Saturday, December 6, 2014

Weekly Commentary, July 19, 2013: Inflationphobia

Chairman Bernanke last week buttressed global markets with his “If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that” comment. In this week’s Congressional testimony, he followed up his market-pleasing ways with a notably dovish spin on the inflation outlook. Bernanke is now signaling that extraordinary monetary stimulus is in the cards until inflation “normalizes” back to the FOMC’s 2% target rate. The markets can also rest assured that he’s prepared to significantly boost the $85bn QE in the event of a downside inflation surprise. From my analytical perspective, there are strong arguments that an inflation rate is an even a poorer data point than unemployment for basing the scope of aggressive experimental monetary stimulus. 

So expect the inflation discussion to become even more topical. Bruce Bartlett is in the middle of a series of “Inflationphobia” articles for the New York Times. He compares classical economists to “generals and admirals… always fighting the last war…” with “strategies that are inherently out of date.” 

“Economists learned from the Great Depression that easy money and fiscal stimulus could stimulate growth. Pre-Depression classical economics had been based on a rigid balanced budget requirement for government and a gold standard that provided no discretion for the monetary authorities. The new economic orthodoxy became associated with the theories of the British economist John Maynard Keynes and came to be called Keynesian economics. Supporters of classical economics were relegated to the sidelines of economic discussion, but they never went away… Fortunately, the Fed was led by Ben Bernanke, whose expertise as an academic economist was the Great Depression. He knew that the Fed’s errors had contributed mightily to the depression’s origins, length and depth, and resolved not to make the same mistakes twice… But the classical economists, whose ranks were much strengthened by the failure of Keynesian economics in the fight against inflation and the apparent triumph of classical policies in the 1980s and 1990s, immediately saw an inevitable replay of the 1970s. They were fighting the last war… While the Fed has generally maintained an easy money policy, inflation has remained dormant… But the constant drumbeat of attacks on the Fed for fostering inflation has constrained its actions, condemning the economy to slower growth and higher unemployment than necessary.”

And from this week’s “Inflationphobia, Part II: Last week, I discussed the phenomenon of inflationphobia – an irrational fear of inflation that is constraining the Federal Reserve and holding back the economy. The roots of inflationphobia go back at least to the Great Depression, when inflationphobes made the same arguments year after year despite continuing deflation – a falling price level. The defining characteristic of the Great Depression was deflation, which began in 1927, two years before the stock market crash… The great economist Irving Fisher thought that the increasing real burden resulting from deflation was the core cause of the Great Depression.”

Irving Fisher was a great economist that was oblivious to the Roaring Twenties Bubble. He famously stated that American stocks were at a “permanently high plateau” days before his wealth was destroyed in the 1929 stock market crash. He went on to write seminal analysis on debt deflation and financial crisis that contemporary economists still use to justify inflationary monetary policy. More appropriately, his work would be used as a warning of the perilous risks associated with Credit booms, speculative Bubbles and Bubble economies.

I have a few issues with the current “inflation” “debate”. As I’ve noted previously, it’s misguided to compare the current backdrop to the Great Depression. If anyone is mistakenly “fighting the last war,” it’s the Bernanke Federal Reserve and inflationism more generally. Second, it is equally misguided to focus the “inflation” discussion simply on an aggregate measure of consumer price inflation. For one, it shouldn’t be ignored that some of contemporary history’s greatest Bubbles were inflated during periods of seemingly benign consumer prices (notably, the Twenties and Japan 1980s).

I had the good fortune of being introduced to the Richebacher Letter in 1990 and had the opportunity to assist the great German economist, Dr. Kurt Richebacher, with his monthly publication for a number of years back in the nineties (and somewhat beyond). He was certainly no “classical” economist. The so-called “Austrians” just have a superior conceptual framework when it comes to analyzing inflation and inflationary processes. 

For me, the primary focus on Credit always resonated. An expansion of debt – “Credit inflation” – will have consequences, although the nature of the inflationary effects can differ greatly depending on the nature of the underlying Credit expansion, the particular prevailing flow of the new purchasing power and, importantly, the structure of the real economy (domestic and global). The increase in purchasing power may or may not increase a general measure of consumer prices. It might be directed to imports and inflate trade and Current Account deficits. It may fuel investment. Or it could flow into housing and securities markets – perhaps inflating asset Bubbles.

Dr. Richebacher persuasively argued that rising consumer price inflation was the least problematic inflationary manifestation, as it could be rectified by determined (Volcker-style) monetary tightening. Presciently, Richebacher viewed asset inflation and Bubbles as the much more dangerous inflationary strain - too easily tolerated, accommodated or even propagated.

It’s no coincidence that periods of low consumer price inflation preceded the Great Depression and the bursting of the Japanese Bubble. I would further note that consumer price inflation was relatively contained prior to the bursting of the tech and mortgage finance Bubbles. But to claim this dynamic was caused by tight monetary policy is flawed thinking. It was just the opposite. 

I would argue that major monetary inflations, along with attendant investment and asset Bubbles, tend to boost the supply of goods and services. Myriad outlets arise that readily absorb inflated spending levels, working to avail the system of a rapid increase in aggregate consumer prices. Booming asset markets become magnets for inflationary monetary flows, while a boom-time surge in more upscale and luxury spending patterns also works to restrain general price inflation. Moreover, a boom in trade and international flows ensures strong capital investment and an increased supply of inexpensive imports (think China, Asia and technology). 

The thrust of the analysis is that low consumer price inflation has been integral to central banks accommodating the most precarious Credit Bubbles. I’ve always been leery of the notion of “inflation targeting,” believing that such an approach risked institutionalizing central bank accommodation of Credit excess and asset inflation. Bernanke’s recent focus on below target inflation and potential market tightening of “financial conditions” has been music to the ears of a speculative marketplace. The markets hear a nervous Fed providing assurances of aggressive intervention in the event of marketplace de-risking/de-leveraging. Especially in a high risk backdrop, such talk can significantly alter market risk perceptions.

I'm not afflicted with Inflationphobia. Instead, I have a rational aversion to Credit and speculative excess. At this point, it should be obvious that a huge issuance of mis-priced debt is problematic. Central banks should avoid accommodating speculative leveraging. The Fed should be very leery of engineering market risk (mis)perceptions. After all, we have witnessed a more than two-decade period of serial global booms and busts. The Fed believes we’re in a post-Bubble environment, although officials have repeatedly stated it’s not possible to recognize the existence a Bubble while it's inflating. Then isn’t it dangerous to embark on an experimental monetary inflation, especially when the Fed is devoid of a framework that would prevent it from again accommodating dangerous financial Bubble excess?

The structure of the consumption and services-based U.S. economy has evolved over the years to easily absorb Credit excess with minimal impact on the consumer price index. After dropping to as low as $25bn during the 2009 recession, the monthly US. Trade deficit recently jumped back up to $45bn. China and Asia can these days produce quantities of Ipads, smartphones and tech products sufficient to absorb enormous amounts of purchasing power (this doesn’t even include downloads!). That a large proportion of the population is stuck with stagnant income also works to keep consumer inflation in check. As always, the late phase of Credit booms sees inequitable wealth redistribution and a small segment of the population enriched by outsized gains. 

There’s another side to the seemingly placid U.S. inflationary backdrop. For the past twenty years, Federal Reserve accommodation has been instrumental in unending booms and busts around the globe. In contrast to the U.S., the structure of the developing economies is generally much more susceptible to destabilizing inflation dynamics. We’re now five years into a historic inflationary cycle in China and throughout many developing economies. The deleterious inflationary consequences have reached the point that a strong case can be made that this spectacular Bubble period has begun to falter.

As I’ve stated repeatedly, I believe the fragile global backdrop at least partially explains the Fed’s determination to stick with aggressive monetary stimulus. Importantly, with much different financial and economic structures, EM officials do not today enjoy the Fed’s luxury of easily sustaining their respective booms. China, Brazil, India and others now face a market-based tightening of financial conditions, while various consequences of a protracted inflationary cycle preclude another round of aggressive stimulus programs. 

The global economy is increasingly vulnerable to the downside of the EM Credit cycle. With abundant liquidity courtesy of Fed and Bank of Japan QE, there still remains ample fuel to worsen the wide divergence building between economic fundamentals and securities prices. All bets are off in the event of market de-risking and de-leveraging. Yet when “risk on” is in play, it becomes a game of betting on which markets provide the strongest magnets for speculative flows (and Fed/BOJ liquidity). Faltering developing markets may be a significant risk to the global economy, yet it also provides a competitive advantage to U.S. and Japanese equities Bubbles. Meanwhile, cracks in the U.S. and global “bond” Bubble – while negative for global growth - also lend short-term support to U.S. stocks in this game of performance-chasing, trend-following and Bubble-inflating speculation. 

Whether the Fed recognizes it or not, it’s now fully immersed in the stock market Bubble blowing business. Things got crazy in 1999 – when investors/speculators disregarded deteriorating industry fundamentals and technology stocks launched into a final moonshot. The Nikkei went crazy in 1989 in the face of troubling Japanese fundamentals. U.S. stocks went nuts in 1929 despite rapidly deteriorating global fundamentals. 

As fundamentals begin to deteriorate, this naturally leads to increased hedging and more bearish bets. Both provide latent market melt-up fuel. Central banks need to be mindful that their interventions will likely spark destabilizing short squeezes, the reversal of hedges and the potential for intense speculation. Instead – and this seems particularly the case during periods of perceived acute market vulnerability – the Fed is keen to spur market rallies and disregard Bubble risks.

