Sunday, December 14, 2014

Weekly Commentary, November 15, 2013: Hearing Janet Yellen

Senator Robert Menendez: “Some commentators have suggested that in addition to managing inflation and promoting full employment, the Fed should also monitor and attempt to fight asset bubbles. Do you think it is a feasible job and something that the Fed should be doing? And if so, how would you go about it?”

Janet Yellen: “Well, Senator, I think it’s important for the Fed, as hard as it is, to attempt to detect asset bubbles when they are forming. We devote a good deal of time and attention to monitoring asset prices in different sectors, whether it’s house prices or equity prices and farmland prices, to try to see if there is evidence of price misalignments that are developing. By and large, I would say that I don’t see evidence at this point in major sectors of asset price misalignments, at least of the level that would threaten financial stability. But if we were to detect such misalignments or other threats to financial stability, in my view I would like as a first line of defense - we have a variety of supervisory tools, micro- and macro-prudential, that we can use to attempt to limit the behavior that is giving rise to those asset price misalignments. I would not rule out using monetary policy as a tool to address asset price misalignments, but because it’s a blunt tool and because Congress has asked us to use those tools to achieve the goals of maximum employment and price stability - which are very important goals in their own right - I would like to see monetary policy first and foremost directed toward achieving those goals Congress has given us and to use other tools in the first instance to try to address potential financial stability threats. But an environment of low interest rates can induce risky behavior. And I would not rule out monetary policy conceivably having to play a role.”

Senator Richard Shelby: “What have you learned since you were president of the [Federal Reserve Bank of] San Francisco… You were there during the housing bubble and the debacle. As a regulator, I hope that you and others have learned a lot, not just the Federal Reserve, but others, that you can't let a bubble continue, to continue to grow.”

Yellen: “Senator, I think in the aftermath of the crisis, all of us have spent a great deal of time attempting to draw the appropriate lessons. There have been many of them. The Federal Reserve is very focused on broad financial stability, mandates both in terms of our monitoring of the economy, attempting to understand the threats that exist broadly in the financial system and to improve our supervision, especially of the largest institutions, to make sure that we are identifying those threats that can be risks to the economy.”

Senator Sherrod Brown: “Do you agree with what I assume you’re hearing from bankers too and from others… do you agree with chairman Bernanke and Mr. Dudley that a system where ‘too big to fail’ institutions have, in Dudley’s words, an apparent lack of respect for law, regulation and the public trust? Do you agree we haven't solved the problem? And what do you do as Fed chair to address ‘too big to fail’?”

Yellen: “Senator, I would agree that addressing ‘too big to fail’ has to be among the most important goals of the post-crisis period. That must be the goal that we try to achieve. ‘Too big to fail’ is damaging. It creates moral hazard. It corrodes market discipline. It creates a threat to financial stability and it does unfairly, in my view, advantage large banking firms over small ones. My assessment would be that we are making progress, that Dodd-Frank put into place an agenda that, as we complete it, should make a very meaningful difference in terms of ‘too big to fail.’ We’ve raised capital standards. We will raise capital standards further for the largest institutions that pose the greatest risk by proposing so-called SIFI capital surcharges. We have on the drawing boards the possibility of requiring that the largest banking organizations hold additional unsecured debt at the holding company level to make sure that they are capable of resolution.”

Senator Dean Heller: “A quick question about quantitative easing: Do you see it causing an equity bubble in today’s stock market?”

Yellen: “I mean, stock prices have risen pretty robustly. But I think that if you look at traditional valuation measures, the kind of things that we monitor, akin to price-equity ratios, you would not see stock prices in territory that suggests bubble-like conditions. When we look at a measure of what’s called the equity risk premium, which is the differential between the expected return on stocks and safe assets like bonds, that premium is not - is somewhat elevated historically, which again suggests valuations that are not in bubble territory.”

Senator Robert Corker: “We talked a little bit about the Fed in the early summer began to talk about moderating the pace at which it was going to be making purchases. And the market had a pretty stringent reaction. It was like… the Federal Reserve appeared as if it had touched a hot stove and that this policy was going to greatly affect, if you will, the wealth effect that you were trying to create… And so the Fed jumped back. And it seemed to me - and I think you discussed this a little bit in the office - that the Fed had become a prisoner to its own policy. That to really try to step away from QE3 was really going to shatter possibly the markets and therefore take away from the wealth effect. And I wonder if you could talk a little bit about some of the discussions that were taking place during that time.”

Yellen: “Well, Senator, I don’t think that the Fed ever can be or should be a prisoner of the markets…”

Senator Robert Corker: “But to a degree in this case, it did affect the Fed, did it not?”

Yellen: “Well, we do have to take account of what is happening in the markets, what impact market conditions are likely to have on spending and the economic outlook. So it is the case, and we highlighted this in our statement, when we saw a big jump in rates - a jump that was greater than we would have anticipated from the statements that we made in May and June - and particularly saw mortgage interest rates rise in the space of a few months by over a hundred basis points, we had to ask ourselves whether or not that tightening of conditions in a sector where we were seeing a recovery and a recovery that could really - recovery in housing that could drive a broader recovery in the economy - we did have to ask ourselves whether or not that could potentially threaten what we were trying to achieve. But overall, we are not a prisoner of the markets. I continue to feel that we’re seeing an improvement in the labor market, which was the goal of the program. And we will continue to evaluate incoming data and to make decisions on the program in that light going forward.”

Corker: “Thank you. I’d [say] just a little bit of a prisoner, maybe not fully, I understand… My last question is you talked a little bit about monitoring sort of the financial markets and know that it is, again, monetary policy is a blunt instrument. I know that you’ve been credited, with back in 2005, signaling that the housing market was bubbling, if you will, in that part of the country. I guess my question is: do you believe that under your leadership the Fed would have the courage to, when it saw asset bubbles, even though you only have blunt instruments, and I realize that, would it have the courage to actually prick those bubbles and ensure that we didn’t create another crisis?

