Friday, March 31, 2017

Weekly Commentary: Q1: Sure Bets That Weren’t

An intriguing first quarter. The year began with bullish exuberance for the Trump policy agenda. With the GOP finally in control of Washington, there was now little in the way of healthcare reform, tax cuts/reform, infrastructure spending and a full-court press against regulation. As Q1 drew to a close, by most accounts our new Executive Branch is a mess - the old Washington swamp as stinky a morass as ever. And, in spite of it all, the global bull market marched on undeterred. Everyone’s still dancing. From my perspective, there’s confirmation that the risk market rally has been more about rampant global liquidity excess and speculative Market Dynamics than prospects for U.S. policy change.

It’s not as if market developments unfolded as anticipated. Key “Trump trades” stumbled – longs and shorts across various markets. The overly Crowded king dollar faltered, with the Dollar Index down 2.0% during Q1. The Mexican peso reversed course and ended the quarter up 10.6% versus the dollar, at the top of the global currency leaderboard. The Japanese yen - another popular short and a key funding instrument for global carry trades – jumped 5% . China’s renminbi gained 0.84% versus the dollar. WSJ headline: “A Soaring Dollar and Falling Yuan: The Sure Bets That Weren’t”

Shorting Treasuries was another Trump Trade Sure Bet That Wasn’t. And while 10-year yields jumped to a high of 2.63% on March 13, yields ended the quarter down six bps from yearend to 2.39%. Despite a less dovish Fed, a hike pushed forward to March, and even talk of shrinking the Federal Reserve’s balance sheet - bond yields were notably sticky. Corporate debt enjoyed a solid quarter. Investment grade bonds (LQD) gained 1.2% during the quarter, with high-yield (HYG) returning 2.3%.

The S&P500 gained 5.5% during Q1. And while most were positioned bullishly, I suspect many hedge funds (and fund managers generally) will be disappointed with Q1 performance. There was considerable Trump Trade enthusiasm for the higher beta small caps and broader market. Badly lagging the S&P500, it took a 2.3% rise in the final week of the quarter to see the small cap Russell 2000 rise 2.1% in Q1. The mid caps (MID) were only somewhat better, rising 3.6%.

Technology stocks had been low on the list of Trump Trades going into the quarter, perhaps helping to explain a gangbuster Q1 in the markets. The popular QQQ ETF (Nasdaq100) returned 12.0% during Q1. The Morgan Stanley High Tech index rose 13.5%, and the Semiconductors jumped 11.6%. The Biotechs (BTK) surged 16.0%.

A Trump Trade darling entering 2017, the financials struggled during Q1. March’s 4.0% decline reduced the bank stocks’ (BKX) Q1 gain to an unimpressive 0.3%. Somewhat lagging the S&P500, the broker/dealers (XBD) posted a 5.4% Q1 advance. The NYSE Financial Index gained 3.7%, while the Nasdaq Bank Index dropped 3.1%.

King dollar bullishness had investors underweight the emerging markets (EM) going into 2017. A weakening dollar coupled with huge January Chinese Credit growth helped spur a decent EM short squeeze. Outperformance then attracted the performance-chasing Crowd. By the end of March, EM (EEM up 12.5%) had enjoyed the best quarter in five years (from FT).

March 31 – Financial Times: “Capital flows to emerging markets have continued to surge ahead after a strong start to the year, with cross-border portfolio flows in March at their highest monthly level since January 2015 and broad capital flows to China turning positive in February for the first time in almost three years, according to the Institute of International Finance. The IIF… said flows from non-resident investors into EM bonds and equities were an estimated $29.8bn in March, up from $17.2bn in February…”

A Bloomberg headline from the final day of the quarter: “Rupee Caps Best First Quarter Since 1975 Amid $12 Billion Inflow.” India’s equities (Sensex) posted an 11.2% Q1 gain. A short squeeze also helped Turkish stocks (Borsa Istanbul) to a 13.8% first quarter rise. Latin American equities enjoyed a spectacular start to 2017. Stocks rose 6.4% in Mexico, 8.0% in Brazil, 15.2% in Chile and 19.2% in Argentina. With the notable exception of Russia, Eastern Europe’s equities also enjoyed a solid Q1.

March 31 – Bloomberg (Lilian Karunungan): “All of Asia’s emerging-market currencies, apart from the Philippine peso, strengthened this quarter as optimism over the region’s economic outlook lured inflows. India’s rupee led the advance in March. Regional equities had their best three months since 2010.”

Chinese stocks for the most part posted a solid Q1, with the Shanghai Composite gaining 3.8%. China’s growth-oriented ChiNext index declined 2.8%. Stocks gained 6.0% in Taiwan, 6.6% in South Korea, 5.1% in Indonesia, 6.0% in Malaysia, 6.9% in the Philippines and 8.6% in Vietnam.

Europe lavished in boundless free "money."  Germany’s DAX equites index jumped 7.3% and Frances’s CAC40 gained 5.4%, yet bigger gains were enjoyed in the Periphery. Spanish stocks surged 11.9%. The Italian Mid Cap index surged 17.5%. Portuguese stocks rose 8.1%.