The Fed made a grievous mistake when it used a mortgage Credit boom to orchestrate post-tech Bubble reflation. The Fed’s aggressive interventions in 2007 and early-2008 stoked late-cycle market excess (i.e. $145 crude and highly correlated global risk markets) that ensured a worse outcome in late-2008. I believe a bigger mistake was committed when the Fed targeted rising stock, bond and risk asset prices for its epic post-mortgage finance Bubble reflation.

More from Mr. Bartlett’s Inflationphobia II: “In an editorial probably written by Mr. Hazlitt, The Times rejected any resort to inflation no matter how much prices fell. ‘The one thing your inflationist cannot have too much of is inflation,’ the editorial said. ‘Give him one dose and he becomes much more emphatic in his demands for another.’ In other words, it’s always a slippery slope – a little inflation today invariably leads to hyperinflation tomorrow. If economic stagnation and high unemployment result, it’s a small price to pay to avoid something worse, the inflationphobes always assert.”

Henry Hazlitt had a much clearer understanding of inflation than contemporary economists. Throughout history, inflation has repeatedly proved itself a “slippery slope” – so slippery the Fed and most pundits don’t even realize we’ve been sliding. At $2 TN, the Fed had constructed a reasonably well-defined “exit strategy” that it was to implement to normalize its balance sheet. Now, briskly on the way to $4 TN, the Bernanke Fed is adamant in signaling to the markets that it is determined to avoid normalization. In the most gingerly way imaginable, the Fed recently signaled its intention to, in coming months, begin cautiously backing off from $85bn monthly QE. Well, the markets threw a fit and the Fed abruptly back-peddled. 

That’s right: “Give him one dose and he becomes much more emphatic in his demands for another.” And “he” would be stock and bond market Bubbles, the gigantic global speculator community, the maladjusted U.S. economy, the highly distorted global economy and financial “system,” and so on. With massive monetary inflation today having little impact on economic stagnation and high unemployment, resulting market Bubbles and worsening imbalances are a high price to pay.

For the Week:

The S&P500 added 0.7% (up 18.6% y-t-d), and the Dow gained 0.5% (up 18.6%). The Morgan Stanley Consumer index advanced 0.9% (up 24.7%), and the Utilities jumped 1.7% (up 11.9%). The Banks surged 2.4% (up 28.8%), and the Broker/Dealers gained 1.0% (up 42.4%). The Morgan Stanley Cyclicals were 1.6% higher (up 20.8%), and the Transports jumped 2.3% (up 24.1%). The S&P 400 MidCaps rose 1.1% (up 21.0%), and the small cap Russell 2000 gained 1.4% (up 23.7%). The Nasdaq100 declined 1.1% (up 14.4%), and the Morgan Stanley High Tech index fell 1.2% (up 13.3%). The Semiconductors slipped 0.7% (up 26.6%). The InteractiveWeek Internet index added 0.3% (up 23.7%). The Biotechs declined 0.5% (up 40.1%). With bullion up $10, the HUI gold index rallied 6.8% (down 45.9%). 

One-month Treasury bill rates ended the week at one basis point and three-month bill rates closed at two bps. Two-year government yields declined 4 bps to 0.30%. Five-year T-note yields ended the week down 12 bps to 1.30%. Ten-year yields dropped 10 bps to 2.48%. Long bond yields declined 6 bps to 3.56%. Benchmark Fannie MBS yields fell 15 bps to 3.32%. The spread between benchmark MBS and 10-year Treasury yields narrowed 5 to 84 bps. The implied yield on December 2014 eurodollar futures dropped 9 bps to 0.605%. The two-year dollar swap spread declined about a basis point to 17 bps, and the 10-year swap spread declined about 2 to 21 bps. Corporate bond spreads narrowed further. An index of investment grade bond risk declined 5 bps to 73 bps. An index of junk bond risk dropped 24 to a two-month low 351 bps. An index of emerging market debt risk fell 20 to 311 bps.

Debt issuance has bounced back. Investment grade issues included Morgan Stanley $5.15bn, Goldman Sachs $2.5bn, Citigroup $2.5bn, Bank of America $2.0bn, Howard Hughes Medical $1.2bn, Kroger $1.0bn, New York Life $600 million, ERAC USA Finance $500 million, City of Hope $350 million, and Export Lease Eleven $160 million. 

In a reversal of fortunes, junk bond funds enjoyed inflows of $2.67bn (from Lipper). Junk issuers this week included Ally Financial $1.375bn, Harbinger Group $925 million, Smithfield Foods $900 million, Titlemax Finance $525 million, Chemtura $450 million, RKI Exploration $350 million, Chassix $350 million, Mercer International $270 million, Nationstar Mortgage $250 million, Magnachip Semiconductor $350 million and MedImpact $160 million. 

Convertible debt issuers included Forest City Enterprises $250 million, Ares Capital $250 million and Jakks Pacific $100 million.

International dollar debt issuers included KFW $5.0bn, National Australia Bank $2.6bn, Ontario $2.5bn, Royal Bank of Canada $1.75bn, Canadian Imperial Bank $1.5bn, Myriad International $1.0bn, Schaeffler Holding $1.0bn, Bank Nederlandse Gemeenten $1.0bn, Russian Agriculture Bank $800 million, Export Development Canada $500 million, Nova Chemicals $500 million, Japan Tobacco $500 million, International Bank of Reconstruction & Development $500 million and Interamerican Development Bank $250 million.

Ten-year Portuguese yields dropped 59 bps to 6.62% (down 13bps y-t-d). Italian 10-yr yields declined 8 bps to 4.40% (down 10bps). Spain's 10-year yields fell 10 bps to 4.66% (down 61bps). German bund yields declined 4 bps to 1.52% (up 20bps), while French yields were unchanged at 2.18% (up 18bps). The French to German 10-year bond spread widened 4 to 66 bps. Greek 10-year note yields sank 68 bps to 9.78% (69bps). U.K. 10-year gilt yields fell 4 bps to 2.28% (up 46bps).

Japan's Nikkei equities index added 0.6% (up 40.4% y-t-d). Japanese 10-year "JGB" yields ended the week down a basis point to 0.80% (up 2bps). The German DAX equities index gained 1.5% for the week (up 9.5%). Spain's IBEX 35 equities index rallied 1.3% (down 2.8%). Italy's FTSE MIB surged 4.5% (down 0.9%). Emerging markets were mixed. Brazil's Bovespa index jumped 4.1% (down 22.2%), while Mexico's Bolsa declined 1.1% (down 8.7%). South Korea's Kospi index was little changed (down 6.3%). India’s Sensex equities index gained 1.0% (up 3.7%). China’s Shanghai Exchange fell 2.3% (down 12.2%).

Freddie Mac 30-year fixed mortgage rates fell 14 bps to 4.37%, with a 11-week gain of 102 bps (up 84bps y-o-y). Fifteen-year fixed rates were down 12 bps to 3.41% (up 58bps). One-year ARM rates were unchanged again at 2.66% (down 3bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 49 bps to 4.66% (up 45bps).

Federal Reserve Credit jumped $21.3bn to a record $3.478 TN. Fed Credit expanded $692bn during the past 41 weeks. Over the past year, Fed Credit surged $620bn, or 21.7%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $736bn y-o-y, or 7.1%, to a record $11.168 TN. Over two years, reserves were $1.110 TN higher, for 11% growth.

M2 (narrow) "money" supply declined $8.8bn to $10.645 TN. "Narrow money" expanded 6.7% ($668bn) over the past year. For the week, Currency increased $0.5bn. Total Checkable deposits dropped $33.5bn, while Savings Deposits gained $24.5bn. Small Time Deposits slipped $2.8bn. Retail Money Funds increased $2.5bn.

Money market fund assets gained $8.5bn to $2.632 TN. Money Fund assets were up $93bn from a year ago, or 3.7%.

Total Commercial Paper outstanding gained $8.7bn this week to $999bn. CP has declined $66bn y-t-d, while having expanded $17bn, or 1.7%, over the past year. 

Currency and 'Currency War' Watch: 

The U.S. dollar index declined 0.5% to 82.61 (up 3.6% y-t-d). For the week on the upside, the Mexican peso increased 2.3%, the Swedish krona 2.0%, the New Zealand dollar 1.8%, the Norwegian krone 1.6%, the Australian dollar 1.4%, the South African rand 1.1%, the British pound 1.1%, the Brazilian real 0.9%, the euro 0.6%, the Danish krone 0.6%, the Swiss franc 0.6%, the Canadian dollar 0.3%, and the South Korean won 0.2%. For the week on the downside, the Japanese yen declined 1.4%, the Singapore dollar 0.3% and the Taiwanese dollar 0.2%.

Commodities Watch: 

The CRB index increased 1.5% this week (down 1.4% y-t-d). The Goldman Sachs Commodities Index rose 0.9% (up 0.6%). Spot Gold gained 0.8% to $1,296 (down 23%). Silver declined 1.7% to $19.46 (down 36%). September Crude jumped another $2.10 to $108.05 (up 18%). September Gasoline added 0.2% (up 13%), and September Natural Gas gained 4.0% (up 13%). September Copper declined 0.5% (down 14%). September Wheat declined 2.4% (down 17%), and July Corn slipped 0.3%.

U.S. Bubble Economy Watch: 

July 19 – Bloomberg (Steven Church, Dawn McCarty and Margaret Cronin Fisk): “Detroit, the cradle of the automobile assembly line and a symbol of industrial might, filed the biggest U.S. municipal bankruptcy after decades of decline left it too poor to pay billions of dollars owed bondholders, retired cops and current city workers. ‘I know many will see this as a low point in the city’s history,’ Michigan Governor Rick Snyder… said in a letter… authorizing the filing in U.S. Bankruptcy Court in Detroit. ‘Without this decision, the city’s condition would only worsen.’ Michigan’s largest city joins Jefferson County, Alabama, and the California cities of San Bernardino and Stockton in bankruptcy. The filing shattered the presumption of many bondholders that local governments, eager to continue borrowing at reasonable rates, would do whatever it took, including raise taxes, to come up with the money to meet bond obligations. Kevyn Orr, the city’s emergency manager, said the debt is $18 billion.” 