Yellen: “Senator, no one who lived through that financial crisis would ever want to risk another one that could subject the economy to what we’re painfully going through and recovering from. And we have a variety of different tools that we could use if we saw something like that occur. They include tools of supervision and monetary policy is a possibility.”

Corker: “And you would have the courage to do that?”

Yellen: “I believe that I would, and I believe that this is a most important lesson learned from the financial crisis, Senator.”

The Wall Street Journal went with the headline “Yellen Stands by Fed Strategy.” From Bloomberg: “Yellen Signals She’ll Continue QE Undeterred by Bubble Risk.” New York Times: “Message From Yellen is Full Speed Ahead on the Stimulus.” Forbes: “Janet Yellen: No Equity Bubble, No Real Estate Bubble, And No QE Taper Yet.” My personal favorite came via the Financial Times: “Federal Reserve Continues to Support Market ‘Melt Up.’”

When Dr. Bernanke was designated head of the Federal Reserve back in 2006, I assumed that the Credit Bubble had become so obviously problematic that the powers that be sought the individual with the strongest academic credentials to ready a massive experimental post-Bubble reflation operation. These days, I’ll presuppose they see no alternative than to press forcefully ahead with monetary inflation. Ms. Yellen is the loyal soldier, with a similar academic mindset to Bernanke. Importantly, she’s fully wedded to the QE program and has the best academic credentials to support the guise of a jobless rate target. Like Bernanke, she’s amiable and seemingly earnest. Difficult to see her as a strong leader, at least outside the ardent dovish contingent. They’ll be no tough love for the markets. No new direction for a Fed sprinting blindly ahead in a perilously flawed policy course.

Members of the Senate Banking Committee were ready to raise the key issues of “asset Bubbles” and “too big to fail.” Fitting of her reputation, Dr. Yellen arrived well-prepared. She easily handled issues already vetted in private meetings.

The 2008 fiasco forced the Fed to jettison the Greenspan/Bernanke doctrine that insisted asset Bubbles were only recognizable in hindsight. Yellen: “I think it’s important for the Fed, as hard as it is, to attempt to detect asset bubbles when they are forming. We devote a good deal of time and attention to monitoring asset prices in different sectors, whether it’s house prices or equity prices and farmland prices, to try to see if there is evidence of price misalignments that are developing…”

This is a major modification in Fed “lip service” of no consequence. Any concern the markets had that the Fed might actually contemplate a little tough love for overheated securities markets was put to rest with the rapid about face on taper this past summer. It’s worth noting that the Fed’s balance sheet has expanded $1.0 TN over the past year, or 35.6%. Over this period, the S&P500 has returned 35.8%. The small cap Russell 2000 returned 47.1%; the S&P 400 Mid-Caps 40.7%; and the Nasdaq Composite 42.7%. On the individual stock front, Tesla enjoys a 12-month gain of 344%, Netflix 333%, Micron Technologies 256%, Zillow 248%, 3D Systems 216%, Best Buy 218%, First Solar 173%, Green Mountain Coffee 156%, Deckers 154%, TripAdvisor 131%, GameStop 121%, Facebook 121% and Chipotle 108% (to name a few). Meanwhile, the IPO market is the hottest since 2000. From my vantage point, the breadth of current speculative excess exceeds even 1999.

At $343 billion, global telecom M&A volume has doubled 2012 to the highest level since 2000 (Dealogic). It will be a record year in junk bond and leveraged loan issuance, not to mention a record year in investment grade bond issuance. National home prices are inflating at double-digit rates, while key housing and real estate markets are indicating all the signs of problematic Bubble excess. Meanwhile, “money” flows into global risk markets via huge inflows into mutual funds and hedge funds. If the Fed is serious about efforts to “detect asset bubbles when they are forming,” I’d be curious to know what it might take to garner their interest.

The “too big to fail” issue is a similar red herring. I do concur with Dr. Yellen’s comment: “’…Too big to fail’ has to be among the most important goals of the post-crisis period. That must be the goal that we try to achieve. ‘Too big to fail’ is damaging. It creates moral hazard. It corrodes market discipline. It creates a threat to financial stability…” Yet there’s a major dilemma: Is the Fed supposed to impose regulatory discipline on the big banks while it grows it balance sheet by $1 TN in twelve months? Clearly, I take a much different analytical view of the “too big to fail” issue than our academic Fed. Isn’t the issue really about government involvement and backstops distorting market perceptions and fostering excessive risk-taking?

The root of the problem is that the regulator needs a regulator. Today’s prevailing Bubble excesses are clearly not emanating from excess bank lending or, likely, even egregious proprietary trading. Instead, monetary instability is spurred by the Fed’s endless zero-rate policy and its ongoing $85bn money-printing operation. After the “Greenspan put” and asymmetrical monetary policy (“tighten” gingerly and loosen forcefully to support the markets), the “Bernanke put,” and QE1, QE2, and open-ended QE3, the Fed has at this point zero credibility on the issue of “too big to fail.” After all, fueling asset inflation has been fundamental to the Fed’s monetary experiment. Powerful speculators these days trade/leverage with impunity knowing that the Federal Reserve has indeed become prisoner to a dysfunctional marketplace.

Dr. Yellen asserts that the Fed has learned “appropriate lessons.” They clearly have not. Indeed, the Fed’s role in fomenting highly distorted markets has never been greater. I have argued that critical “too big to fail” market distortions have evolved from the big banks to the entirety of global securities markets. And the Fed is today, along with fellow global central banks, propagating the greatest distortion in the pricing and allocation of finance in history. Regrettably, it has regressed into the “granddaddy of all Bubbles.” And, at this point, it’s delusional to maintain faith in the existence of “a variety of supervisory tools, micro- and macro-prudential, that we can use to attempt to limit the behavior that is giving rise to those asset price misalignments.”

