Friday, December 2, 2016

Weekly Commentary: Trump, Bonds, Peripheries, China and Italy

The trading week saw WTI crude surge 12.2%. The GSCI commodities index jumped 5.8%. Wheat dropped 3.6% and corn fell 3.1%. Italian 10-year yields fell 18 bps, and Greek yields dropped 37 bps. Meanwhile, Portuguese yields jumped 13 bps. In U.S. equities, Bank stocks (BKX) jumped 1.5%, while the Morgan Stanley High Tech index dropped 3.4%. The Biotechs (BTK) sank 6.4%. The DJIA was little changed, while the small caps fell 2.4%. Just another week for unstable global markets.

Pre-election trepidation morphed into post-election market exuberance, in only the latest demonstration of the power of an over-liquefied market backdrop. Here in the U.S., the bullish imagination has been captivated by the Trump administration’s pro-growth agenda, with its focus on tax and health-care reform, deregulation and infrastructure spending. The DJIA this week added slightly to record highs.

Meanwhile, a decidedly less halcyon reality seems to be coming into somewhat clearer focus: Trump’s victory likely marks a major inflection point for global markets. Bond yields have shot higher, while inflation expectations are being reset. The U.S. dollar has surged, while the emerging markets have come under pressure. From U.S. equity and bond ETFs to international financial flows, “money” is sloshing about chaotically.

There’s an extraordinary amount of confusion throughout the markets. For over a year I’ve posited that the global Bubble has been pierced. This view was in response to faltering EM, mounting Chinese instability, the collapse in crude and energy-related debt problems (from U.S. junk to global corporates and sovereigns). Especially in response to early-2016 global market instability, the Fed froze its baby-step “tightening” cycle, while the Bank of Japan and European Central Bank (and others) ratcheted up what were already desperate QE measures. In China, officials threw up their hands and set the Credit floodgates wide open.

It’s worth noting that the S&P500 rallied 22% from February 2016 lows. U.S. bank stocks (BKX) have surged a stunning 60%. From January lows to November highs, Brazilian stocks jumped 75%. Emerging Market equities (EEM) rallied almost 40%. Chinese stocks recovered 25%. Basically, EM stocks, bonds and currencies rallied sharply from Asia to Eastern Europe to Latin America.

Waning badly early in the year, confidence in central banking was rejuvenated by an audacious display of concerted “whatever it takes.” I believe history will view ECB and BOJ QE moves as dangerously misguided, while the Fed (again) failed to heed the lessons of leaving policy way too loose for too long. Forces that central bankers set in motion early in the year may have largely run their course.

These days it’s important to appreciate that the primary effects of monetary stimulus can change profoundly depending on prevailing market dynamics. Recall that the first (2009) QE basically accommodated speculative de-leveraging and the transfer of securities from troubled holders onto the Federal Reserve’s balance sheet. General inflationary impacts – within the securities markets as well as throughout the real economy – were muted. QE2 (late-2010 into 2011) stoked the powerful inflationary (“bullish”) bias that had evolved in bond prices and throughout the emerging markets. Concerted “whatever it takes” “QE3 and beyond” that unfolded in the second-half of 2012 threw fuel both on Bubbling global securities markets as well as China’s “Terminal Phase” of excess. The upshot has been only greater over-investment, over-capacity, asset inflation, inequitable wealth distribution and social tension. In many real economies around the world (notably Japan, Europe and the U.S.), consumer price inflation trended even lower.

Importantly, the predominant consequence from the 2016 QE bonanza was to spur global bond Bubbles to precarious speculative “melt-up” dynamics. Yields around the world collapsed indiscriminately to record lows. Japanese 10-year yields sank to negative 30 bps. German bund yields dropped to negative 19 bps and Swiss yields to negative 63 bps. Having issued bonds going back to 1693, UK Gilt yields dropped to a record low 52 bps. Few, however, benefited more than Europe’s troubled periphery. In one of history’s more spectacular asset mispricings, Italian bond yields sank to an incredible 1.05% and Spanish yields fell to 88 bps. In the U.S., Treasury yields dropped to 1.36%. Brazil (dollar) yields sank to about 4%, with Mexican (dollar) yields below 3%.

There’s a major problem associated with destabilizing speculative “blow-offs:” They notoriously conclude with sharp reversals, catching everyone by surprise and unearthing all kinds of excesses and associated maladjustment. Coming in conjunction with mounting global anti-establishment fervor, political instability and President-elect Donald Trump, the current bond market reversal ensures uncertainty even more acute than normal: A historic bond market Bubble meets historic social, political and geopolitical uncertainty – not to mention uncharted territory with respect to global monetary policy and economic structure.

Trump policies notwithstanding, global economic prospects remain murky at best. Record stock prices more reflect expectations of winning the money game than an indication of a brightening future. And with air now being released from the Bubble, the best days for bond prices have passed. Especially in the era of king dollar, “money” is now fully expected to deluge the world’s premier asset class - U.S. equities.

Let’s ponder for a moment The Other Side of the Story. Surging global bond yields will entail enormous amounts of speculative de-leveraging. This has yet to become a major issue for the markets only because of the ongoing $2.0 TN of global QE. Yet in this post-Bond Bubble and Trump to the White House backdrop, QE is rather suddenly no longer the bond market’s best friend. QE instead only exacerbates flows into stocks and king dollar – and perhaps even real economies where a shift in inflation trends is already indicated.