July 16 – Bloomberg (Jeanna Smialek): “Confidence among U.S. homebuilders rose more than forecast in July to the highest level since January 2006 as companies grew more optimistic about sales prospects.”

Federal Reserve Watch:

July 17 – Banking Daily (Claire Compton): “Federal Reserve Chairman Ben Bernanke told members of the House Financial Services Committee July 17 that the U.S. economic recovery so far in 2013 has fallen short of expectations, and warned that downside risks remain from poor fiscal policy or a worsening global recovery. Bernanke… anticipates the Fed will begin tapering asset-purchases by the end of this year, but only if its current economic forecast holds… However, a slower recovery could also extend the current policy or even prompt the FOMC to take stronger actions. ‘If needed, the committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability,’ Bernanke said.”

Central Bank Watch:

July 18 – Bloomberg (Jana Randow): “The European Central Bank altered its collateral rules for refinancing banks and said it’s looking at ways to boost lending to small- and medium-sized companies by changing the eligibility of asset-backed securities. The… ECB will reduce the risk premium, or haircut, applicable to asset-backed securities to 10% from 16%... The central bank will also lower the quality threshold for six ABS classes that are subject to loan-level reporting requirements to two A- ratings from two AAA ratings.”

U.S. Fixed Income Bubble Watch:

July 19 – Bloomberg (Michelle Kaske): “Michigan’s debt is trailing the municipal market by the most in two years and its borrowing costs are rising relative to similarly rated states as Detroit’s bankruptcy filing shakes investor confidence. Bonds of Michigan and its local issuers have lost 3.4% this year, exceeding the 3.1% decline across the $3.7 trillion municipal market… For Michigan, it’s the steepest drop since at least 2005.” 

July 16 – Bloomberg (Meera Louis): “China’s holdings of U.S. Treasuries rose to a record in May even as net selling by private foreign investors in notes and bonds reached an all-time high… China stayed the biggest foreign owner of Treasuries as its holdings increased by $25.2 billion to $1.316 trillion… Japan, the second-largest holder, cut its holdings to $1.11 trillion. The net long-term portfolio investment outflow was $27.2 billion after a revised decline of $21.8 billion the prior month.” 

July 17 – Bloomberg (Lisa Abramowicz): “Firms from KKR & Co. to Goldman Sachs Group Inc. are plowing ahead with plans for closed-end funds that borrow money to amplify wagers on debt securities, even after investors in the newest ones suffer losses from last month’s bond-market rout. At least five new credit-focused, closed-end vehicles are in the works…”

July 18 – Bloomberg (Tim Jones and Amanda J. Crawford): “Mounting pension liabilities have cost Chicago another cut in its credit standing as Moody’s… reduced the general-obligation debt rating for the nation’s third-largest city by three steps to A3, citing a $36 billion retirement-fund deficit and “unrelenting public safety demands” on the budget. Moody’s also placed the city’s $7.7 billion in general- obligation bonds under a negative outlook… The magnitude of the estimated deficit for all plans ranges from $900 billion to more than $4 trillion, depending on the assumptions used.”

Bursting EM Bubble Watch:

July 19 – Reuters (Alonso Soto): “Plans by the world’s leading emerging economies to join forces to battle the latest bout of global financial turbulence could remain on the drawing board once again at the G20 meeting in Moscow this week. An exodus of capital from Brazil, Russia, India, China and South Africa prompted by an expected scale-back in U.S. monetary stimulus has raised fears about the health of their economies, which are already losing some of their luster. The reversal of the ‘monetary tsunami’ - as Brazil called the flood of cheap money from developed nations - prompted the South American nation's president, Dilma Rousseff, to phone her Chinese counterpart in June to discuss ‘coordinated action’ to offset the sharp appreciation of the U.S. dollar. Indeed, there are reasons for the BRICS to worry. Massive capital outflows have weakened most of their currencies, raising inflationary pressures and forcing Brazil and India to tighten liquidity at a time when their economies are underperforming.” 

July 19 – Bloomberg (Gabrielle Coppola): “Corporate bonds sales in Brazil’s local market are on pace for their slowest year since 2010 after a global selloff triggered by the prospect of reduced U.S. stimulus prompted companies to scrap borrowing plans. Debt issuance… totaled 44.4 billion reais ($20bn) in the first half of the year, a 19% drop from the same period a year ago…” 

July 19 – Bloomberg (Shikhar Balwani): “India’s 10-year bonds headed for their biggest weekly drop since March 2009 after the central bank raised two interest rates to steady the nation’s currency. The notes fell today before the Reserve Bank of India’s scheduled sale of 150 billion rupees ($2.5bn) of bonds, with only 121.89 billion rupees underwritten. The RBI yesterday sold 21% of its target in an open-market auction meant to drain cash from the banking system.”

July 19 – Bloomberg (Sungwoo Park): “South Korea’s corporate bond sales this month have plunged to about a tenth of offerings a year ago, as borrowing costs near a 10-month high hamper growth prospects of Asia’s fourth-largest economy. Sales total 322 billion won ($286 million) since June 30 versus 3.01 trillion won a year earlier and 1.25 trillion won last month… Corporate note sales slid to the least since September 2008 last quarter…”

Global Credit Watch: 

July 19 – Financial Times (Christopher Thompson): “Sub-investment grade companies face a record $101bn refinancing wave next year, raising fears of a shake out among debt-burdened companies. The amount of debt owed by companies in Europe, the Middle East and Africa rated as below investment grade, or ‘junk’, that is due in 2014 has risen to $101bn, up from $84bn this year, according to Moody’s… Nearly half of that debt carries a negative outlook compared to 34% a year earlier."

China Bubble Watch: 

July 18 – Bloomberg: “As China’s cash squeeze claims victims across the nation -- from a bailout-seeking shipyard to a solar-panel maker missing a bond payment -- there are places where Chinese money remains cheap and plentiful. Like Nigeria. China Development Bank Corp. and Export-Import Bank of China are lending billions of yuan to some of the world’s riskiest regimes at interest rates hundreds of bps below the cheapest commercial loans available at home. That lending in turn generates overseas contracts to build airports, roads and shopping malls for state-owned Chinese companies that are mired in debt. ‘As opportunities go down and risks go up at home, these policy banks have gained a lot of power and they want to sustain themselves,’ Kevin Gallagher, author of the 2010 book ‘The Dragon in the Room’ about Chinese investment in Latin America, said… ‘The majority of the countries that are getting the finance are countries with bond spreads that are through the roof.’”

July 16 – Bloomberg (Blake Schmidt): “Zhang Defa hurried into an Industrial & Commercial Bank of China Ltd. branch in Shanghai on a sizzling July afternoon breathlessly looking for the manager. The day before, Zhang had received a text message saying the bank was selling a 37-day wealth-management product with a 5% expected annualized return, principal guaranteed. He was too late. The offer, requiring a minimum of 500,000 yuan ($81,000), had sold out in less than three hours… ‘This is crazy, but where else can I put my money without losing sleep these days?’ said Zhang, 61, a retired engineer who has been moving cash out of his savings accounts into such investments for more than a year. ‘The return is fairly decent, and more importantly, I know my money is safe at a government- owned bank. Even if the bank runs out of the money, the government won’t.’ China’s credit crunch in June spurred hundreds of millions of households and companies to divert a record share of their savings into wealth-management products, known as WMPs. The amount of such investments surged eightfold from 2009 to 8.2 trillion yuan as of the end of March… That’s almost the size of the Australian economy. Fitch Ratings put the amount even higher in May, at 13 trillion yuan. The flows are fueled in part by government efforts to curb property speculation and bolster the stock market, which has lost almost 40% of its value since 2010.” 

July 15 – Bloomberg: “China’s economy slowed for a second quarter as growth in factory output and fixed-asset investment weakened, adding to risks that the government will miss its expansion target as Premier Li Keqiang reins in a credit boom. Gross domestic product rose 7.5% in April-to-June from a year earlier… down from 7.7% in the first quarter. June production growth matched the weakest pace since the 2009 global recession.”

July 17 – Bloomberg: “Chinese Finance Minister Lou Jiwei said the nation won’t use ‘large-scale fiscal stimulus’ measures this year, adding to signals that the government will tolerate a slowdown in the economy. China will promote growth and boost employment while fine- tuning policies and keeping the fiscal deficit unchanged, and will also avoid big adjustments to short-term macroeconomic policies, Lou said in July 11 comments…”

July 18 – Bloomberg: “China’s June new home prices rose in all but one city, led by the biggest metropolitan centers and underscoring Premier Li Keqiang’s struggle to rein in speculative investment even as the economy cools. Prices climbed in 69 of the 70 cities the government tracked last month from a year earlier… The southern business city of Guangzhou posted the biggest increase with a 16% advance from a year earlier. Prices climbed 13% in Beijing and 12% in Shanghai. All three cities had their biggest gains since the government changed its methodology for the data in January 2011. ‘With the economy slowing down and other industries weakening, investors don’t have many choices but seek out property investment for good returns,’ Yao Wei, China economist at Societe Generale… said… ‘Many of the government measures have targeted the supply, which actually pushed home prices up further.’” 