It is paramount for a central bank to recognize Bubble Dynamics early before they foment major financial excess – before they inflict deep impairment upon economic structures – before they gain powerful constituencies (as monetary inflations invariably do). And I strongly believe this key regulatory role became wholly impractical when market-based Credit (as opposed to traditional bank lending) assumed such a prevailing role in Credit systems and economies (at home and then abroad).

Indeed, what commenced during the Greenspan era only accelerated throughout Bernanke’s chairmanship: Progressively, Federal Reserve policymaking directly targeted the securities markets and asset inflation as its prevailing monetary policy transmission mechanism. And here we are today, with top Fed officials having stated that the Fed is prepared to “push back” against a “tightening of financial conditions” with even larger quantities of QE. The harsh reality is that Bubble markets will eventually burst with a problematic tightening of “financial conditions” commensurate with the excesses of the preceding boom. And there is simply no precedent for a global securities Bubble fueled by Trillions of central bank liquidity and bolstered by promises of ongoing liquidity backstops. And the greater the Bubble, the tighter the noose becomes around the necks of the markets’ central banker hostages.

From Dr. Yellen’s prepared remarks to the Senate Banking Committee: “A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

The new chairperson’s hopeful view is detached from reality. In a critical upshot of years of flawed policymaking, central bank liquidity these days greatly prefers Bubble securities markets to real economies. Having now fueled a full-fledged global securities market Bubble, there will be no “returning to a more normal approach to monetary policy.” It’s a myth in the same vein as the Fed’s 2011 “exit strategy.” It’s now a matter of how long until this “how crazy do things get” market phase runs its fateful course.

I sympathize with Dr. Yellen. Her predecessors were never held accountable. Deeply flawed economic doctrine has yet to be called out. History’s greatest monetary experiment has not yet run its course. Inflationism, with the contemporary version cloaked in sophisticated and elegant rationalizations, is widely accepted by policymakers, Wall Street, the media and popular commentators alike. Meanwhile, the great flaw in discretionary monetary policymaking has come to fruition: a major error has ensured a series of ever greater policy blunders and a course toward catastrophic failure. It’s an unbelievable fiasco - and I don’t see how this historic Bubble doesn’t burst on her watch.

For the Week:

The S&P500 gained 1.6% (up 26.1% y-t-d), and the Dow rose 1.3% (up 21.8%). The Utilities increased 0.9% (up 10.6%). The Banks added 0.6% (up 29.3%), and the Broker/Dealers jumped 2.4% (up 57.0%). The Morgan Stanley Cyclicals were up 2.1% (up 35.3%), and the Transports surged 2.8% (up 35.9%). The S&P 400 Midcaps jumped 2.0% (up 28.6%), and the small cap Russell 2000 rose 1.5% (up 31.4%). The Nasdaq100 gained 1.7% (up 28.6%), and the Morgan Stanley High Tech index jumped 2.2% (up 26.4%). The Semiconductors advanced 1.6% (up 32.5%). The Biotechs surged 4.4% (up 43.8%). Although bullion was little changed, the HUI gold index declined 1.1% (down 48.9%).

One-month Treasury bill rates ended the week at 5 bps, and three-month rates closed at 7 bps. Two-year government yields were down 2 bps to 0.29%. Five-year T-note yields ended the week down 7 bps to 1.34%. Ten-year yields fell 5 bps to 2.70%. Long bond yields declined 5 bps to 3.79%. Benchmark Fannie MBS yields sank 10 bps to 3.32%. The spread between benchmark MBS and 10-year Treasury yields narrowed 5 to 62 bps. The implied yield on December 2014 eurodollar futures fell 4 bps to 0.39%. The two-year dollar swap spread was little changed at 11 bps, while the 10-year swap spread dropped 6 to 7 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined one to 70 bps. An index of junk bond risk fell 5 bps to 345 bps. An index of emerging market (EM) debt risk rose 6 bps to 332 bps.

Debt issuance somewhat came off the boil. Investment grade issuers included Bank of New York Mellon $1.2bn, State Street $1.0bn, Williams Partners LP $1.0bn, Goldman Sachs $1.0bn, Air Lease Corp $700 million, Ares Capital $600 million, Black Hills Corp $525 million, Maxim Integrated Products $500 million, Huntington National Bank $500 million, Wisconsin Public Service $450 million, FMC $400 million, GATX $300 million, Corning $250 million, Penta Aircraft Leasing $147 million, and Potomac Electric Power $150 million.

Junk bond fund saw inflows of $219 million (from Lipper). This week's issuers included Stone Energy $750 million, CenturyLink $750 million, Hiland Partners LP $750 million, Empresa de Energia $722 million, Post Holdings $550 million, IAC/InterActiveCorp $500 million, Bonanza Creek Energy $500 million, Level 3 $300 million, Appvion $250 million, Toll Brothers $600 million, Energy Transfer Equity $450 million, and Sophia Holding Finance $400 million.

Convertible debt issuers this week included Sina Corp $800 million, iStar Financial $200 million and Emulex $150 million.

International dollar debt issuers included Thomson Reuters $1.5bn, Volkswagen $1.15bn, Barclays $2.0bn, Skandinaviska Enskilda $1.0bn, Shell International $2.75bn, Valeant Pharmaceuticals $900 million, MDC Partners $660 million, Navios Maritime $650 million, Beverage Packaging Holdings $650 million, Kommunalbanken $500 million, and Santander Brazil $252 million.

Ten-year Portuguese yields slipped 2 bps to 5.87% (down 89bps y-t-d). Italian 10-yr yields fell 5 bps to 4.09% (down 41bps). Spain's 10-year yields were down 5 bps to 4.06% (down 121bps). German bund yields declined 5 bps to 1.71% (up 39bps). French yields fell 5 bps to 2.18% (up 18bps). The French to German 10-year bond spread was unchanged at 47 bps. Greek 10-year note yields rose 23 bps to 8.24% (down 223bps). U.K. 10-year gilt yields were down a basis point to 2.75% (up 93bps).