So, it’s this confluence of surging bond yields, de-leveraging, unwieldy flows and the potential for inflationary pressures to take root that is now rocking Peripheries around the globe. Importantly, policy confusion and uncertainty are poised to become a pressing market issue. With central bank liquidity inflating Bubbles and exacerbating instability more generally (rather than propping up bond prices), will this speed up rate “normalization” in the U.S. and QE “tapering” especially from the ECB and BOJ? Inquiring markets will want to know.

U.S. Treasury yields closed the week up another eight bps to a 16-month high 2.39%, after trading up to 2.49% on Thursday. Higher global yields again weighed on EM. This week’s trading action saw the Argentine peso drop 2.4% and the Brazilian real and Turkish lira fall 1.8%. All three of these Periphery economies have serious issues that will be aggravated by a tightening of global finance. Stocks were down 2.0% in Brazil, 2.5% in Argentina and 1.8% in Mexico this week. More noteworthy, EM yields made another leg higher. Local yields jumped 36 bps in Brazil, 27 bps in Turkey, 19 bps in Argentina, 15 bps in South Africa, 32 bps in Poland, 19 bps in Hungary, 11 bps in South Korea and 14 bps in China.

Pursuing the theme of tightening global liquidity and associated effects on EM, (King of EM) China instability appears poised to reemerge as a market concern. A few headlines from the week: “China Limits Gold Imports and Renminbi Outflows” (FT); “Beijing Plan to Curb Outflows Fuels Fears Over Foreign Deals” (FT); “China Capital Curbs Sow Doubt Over Renminbi Ambitions” (FT); “Bank of China Sharply Limits Forex Sales to Companies in Shanghai” (Reuters); “PBOC Headache Worsens as New $50,000 Conversion Quota Looms” (Bloomberg); “Foreign Companies Face New Clampdown for Getting Money out of China” (WSJ); “China has Quietly Hiked Borrowing Costs Through PBOC Operations” (Bloomberg).

December 1 – Wall Street Journal (James T. Areddy and Lingling Wei): “Multinational companies are suddenly finding themselves in the crosshairs as China dials back its effort to turn the yuan into a global currency, alarmed that it has accelerated the flight of capital from its shores. In recent days, according to bankers and officials familiar with the situation, China’s foreign-exchange regulator has instructed banks to sharply limit how much companies move out of the country and into their other operations around the world. Until this week, it was possible for big companies to ‘sweep’ $50 million worth of yuan or dollars in or out of China with minimal documentation. Now, these people say, the cap is the equivalent of $5 million, a pittance for the largest corporations. Beijing is fighting an increasingly vicious cycle of capital outflows that weaken the yuan.”

December 2 – Reuters (Samuel Shen and Engen Tham): “Bank of China, one of the country's ‘Big Four’ state banks, has begun to sharply limit corporate customers' ability to purchase foreign currency in Shanghai, in what sources said on Friday was a bid to help stem capital outflows and ease depreciation pressure on the yuan. Under the unwritten new policy, described by two sources familiar with the details, bankers at China's fourth-biggest lender began this week to discourage companies wishing to change yuan into dollars. Those firms which insisted on doing so were told they would be restricted to exchanging a maximum of $1 million… The policy comes as China's government adopts increasingly aggressive measures to control movements of yuan out of the country and snuff out expectations that the currency would continue to spiral lower.”

November 30 – Bloomberg: “China added new restrictions on pulling yuan out of the country as authorities seek to prevent a flood of capital outflows from destabilizing the financial system. Officials won’t approve requests to bring the yuan overseas for the purpose of converting into foreign currencies unless applicants provide a valid business reason… The monetary authority has noticed funds are increasingly leaving the country as yuan payments… The equivalent of $275 billion exited the country via yuan payments this year through October, versus a $101.5 billion inflow in the same period of 2015…”

Keep in mind that Chinese international reserves ended October at a more than five-year low $3.12 TN, this after peaking in June, 2014 at $3.99 TN. Policymakers are surely responding to what must be a surge of outbound flows. So-called “disorderly capital flight” is invariably a risk to an EM economy combating a faltering Bubble with loose finance and monetary inflation. Unprecedented annual Credit expansion of about $3.0 TN has thus far stabilized China’s faltering Bubble. But the issue then becomes an unstable currency as copious amounts of liquidity seek an exit. I would expect this week’s measures meant to slow outflows will heighten anxiety to get “money” out of China before more draconian controls are deemed necessary. King dollar and Trump uncertainty seriously complicate China’s financial and economic dilemmas.

And speaking of serious dilemmas, let’s not forget Europe. Italy’s political referendum will take place Sunday. Prime Minister Matteo Renzi has threatened to resign if voters don’t approve his plan for political reform. Between political opposition and a spirited anti-establishment movement, the vote is not projected to go Renzi’s way. But after sailing through Brexit and Trump’s win, there’s not a great deal of trepidation heading into Sunday. It is true that Italy is well-accustomed to political instability. Perhaps it’s complacency’s turn to be surprised.

The Italian banking system is a mess, and prospects for the Italian economy remain poor. Years of QE have done little to promote reform but a lot to inflate a Bubble in Italian debt (much of it held by Italian banks). It might be at least a year until Italian voters have the opportunity for voicing opinions on remaining in the euro. Yet in this unfolding uncertain global liquidity backdrop, it would not be surprising if the markets again begin pondering the long-term viability of the euro monetary experiment. The Germans and Italians sharing a currency forever? The Trump win has both emboldened Italy’s powerful anti-establishment movements and heightened Italy’s vulnerability to a deteriorating global financial backdrop.