July 19 – Bloomberg: “China’s rating firms cut the most bond issuer ranking on record in June and brokerages said they are preparing for the onshore market’s first default as the world’s second-biggest economy slows. A total of 38 issuers were downgraded last month, according to Guotai Junan Securities Co., the most since the nation’s third-biggest brokerage started compiling the data in 2005… ‘The government can’t save everyone,’ said Xu Hanfei, a bond analyst at Guotai Junan in Shanghai. ‘In the future, downgrades may spread to high-grade bonds, especially those which rely heavily on support from the central or local governments.’ …The yield on one-year AA-rate bonds gained 16 basis points this week to 5.12 percent on July 17, according to data compiled by ChinaBond… There have been no defaults in the publicly-traded domestic debt market since the central bank started regulating it in 1997…”

July 16 – Bloomberg: “Posters of the Chinese character for good luck adorn shops bolted shut in the northern city of Ordos, where cranes stand silently above half-finished developments and doors on workers’ dormitories creak in the wind. Apartment sales have come to a virtual halt in the central district, real-estate agent Zhang Wei says. With the municipality’s revenue falling, the Inner Mongolian city that saw a surge in building during China’s record credit boom is now a showcase for the speculative financing Premier Li Keqiang is trying to curb. ‘In the past few years there was a lot of coal so people came from all over the country,’ says Gao Wei… ‘Now the economy has collapsed, they’ve all gone.’ Ordos’s implosion stands at one extreme of a national slowdown that a government report yesterday signaled may deepen this quarter, with industrial output gains last month matching the weakest since the 2009 global recession.” 

July 16 – Bloomberg: “China’s liquidity squeeze affects business owners and their ability to purchase luxury cars, says Mizuho analyst Ole Hui… Dealers are significantly indebted and dependent on short-term financing; liquidity squeeze could cause refinancing problems and high interest expenses, report says. Ongoing large discounts and high gearing are negative risk factors to the auto and dealer sectors: Mizuho report…” 

July 18 – Bloomberg: “The International Monetary Fund said risks are increasing that China’s economic growth this year will fall short of the lender’s forecast as it urged the nation to follow through on policy reforms to sustain expansion. ‘Downside risks’ to the IMF’s 7.75% growth estimate have risen after a gauge of manufacturing weakened in June, the… fund said… in its annual assessment of China’s economy… The world’s second-biggest economy is becoming increasingly vulnerable to risks from an expansion of non-traditional sources of credit and borrowing by local governments, the IMF said.”

July 17 – Bloomberg: “Since the 1980s, China has modernized its hospitals, added a decade to life expectancy, halved infant mortality, and eliminated diseases such as polio. Now it aims to stamp out medical corruption. Efforts to clean up the nation’s $350 billion health-care industry have gained prominence since police said last month they were investigating GlaxoSmithKline Plc for suspected economic crimes. Today, the China Food and Drug Administration said it will ‘severely crack down’ on fake medications, forged documents and bribery. Six years after executing its chief drug regulator for accepting bribes for approving fake medicines, the government is focusing on ensuring an eightfold increase in health spending over the past decade doesn’t also line the pockets of drugmakers, doctors and hospital officials. ‘We know that China’s corruption is so entrenched in the pharmaceutical space that in order to get things done you have to bribe officials; it’s an open secret,’ said Yanzhong Huang, senior fellow for global health at the Council on Foreign Relations… ‘Rampant bribes, commissions and corruption raises drug prices. This makes it difficult for public hospital reform to push forward.’”

Japan Bubble Watch:

July 16 – Bloomberg (Marco Lui and Anna Kitanaka): “Eight months into the biggest equity rally in three decades, Japanese executives are gaining faith in the nation’s recovery as they reward shareholders with stock buybacks and pledge to increase capital spending. Topix companies bought 1.78 trillion yen ($17.8bn) of their own shares in the half ended June 30, the most since 2005…”

July 15 – Bloomberg: “Japan confirmed that Chinese ships passed through a strait just north of its territory for the first time, a possible show of force after Japan expressed concern that China is expanding its reach in the region… The passage through the strait, also called La Perouse, followed Chinese naval drills with Russia and may exacerbate tensions running high over a territorial dispute and China’s growing military power.”

India Watch:

July 16 – Bloomberg (Kartik Goyal and Unni Krishnan): “India stepped up efforts to help the rupee after its plunge to a record low, raising two interest rates in a move that escalates a tightening in liquidity across most of the biggest emerging markets. Bond yields and the rupee surged… ‘The importance of this move is that it signals that the RBI is willing to act and make it much more costly to short the rupee,’ JPMorgan Chase & Co. analysts Jahangir Aziz and Sajjid Chinoy said… ‘These measures are only preconditions to the RBI squeezing rupee liquidity to engineer much higher short-term interest rates.’” 

July 17 – Bloomberg (Jeanette Rodrigues): “India failed to sell treasury bills at a weekly auction after the central bank tightened policy for the first time since 2011, driving up interbank funding costs by the most in more than a year. The Reserve Bank of India, which held the sale, rejected bids worth 293 billion rupees ($4.9bn) received for a combined 120 billion rupees of 91- and 182-day notes offered, it said… The overnight interbank borrowing rate in Mumbai surged 170 bps to 8% today after the RBI increased on July 15 two of its interest rates by 2 percentage points each… to arrest a slide in the rupee. The failure of the bill sale follows an offering of bonds yesterday by state governments, where the borrowers met only 26% of an 86 billion rupee target. With this week’s rate increases, RBI Governor Duvvuri Subbarao joins policy makers from Brazil to China in reining in money-market liquidity to stem currency losses and ensure stability in the financial system. The rupee has lost 8.7% since March 31 in Asia’s worst performance.” 

July 19 – Bloomberg (Andrew MacAskill and Rakteem Katakey): “The volatility in the Indian rupee is the ‘immediate cause of worry’ as the government seeks to revive economic growth from the slowest pace in a decade, Prime Minister Manmohan Singh told businessmen today. Listing the steps his government has already taken to curb the record current-account deficit, he said more measures to lure foreign direct investment are on the anvil and told investors not to be overwhelmed by ‘negative sentiments’ about Asia’s third-largest economy… ‘The most immediate cause of worry is the recent volatility in foreign-exchange markets… I agree that we’ve had one bad year, but I assure you that we will get out of it.’”

July 18 – Bloomberg (Anurag Joshi, Anoop Agrawal and Divya Patil): “Rupee-denominated bond sales were already having their slowest start to a month in almost six years before India wrecked prospects of a revival by unexpectedly raising interest rates. Companies have issued 6 billion rupees ($100 million) of notes so far in July, the least since the same period of August 2007… Five-year interest costs for top-rated borrowers soared 70 bps, the most since October 2008, to 9.48% on July 17 from a three-year low of 8.12% on May 29. Similar-maturity Chinese notes yield 4.76%.”

Latin America Watch: 

July 18 – Bloomberg (Blake Schmidt): “The implosion of Brazilian billionaire Eike Batista’s empire is increasing pressure on the nation’s state development bank to disclose the loans it made to his companies. While BNDES, as the government-owned lender is known, has said it made loans totaling 10.4 billion reais ($4.7bn) to Batista’s companies in response to a request by Bloomberg under Brazil’s freedom of information law, it has declined to say how much is outstanding. Rio de Janeiro-based BNDES has rejected requests by prosecutors and lawmakers to reveal how much debt it is owed by the companies… Yields on BNDES’s bonds due in 2022 have jumped 205 bps…this year. The collapse of Batista’s fortune, down an estimated $31 billion from its peak, is raising concern BNDES may suffer losses, posing a risk to taxpayers, said Aldo Musacchio, professor of business administration at the Harvard Business School.”

Europe Crisis Watch: 

July 16 – Bloomberg (Mathieu Rosemain and Scott Hamilton): “European car sales slumped to a two- decade low, German investor confidence unexpectedly dropped and euro-area exports fell for a second month, adding to signs that the region is struggling to emerge from recession. Auto registrations decreased 6.3% in June… Exports from Germany, Europe’s largest economy, slumped 9% in May to 38.1 billion euros ($50 billion)… French shipments fell 4.6%, while Italian and Spanish exports rose 3.6% and 0.8%... The region’s car sales in the first half fell 6.7% to 6.44 million vehicles.” 

Germany Watch:

July 19 – Bloomberg (Tony Czuczka and Arne Delfs): “German Chancellor Angela Merkel rejected a second Greek debt write-down as officials weigh additional measures to prop up the bailed-out nation. ‘I’ve said repeatedly that I don’t see a debt cut for Greece,’ Merkel told reporter… ‘All this talk about it sometimes worries me... You have to consider the consequences’ of a second write-down, Merkel said. ‘Maybe someone else would like to have a debt cut then. That can lead to such massive insecurity among investors into the euro region that everything we did in the last few years would be called into question. It’s not for nothing that when we did the debt relief, we chose a voluntary agreement with the private creditors. You have to look far beyond Greece to see what this would mean.’” 

Spain Watch: 

July 18 – Bloomberg (Ben Sills): “Spanish Prime Minister Mariano Rajoy faces increased pressure to respond to a corruption investigation into his People’s Party as a judge weighs a request to call him as a witness… Rajoy has denied the allegations from Barcenas that he accepted cash payments before becoming premier. He said he won’t yield to what he called ‘blackmail.’ The scandal has overwhelmed the political agenda as ministers aim to persuade investors the recession is ebbing. The risk premium on Spanish 10-year bonds rose the past two days reaching 322 bps… compared with 271 bps on May 3.”