Japan's Nikkei equities index surged 7.7% (up 45.9% y-t-d). Japanese 10-year "JGB" yields were up 4 bps to 0.63% (down 15bps). The German DAX equities index gained 1.0% to another all-time high (up 20.4%). Spain's IBEX 35 equities index slipped 0.5% (up 18.7%). Italy's FTSE MIB fell 1.5% (up 14.8%). Emerging markets were mostly higher. Brazil's Bovespa index rallied 2.3% (down 12.3%), and Mexico's Bolsa surged 2.9% (down 6.1%). South Korea's Kospi index gained 1.1% (up 0.4%). India’s Sensex equities index fell 1.3% (up 5.0%). China’s Shanghai Exchange rallied 1.4% (down 5.9%).

Freddie Mac 30-year fixed mortgage rates jumped 19 bps to an eight-week high 4.35% (up 105bps y-o-y). Fifteen-year fixed rates were 8 bps higher to 3.35% (up 70bps). One-year ARM rates were unchanged at 2.61% (up 6bps ). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 11 bps to 4.52% (up 152bps).

Federal Reserve Credit jumped $19.2bn to a record $3.822 TN. Over the past year, Fed Credit was up $1.003 TN, or 35.6%.

M2 (narrow) "money" supply dropped $32.4bn to $10.948 TN. "Narrow money" expanded 6.2% ($636bn) over the past year. For the week, Currency decreased $0.9bn. Total Checkable Deposits fell $30.3bn, while Savings Deposits increased $6.2bn. Small Time Deposits declined $2.0bn. Retail Money Funds were down $5.4bn.

Money market fund assets slipped $3.2bn to $2.669 TN. Money Fund assets were up $93bn from a year ago, or 3.6%.

Total Commercial Paper declined $3.4bn to $1.067 TN. CP was up $1.3bn y-t-d, and increased $98bn, or 10.1%, over the past year.

Currency Watch:

November 11 – Bloomberg (Emma Charlton and John Detrixhe): “The global currency wars are heating up again as central banks embark on a new round of easing to combat a slowdown in growth. The European Central Bank cut its key rate last week in a decision some investors say was intended in part to curb the euro after it soared to the strongest since 2011. The same day, Czech policy makers said they were intervening in the currency market for the first time in 11 years to weaken the koruna. New Zealand said it may delay rate increases to temper its dollar, and Australia warned the Aussie is ‘uncomfortably high.’”

The U.S. dollar index declined 0.6% to 80.85 (up 1.4% y-t-d). For the week on the upside, the Mexican peso increased 1.8%, the South African rand 1.7%, the New Zealand dollar 1.0%, the euro 1.0%, the Danish krone 1.0%, the Swiss franc 0.7%, the British pound 0.6%, the Canadian dollar 0.4%, the Norwegian krone 0.4% and the South Korean won 0.1%. For the week on the downside, the Japanese yen declined 1.1%, the Swedish krona 0.6% the Taiwanese dollar 0.4%, and the Australian dollar 0.2%. The Brazilian real and Singapore dollar were little changed.

Commodities Watch:

The CRB index was unchanged this week (down 7.0% y-t-d). The Goldman Sachs Commodities Index rallied 1.1% (down 4.6%). Spot Gold added 0.1% to $1,290 (down 23%). Silver dropped 2.8% to $20.73 (down 31%). December Crude slipped 76 cents to $93.84 (up 2%). December Gasoline jumped 4.1% (down 4%), and December Natural Gas gained 2.8% (up 9%). March Copper fell 2.5% (down 13%). December Wheat declined 0.8% (down 17%), and December Corn lost 1.1% to a new three-year low (down 40%).

U.S. Fixed Income Bubble Watch:

November 15 – Wall Street Journal (Mike Cherney): “Highly rated companies are selling bonds in the U.S. at the fastest pace on record, with total bond sales for 2013 surpassing $1 trillion this week, data provider Dealogic said.. Only two other years, 2009 and 2012, saw bond sales surpass the $1 trillion mark since Dealogic began keeping records in 1995.”

November 12 – Bloomberg (Callie Bost): “A measure of the strength of investor protections in speculative-grade U.S. bond offerings deteriorated in the 12 months ended September, according to Moody’s… Moody’s covenant-quality index, in which 5 indicates the weakest protections and 1 the strongest, rose to 3.64 from 3.41 in the year ended August, analysts Alexander Dill and Kyle Goodwin wrote… The measure for deals in September alone climbed to 4.05, the highest monthly reading in data going back to January 2011. Corporate issuers sold a record $56 billion of dollar-denominated junk bonds in September, a 33% increase from a year earlier…”

November 12 – Bloomberg (Lisa Abramowicz): “In a year of record withdrawals from taxable bond funds, no category has been harder hit than the biggest broad market strategies managed by firms… Investors yanked $61.8 billion from intermediate-maturity debt funds in the first nine months of the year, while pouring $46.2 billion into bonds maturing in less than three years… Buyers are showing a preference for shorter-maturity and high-yield bonds that are less sensitive to rising benchmark borrowing costs as the Federal Reserve weighs curtailing the pace of its unprecedented stimulus that’s bolstered credit markets.”

November 15 – Bloomberg (Michelle Kaske): “Puerto Rico’s general-obligation debt, graded one step above junk level, may be cut by Fitch Ratings if the island commonwealth’s access to credit markets continues to be limited. Fitch will decide by the end of June whether to lower its score on Puerto Rico bonds to non-investment grade, Karen Krop, a New York-based analyst, said…”

Federal Reserve Watch:

November 12 – Wall Street Journal (Andrew Huszar): “I can only say: I’m sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed's first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.”