Global financial conditions have begun to tighten – ominously, even in the face of $2.0 TN of ongoing global QE. While pretty clear in the near-term, intermediate and long-term QE prospects are really fuzzy. Heightened uncertainty now has “money” on the move, with associated instability an immediate issue for the fragile Periphery. Europe remains a global weak link, with their banking system at the heart of the continent’s fragility. Italian banks are the European banking system’s weak link. In this context, Italy’s Sunday referendum should not be taken lightly. In the event of a no vote and Renzi resignation, will political uncertainty (and capital flight) push Italy’s fragile banks over the edge? Recall 2012: Fears surrounding Italian banks and Italy’s long-term commitment to the euro over time escalated into fear of euro disintegration.

For the Week:

The S&P500 declined 1.0% (up 7.2% y-t-d), while the Dow added 0.1% (up 10%). The Utilities declined 1.0% (up 7.8%). The Banks gained another 1.5% (up 20.7%), and the Broker/Dealers added 0.2% (up 14.6%). The Transports were little changed (up 20.5%). The S&P 400 Midcaps fell back 1.0% (up 16.2%), and the small cap Russell 2000 dropped 2.4% (up 15.7%). The Nasdaq100 fell 2.7% (up 3.2%), and the Morgan Stanley High Tech index sank 3.4% (up 9.3%). The Semiconductors dropped 4.7% (up 27.9%). The Biotechs were clobbered 6.4% (down 17.4%). Although bullion was down $6, the HUI gold index rallied 4.3% (up 65%).

Three-month Treasury bill rates ended the week at 46 bps. Two-year government yields slipped two bps to 1.10% (up 5bps y-t-d). Five-year T-note yields declined two bps to 1.82% (up 7bps). Ten-year Treasury yields added two bps to 2.38% (up 13bps). Long bond yields rose six bps to 3.06% (up 4bps).

Greek 10-year yields fell 37 bps to 6.44% (down 88bps y-t-d). Ten-year Portuguese yields jumped 13 bps to 3.70% (up 118bps). Italian 10-year yields fell 18 bps to 1.90% (up 31bps). Spain's 10-year yields slipped three bps to 1.54% (down 23bps). German bund yields gained four bps to 0.28% (down 34bps). French yields fell five bps to 0.72% (down 27bps). The French to German 10-year bond spread narrowed nine to 44 bps. U.K. 10-year gilt yields slipped three bps to 1.38% (down 58bps). U.K.'s FTSE equities index dropped 1.6% (up 7.8%).

Japan's Nikkei 225 equities index added 0.2% (down 3.2% y-t-d). Japanese 10-year "JGB" yields increased a basis point to 0.04% (down 22bps y-t-d). The German DAX equities index dropped 1.7% (down 2.1%). Spain's IBEX 35 equities index declined 0.8% (down 9.8%). Italy's FTSE MIB index rallied 3.5% (down 20.2%). EM equities were mostly lower. Brazil's Bovespa index fell 2.0% (up 39%). Mexico's Bolsa lost 1.8% (up 3.7%). South Korea's Kospi slipped 0.2% (up 0.5%). India’s Sensex equities index dipped 0.3% (up 0.4%). China’s Shanghai Exchange declined 0.6% (down 8.3%). Turkey's Borsa Istanbul National 100 index fell 1.3% (up 2.3%). Russia's MICEX equities index gained 1.5% (up 21%).

Junk bond mutual funds saw inflows of $342 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained five bps to a 16-month high 4.08% (up 15bps y-o-y). Fifteen-year rates rose nine bps to 3.34% (up 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.09% (up 20bps).

Federal Reserve Credit last week declined $11.2bn to $4.411 TN. Over the past year, Fed Credit contracted $29.2bn (down 0.7%). Fed Credit inflated $1.600 TN, or 57%, over the past 212 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $6.4bn last week to $3.127 TN. "Custody holdings" were down $198bn y-o-y, or 6.0%.

M2 (narrow) "money" supply last week jumped $46.5bn to a record $13.262 TN. "Narrow money" expanded $990bn, or 8.1%, over the past year. For the week, Currency increased $2.6bn. Total Checkable Deposits gained $19.0bn, and Savings Deposits rose $19.7bn. Small Time Deposits were little changed. Retail Money Funds expanded $6.0bn.

Total money market fund assets increased $13.9bn to a 13-week high $2.719 TN. Money Funds declined $22.3bn y-o-y (0.8%).

Total Commercial Paper added $1.8bn to $924bn. CP declined $119bn y-o-y, or 11.4%.

Currency Watch:

The U.S. dollar index declined 0.7% to 100.77 (up 2.1% y-t-d). For the week on the upside, the South African rand increased 2.2%, the British pound 2.0%, the Norwegian krone 1.9%, the Canadian dollar 1.7%, the New Zealand dollar 1.4%, the euro 0.7%, the Danish krone 0.7%, the Singapore dollar 0.6%, the South Korean won 0.4%, the Swedish krona 0.4%, the Swiss franc 0.3%, the Australian dollar 0.2% and the Mexican peso 0.1%. For the week on the downside, the Japanese yen declined 0.3% and the Brazilian real fell 1.8%. The Chinese yuan rallied 0.6% versus the dollar (down 5.6%).

