees for ABS,’ Mr. Weidmann said… Such a transfer of risk to taxpayers contradicts efforts in recent years to make banks' investors and creditors, rather than taxpayers, pay for losses, Mr. Weidmann said.”

Global Bubble Watch:

September 14 – Bloomberg (Boris Groendahl): “Cross-border lending by global banks rose by $580 billion in the first quarter, the first ‘substantial’ increase since 2011, the Bank for International Settlements said. Cross-border claims of banks reporting to the BIS rose 2% to $29.4 trillion in the three months through March… That was driven by a 1.7 percent expansion of lending to other banks, the first quarterly rise in more than two years, the BIS said… ‘The expansion was broadly spread across countries and sectors,’ said the BIS, the record-keeper of the world’s central banks. ‘Claims on both advanced and emerging-market economies grew considerably.’”

September 16 – Bloomberg (Nabila Ahmed and Matt Robinson): “One year after pulling off the largest bond offering ever, Wall Street debt underwriters are pitching their clients on the possibility of something even bigger. With investors clamoring for higher-yielding assets and companies on the biggest acquisition spree since 2007, bankers are talking up the ability of credit markets to fund a ‘mega deal’ that Citigroup Inc. says could be backed by $100 billion or more of financing… ‘We are prompting issuers to think outside of the box -- in terms of the art of the possible,’ said Tom Cassin, the… co-head of investment-grade finance at JPMorgan… ‘We have got clients that are certainly intrigued by it and interested in it.’”

September 19 – Bloomberg (Caleb Melby and David De Jong): “China’s richest person got even wealthier today as Alibaba Group Holding Ltd. soared on its first day of trading. Jack Ma, who started the e-commerce company in his apartment in 1999, has added $4.7 billion to his net worth. His stake surged $3.9 billion after the Chinese company’s shares rose 35.8%... The gain makes him second-richest person in Asia, trailing Hong Kong’s Li Ka-Shing, according to the Bloomberg Billionaires Index.”

September 15 – Bloomberg (Anchalee Worrachate): “Some of the very factors that have becalmed developed nations are increasing risks for emerging markets, affecting $1.4 trillion in funds focused on those assets, the Bank for International Settlements said. Unprecedented stimulus by central banks and historically low volatility levels across asset classes have made it more likely that emerging markets destabilize, the… institution said… in its quarterly report. Governments and companies from Latin America to Asia have boosted borrowing in local and foreign currencies, leaving them more vulnerable when interest rates climb or their exchange rate falls. The stability that has developed since the worst days of the global financial crisis has encouraged investors to funnel money into higher-yielding assets in emerging markets, swelling them by about 55% to $1.4 trillion in May compared with October 2007…”

September 17 – Bloomberg (Ye Xie): “It’s back. The rout that gripped emerging-market currencies last year is again threatening to send exchange rates to their weakest levels since 2009. An index of 20 major developing-nation exchange rates fell yesterday to within 0.3% of a 5 1/2-year low reached in February. Options betting on a drop in the ‘fragile five,’ or those currencies vulnerable to capital flight such as South Africa’s rand and Turkey’s lira, cost the most in seven months. As recently as July, developing-nation currencies were enjoying a renaissance, flirting with their highest levels of the year…”

September 16 – Bloomberg (Christopher Langner and Lilian Karunungan): “Southeast Asia’s 100 largest publicly traded companies are becoming more vulnerable to default as their debt surges and profitability weakens. Debt-to-earnings ratios rose last year at the fastest pace since 2011, as average return on capital at the biggest firms by market value fell for the first time since 2008… In the past four years, their debt rose 89% to the equivalent of $501 billion. Average economic growth in Indonesia, Malaysia, Singapore, Philippines, Thailand and Vietnam fell to just under 5% last year from 8.5% in 2010, forcing companies to rely more on borrowing than earnings to finance their investments. Outbound acquisition activity from the Asean region has tripled in the past five years as companies sought growth abroad. ‘More and more debt is financing less and less growth,’ Singapore-based Xavier Jean, a director of corporate ratings for Standard & Poor’s, said… ‘The only way for these companies to keep growing seems to be leveraging up.’ S&P released a study last week that said the escalating debt levels among Asean’s blue-chip companies will increase vulnerability when interest rates start to rise. Internal cash flows and cash balances funded only about half of the $300 billion the region’s largest companies spent on expansion and acquisitions between 2008 and the first quarter of 2014, S&P said. About $150 billion of debt was issued to bridge the gap.”