November 15 – Financial Times (Michael Mackenzie): “A ‘melt up’ sounds like the kind of tasty snack on offer from one of the many Manhattan food trucks parked around office precincts at lunchtime. But it has also become the buzz term for US markets as a big year for equities and risky corporate debt enters its closing stages and late arrivals pour money into asset classes that have prospered… As with dotcoms in 2000 and housing and credit values in 2007, there is a nagging undercurrent that valuations may have reached a moment when things increasingly don’t look right. Then again, there seems to be no end to the soothing mood music played by the Federal Reserve, and a year-end melt up could now help garner more customers… The message of ‘keep calm and carry on’ from Dr Yellen not only helped push equities higher it also bolstered long-term Treasury yields, among this year’s most maligned asset class.”

November 14 – Reuters (Ann Saphir): “There is no evidence that the Federal Reserve’s massive bond-buying effort has led U.S. stock prices higher, according to a report… by the economics research arm of McKinsey & Company. Instead, study co-authors Richard Dobbs and Susan Lund found that the biggest impact of quantitative easing by the world's major central banks has been the cost-savings delivered to governments. Since 2007, bond-buying programs in the United States, the UK and the euro zone have reduced costs for governments by a total of $1.6 trillion. The finding will come as a surprise to many investors who attribute the rise in stock prices in the United States and elsewhere since the 2007-2009 financial crisis at least in part to easy central bank policies. All told, major central banks have added $4.7 trillion to their balance sheets over the past five years… The findings are sure to resonate among central bankers as they debate when and how fast they may be able to scale down the monetary stimulus they have used to keep deflation at bay and try and pull ravaged economies from the depths of recession.”

November 13 – Bloomberg (Caroline Salas Gage, Craig Torres and Kristen Haunss): “Fees for bankers and payouts for leveraged-buyout funds are at risk of being crimped as federal regulators crack down on underwriting standards in the market for high-risk, high-yield loans. The government, in an annual review of bank credit, looked at a $429 billion sample of leveraged loans and found 42% were ‘criticized,’ or classified as having a deficiency that might lead to a loss. Starting in September, it sent letters demanding banks draw up plans to improve the quality of their loans and a warning that regulators will pay close attention to high-risk loan performance in stress tests… The attempt to curb froth in the leveraged-loan market will test whether regulators have the tools to stop asset-price bubbles from emerging more than five years after the financial crisis triggered the worst recession since the Great Depression.”

Central Bank Watch:

November 11 – Reuters (Andy Bruce): “After slashing interest rates to almost nothing and printing trillions of dollars, central banks are becoming increasingly reliant on another policy weapon: sucker punching markets. The European Central Bank shocked investors and forecasters last Thursday by cutting its main refinancing rate to a record low… It was the second big central bank surprise in less than two months, after the U.S. Federal Reserve decided in September not to trim its monthly bond purchase stimulus. And beyond the immediate impact on financial markets, central banks' shock therapy tactics have also had a lasting effect… With scant room left to cut interest rates again and appetite for more rounds of money printing waning, economists say surprising markets will increasingly feature in policymaking. ‘It makes sense that with the artillery becoming depleted, central banks want more bang for their buck now. One way of doing that is to launch surprises in markets,’ said Philip Shaw, chief economist at Investec in London.”

November 13 – Bloomberg (Rich Miller, Simon Kennedy and Michelle Jamrisko): “Central banks are finding it’s easier to push up stock and home prices than it is to prevent inflation from falling short of their targets. While declining costs for everything from gasoline to coffee can be good news for consumers, disinflation makes it harder for borrowers to pay off debts and businesses to boost profits… Federal Reserve Chairman Ben S. Bernanke and his central-bank counterparts are trying to avert the deflationary danger by pumping up their economies with lower interest rates and monetary stimulus. They have bet the run-up in stock and home prices they’ve engineered would boost consumer and corporate confidence and spur faster growth and higher inflation. Now they’re having to maintain or intensify their aid -- running the risk those efforts do more harm than good by boosting equity and property prices to unsustainable levels.”

U.S. Bubble Economy Watch:

November 12 – Bloomberg (Masaki Kondo): “The rich are feeling the benefits of the Federal Reserve’s monetary stimulus more than the poor, as gains in U.S. stocks bolster confidence among the better off. The… gap in sentiment between U.S. households with income of over $50,000 and those earning less than $15,000 widened to the most since February 2007… The Standard & Poor’s 500 Index has more than doubled to a record from a low in March 2009, while the S&P/Case-Shiller gauge of home prices advanced about 17% during the period.”

November 11 – Wall Street Journal (Alexandra Scaggs): “Five years after the financial crisis, individual investors are piling into stocks again amid signs that the U.S. economy is slowly gaining steam. The buyers, many with investment portfolios that were scorched during the market meltdown, are climbing aboard a ride to new highs in the Dow Jones Industrial Average. But the renewed optimism among retail investors is considered by many professionals to be a warning sign, thanks to a long history of Main Street arriving late to market rallies… Now, following a 24% increase this year in broad market indexes, individuals are feeling optimistic in a way they haven't since the roaring bull market of the late 1990s.”

Global Bubble Watch:

November 15 – Financial Times (Vivianne Rodrigues): “Global borrowers with weaker credit quality are taking advantage of investors’ relentless search for higher yields to sell a record amount of bonds so far in 2013. Intelsat… and the luxury chain Neiman Marcus have been among the low-rated borrowers to have sold a combined $38.1bn debt this year, according to Dealogic. That amount surpassed the previous record of $37bn for the whole of 2012. Bonds with the lowest possible credit ratings have soared in popularity with investors, who have been diverted from top tier government and corporate debt where central banks are suppressing interest rates. Heavy buying has pushed down the average yield on triple C rated bonds to 7.75% from 9.80% a year ago… As the Federal Reserve kept in place its policy of buying $85bn of mortgage and Treasury bonds each month, investors have moved out to riskier and higher-yielding parts of the fixed income market.”