Commodities Watch:

November 30 – Reuters (Rania El Gamal, Alex Lawler and Ahmad Ghaddar): “OPEC has agreed its first oil output cuts since 2008 after Saudi Arabia accepted ‘a big hit’ on its production and dropped its demand on arch-rival Iran to slash output, pushing up crude prices by around 10%. Fast-growing producer Iraq also agreed to curtail its booming output, while non-OPEC Russia will join output cuts for the first time in 15 years to help the Organization of the Petroleum Exporting Countries prop up oil prices. ‘OPEC has proved to the skeptics that it is not dead. The move will speed up market rebalancing and erosion of the global oil glut,’ said OPEC watcher Amrita Sen from consultancy Energy Aspects.”

November 27 – Bloomberg (Narae Kim): “In China, money flow is tightly controlled and capital markets are relatively underdeveloped, meaning the economy works like squeezing a balloon. You press it in one place, and it bulges in another. Policy-maker moves to cool one expansion only serve to inflate another. Now that ‘gyration of bubbles,’ according to Société Générale SA’s chief China economist Wei Yao, has been heating up the commodities market again. Earlier this month, thermal and coking coal futures hit a record high since their debut in 2013 while zinc soared to the highest since 2011. Steel rebar, nickel, tin, iron ore and rubber futures also climbed to multi-year highs.

The Goldman Sachs Commodities Index jumped 5.8% (up 24% y-t-d). Spot Gold declined 0.5% to $1,178 (up 11%). Silver rallied 1.5% to $16.80 (up 22%). Crude surged $5.62 to $51.68 (up 40%). Gasoline jumped 13.3% (up 22%), and Natural Gas surged 12.1% (up 47%). Copper declined 2.1% (up 23%). Wheat sank 3.6% (down 14%). Corn fell 3.1% (down 3.2%).

Italy Watch:

November 27 – Financial Times (Rachel Sanderson): “Up to eight of Italy’s troubled banks risk failing if prime minister Matteo Renzi loses a constitutional referendum next weekend and ensuing market turbulence deters investors from recapitalising them, officials and senior bankers say. Mr Renzi, who says he will quit if he loses the referendum, had championed a market solution to solve the problems of Italy’s €4tn banking system and avoid a vote-losing ‘resolution’ of Italian banks under new EU rules. Resolution, a new regulatory mechanism, restructures and, if necessary, winds up a bank by imposing losses on both equity and debt investors, particularly controversial in Italy, where millions of individual investors have bought bank bonds. The situation is being closely watched by financiers and policymakers across Europe and beyond, who worry that a mass failure of Italian banks could trigger panic across the eurozone banking system.”

November 29 – Wall Street Journal (Giovanni Legorano): “The day of reckoning for Banca Monte dei Paschi di Siena SpA, Italy’s No. 3 lender by assets and one of Europe’s most troubled, is drawing near. Long-simmering political, financial and market tensions promise to come to a head next week when it becomes clear whether Monte dei Paschi will be able to succeed in executing a make-or-break plan to bring itself back to health. This weekend will be decisive, when Italians vote on a referendum that could open the door to political instability and unnerve investors, threatening to derail Monte dei Paschi’s rescue plan. That in turn could force a state bailout of the lender, perhaps by year-end—deeply complicating Italy’s efforts to clean up its banking sector. Nervous investors have pummeled Italian banking stocks ahead of Sunday’s vote, sending the FTSE Italia All-Share Banks Index down 12% in the past month…”

December 1 – Reuters (John Geddie): “Speculators convinced the euro zone faces fresh instability have zeroed in on Italy's constitutional reform referendum on Sunday, amassing huge bets on a slump in Italian banks and bonds should Prime Minister Matteo Renzi lose the vote. Blindsided by skewed bookmakers' odds and equivocal opinion polls, financial markets ended up on the wrong side of Britain's vote to leave the European Union in June and Donald Trump's surprise U.S. election win last month… ‘There are colossal short positions on Italy from the U.S. and other countries where big investors are based,’ Raffaele Jerusalmi, the CEO of the Italian stock exchange said this week.”

November 30 – CNBC (Silvia Amaro and Julia Chatterley): “As political uncertainty looms in Italy, the populist Five Star Movement said it would renegotiate the country's membership of the euro if it came into power. Luigi Di Maio, a member of the Five Star Movement, wants to ‘re-discuss the EU and euro parameters’ to address poverty and investment issues in Italy. If such negotiations failed, Italy would have a referendum on a new kind of relationship with the euro area. ‘If (the EU) won't listen to us, we will propose a referendum on the euro to ask the Italian citizens what they want to do,’ Maio told CNBC… ‘Those who brought us in the euro never asked us if we did want to join it. Now we ask the citizens if they want to stay in the common currency or begin to address a two-tier euro scenario or a return to monetary sovereignty,’ Maio said.”

November 29 – Wall Street Journal (Manuela Mesco and Deborah Ball): “The founder of Italy’s populist 5 Star Movement showed off his growing confidence in a video posted ahead of Sunday’s pivotal national referendum. ‘An era is going up in flames,’ Beppe Grillo said as Donald Trump’s Election Night acceptance speech played in the background. ‘It’s the risk-takers, the stubborn, the barbarians who will carry the world forward…We will end up in government, and they will be asking, ‘How did they do it?’ Italian voters will decide Sunday on a constitutional change that would effectively strip the Senate of most of its powers. It is a gamble by Prime Minister Matteo Renzi—for Italy and abroad—and a centerpiece of his efforts to more quickly revamp Italy’s sickly economy.”