Italy Watch:

July 19 – Bloomberg (Andrew Frye and Chiara Vasarri): “Italy’s ruling coalition is fraying as Prime Minister Enrico Letta appeases adversaries while alienating long-time allies. The pressure builds today with a no-confidence motion against Interior Minister Angelino Alfano in the Senate and the possible indictment of Silvio Berlusconi, Letta’s coalition partner, on bribery charges in Naples. Lawmaker criticism of both Berlusconi and his ally Alfano has driven a wedge between Letta and some of his oldest supporters. The distinction between partners and rivals is increasingly obscure as tension mounts among the three parties that rallied around Letta three months ago.”

July 17 – Bloomberg (Andrew Frye): “The Bank of Italy said the recession in the euro-area’s third-biggest economy is worse than expected and unemployment, already at a record high, is set to climb next year even after activity starts to improve. Joblessness will probably rise to almost 13% before ‘demonstrating a timid recovery’ in the second half of 2014, the central bank said… Unemployment advanced to 12.2% in May, the highest since the data series began in 1977.”

Weekly Commentary, July 5, 2013: Mis-pricing Risk

U.S. bonds were crushed Friday on the back of stronger-than-expected payroll data. Long-bond yields jumped 21 bps to an almost 23-month high 3.71%. Ten-year yields rose 24 bps to 2.74% - the highest level since August 5, 2011. Benchmark MBS yields surged 30 bps during the session to a 23-month high 3.69%. The spread between 10-year Treasury yields and benchmark MBS widened six on Friday to a one-year high 95 bps. Notably, MBS yields were up 75 bps in 14 sessions and 140 bps since May 1st.

June 29 – Financial Times (Robin Wigglesworth, Michael Mackenzie and Josh Noble): “Central banks sold a record amount of US Treasury debt last week while bond funds suffered the biggest ever investor withdrawals as markets shuddered at the prospect of the US Federal Reserve ending its quantitative easing program. Holdings of US Treasuries held at the Fed on behalf of official foreign institutions dropped a record $32.4bn to $2.93tn, eclipsing the prior mark of $24bn in August 2007. It was the third week of outflows in the past four. Private investors are also dumping fixed income. Bond funds tracked by EPFR Global, a data provider, saw total redemptions of $23.3bn in the week to June 26. US funds were the worst hit, with withdrawals totaling $10.6bn, but emerging market debt funds also saw record redemptions of $5.6bn.”

With unprecedented outflows from the bond complex coupled with notable global central bank selling, the Bubble in U.S. fixed income would appear in serious jeopardy. And while analysts and money managers will continue talk of a “fair value” range for Treasury securities, for the time being flow of funds analysis trumps valuation. Will foreign central banks continue reducing their enormous holdings of U.S. Treasury and Agency securities? How much leverage has accumulated throughout U.S. fixed income – especially in corporates, MBS and municipal debt? How long until some hedge funds are in trouble? Redemptions coming? Derivative problems? Will investors continue their retreat from U.S. fixed income mutual funds and ETFs?

A few data points are in order. Since the end of 2007, Rest of World (ROW from the Fed’s Z.1) Treasury holdings have jumped $3.325 TN, or 140%, to $5.701 TN. Over this period, “Official” central bank Treasury holdings were up $2.233 TN, or 134%, to $4.059 TN. I have previously highlighted the extraordinary expansion of central bank International Reserve Assets (as accumulated by Bloomberg). Since the end of 2007, International Reserves have inflated $5.061 TN, or 84%, to $11.122 TN. The Fed’s $85bn monthly QE suddenly doesn’t seem as powerful.

Ongoing selling by foreign central banks could be driven by two key dynamics. First, one would think (thinly capitalized) central banks would seek to contain losses on their outsized bond holdings. Keep in mind that the higher bond yields jump, the more individual central banks will need to monitor the scope of losses and the degree of capital impairment. Second, “developing” central banks will most likely be forced to sell Treasuries and other bond holdings to fund investor and “hot money” flows exiting their markets and economies.

A prominent bullish view has held that emerging market (EM) central banks built up robust international reserve positions (including large quantities of Treasuries) that would be available to backstop their systems in the event of global market turbulence. Well, a surge of outflows (and currency market intervention) coupled with a spike in yields is now in the process of depleting reserves much more quickly than anyone had anticipated. There is a clear possibility that we’re early in what could be unprecedented flows seeking to exit the faltering EMs. Recalling the 1997 SE Asian experience, it was a case of “those who panicked first panicked best.” The more reserve positions were depleted, the faster “hot money” ran to the rapidly closing exits.

As a rough guide, the pain and dislocation associated with a bursting Bubble are commensurate with the degree of excess during the preceding boom (traditional “Austrian”-type analysis). And I’ll be the first to admit this is not the first occasion I’ve believed the U.S./global bond Bubble was in trouble. Timing a Bubble’s demise is always a challenge (at best) – especially in an environment of epic central bank liquidity support. But this time has a different feel to it.

Importantly, the longer the inevitable day of reckoning is delayed the worse the consequences. Years of aggressive market intervention ensured a most protracted period of unprecedented excess – excesses that encompassed virtually all markets and all risk categories. Perhaps Federal Reserve policymaking ensured that the greatest Bubble excess and market distortions materialized in perceived low-risk (fixed income and equities) strategies.

“The danger of mis-pricing risk is that there is no way out without investors taking losses. And the longer the process continues, the bigger those losses could be. That’s why the Fed should start tapering this summer before financial market distortions become even more damaging.” Martin Feldstein, Wall Street Journal op-ed, July 2, 2013

I appreciate Mr. Feldstein’s focus on “the danger of mis-pricing risk” – I only wish this would have been part of the monetary policy debate starting a few years back (before the damage had been done). I would argue that never has so much mis-priced debt been issued on a global basis. Moreover, never have inflated bond prices – artificially low borrowing costs – had such a profound impact on securities and asset pricing around the world. Never have risk perceptions and market risk premiums in general been so distorted by aggressive central bank market intervention.

The Mis-pricing of Risk implies market re-pricing risk. And the greater the scope of mis-pricing – in the volume of securities issuance, price level distortions and risk misperceptions – the greater the scope of Latent Bubble Market Risks. Mis-pricing also implies wealth redistribution – and this has traditionally been from the less sophisticated to the more sophisticated. Actually, when enormous quantities of non-productive debt are issued at artificially high prices there is initially a perceived increase in wealth (more debt instruments at higher prices). This debt (“bull market”) expansion coupled with perceived wealth creation spurs spending, corporate profits and higher equities and asset prices. But when the Bubble begins to falter – with re-pricing, market losses, risk aversion and tightened financial conditions – the downside of the Credit cycle commences.

I believe we have commenced a “repricing” process that will unfold over weeks, months and years – with vast ramifications and unknown consequences. With this in mind, let’s at least contemplate a few near-term issues.

Various reports claim the strong market reaction to Bernanke’s policy statement caught the Fed by surprise. Despite attempts by various officials to calm the markets, bond yields have just kept rising. As such, it’s now reasonable to suggest the Fed did not anticipate being on the wrong side of a spike in market yields. How much higher do Treasury bond and MBS yields need to rise before the Fed is held to account - and forced to explain - the large losses suffered in its $3.4 TN (and ballooning) portfolio? At this point, the Federal Reserve is akin to a novice trader that keeps adding to a losing position.

Suddenly, with the potential bursting of the global bond Bubble, there’s a litany of important issues that come to the fore. Could mounting losses on its holdings play a role in the Fed’s “tapering” timeline? Keep in mind the market perception that any jump in Treasury yields would likely ensure the Fed’s ongoing QE support. Now much too complacent? What if the markets begin fretting that escalating losses on Fed holdings might become part of the debate – and provoke a less cavalier approach by our central bank – and others - in managing risk? In a way, Fed critics finally have a concrete issue to build their case around.

Market players have surely been stunned by how poorly the bond market has traded – especially with the Fed providing $85bn of monthly support. Assuming the Fed cannot keep purchasing Treasuries and MBS forever, perhaps there is now added impetus for investors, hedge funds, foreign central banks, sovereign wealth funds and others to push liquidations forward. If money managers now realize they are holding higher risk exposures than desired, it might be advantageous to make necessary portfolio adjustments prior to the Fed winding down its QE operations. If foreign central banks have begun a process of reducing bond holdings, does this accelerate hedge fund selling? Are the sophisticated players now anxious to reduce holdings before the next wave of bond fund redemptions and ETF-related selling? How does it work when the “Masters of the Universe” – having accumulated Trillions of assets under management by adeptly playing a most-protracted market Bubble – find themselves on the wrong side of rapidly moving markets?

I am intimately familiar with the bull story for U.S. equities. Corporate profits are strong and stock valuations are attractive. Bond yields are rising because of the underlying strength of the U.S. economy. The “great rotation.” The U.S. economy remains the most vibrant in the world. U.S. equities are the preferred asset class for the current environment.

Well, the U.S. stock market is an integral facet of the greater Credit Bubble. Massive federal deficits, ultra-loose financial conditions and artificially low borrowing costs have been instrumental in inflating profits. Mis-priced debt and meager risk premiums have been instrumental in myriad financial engineering mechanisms that have inflated corporate earnings and stock prices. Abundant cheap finance has fueled a powerful global mergers and acquisition boom. If the bond Bubble is indeed bursting, the markets are only in the earliest phase of re-pricing risks and asset prices.

In recent CBBs I have stated that, at least in terms of systemic stability, it would be preferable for some air to begin coming out of U.S. stock prices. Fine, but this would be rather UnBubble-like. With fixed income in some serious trouble, the equity market game becomes all the more critical for all the players. And perhaps this is an important “Mis-pricing Risk” associated with the Fed’s ongoing QE: investors that have been hit with unexpected bond losses now increase their bets on inflated stock prices. After leading unsuspecting savers into the wild world of mis-priced fixed income instruments, the Fed will apparently ensure the public becomes overly exposed to unappreciated risks in the U.S. equity market.