November 13 – Financial Times (Sam Jones): “Hedge funds have raised more than $100bn in new capital from investors so far this year in spite of underperforming most equity markets… New data from Eurekahedge… reported total hedge fund industry assets at $1.9tn as of the end of October… The average hedge fund has made 5% on its investments so far this year, according to Eurekahedge, compared with a return of 16% for the MSCI world index and 24% for the S&P 500.”

November 11 – Bloomberg (John Glover): “Sales of convertible bonds in Europe are at a four-year high as companies take advantage of investor demand stoked by a 15.4% stock market surge. Air France-KLM… and the Milan-based cable maker Prysmian SpA are among companies that have sold $25 billion of notes this year that can be swapped for equity… Globally, convertible issuance is the highest in three years. Investors are increasingly gravitating toward riskier assets as central banks, led by the European Central Bank’s surprise interest-rate cut last week, step up efforts to suppress borrowing costs and stimulate growth.”

November 11 – Financial Times (Arash Massoudi): “Wall Street bankers, buoyed by the successful launch of Twitter, are on track to earn bumper fees as US companies look set to raise a record amount in a single year from a tide of initial public offerings. The frenetic pace of activity has strained equity capital markets desks, according to bankers, as the top deal underwriters cut staff after the financial crisis when the IPO market dried up. Despite the strain, banks are on pace to generate their biggest IPO fees in over a decade. Resurgent interest in US stocks has paved the way for 192 companies to raise $51.8bn from new stock offerings, putting the market on track to rival sums raised by US companies at the height of the dotcom bubble in 2000, according to Dealogic… In the coming weeks, those numbers are expected to climb significantly as US markets, already above historic highs, lure a fresh batch of market debutantes.”

November 14 – Bloomberg (Katya Kazakina and Philip Boroff): “Andy Warhol led Sotheby’s biggest auction as the Pop Art icon’s silk-screen painting ‘Silver Car Crash (Double Disaster)’ sold for $105.4 million in New York. Last night’s $380.6 million contemporary-art sale was just short of the high presale estimate of $394.1 million. Auction records were established for seven artists, including Warhol, Cy Twombly, Agnes Martin and Martin Kippenberger… The jump in contemporary-art prices -- 10 artists set records at Christie’s sale Tuesday night -- is driven in part by flush new collectors and museums amassing masterpieces, as well as investors seeking diversification, dealers and longtime collectors said. ‘I am an art collector; this is not about collecting,’ said former talent agent Michael Ovitz as he exited the cavernous saleroom.”

November 13 – Bloomberg (Katya Kazakina and Philip Boroff): “A Francis Bacon triptych became the priciest artwork at auction in the biggest sale ever last night in New York. Bacon’s ‘Three Studies of Lucian Freud’ sold for $142.4 million at Christie’s to Acquavella Galleries. It bested Edvard Munch’s ‘The Scream,’ which Sotheby’s sold in May 2012, by more than $20 million. A few minutes later Jeff Koons’s sculpture ‘Balloon Dog (Orange)’ fetched $58.4 million, an auction record for a living artist. The third-priciest lot was a graphic oversized Coca-Cola bottle by Andy Warhol that went for $57.3 million.”

EM Bubble Watch:

November 13 – Bloomberg (Yalman Onaran): “The world’s largest emerging markets recovered quickly from the 2008 financial crisis because consumers and companies went on a borrowing binge. Now that credit spree is coming back to haunt banks in those countries. As economies cool, delinquent loans are rising from Turkey to South Africa. India is injecting money into state-run lenders facing a surge in soured debt, while Chinese banks have been told to increase provisions for the same reason… While the flight of capital halted after the Fed decided in September to continue its asset purchases, a reversal could threaten economies and banks in developing nations. ‘Credit growth in emerging markets has been phenomenal since 2008 because risk has been underpriced once again, thanks to zero percent interest rates in the developed world,’ said Satyajit Das, author of a half dozen books on financial risk… ‘Many borrowers will struggle to repay the debt, and the money flows out of these markets will make the problems worse. We’re ripe for a new emerging-market crisis.’”

November 11 – Bloomberg (Yudith Ho): “Indonesia’s rupiah and bonds plunged as U.S. jobs data that topped estimates fueled concern the Federal Reserve will bring forward a plan to cut stimulus that’s buoyed emerging markets. The currency slid the most since August while the yield on 10-year government notes had the biggest increase in four months.”

November 12 – Bloomberg (Novrida Manurung): “Indonesia’s central bank unexpectedly raised its benchmark interest rate, stepping up its campaign to contain inflation and shore up the rupiah. Governor Agus Martowardojo and his board increased the reference rate by 25 bps to 7.5% percent… This is the fifth unexpected rate increase since Martowardojo took office in May, as he seeks to bolster the policy credibility of a nation that was among the worst hit in recent months as capital flowed out of emerging markets and the current-account deficit widened to a record.”

China Bubble Watch:

Nov. 14 (Bloomberg) -- Chinese lenders paid the highest rate of interest since June to borrow government funds today, reflecting tighter monetary conditions in the world’s second- largest economy. The People’s Bank of China auctioned 30 billion yuan ($4.9bn) of three-month treasury deposits on behalf of the Ministry of Finance at 6%... Interest-rate swaps and money-market rates also advanced as the central bank refrained from adding funds via reverse-repurchase agreements. ‘People are surprised the PBOC refrained from conducting reverse repos today, and the treasury deposit auction result came higher than expected,’ said Li Liuyang, chief financial market analyst at Bank of Tokyo-Mitsubishi… in Shanghai. ‘All these indicate liquidity is tight.’”