November 28 – Bloomberg (Sonia Sirletti, Tom Beardsworth and Chiara Albanese): “Banca Monte dei Paschi di Siena SpA started the first crucial stage of its turnaround plan on Monday as fresh worries about the future of Italy’s government rattled financial markets. The Italian lender is asking bondholders to swap 4.3 billion euros ($4.6bn) subordinated bonds for equity, a step that would allow the bank to proceed with a share sale by the end of the year. Bond investors have five days from Nov. 28 to sign up. The board of directors at Assicurazioni Generali SpA, Italy’s biggest insurer and an investor in the bonds, voted in favor of a conversion.”

Europe Watch:

November 30 – Bloomberg (Joao Lima): “Portugal’s string of good news is getting little attention from investors. Its Prime Minister Antonio Costa just got his second budget through parliament, its economy is picking up and the country stands out as a beacon of stability in the midst of the turmoil set off by Brexit, a referendum in Italy that might bring down the government and rising populism. For all that, investors aren’t showing Portugal’s bonds any love… Portugal’s 10-year bonds yield 3.7%, up from 2.4% at the start of January 2015, the month when ECB President Mario Draghi unveiled his quantitative easing program. It peaked at 18% in 2012 at the height of the euro region’s debt crisis.”

November 28 – Reuters (Ingrid Melander and Michel Rose): “Hardline reformist Francois Fillon scored a resounding win in France's conservative primaries on Sunday, making him favorite to win a presidential election five months from now against the popular far-right and a deeply divided left. Fillon, a former prime minister who wants to raise the retirement age, cut back social security and scrap the 35-hour working week, would easily beat National Front leader Marine Le Pen in a run-off second round, a flash opinion poll said right after his primaries victory.”

ECB Watch:

November 29 – Financial Times (Dan McCrum): “The calendar is not kind to the European Central Bank. A week on Thursday, its governing council will deliberate, just days after Italy’s vote on constitutional reform, and a week before the bank’s US counterpart holds a meeting which could move the world’s bond and currency markets. Temporal pressure of another kind is also building, as the ECB buys €80bn of bonds each month in a programme that runs until March. Extending it could create a new problem, as there may not be enough German Bund’s available next year to keep the ECB’s spending on the eurozone member country’s debt in line with a carefully agreed formula. So Mario Draghi, head of the bank, must somehow ensure stability following a referendum many expect the Italian government to lose, without unduly favouring that country’s sovereign bonds. He must try to keep borrowing costs suppressed across a continental economy where inflation is absent, while also keeping banks healthy and profitable so they lend to businesses and consumers.”

November 29 – Reuters (Balazs Koranyi and Frank Siebelt): “The European Central Bank is ready to temporarily step up purchases of Italian government bonds if the result of a crucial referendum on Sunday sharply drives up borrowing costs for the euro zone's largest debtor, central bank sources told Reuters. Italian government debt and bank shares have sold off ahead of the Dec. 4 referendum on constitutional reforms because of the risk of political turmoil. Opinion polls suggest the 'No' camp is heading for victory, which could force out Prime Minister Matteo Renzi in the latest upheaval against the ruling establishment sweeping the developed world. The ECB could use its 80-billion-euro ($84.8bn) monthly bond-buying programme to counter any immediate, further spike in bond yields after the vote, smoothing market moves and supporting bonds, according to four euro zone central bank sources…”

November 28 – Wall Street Journal (Tom Fairless and Todd Buell): “European Central Bank President Mario Draghi issued a blunt warning over the risks that low interest rates pose to the eurozone’s €10 trillion ($10.6 trillion) economy—just as the ECB prepares to decide whether to hold rates down for longer. The warning underlines the dearth of policy choices central banks face as they seek to further stimulate their economies after years of aggressive easy-money policies. Speaking at the European Parliament in Brussels…, Mr. Draghi said a lengthy period of low rates had created ‘fertile terrain’ for financial-market risks, including a buildup of debt and excessive risk-taking. In an unusual move, the ECB chief also flagged ‘significant vulnerabilities’ in eight European real-estate markets, as a result of rising debt levels or excessive valuations.”

November 30 – Reuters (Paul Day): “Populism and waning national appetite for vital reforms threaten European integration, putting at risk the continent's prosperity and raising the specter of falling incomes, European Central Bank President Mario Draghi said… The ECB has bought governments time with its super-easy monetary policy, yet reform efforts looks to be softening, a major worry as productivity growth is already weak, innovation is low and aging populations will be a huge drag, Draghi said. ‘Monetary policy is providing support and space for governments to carry out necessary structural reforms,’ Draghi said… ‘It is a window of opportunity they should seize.’”

China Bubble Watch:

November 29 – Financial Times (Gabriel Wildau, Don Weinland and Tom Mitchell): “China is readying new restrictions on outbound foreign investment in an effort to curb capital outflows that are putting downward pressure on the renminbi and draining foreign exchange reserves... The State Council is most concerned about outbound mergers and acquisitions worth more than $10bn, said two people familiar with the government’s deliberations. They added that Chinese officials would scrutinise purchases of more than $1bn if they were outside the investor’s core business. Meanwhile, state-owned enterprises will not be allowed to invest more than $1bn on a single overseas real estate transaction. News of the stricter measures worried many company executives, investment bankers and M&A lawyers… as they tried to assess the impact on their pending transactions… According to commerce ministry data, Chinese companies’ overseas purchases have surged past last year’s record of $121bn for non-financial outbound investments, reaching $146bn over the first 10 months of 2016.”