September 16 – Bloomberg (Lisa Abramowicz): “Bond buyers have generally grown more risk-averse as 2014 drags on -- except when it comes to emerging-market debt. Dollar-denominated notes of developing nations from Mexico to Indonesia have returned 7% this year, more than U.S. high-yield and investment-grade bonds… While these more-fragile economies have benefited from low borrowing costs across the globe, they may stumble when those rates rise as cash starts leaving, according to analysts at the Bank of International Settlements, which is based in Basel, Switzerland. Investors tend to move in herds in these markets, ‘accentuating both booms and busts,’ BIS analysts Ken Miyajima and Ilhyock Shim wrote… While foreign investors may boost growth now, ‘this comes at a price,’ they wrote… Cheap borrowing costs have prompted companies in emerging- market nations to sell a lot of debt overseas, relying more on investors and less on banks… The amount of notes outstanding on the Bank of America Merrill Lynch U.S. Emerging Markets External Sovereign & Corporate index has surged to $1.6 trillion from $546 billion at the end of 2007”

September 17 – Bloomberg (Dakin Campbell): “Citigroup Inc. is diving deeper into derivatives. In the past five years, the firm that took the largest U.S. bank bailout of the financial crisis increased the total amount of derivatives on its books by 69%... At the end of June, Citigroup had $62 trillion of open contracts, up from $37 trillion in June 2009… The third-largest U.S. lender has amassed the largest stockpile of interest-rate swaps, a type of derivative that can swing in value when central banks raise rates. More than 92% of the bank’s derivatives don’t trade on exchanges, making it harder for regulators to spot dangers in the market.”

September 16 – Bloomberg (Zijing Wu, Fox Hu and Leslie Picker): “Alibaba Group Holding Ltd. raised the amount it’s seeking in its initial public offering to as much as $21.8 billion, coming a step closer to breaking a global fundraising record…”

September 15 – Bloomberg (Narayanan Somasundaram and Nichola Saminather): “Sydney mortgage broker Luke Gardiner, who started his business just last year, is already overwhelmed with customers. ‘There has not been a slow period in the last 12 months,’ said the broker, whose Gardiner Financial Services Pty arranged more than A$5 million ($4.5 million) in mortgages in both June and July… ‘I’ve been waiting for a break, but it hasn’t come.’ Driving the growth is demand for high-risk mortgages such as interest-only loans and financing to buy rental properties.”

Geopolitical Watch:

September 19 – Bloomberg (Nicole Gaouette): “The U.S. intelligence community published its blueprint for confronting threats at a time when the number and complexity of challenges have exploded and -- officials say -- its capabilities have eroded. ‘The United States is facing the most diverse set of threats I’ve seen in my 50 years in the intelligence business,’ Director of National Intelligence James Clapper said. The 2014 National Intelligence Survey outlines strategic and emerging threats facing the U.S. and lays out priorities for the intelligence community in the coming four years. This year’s survey examines long-standing challenges posed by China, Russia, North Korea and Iran and newer dynamics, including the rise of non-state actors such as Islamic State, the destabilizing impact of food and water shortages, the disruptive effects of social media and demographic changes. As the rise of China and other nations diffuses global power and transnational criminal groups seek to destabilize governments and economies, the U.S. will have to find new ways to defend itself… ‘There’s never been a time when we’ve faced the number and complexity of security threats,’ John Brennan, director of the Central Intelligence Agency, said…”

September 19 – Bloomberg (Volodymyr Verbyany and Aliaksandr Kudrytski): “Clashes in eastern Ukraine flared, further rattling a cease-fire signed two weeks ago, as government troops fought with pro-Russian separatists and the country’s currency plunged to a record.”