November 11 – Bloomberg: “China’s 10-year bonds fell, pushing the yield to a five-year high, as signs of an economic pickup reduced demand for the relative safety of government debt. Industrial production gained 10.3% in October from a year earlier… ‘Government bonds are suffering from a double whammy of better-than-expected data and expectations of tightening liquidity,’ said Huang Hai, Beijing-based deputy head of the research department at SDIC CGOG Futures…”

November 11 – Bloomberg (Lisa Abramowicz): “China’s broadest measure of new credit trailed estimates in October, suggesting authorities are trying to keep shadow-finance risks in check as leaders map out a blueprint to sustain growth. Aggregate financing was 856.4 billion yuan ($140.6bn)… below all nine projections in a Bloomberg News survey. New local-currency loans of 506.1 billion yuan compared with the 580 billion yuan median estimate of analysts… ‘This confirms our view that monetary policy has tightened and growth will slow going forward,’ said Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong.”

November 14 – Bloomberg (Justina Lee): “Chinese local governments’ $1.6 trillion in bank borrowings are a major obstacle to the freeing up of interest rates in the world’s second-largest economy, according to BNP Paribas SA and Capital Economics Ltd. The financing arms of municipal authorities owed lenders 9.7 trillion yuan ($1.6 trillion), or 14% of all loans, in mid-2013, according to China Banking Regulatory Commission figures. Most have weak credit profiles, Moody’s… said in a Nov. 5 report, noting that only 53% of 388 such companies it surveyed in June had enough cash to cover estimated debt payments and interest this year without refinancing.”

November 11 – Bloomberg: “China’s passenger-vehicle sales last month climbed the most since January… Wholesale deliveries of cars, multipurpose and sport utility vehicles rose 24% to 1.61 million units in October… That compares with the median estimate of 1.5 million units…”

November 12 – Bloomberg (Lisa Abramowicz): “Chinese developers’ sales of dollar bonds more than doubled this year, reflecting confidence the government will tolerate a sustained property boom as home prices climb at the fastest pace since January 2011. The companies sold $17.88 billion of the notes as of Oct. 20, up from about $8 billion for the whole of 2012… The average yield on Chinese issuers’ dollar debt was 4.42% in 2013, less than the 5.51% in the previous five years…”

November 13 – Bloomberg: “Record borrowing costs are prompting China’s biggest lender for low-cost homes to scale back bond sales, hampering a plan to house 260 million migrant workers. China Development Bank Corp. cut an auction of bonds yesterday to 10 billion yuan ($1.6bn) after initially planning to offer 24 billion yuan. The average yield on 10-year debt from the country’s largest policy lender soared to a record 5.56% on Nov. 11… The country’s second-biggest issuer doesn’t take deposits and relies primarily on bond sales to raise funds. ‘CDB’s huge issuance this year is helping push up its yields while the overall demand for bonds is weak,’ said Xu Hanfei, a Shanghai-based bond analyst at Guotai Junan, the nation’s third-biggest brokerage. ‘The expected reduction in bond issuance from now on will definitely result in less support for urbanization and infrastructure projects.’”

Japan Bubble Watch:

November 14 – Bloomberg (Chikako Mogi): “Japanese companies eased off on capital-spending growth in the third quarter and failed to step up exports even with a cheaper yen, contributing to an economic slowdown that puts pressure on Prime Minister Shinzo Abe. Gross domestic product rose at an annualized 1.9%, down from 3.8% the previous quarter, with the gain relying on government spending and an accumulation of inventories… A widening trade gap lopped off 1.8 percentage point from growth. Corporate investment increased 0.7%, down from 4.4%... ‘Warning lights are flashing for Abenomics,’ said Kiichi Murashima, chief economist at Citigroup Inc. in Tokyo. ‘With the absence of further weakening in the yen and a clear global recovery, Japan’s recovery is losing momentum.’”

November 12 - Reuters – “Japan's government is finalizing plans to borrow an additional 3 trillion yen ($30bn) to pay for compensating Fukushima evacuees and cleaning up the area outside the wrecked nuclear plant, said people with knowledge of the situation. The additional borrowing would mark both a recognition of the project's mounting costs and the difficulty of hitting initial targets for reducing radiation levels in the towns and villages hardest hit by the fallout from the worst nuclear accident since Chernobyl. The new government borrowing program would increase the amount earmarked for Fukushima-related expenses to the equivalent of just over $80 billion… That $80 billion excludes the cost of decommissioning Fukushima's six reactors, a process expected to take decades.”

India Watch:

November 14 – Bloomberg (Unni Krishnan): “Indian inflation accelerated more than economists estimated in October, adding pressure on central bank Governor Raghuram Rajan to raise interest rates again. The wholesale-price index advanced 7% from a year earlier, compared with a 6.46% climb in September…”

Europe Watch:

November 11 – Financial Times (Peter Spiegel and Stefan Wagstyl): “Divisions at the heart of the European Central Bank over last week’s rate cut have revived fears in Frankfurt of a German popular backlash against the bank’s policy making, even as the ECB faces decisions critical to the eurozone’s future. People involved in the policy debates said divisions between northern and southern representatives on the ECB board have been mounting since market pressures on the eurozone relaxed, with council members freed up to revert to national interests. Last week, two German members of the ECB’s 23-member governing council led a six-man revolt against Thursday’s move to cut the bank’s benchmark lending rate by 25 bps. The cut was quickly followed by public broadsides from Germany’s influential conservative economist Hans-Werner Sinn and some mainstream financial media. Among those who voted with the two Germans on Thursday were the heads of the Dutch and Austrian central banks. One senior official said at least a quarter of the governing council is splitting from Mario Draghi, ECB president, on many major policy initiatives. Officials said the bank’s leadership was even more concerned that growing anti-ECB sentiment in Germany could hamper Mr Draghi’s ability to move aggressively against signs of deflation and on other issues sensitive to Berlin. These include the future of the EU’s ‘banking union’ and the provision of new cheap long-term loans to struggling eurozone banks. ‘This indeed can be a problem for the coming difficult decisions,’ said one person involved in the discussions. ‘It shows a big problem: that the ECB is heavily losing trust and confidence in the largest country of the euro area, namely Germany.’”