December 1 – Bloomberg: “People’s Bank of China Governor Zhou Xiaochuan already has one policy headache with the currency falling to near an eight-year low. He could have an even bigger one next month. That’s when a $50,000 cap on how much foreign currency individuals are allowed to convert each year resets, potentially aggravating capital outflow pressures that are already on the rise. If just 1% of China’s almost 1.4 billion people max out those limits, that’s an outflow of about $700 billion -- more than the estimated $620 billion that Bloomberg Intelligence estimates indicate has already flowed out in the first 10 months of this year.”

November 29 – Financial Times (Don Weinland, Tom Mitchell and Gabriel Wildau): “The days when a Chinese iron ore miner could buy a UK video game developer are drawing to a close as Beijing tightens up on cross-border investment by its companies. Investment banks in Asia have worked overtime this year on bringing an expansive range of acquisition targets to aggressive Chinese groups, many of which have strayed far beyond the acquirers’ original scope of business. …Overseas purchases by Chinese companies have surged past last year’s record of $121bn for non-financial outbound investments, reaching $146bn over the first 10 months of 2016.”

November 27 – Bloomberg (Lianting Tu): “Without a policy announcement, China’s central bank has effectively tightened monetary conditions in recent weeks, an analysis of its transactions shows. The People’s Bank of China has cut back on seven-day open-market operations and is instead injecting more funds through 14-day and 28-day contracts. That’s had the effect of raising short-term borrowing costs and pressing up bond yields. It’s another sign of selective tightening by the PBOC that’s reinforced the views of many economists that China has turned the corner away from monetary stimulus.”

November 29 – Bloomberg: “China’s government is stepping up efforts to contain runaway property prices, with the central bank clamping down further on mortgage lending in areas deemed overheated, people with knowledge of the matter said. Some lenders in those cities have been asked to suspend distributing new home loans…”

November 27 – Bloomberg (Chisaki Watanabe): “China risks wasting $490 billion by building more coal power plants than it needs as slower power demand growth and less polluting energy sources squeeze coal generation out of the power mix, according to a study from an environmental think tank. As of July, the country had 895 gigawatts of operating coal capacity being utilized less than half the time, with another 205 gigawatts under construction, …Carbon Tracker Initiative said…”

Fixed-Income Bubble Watch:

November 30 – Bloomberg (Eliza Ronalds-Hannon and Charlotte Ryan): “Treasuries wrapped up their worst month since 2009 as investors pulled money from the U.S. bond market on speculation Donald Trump’s victory in the presidential election will pave the way for increased fiscal stimulus. A Bloomberg Barclays index tracking the Treasuries market lost 2.4% this month through Nov. 29. U.S. government debt extended declines Wednesday as OPEC reached a deal to cut oil output, while Trump’s pick for Treasury secretary said he’ll consider adding longer maturities. As U.S. 10-year yields held close to the highest levels this year, the difference over German bunds, Europe’s benchmark sovereign securities, approached the widest on record, according to closing-price data going back to 1990.”

November 30 – Bloomberg (Scott Lanman and Liz McCormick): “Steven Mnuchin, President-elect Donald Trump’s pick for U.S. Treasury secretary, said he’ll explore issuing debt maturing in more than 30 years to cushion the effect of rising interest rates, signaling incoming officials may be open to ideas that the current administration has been unwilling to implement. ‘Interest rates are going to stay relatively low for the next couple of years,’ Mnuchin said… Among other initiatives, ‘we’ll look at potentially extending the maturity of the debt, because eventually we are going to have higher interest rates, and that’s something that this country is going to need to deal with.’”

November 30 – Bloomberg (Joe Light): “Steven Mnuchin, president-elect Donald Trump’s nominee to be U.S. Treasury Secretary, said Fannie Mae and Freddie Mac should leave government control and that the incoming administration ‘will get it done reasonably fast.’ The comments… sent shares of the mortgage-finance giants soaring Wednesday. Fannie Mae and Freddie Mac each jumped 46%, the most since March 2013. The fight over the future of the mortgage companies has been raging since they were bailed out in 2008 for an eventual cost of $187.5 billion.”

December 1 – Reuters (Trevor Hunnicutt): “Investors pulled $4.1 billion from U.S.-based taxable-bond mutual funds, the most since June, as a bond selloff forced interest rates higher and rattled investors, Lipper… showed… ‘Investors are pulling the trigger and are starting, maybe, the rotation out of bond funds," said Tom Roseen, head of research services for Thomson Reuters Lipper. Municipal bond funds continued to be punished as well, losing $2.1 billion to redemptions. Investment-grade corporate bonds posted $1.3 billion in outflows during the seven days through Nov. 30.”

November 30 – Financial Times (Eric Platt): “Investors are buying up riskier corporate debt in a bet that US economic expansion will accelerate due to the boost of government stimulus and tax cuts proposed by president-elect Donald Trump. Despite a $1.6tn hit to fixed-income portfolios in the wake of the global bond market rout, losses concentrated within the sovereign debt sphere, investors have warmed to the idea that a burst of stimulus at the start of Mr Trump’s first term in January will buoy the sales of US companies while tax cuts bolster margins and earnings.”