As noted in my “Issues 2013” CBB from early January: A market Bubble implies bipolar outcome possibilities. Either the entrenched Bubble bursts or it becomes an issue of “how crazy do things get?” If the U.S. stock market has evolved into the speculative Bubble of choice, there are a couple things the Fed might want to contemplate. First, QE may now work to spur similar late-cycle speculative excesses that are now coming home to roost throughout the fixed income universe. Second, inflating stock prices may work to pull additional liquidity away from an already liquidity-challenged bond market. It is, after all, the nature of liquidity to seek the inflating asset market.

For the Week:

The S&P500 jumped 1.6% (up 14.4% y-t-d), and the Dow rose 1.5% (up 15.5%). The Morgan Stanley Consumer index gained 1.4% (up 19.1%), while the Utilities dropped 1.9% (up 5.3%). The Banks surged 4.1% (up 24.7%), and the Broker/Dealers jumped 4.2% (up 38.6%). The Morgan Stanley Cyclicals were up 1.9% (up 14.9%), and the Transports gained 1.9% (up 18.5%). The broader market was notably strong. The S&P 400 MidCaps jumped 2.2% (up 16.2%), and the small cap Russell 2000 surged 2.9% (up 18.4%). The Nasdaq100 rose 1.8% (up 11.4%), and the Morgan Stanley High Tech index increased 1.6% (up 10.4%). The Semiconductors gained 1.6% (up 24.0%). The InteractiveWeek Internet index rose 1.7% (up 17.3%). The Biotechs surged 4.1% (up 31.7%). Although bullion was down only $11, the HUI gold index fell another 5.3% (down 51.4%).

One-month Treasury bill rates ended the week at three bps and three-month bill rates closed at four bps. Two-year government yields increased four bps to 0.40%. Five-year T-note yields ended the week up 22 bps to 1.61%. Ten-year yields surged 25 bps to 2.74%. Long bond yields jumped 21 bps to 3.71%. Benchmark Fannie MBS yields surged 37 bps to a 23-month high 3.69%. The spread between benchmark MBS and 10-year Treasury yields widened 12 to a one-year high 95 bps. The implied yield on December 2014 eurodollar futures jumped 11.5 bps to 0.79%. The two-year dollar swap spread jumped 3 to 19 bps, and the 10-year swap spread gained 6 to 26 bps. Corporate bond spreads mostly narrowed. An index of investment grade bond risk was little changed at 87 bps. An index of junk bond risk declined 3 to 432 bps. An index of emerging market debt risk declined 20 to 321 bps.

Debt issuance slowed to a crawl. I saw no investment grade issues.

Outflows from junk bond funds and ETFs jumped to $4.63bn (from Lipper). I saw no junk issues this week.

Convertible debt issuers included Healthways $125 million.

International dollar debt issuers included Israel Electric $1.4bn, KFW $1.0bn, Nigeria $1.0bn, Mona Lisa RE $150 million and Tradewynd RE $125 million.

Italian 10-yr yields fell 12 bps to 4.42% (down 8bps y-t-d). Spain's 10-year yields dropped 11 bps to 4.64% (down 63bps). German bund yields slipped a basis point to 1.72% (up 40bps), and French yields declined 5 bps to 2.29% (up 29bps). The French to German 10-year bond spread narrowed four bps to 57 bps. Ten-year Portuguese yields traded above 8% before ending the week 59 bps higher at 6.91% (up 16bps). Greek 10-year note yields jumped 32 bps to 10.94% (up 47bps). U.K. 10-year gilt yields rose 4 bps to 2.48% (up 66bps).

Japan's Nikkei equities index surged another 4.6% (up 37.7% y-t-d). Japanese 10-year "JGB" yields ended the week up a basis point to 0.85% (up 7bps). The German DAX equities index fell 1.9% for the week (up 2.5%). Spain's IBEX 35 equities index rallied 1.4% (down 3.7%). Italy's FTSE MIB was up 1.9% (down 4.6%). Emerging markets were mixed. Brazil's Bovespa index dropped another 4.7% (down 25.8%), while Mexico's Bolsa was unchanged (down 7.1%). South Korea's Kospi index dropped 1.6% (down 8.2%). India’s Sensex equities index added 0.5% (up 0.4%). China’s Shanghai Exchange rallied 1.4% (down 11.5%).

Freddie Mac 30-year fixed mortgage rates fell 17 bps to 4.29%, with an nine-week gain of 94 bps (up 67bps y-o-y). Fifteen-year fixed rates were down 11 bps to 3.39% (up 50bps). One-year ARM rates were unchanged at 2.66% (down 2bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 2 bps to 4.68% (up 42bps).

Federal Reserve Credit increased $2.0bn to a record $3.445 TN. Fed Credit expanded $659bn during the past 39 weeks. Over the past year, Fed Credit surged $599bn, or 21.1%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $653bn y-o-y, or 6.2%, to $11.122 TN. Over two years, reserves were $1.244 TN higher, for 13% growth.

M2 (narrow) "money" supply fell $22.1bn to $10.572 TN. "Narrow money" expanded 6.3% ($624bn) over the past year. For the week, Currency increased $3.7bn. Total Checkable deposits gained $11.4bn, while Savings Deposits dropped $38bn. Small Time Deposits slipped $3.1bn. Retail Money Funds gained $3.9bn.

Money market fund assets added $1.7bn to $2.596 TN. Money Fund assets were up $63bn from a year ago, or 2.5%.

Total Commercial Paper outstanding declined $4.1bn this week to $1.036 TN. CP has declined $30bn y-t-d, while having expanded $63bn, or 6.5%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index jumped 1.6% to a three-year high 84.45 (up 5.9% y-t-d). For the week on the downside, the South African rand declined 3.2%, the Norwegian krone 2.9%, the British pound 2.1%, the Japanese yen 2.0%, the Swiss franc 2.0%, the Swedish krona 1.5%, the Danish krone 1.4%, the euro 1.4%, the Mexican peso 1.1%, the Singapore dollar 1.1%, the Brazilian real 0.9%, the Australian dollar 0.8%, the Canadian dollar 0.6%, the New Zealand dollar 0.4% and the Taiwanese dollar 0.2%.

Commodities Watch:

July 5 – Bloomberg (Mark Shenk): “West Texas Intermediate crude rose to a 14-month high after the U.S. reported adding more jobs than forecast in June, boosting economic optimism, and on concern that unrest in Egypt will escalate. Futures capped the biggest weekly gain in more than two years…”

The CRB index rallied 1.9% this week (down 4.8% y-t-d). The Goldman Sachs Commodities Index jumped 3.7% (down 1.9%). Spot Gold declined 0.9% to $1,223 (down 27%). Silver dropped 3.8% to $18.74 (down 38%). September Crude surged $6.66 to $103.22. (up 12%). September Gasoline jumped 6.7% (up 5%), and September Natural Gas rallied 1.5% (up 8%). September Copper was little changed (down 16%). July Wheat increased 1.2% (down 16%), and July Corn gained 0.8% (down 2%).

U.S. Bubble Economy Watch:

July 5 – Bloomberg (Michelle Kaske): “The steepest losses in almost three years for U.S. municipal debt may wind up helping bondholders. Issuers jolted by rising yields are scaling back sales to the slowest pace since 2011, helping limit declines in the $3.7 trillion market. From California to New York, localities may postpone or reduce borrowings in the second half of 2013 after benchmark 10-year yields reached 2.96% in June, the highest level since April 2011…”

July 2 – Bloomberg (David M. Levitt): “Manhattan office rents rose to the highest in more than four years, helped by small firms signing pricier leases, Cushman & Wakefield Inc. reported. Asking rents averaged $61.81 a square foot at the end of June, up 5% from a year earlier… There have been 36 deals for more than $100 a square foot this year, compared with 35 for all of 2012. Smaller financial companies and foreign banks were behind the surge, said Melissa Bazar, an executive director at Cushman. ‘The boutique guys are making money again. There’s more confidence with the financial boutique firms,’ she said…”

Central Bank Watch:

July 5 – New York Times (Jack Ewing and Julia Werdigier): “Answering critics who said they were running out of ways to promote growth and lending, the European Central Bank and the Bank of England on Thursday did something neither had done before, committing themselves to keeping interest rates low indefinitely. The bid to reassure investors brought the two central banks into closer alignment with the Federal Reserve, which, under Chairman Ben S. Bernanke, has adopted a policy of becoming more open about its intentions… Mario Draghi, the president of the European Central Bank, said… that crucial interest rates would ‘remain at present or lower levels for an extended period of time.’ Until Thursday, the central bank had steadfastly refused to pin itself down on future policy… Only hours earlier, Mark J. Carney, who became governor of the Bank of England on Monday, made a similar break with tradition. The British central bank said… that any expectations that interest rates would rise soon from their current record low level were misguided.”

U.S. Fixed Income Bubble Watch:

June 29 – Financial Times (Robin Wigglesworth, Michael Mackenzie and Josh Noble): “Central banks sold a record amount of US Treasury debt last week while bond funds suffered the biggest ever investor withdrawals… Holdings of US Treasuries held at the Fed on behalf of official foreign institutions dropped a record $32.4bn to $2.93tn, eclipsing the prior mark of $24bn in August 2007. It was the third week of outflows in the past four. Private investors are also dumping fixed income. Bond funds tracked by EPFR Global… saw total redemptions of $23.3bn in the week to June 26. US funds were the worst hit, with withdrawals totalling $10.6bn, but emerging market debt funds also saw record redemptions of $5.6bn.”