November 8 – Bloomberg (Jim Brunsden and Stefan Riecher): “The European Central Bank set up a clash with German Finance Minister Wolfgang Schaeuble over how much to centralize the handling of failing lenders, a conflict that threatens to delay completing a banking union. In an opinion published on its website today, the ECB called for the planned Single Resolution Mechanism to be based around ‘a strong and independent’ authority with a central fund. That effectively rejects Schaeuble’s proposal to limit the project to a network of national bodies. The ECB also said that the SRM should cover all banks in the euro area and other participating nations… Governments are split over the SRM, part of a euro-area effort to break the financial links between sovereigns and banks, as officials race to meet a self-imposed deadline for agreement by the end of the year.”

November 14 – Bloomberg (Stefan Riecher): “The euro area’s recovery came close to a halt in the third quarter as German growth slowed, France’s economy unexpectedly shrank and Italy extended its record-long recession. Gross domestic product in the 17-nation euro area rose 0.1% in the three months through September, cooling from a 0.3% expansion in the second quarter… Growth in Germany, the region’s largest economy, eased to 0.3% from 0.7%... ‘The bleak GDP estimate shows just how fragile and hesitant the eurozone’s recovery is -- so much so that it’s questionable whether current economic conditions even qualify as a recovery,’ said Nicholas Spiro, managing director of Spiro Sovereign Strategy… ‘While the slowdown extends to Germany, it’s the dire state of the French and Italian economies that looms large.’”

November 15 – Bloomberg (Ian Wishart): “The European Union confronted the euro area’s biggest economies over their spending plans for next year as austerity demands restrain the bloc’s recovery from the longest recession in its history. The EU said that Germany, Europe’s largest economy, has made ‘no progress’ in following recommendations to spur domestic demand, that Spain’s budget risked missing deficit targets and that Italy’s 2014 plan was in danger of breaching debt-reduction rules.”

November 12 – Bloomberg (Sonia Sirletti): “Italy banks’ gross non-performing loans rose 22.8% in Sept. from a year earlier, Bank of Italy says… Loans to private sector fell 3.5% y/y in Sept.: BOI Private sector deposits rose 3.7% y/y in Sept…”

Germany Watch:

November 13 – Bloomberg (Ian Wishart): “European Union regulators began a probe of Germany’s trade surplus, using enhanced powers over how euro nations manage their economies. The decision to step up monitoring of imbalances in the German economy follows criticism that the country’s current- account surplus… is limiting exports from other euro countries by adding to the strength of the single currency. The opening of an in-depth review into the imbalances in Germany’s economy comes after the U.S. Treasury blamed German surpluses for draining European and global growth. The International Monetary Fund also reprimanded Germany for its surpluses… ‘Crucially, a rise in domestic demand in Germany should help to reduce upward pressure on the euro exchange rate, easing access to global markets for exporters in the periphery,’ EU Economic and Monetary Affairs Commissioner Olli Rehn said…”

November 15 – Bloomberg (Rebecca Christie and Rainer Buergin): “Germany argued against a joint backstop for struggling euro-area banks as European finance ministers renewed their debate on how to handle the costs of managing failed lenders. German Finance Minister Wolfgang Schaeuble called on his colleagues to rein in their ambitions for the Single Resolution Mechanism proposed by the European Commission, which includes a common fund filled by levies on the financial industry. While an agreement is unlikely today, it can be achieved by year-end as long as European Union member states don’t insist on a joint fund immediately, he said. ‘It’s not disputed in principle that we need a European fund,’ Schaeuble told reporters… ‘A fund needs a levy’ on banks, ‘but the levy needs a clear legal basis. There are different opinions on that, but if you want a safe legal basis, you’d better take the safe route.’”

November 15 – Bloomberg (Simon Kennedy): “German economists are rebutting accusations from the U.S. Treasury Department and Nobel laureate Paul Krugman that their nation’s current account surplus is too large and poses a threat to global growth. Stung by a month of criticism from across the Atlantic and also within Europe, Andreas Rees of UniCredit Bank AG and Berenberg Bank’s Holger Schmieding both wrote reports in the past week defending Europe’s largest economy from the charge that its surfeit impedes the economic recovery regionally and abroad… Germany’s ‘anemic pace of domestic demand and dependence on exports’ has helped create a ‘deflationary bias for the euro area as well as for the world economy,’ the Treasury, under Secretary Jack Lew, said in an Oct. 31 report. Krugman wrote in a Nov. 1 article that ‘by running inappropriate large surpluses, Germany is hurting growth and employment in the world at large.’ ‘I have two problems with the latest onslaught,’ Rees wrote… ‘First, in my opinion, it is flawed economic thinking. Second, to make things worse, critics obviously do not know the facts.’”

November 12 – Reuters: “Germany should be allowed to hold referendums on major European policy decisions that involve transferring powers to Brussels or committing money at EU level, German coalition negotiators have proposed in what would be a dramatic shift in policy. The proposal was spelled out in a document put together by one of the working groups negotiating policy compromises to enable a coalition government between Chancellor Angela Merkel's conservatives and the center-left Social Democrats (SPD). It has not yet been approved by a larger coalition panel led by Merkel, meaning it may never see the light of day. But it points to unease among some parties, notably Merkel's allies in the Bavarian Christian Social Union (CSU), with the transfer of competencies to the European Union and use of German money to support struggling partners during the euro crisis.”

November 15 – Bloomberg (Dalia Fahmy): “German home prices rose by the most in ten years in the third quarter as more investors and individuals bought apartments amid low interest rates. Prices for houses, apartments and residential buildings climbed 4.9% from a year earlier, according to an index… by the VDP Association of German Pfandbrief Banks. That’s the biggest gain since at least the first quarter of 2003, when VDP began compiling data. The office-price index rose 6.9%...”