Global Bubble Watch:

December 1 – Bloomberg (Garfield Clinton Reynolds and Anooja Debnath): “The 30-year-old bull market in bonds looks to be ending with a bang. The Bloomberg Barclays Global Aggregate Total Return Index lost 4% in November, the deepest slump since the gauge’s inception in 1990. Bonds in Europe extended declines with their U.S. peers as OPEC’s agreement on Wednesday to cut oil production added to prospects of higher inflation. The reflation trade has been driving markets since Donald Trump’s presidential election win due to promises of tax cuts and $1 trillion in infrastructure spending… November’s rout wiped a record $1.7 trillion from the global index’s value in a month that saw world equity markets’ capitalization climb $635 billion. The yield on 10-year U.S. notes rose 56 bps in November, the biggest jump since 2009…”

December 1 – Reuters (Leika Kihara): “Bank of Japan board member Makoto Sakurai said the central bank will continue to buy massive amounts of government bonds even under a new policy framework targeting interest rates, shrugging off the view that its bond-buying programme was nearing a limit. But the former academic urged the government and companies to do more to help the BOJ beat subdued inflation and growth in Japan by raising wages and promoting innovation.”

November 27 – Bloomberg: “There’s a Chinese saying that stems from the philosophy in Sun Tzu’s ancient text ‘The Art of War’: You can kill 1,000 enemies, but you would also lose 800 soldiers. Centuries later, the proverb is suddenly apt again, being mentioned frequently in discussions around Beijing. Now, it highlights the potential damage U.S. President-elect Donald Trump could inflict if he makes good on his threat to start a trade war with China, the world’s second-biggest economy. Having backed off some other campaign pledges, it’s unclear if Trump will end up slapping punitive tariffs on China... Still, the message from China is that any move to tax Chinese imports would bring retaliation: The U.S. economy would take a hit and America would damage its longstanding ties with Asia.”

U.S. Bubble Watch:

November 29 – Bloomberg (Michelle Jamrisko): “The U.S. economy expanded more than previously reported last quarter on a sunnier picture of household spending, the primary growth engine. Gross domestic product rose at a 3.2% annualized rate in the three months ended in September, the fastest in two years…”

November 29 – Wall Street Journal (Laura Kusisto): “U.S. home prices have climbed back above the record reached more than a decade ago, bringing to a close the worst period for the housing market since the Great Depression and stoking optimism for a more sustainable expansion. The average home price for September was 0.1% above the July 2006 peak, according to the S&P CoreLogic Case-Shiller U.S. National Home Price index... Adjusted for inflation, the index still is about 16% below the 2006 high. Home prices jumped 5.5% over the past year.”

November 29 – Bloomberg (Patricia Laya): “Consumer confidence rose in November to the highest level since July 2007 on increased optimism about the U.S. labor market and economy, according to… the Conference Board. Confidence index increased to 107.1 (forecast was 101.5) from a revised 100.8. Present conditions gauge rose to 130.3, also the highest since July 2007, from 123.1…”

November 30 – CNBC (Elizabeth Gurdus): “In line with President-elect Donald Trump's proposals, Steve Mnuchin told CNBC… his focus as Treasury secretary will be stimulating economic growth and creating jobs through tax reform. ‘By cutting corporate taxes, we're going to create huge economic growth and we'll have huge personal income,’ Mnuchin told ‘Squawk Box’… Reducing the corporate tax rate from 30% to 15% will be a major goal for the Trump administration, the former Wall Street executive said.”

November 29 – Wall Street Journal (Aaron Back): “After a yearslong boom in lending, signs of trouble are popping up in auto loans. In the past few weeks, some auto lenders have warned that default rates are creeping up. Used-car prices are also falling faster than many anticipated, leading to lower recovery amounts when borrowers do default. The latest stress signal comes from auto research firm, which said in a recent report that record numbers of shoppers are trading in old cars for new ones when they still have substantial amounts due on their existing car loans.”

December 1 – New York Times (Michael Corkery): “Regulators are airing ‘significant concern’ about the millions of Americans who are falling behind on their car loans, even as auto lending continues to boom at a near record pace. …The Federal Reserve Bank of New York noted increasing distress among auto borrowers with shaky credit, as subprime delinquencies rose in the third quarter. In the third quarter, 2% of subprime auto loan balances became at least 90 days delinquent, up from 1.6% in the third quarter of 2014.”

November 30 – Wall Street Journal (Josh Mitchell): “The federal government is on track to forgive at least $108 billion in student debt in coming years, as more and more borrowers seek help in paying down their loans, leading to lower revenues for the country’s wider program to finance higher education. The Government Accountability Office disclosed that sum… in a report to Congress that for the first time projected the full costs of plans that set borrowers’ monthly payments as a share of their earnings and which eventually forgive portions of their debt. The GAO report also sharply criticized the government’s accounting methods for its $1.26 trillion student-loan portfolio, pointing to flaws that have led it to alter projected revenues widely over the years.”

Federal Reserve Watch:

November 28 – The Hill (Peter Schroeder): “The Federal Reserve could be in for a bumpy ride as resurgent Republicans led by President-elect Donald Trump look to make a big mark on the central bank. The right has grown increasingly irritated by the central bank’s policies since the financial crisis and may now be poised to finally push through long-stalled changes to overhaul its operations. ‘We knew there was going to be limited progress under Barack Obama’s administration,’ said Rep. Bill Huizenga (R-Mich.), who authored a broad Fed reform bill in the last Congress. ‘Now, with a partner at 1600 Pennsylvania Avenue that’s interested in moving the needle, frankly we’d be dumb not to try to pursue this.’ For years, GOP-led efforts to impose new rules and restrictions on the Fed ran aground amid substantial Democratic opposition…”

Central Banker Watch:

November 30 – Reuters (David Milliken and Huw Jones): “Donald Trump's victory in the U.S. presidential election has increased the threats to the world economy from higher interest rates and less trade, the Bank of England said… The BoE also pointed to potential dangers from rapid Chinese credit growth or a disorganized British departure from the European Union in a half-yearly assessment of risks to Britain's financial system. BoE Governor Mark Carney highlighted a big rise in U.S. market interest rates since Trump's victory, which the Bank said could be a precursor to a destabilizing sharp move higher in global government borrowing costs from previous record lows.”