China Bubble Watch:

September 18 – Bloomberg: “China’s new-home prices fell in all but two cities monitored by the government last month… Prices dropped in 68 of the 70 cities in August from July, including in Beijing and Shanghai... Home sales slumped 11% in the first eight months of this year… Prices fell in 19 cities from a year earlier, led by a 5.4% slide in Hangzhou, as compared to three cities in July… New-home sales in the first 14 days of September in the 40 cities tracked by Centaline fell 4.7%, when measured by the combined space of homes sold, from the same period in August, trailing expectations for a traditionally strong month…”

September 17 – Bloomberg: “Property trusts are funneling the least amount of money into Chinese developers in almost five years as maturing debt balloons, escalating default concerns. Issuance of trusts for real-estate projects, which target wealthy individuals, slid to 30 billion yuan ($4.9bn) this quarter from 67.8 billion yuan in the three months to June 30, the least since the start of 2010… Borrowing costs are rising as developers face $9.1 billion in bonds and loans maturing by year-end… Cash from operations are also facing a squeeze as home sales fell 10.9% in the first eight months of the year… Standard & Poor’s sees a risk that a developer may default in the coming 12 months, highlighting weak earnings at Renhe Commercial Holdings Co. and Glorious Property Holdings Ltd. ‘Given the bad housing sales, fewer trust companies are willing to help property companies raise money,’ said Li Ning, a bond analyst in Shanghai at Haitong Securities Co., the nation’s second-biggest brokerage. ‘Default risks are rising rapidly before so much debt is due next quarter.’ Glorious Property’s $300 million of 13 percent notes due October 2015 yield 22.62%... Renhe Commercial, a developer of underground shopping centers, has $300 million of 11.75% bonds due in May, which yield 39.88%... The amount of property developers’ bonds and loans due in 2015, including both dollar-denominated and yuan debt, is $24 billion… The ratio of debt-to-equity on a Bloomberg Industry gauge of 84 Chinese property companies has climbed to 129.9 percent, the highest since at least 2005 and almost double the Bloomberg World Real Estate Index’s 76%.”

September 14 – Bloomberg: “China’s industrial output rose at the weakest pace since the global financial crisis and fixed-asset investment growth trailed projections, adding to evidence the world’s second-biggest economy is losing momentum. Factory production rose 6.9% from a year earlier in August…, compared with 9% in July… Retail sales gained 11.9% and fixed-asset investment in the January-August period increased 16.5%. The data signal the impact of China’s property slump on the economy is deepening, with the decline in home sales accelerating last month and electricity output falling for the first time since 2009.”

September 16 – Bloomberg: “Foreign direct investment into China, a gauge of external confidence, slumped to a four-year low amid antitrust probes into multinational companies that have spurred a letter of complaint from the U.S. Inbound investment was $7.2 billion in August, down 14% from a year earlier…. after a 17% drop in July. It was the first back-to-back decline of more than 10% since 2009…”

September 15 – Bloomberg (Ambereen Choudhury): “Almost half of China’s wealthy are considering relocating to a developed market within the next five years to find better education and job opportunities for their children, according to a report by Barclays Plc… ‘The reality is that most ultra-high net worth individuals in China are probably making money in China right now,’ Liam Bailey, head of residential research at… Knight Frank LLP, said… ‘So, for business reasons, they need to be relatively close. That might prevent some of them going further afield.’”

September 16 – Bloomberg (Katya Kazakina): “A pair of Chinese porcelain vases sold yesterday for $1.2 million at Doyle New York, soaring 120 times past its low estimate. The two 16-inch tall glazed vases, painted with branches of blooming peonies on a turquoise background, each had a Qianlong- era seal on its base, referring to the reign of the Qianlong Emperor from 1736 to 1795. Estimated at $10,000 to $15,000, they were part of Doyle’s ‘Asian Works of Art’ sale in New York.”