July 4 – Bloomberg (Margaret Collins and Charles Stein): “Investors have pulled about $60 billion from U.S. bond funds since Federal Reserve Chairman Ben S. Bernanke rattled markets by outlining his plan to end the central bank’s unprecedented asset purchases… Bond funds had $28.1 billion in net redemptions in the week ended June 26, the… Investment Company Institute said… Retail investors, who fled volatile stock markets to pour about $1 trillion into the perceived safety of bond funds since the beginning of 2009, reversed that pattern in the past month… Casey, Quirk & Associates LLC, a consulting firm, in May warned that money managers that rely on bonds could face a difficult future as investors shift $1 trillion away from traditional fixed-income strategies.”

July 3 – Bloomberg (Margaret Collins): “Fixed-income mutual funds in the U.S. had their biggest weekly redemptions in more than six years as investors fled bonds… Bond funds had $28.1 billion in net redemptions in the period ended June 26, the… Investment Company Institute said… That’s the biggest withdrawal since the trade group started tracking weekly numbers in January of 2007. Taxable bond funds had redemptions of $20.4 billion and municipal bond funds saw $7.68 billion pulled… Money flowing into equity funds slowed, as the category attracted an estimated $169 million for the week, compared with $1.98 billion in the prior period, according to the ICI.”

July 5 – Reuters: “Investors in funds based in the United States pulled a record amount of cash out of high-yield junk bond funds in the latest week…, data from Thomson Reuters' Lipper service showed… Mutual funds and exchange-traded funds that hold riskier high-yield bonds had $4.63 billion in outflows in the week ended June 5, the most since records began in 1992. All taxable bond funds, meanwhile, had outflows of $9.1 billion, the most since October 2008.”

July 3 – Financial Times (Vivianne Rodrigues): “The second half of the year has started with a whimper for the US corporate debt market as a sell-off in bond prices and record outflows from funds investing in fixed-income assets have spooked borrowers. In contrast to the typically vibrant activity in the first few days of a new quarter, issuance of dollar-denominated bonds has dried up. No corporate debt was offered on Monday and no deal was scheduled for Tuesday… In comparison, the first two trading days of the past quarter saw sales of new high-grade and high-yield bonds in the US reaching $8bn. Companies were choosing to postpone sales until markets stabilised, analysts said, rather than see their newly-issued debt sharply decline in secondary markets.”

July 2 – Bloomberg (Sridhar Natarajan): “Junk-rated companies agreed to boost interest rates on more U.S. loans than any time since at least 2011, as lenders extracted more compensation with prices of the floating-rate debt tumbling from a six-year high. Drug distributor Valeant Pharmaceuticals… to …Water Pik Inc. were among companies that sweetened terms on $17.7 billion of loans in June, accounting for 43% of total deals, according to Standard & Poor’s… That’s 10 times greater than in May and the highest in data going back to January 2011. Twenty issuers failed to get loan financing, versus 22 for the first five months of the year, as the average price of the senior-ranking debt fell by the most since May 2012.”

July 5 – Bloomberg (Jody Shenn and Dan Kruger): “Real estate investment trusts that buy mortgage debt slumped after a better-than-forecast employment report stoked speculation the Federal Reserve will begin to reduce the size of its asset purchases. A Bloomberg index of shares in the REITs tumbled 3.9%..., the largest drop since October 2011.”

Bursting EM Bubble Watch:

July 2 – Wall Street Journal (Alex Frangos and Patrick McGroarty): “Countries from Turkey to Brazil to China are getting hit by a brutal combination of events, as economies slow, investors pull out cash, commodity prices tumble and protesters take to the streets… An outflow of funds from so-called emerging markets has picked up pace over the past month, triggered by expectations among some investors that the days of easy money globally are coming to an end… It is a stark turnaround for these countries, whose growth helped offset weakness in the U.S. and Europe during the financial crisis. Seeking better returns, investors poured money into emerging-market economies in the past four years. Private capital flows into emerging markets from 2009 to 2012 were $4.2 trillion, according to the Institute of International Finance… While the amount of money leaving these markets hasn't reached levels seen during the 2008 crisis, the outflows are expected to continue as sentiment sours further."

July 2 – Bloomberg (Fion Li): “The cost of borrowing in Hong Kong’s Dim Sum bond market jumped the most on record in June, climbing to an all-time high as China’s worst cash squeeze in at least a decade spurred concern an economic slowdown will worsen. The average yield on the securities surged 153 bps, or 1.53 percentage points, to 5.06%, the most since… Index was introduced at the start of 2011… ‘The outbreak of one of the worst liquidity crunches in China’s interbank market has spilled over to offshore,’ said Becky Liu, a Hong Kong-based rates strategist at Standard Chartered Plc, the second-largest Dim Sum bond underwriter. ‘A sharp rise in the cost of funding on the back of tight liquidity has pushed up bond yields.’”

July 2 – Bloomberg (Boris Korby and Julia Leite): “The longest overseas drought for bond sales in three years is causing a backlog among Brazilian companies trying to obtain financing at a time when borrowing costs have soared to a four-year high. While no company has priced bonds abroad since May 15, Banco BTG Pactual SA, the biggest underwriter this year of Brazilian corporate debt by number of mandates, said it has as many as four first-time issuers that want to sell notes… The biggest emerging debt market has been shuttered as yields on debt from companies based in Latin America’s largest country surged to 7.11% last week, the highest since July 2009…”

Global Bubble Watch:

July 5 – Bloomberg (Kelly Bit and Saijel Kishan): “Hedge funds posted their biggest monthly loss in more than a year after signs that the U.S. Federal Reserve may scale back its unprecedented stimulus triggered a selloff across global markets. Hedge funds lost 1.4% in June, the most since May 2012, paring the gain in the first six months of 2013 to 1.4%... Hedge funds that use computer models to decide when to buy and sell securities slumped 6.3% last month, extending losses for the year to 7.1%, and emerging-market stock funds declined 6.6%, leaving them down 9.7% in 2013.”

July 1 – Bloomberg (Victoria Stilwell): “Investors are finding no shelter from the worst corporate-bond losses in almost five years as debt plunges for the most creditworthy to the riskiest borrowers in every industry worldwide. Company debentures erased 2.2% the last three months, the worst quarterly decline since a 5.2% plunge in the period ended September 2008… All 16 industries in the index lost during the period, from a 0.7% decline for the debt of automakers to a 3.5% drop in energy-company bonds… ‘There has been no safe haven,’ said Jeroen van den Broek, head of credit strategy for ING Bank… ‘We’re seeing a complete focus on rates and everything surrounding Bernanke.’”

July 3 – Bloomberg (Alex Morales): “The planet has warmed faster since the turn of the century than ever recorded, almost doubling the pace of sea-level increase and causing a 20-fold jump in heat- related deaths, the United Nations said. The decade through 2010 was the warmest for both hemispheres and for land and sea, the UN’s World Meteorological Organization said… Almost 94% of countries logged their warmest 10 years on record, it said. ‘The decadal rate of increase between 1991-2000 and 2001-2010 was unprecedented,’ WMO Secretary-General Michel Jarraud said… ‘Rising concentrations of heat- trapping greenhouse gases are changing our climate, with far- reaching implications for our environment and our oceans.’”

Global Credit Watch:

July 3 – Bloomberg (Laura Marcinek and Donal Griffin): “Barclays Plc, Deutsche Bank AG and Credit Suisse Group AG had their credit ratings lowered by Standard & Poor’s as new rules and ‘uncertain market conditions’ threaten their business… The four European lenders are among the most exposed to proposed rules that could reduce revenue from trading and investment banking operations, the ratings firm said. ‘We consider that these banks’ debtholders face heightened credit risk owing to the industry’s tighter regulation, fragile global markets, stagnant European economies and rising litigation risk stemming from the financial crisis,’ S&P said. ‘A large number of global regulatory initiatives are increasingly demanding for capital market operations.’”

July 2 – Bloomberg: “Chinese banks’ valuations are close to their lowest on record as the nation’s interbank funding crisis exacerbated investors’ concern that earnings growth will stall and defaults may surge as the economy slows. Industrial & Commercial Bank of China Ltd., the world’s largest lender by market value, ended Hong Kong trading last week at 5.3 times estimated earnings… Investors’ disenchantment with Chinese banks reflects concern that a crackdown on shadow banking and measures to direct new credit away from repaying old loans and toward boosting economic productivity will undermine earnings and trigger a surge of bad loans… ‘The golden era of banking is over,’ said Mike Werner, an analyst at Sanford C. Bernstein… ‘Investors have to recognize that more market discipline is going to be imposed upon the banks.’”

China Bubble Watch:

July 2 – Wall Street Journal (Lingling Wei and Bob Davis): “A rare peek into the actions of China's leaders in a month when a Chinese cash crunch spooked global investors shows a leadership falling short in its struggle to redirect China's economy and also faltering in its efforts to communicate its intentions to markets. The People's Bank of China instigated the cash shortages that catapulted Chinese interest rates to nosebleed highs during the past two weeks because the central bank felt it had no alternative amid what it saw as out-of-control credit growth, according to an internal document… Since 2009, Chinese domestic debt has been growing so rapidly it approximates credit bubbles in the U.S., Europe, Japan and Korea that precipitated recessions. In the spring of 2013, the central bank and banking regulators tightened regulations but to little avail. For the first five months of 2013, domestic credit, called total social financing in China, rose 52% from 2012. According to a… summary of a PBOC internal meeting on June 19, the central bank was especially concerned that in the first 10 days of June, Chinese banks increased lending by 1 trillion yuan ($163bn)—an amount the central bank said ‘had never been seen in history.’ About 70% of that amount consisted of short-term notes that mostly don't show up on banks' balance sheets—making it easier for the banks to get around regulatory lending restrictions-—rather than lending the money to promising companies or projects.”