Japan Watch:

November 28 – Bloomberg (Keiko Ujikane): “Japan’s household spending dropped for an eighth straight month and retail sales fell slightly in October, even as the unemployment rate remained at the lowest in two decades. Household spending fell 0.4% from a year earlier, following a 2.1% decline in September. Retail sales fell 0.1% from a year ago…”

November 28 – Reuters (Osamu Tsukimori): “Japan's trade ministry has almost doubled the estimated cost of compensation for the 2011 Fukushima nuclear disaster and decommissioning of the damaged Fukushima-Daiichi nuclear plant to more than 20 trillion yen ($177.51bn), the Nikkei business daily reported…”

EM Watch:

November 27 – Financial Times (Kiran Stacey and David Keohane): “Indian banks will have to deposit as cash all the extra money they have been given as a result of demonetisation with the Reserve Bank of India, the central bank announced… The RBI made its sudden move after the country’s banks, flush with cash, went on a bond-buying spree, bringing down interest rates and triggering fears of both inflation and even a shortage of bonds. The central bank said on Saturday evening it was putting in place the temporary restrictions on bond buying to tackle ‘large excess liquidity in the system’. Since Narendra Modi, India’s prime minister, announced the withdrawal of 86% of the country’s banknotes on November 8, Indians have rushed to their banks to deposit the old notes. In that time, around 6tn rupees have been put into the banks. In response, banks have bought up around 4.3tn rupees’ worth of government bonds…, causing prices to jump and the yield on a 10-year bond yield fall more than 50 bps to its lowest in more than seven years.”

November 27 – Reuters (Suvashree Choudhury and Rajendra Jadhav): “Life was good for Mitharam Patil, a wealthy money lender from a small village in the Indian state of Maharashtra. Small-time financiers like Patil would typically lend cash to farmers and traders every day, providing a vital source of funding for a rural economy largely shut out of the banking sector, albeit at interest rates of about 24%. All that came crashing down on Nov. 8, when Prime Minister Narendra Modi banned 500 and 1,000 rupee ($7.30-$14.60) banknotes… The action was intended to target wealthy tax evaders and end India's ‘shadow economy’, but it has also exposed the dependency of poor farmers and small businesses on informal credit systems in a country where half the population has no access to formal banking.”

December 1 – AFP: “President Recep Tayyip Erdogan urged Turks on Friday to convert their foreign currencies into gold and lira to stimulate the country's economy as the lira continued its slide against the dollar. ‘For those who have foreign currencies under the pillow, come change this to gold, come change this to TL (Turkish lira). Let the lira win greater value. Let gold win greater value,’ he said… ‘What necessity is there to let foreign currency have greater value?’ he asked.”

November 29 – Bloomberg (Sid Verma): “For Asian markets, 2017 could be the year of the dollar crunch. Foreign portfolio flows have taken a sharp downturn since Donald Trump's election victory, with $15 billion fleeing Asian bonds and stocks this month alone — close to 30% of year-to-date inflows to the region, according to Deutsche Bank AG… Lending spreads, domestic demand and the resolve of domestic central banks to offset liquidity shortages will be tested next year, analysts warn, as key sources of dollar flows to the region — trade and portfolio inflows — may unravel if Trump makes good on his key campaign proposals.”

November 30 – Bloomberg (Kanga Kong and Jaehyun Eom): “The most vulnerable holders of more than $1 trillion in household debt could spark a financial crisis in South Korea that rivals the one seen during the Asian crisis two decades earlier, according to a former Bank of Korea monetary policy board member. ‘It evokes memories of the late 1990s when Korea was bailed out by the International Monetary Fund,’ said Choi Woon Youl, now a lawmaker with the main opposition Democratic Party of Korea… ‘If it was corporate debt that drove the crisis 20 years ago, it is household debt that would take the lead this time."

Geopolitical Watch:

December 2 – Reuters (Jennifer Jacobs and Nick Wadhams): “President-elect Donald Trump spoke Friday by phone with Taiwan President Tsai Ing-Wen in an unprecedented move that’s sure to provoke China, which regards the country as a renegade province. Trump’s transition team sent a statement saying that Taiwan’s president congratulated Trump on his victory and the two ‘noted the close economic, political and security ties” between the nations. The statement didn’t indicate if the call presaged a shift in longstanding U.S. policy against recognizing Taiwan’s sovereignty or allowing direct communication between top leaders.”

Friday Evening Links

[Bloomberg] Treasuries Rise With Stocks After U.S. Jobs Report; Dollar Falls

[Bloomberg] Italy Referendum: What to Watch Into the Night on Sunday

[Bloomberg] Austrians Fearing Worse Future May Decide Too-Close-to-Call Vote

[Bloomberg] Trump Calls Taiwan Leader in Move Likely to Offend China

[FT] China capital curbs sow doubt over renminbi ambitions

[AFP] Erdogan urges Turks to convert foreign currency to lira