Latin America Watch:

September 14 – Bloomberg (Anna Edgerton): “Brazil’s central bank must have autonomy, not independence, President Dilma Rousseff tells reporters at presidential palace in Brasilia. Candidate Marina Silva is proposing central bank independence by law. Central bank without employment as a goal takes food off the table, Rousseff says. Page on Rousseff’s campaign website cites Nobel prize winners Joseph Stiglitz and Paul Krugman on dangers of independent central bank.”

September 13 – Bloomberg (Jonathan Levin): “Brazilian federal prosecutors in Rio de Janeiro state accused former billionaire Eike Batista of financial-market crimes and are seeking to freeze his assets. The charges of insider trading and market manipulation carry jail sentences in Brazil of as much as 13 years… The freeze could affect assets valued at as much as 1.5 billion reais ($641 million)…”

EM Bubble Watch:

September 15 – Bloomberg: “International debt issued by corporates in emerging economies almost tripled to $1.1 trillion in the four years to 2013, according to BIS data. Debt servicing capacity deteriorated over the same period, as evidenced by an increase in debt-to-earnings ratios to about 2.8 from 2.2. Currency depreciation could exacerbate this further. With $130 billion of that debt maturing by 2018, rising interest rates may prove too prohibitive for some corporates to refinance their debt.”

September 17 – Bloomberg (Andras Gergely): “Bondholders are betting that Ukraine’s state-run gas company will pay a $1.6 billion note this month even as Goldman Sachs Group Inc. warns they may face losses of 50% on government debt maturing later. NAK Naftogaz Ukrainy’s securities due Sept. 30 climbed 2.4 cents to the dollar this month to 98.40 cents… The $17 billion International Monetary Fund bailout Ukraine signed in May is boosting optimism the government will have the cash to retire debt of its biggest employer, which posted losses in six of the eight years through 2012.”

September 18 – Bloomberg (Taylan Bilgic): “Turkish President Recep Tayyip Erdogan’s threat to cut ties with rating companies risks harming investor sentiment toward corporate borrowers, which have doubled their foreign debt holdings in the past four years. Erdogan accused two of the raters of trying to ‘bring down Turkey,’ Hurriyet reported. His comments followed Fitch Ratings’ inclusion of Turkey this month on a list of nations most exposed to possible downgrades if higher U.S. interest rates shock markets. The lira is the third-worst performing currency in Europe, the Middle East and Africa this month… Turkish borrowers have become more active on international markets since Fitch and Moody’s Investors Service raised the country to investment grade starting in 2012… Foreign debt holdings of private companies and banks due in one year or less jumped to $110 billion in July from $53 billion in the second quarter of 2010…”

September 17 – Bloomberg (Daria Solovieva and Dana El Baltaji): “A feud between Turkish President Recep Tayyip Erdogan and a U.S.-based Islamic cleric has made sukuk from Asya Katilim Bankasi AS the worst-performing in the world. Debt from the Shariah-compliant lender known as Bank Asya, which was founded by followers of Fethullah Gulen, has lost 29% this year… ‘Only 10 months ago, the leader of the banking sector had a strong record in growth and expansion, but with this political trouble the bank started to suffer,’ Montasser Khelifi, a senior manager… at Quantum Investment Bank Ltd. in Dubai, said… The government must be clear about what the ‘problem’ with Bank Asya is and decide whether it will take over the lender or impose restrictions on it, he said. Erdogan has blamed Gulen and his supporters for a corruption probe that last year implicated some cabinet members, and vowed to crack down on the cleric’s interests in Turkey.”

Japan Bubble Watch:

September 17 – Bloomberg (Grace Huang and Yuji Nakamura): “Sony Corp. Chief Executive Officer Kazuo Hirai is running out of options to turn around Japan’s iconic consumer-electronics maker. The Tokyo-based company said today it would report a wider full-year loss of 230 billion yen ($2.1bn) because it was writing down the value of its faltering smartphone business. Sony also said it won’t pay an annual dividend for the first time since its listing in 1958.”