July 5 – Reuters: “A senior Chinese official said on Friday that the government did not know precisely know how much debt local governments had built up and warned that it could be more than previous estimates. Estimates of local government debt range from Standard Chartered’s 15% of the country’s GDP at end-2012 to Credit Suisse's 36%. Fitch put the figure at 25% when it downgraded China's sovereign debt rating in April. Vice Finance Minister Zhu Guangyao said China had not released official figures since a 2010 auditing report that put local government debt at 10.7 trillion yuan. ‘Currently, [according to] nationwide surveys, I think this number will rise,’ Zhu said, defending the debt as mostly geared toward fuelling infrastructure projects. ‘A very important task for this administration is to clearly determine the level of local financing platforms,’ Zhu told reporters…”

July 5 – Bloomberg: “A Chinese vice finance minister warned the nation must be on ‘high alert’ to the dangers of rising debt in companies set up by local governments to fund investment projects. ‘Prominent risks are not only in the shadow-banking area but also in local government financing vehicles, and we do need to be on high alert,’ Zhu Guangyao said… At the same time, companies are mainly investing in infrastructure projects with relatively good operations and repayment abilities, he said.”

July 1 – Bloomberg (Kristine Aquino and Rachel Evans): “China’s top-rated dollar-denominated bonds are losing more than any other BRIC nation as a record cash crunch threatens to slow economic growth and strain corporate finances. Chinese notes, the only gainers in March as debt from Brazil, Russia and India slumped, lost 6.1% last quarter, the most in Bank of America Merrill Lynch indexes going back to 1999… Company debt tumbled as overnight borrowing rates jumped to the highest level since at least 2003… The surge fueled concerns about nonpayment as People’s Bank of China Governor Zhou Xiaochuan seeks to rein in risky lending while reviving the world’s second-largest economy. The premium investors demand to hold Chinese dollar debt surged to a 10-month high of 225 bps on June 26…”

July 1 – Bloomberg: “China’s new home prices jumped in June by the most since they reversed declines in December, defying the government’s tightened property curbs as increased sales supported developers’ efforts to avoid price cuts. Prices surged 7.4% last month from a year earlier to 10,258 yuan ($1,671) per square meter (10.76 square feet), SouFun Holdings Ltd., the nation’s biggest real estate website owner, said… The Chinese government is facing a dilemma to cool the property market while sustaining growth in the world’s second- largest economy…”

July 3 – Bloomberg: “Zhou Xiaochuan earned distinction as the G-20’s longest-serving central bank chief helping keep China out of a financial crisis the past decade. In the wake of June’s record liquidity squeeze, his legacy hangs in the balance. Zhou and his colleagues at the People’s Bank of China left investors, bankers and market participants in the dark for four days after the overnight lending rate between banks hit a record 11.7% June 20 before releasing a week-old statement… The communications gap fanned speculation over the central bank’s intentions, denting confidence in an institution that steered China through the Asian and global financial crises. Zhou’s challenge now, three months into an unprecedented third term as governor, is to implement the curbing of speculative credit that Premier Li Keqiang’s government wants, without further market disruptions that sow confusion. ‘Zhou’s reputation is still intact at the moment but it may suffer because of this if nothing fundamentally changes,’ said Fraser Howie… co-author of ‘Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.’ ‘They must now follow through and dramatically reduce the dependence on credit.’”

July 4 – Bloomberg: “China’s crackdown on shadow banking is backfiring as a plunge in stocks prompts individual investors to pump increasing amounts of cash into wealth management products that offer yields more than double the deposit rate. A record 1,137 of the investment plans were sold by about 70 banks in the last two weeks, almost 50% more than the similar period ended June 14, according to Benefit Wealth… China Minsheng Banking Corp., the nation’s first privately owned lender, last week sold a 35-day product with an annualized yield of 7%.”

July 2 – Bloomberg: “Chinese landlords are forgoing rent and paying to outfit stores for mass-market fashion brands including Zara and H&M, a bid to blunt the impact of a boom in shopping-mall construction that threatens to push up vacancies… Chinese developers built more malls and expanded into smaller cities as consumer spending and incomes grew, elevating China’s economy to the largest in the world after the U.S. Half of the 32 million square meters (344 million square feet) of shopping centers under construction around the world are in China, according to CBRE Group Inc. About 21 million square meters of retail space is expected to be completed by next year, a 38% increase in supply, according to…Cushman…”

July 5 – Bloomberg: “China suspended the release of industry-specific data from a monthly survey of manufacturing purchasing managers, with an official saying there’s limited time to analyze the large volume of responses… The disappearance of data on industries including steel adds to issues hampering analysis of the world’s second-biggest economy, after fake invoices inflated trade numbers this year.”

July 5 – Bloomberg (Stephanie Tong and Jasmine Wang): “China Rongsheng Heavy Industries Group Holdings Ltd., the nation’s biggest shipyard outside state control, sought government financial support as orders plunged, sending its shares to a record low.”

Japan Bubble Watch:

July 5 – Bloomberg (Candice Zachariahs ang): “Record sales of foreign bonds by Japanese investors are signaling a bottom for the yen to traders who are trimming bets on further declines in the year’s worst- performing major currency. Investors in the Asian nation offloaded 10.6 trillion yen ($106bn) of foreign debt in the first half of 2013, the most since at least 2001… Futures traders reduced bets on a yen drop versus the dollar to the least in four months last week and options protecting against gains in the Japanese currency are trading at a premium.”

July 5 – Bloomberg (Janet Ong): “The Bank of Japan is worried it still may not be strong enough to withstand sudden shocks from overseas, the Wall Street Journal reported, citing unidentified people familiar with the BOJ’s thinking. Concern over whether China can achieve a soft landing likely put it near the top of the agenda of next week’s BOJ policy- board meeting, the people said…”

Asian Bubble Watch:

July 5 – Bloomberg (Simon Kennedy): “China, Hong Kong and India are in a ‘high-risk danger zone’ because their monetary policies have stayed too loose over the past four years, according to Nomura Holdings Inc. A June 28 report by the bank’s economists and strategists showed the average ratio of domestic private debt to gross domestic product across Asia had ballooned to 167% in 2012 and most of the region’s property markets are ‘frothy.’ The debt ratio has increased by over 50 percentage points in Hong Kong and Singapore and between 30 and 40 points in Malaysia, South Korea, China and Thailand.”

Latin America Watch:

July 5 – Bloomberg (Rodrigo Orihuela and Francisco Marcelino): "Brazilian billionaire Eike Batista cut output and jobs at one of his iron-ore mines to contain spending in the latest move to save his commodities empire.”

Europe Crisis Watch:

July 4 – Financial Times (Peter Wise in Lisbon and Joshua Chaffin): “A deepening political crisis in Portugal and Greece’s inability to push ahead with public sector job cuts sent bond yields rocketing, reigniting concerns about the breakdown of eurozone bailout programs after months of relative calm in the bloc. The turbulence reverberated in the rest of the eurozone periphery. While Italy’s bond market was relatively calm, Spain’s 10-year bond yield rose 14 bps to 4.74%, and Greece’s comparable bond yield jumped 34 bps to 11.1%. Investors were also unnerved by another brewing showdown between Greece and its creditors after international lenders warned it that they would withhold an €8.1bn loan payment unless the government redoubled stalled efforts to gut a bloated public sector workforce.”

July 3 – Financial Times (Gene Frieda): “The newly agreed bank recovery and resolution directive swings Europe from one extreme – a system laden with implicit government guarantees that protected bank creditors from bearing losses – to the other. The regime creates a serious time inconsistency problem by requiring private bank creditors to cover any significant losses without first cleaning up legacy debt problems. Without comprehensive efforts to restructure corporate debt, clean up banks’ balance sheets and fortify the European Stability Mechanism, bail-in will leave Europe much more prone to old-fashioned bank runs than in the past.”

Portugal Watch:

July 3 – Bloomberg (David Goodman and Neal Armstrong): “Portugal’s bonds slumped, pushing 10- year yields above 8% for the first time since November, on concern the resignation of two ministers will derail the government’s attempts to implement austerity measures. Spanish and Italian securities fell for a second day after Portuguese Prime Minister Pedro Passos Coelho told voters from Lisbon last night he’s trying to hold his government together.”

Germany Watch:

July 5 – Bloomberg (Stefan Riecher): “German factory orders unexpectedly declined for a second month in May, signaling an uncertain recovery in Europe’s largest economy… Orders… dropped 1.3% from April, when they fell a revised 2.2%... Economists forecast a gain of 1.2%... Orders slid 2% from a year ago…"

Spain Watch:

July 3 – Financial Times (Tobias Buck): “Madrid’s search for a buyer for two of the banks it nationalized last year received a setback after Moody’s downgraded Catalunya Banc and NCG Banco – as well as Bankia – amid warnings that their credit profiles remained ‘very vulnerable’. Bankia, the biggest by far of the lenders that remain in the hands of the Spanish state, had its debt and deposit rating lowered by two notches to B1… All three lenders have a negative outlook, Moody’s said… The rating agency said: ‘Asset quality of all three banks remains weak both in absolute and in relative terms . . . Further credit deterioration is likely.’ It also warned that the lenders would struggle to restore profitability: ‘The banks’ ongoing balance-sheet deleveraging, low interest rates and sizable non-earning assets have significantly diminished their capacity to generate recurring earnings.”