The quarter, however, was not kind to European periphery sovereign debt. Notably, Italian 10-year yields jumped 51 bps. Spanish and French yields rose 29 bps, and Portuguese yields gained 23 bps. With German bund yields rising only 12 bps, European debt spreads widened meaningfully.

For the most part, Bubbling equities markets only exacerbated already extremely loose global financial conditions. First quarter U.S. high-grade debt issuance jumped to $393bn, up 9% from last year’s record pace. Led by record U.S. corporate debt sales, debt issuance boomed around the globe.

March 30 – Financial Times (James Kynge and Thomas Hale): “Emerging market countries sold record levels of government debt in the first quarter of this year, taking advantage of a surge in optimism towards the developing world as trade grows at its fastest rate for seven years and inflationary pressures ebb. Data from Dealogic, a research firm, show that sovereign bond sales from emerging markets rose to $69.6bn in the first three months of the year, an increase of 48 per cent from a year ago and a record amount for a single quarter. Corporate bond sales by companies in developing countries also surged, rising 135% year on year in the first quarter to $105bn…”

March 21 – Dealogic (Olga Tarabrina): “Global M&A volume has reached $705.0bn in 2017 YTD, surpassing $700bn in a YTD period for the first time since 2007 ($903.5bn). Of this, a total of 125 $1bn+ deals, worth $454.9bn, have been announced so far this year, compared to only 94 deals (totaling $260.3bn) 5 years ago. $10bn+ deals account for $167.2bn of the total this year… US-based companies are on top of the heap of cross-border deals, with $95.8 billion in announced acquisitions so far – “the highest YTD level on record.’ … For the first quarter, ‘14 times EBITDA is what the Dealogic figures show as the median EBITDA multiple,’ explained Dealogic’s head of M&A Research, Chunshek Chan. ‘That’s something we really haven’t seen over the course of the data that we have. Historically, we’ve been bouncing between 10 and 12 times, sometimes even 13 times. So 14 times EBITDA is certainly a premium to pay for acquisitions.’”

Various indicators of bullish market sentiment went to extremes. An incredible $124bn flooded into ETFs during the first two months of the year. Margin debt jumped to an all-time high ($528bn) in February, although this pales in comparison to the amount of leverage embedded in derivative trades.

March 31 – Bloomberg (Cecile Vannucci): “Just a week ago, it looked as if the dormant CBOE Volatility Index was awakening. Fast-forward five days, and the gauge known as the VIX is closing in on its lowest quarterly average since the final months of 2006. The measure has lost 18% this year through Thursday as the S&P 500 Index climbed 5.8%.”

March 28 – Bloomberg (Vince Golle): “Americans haven’t been this upbeat about the U.S. stock market since 2000, according to the Conference Board’s latest consumer confidence report… More than 47% of respondents said they expect equities to move higher in the next 12 months, the largest share since January 2000.”

March 23 – CNBC (Evelyn Cheng): “Investor sentiment jumped to a 16-year high in the first quarter, according to the latest Wells Fargo/Gallup Investor and Retirement Optimism Index. The index… rose 30 points to hit 126 in the first quarter… The last time the optimism index was higher was during the tech bubble in November 2000, when the index was at 130.”

The U.S. economy appeared to struggle during the quarter to keep up with booming confidence. University of Michigan Consumer Confidence - Current Conditions jumped to the highest level since July 2005. The Conference Board consumer confidence index surged to the highest level since December 2000. Small business confidence rose to the highest level since 2004.

On the other side of the world, China’s Credit-induced boom caught some momentum. Led by January’s record $545bn expansion of Total Social Financing, total Chinese Credit growth likely exceeded $1.0 TN during Q1. No surprise then that GDP was said to be tracking 6.8% annualized during the quarter. China’s Manufacturing index (PMI) ended the quarter at the strongest level in almost five years. And it’s no surprise that continued timid “tightening” measures have thus far had minimal impact. There were, however, bouts of instability in China’s Wild West money market that portend trouble ahead.

March 31 – China Money Network (Li Dongmei): “China’s announced outbound M&A deals totaled US$23.8 billion during the first three months of 2017, a drop of 75% from US$95.1 billion recorded during same period a year ago, as tightened regulatory controls on capital outflows limited Chinese companies' ability to invest outside of the borders.”

The confluence of a weaker dollar, booming Chinese and global Credit, and latent financial fragilities provided precious metals a nice shine throughout Q1. Palladium jumped 17.1%, silver 14.2%, Gold 8.4% and Platinum 5.2%. The HUI (NYSE Arca Gold Bugs Index) jumped 8.2%. Bloomberg headline: “Metals Enjoy Longest Rally in Seven Years as Low Rates Lure Cash.”

There was yet another facet of the Trump Rally that faded as the quarter wore on: The notion of a fortuitous handoff from monetary stimulus to fiscal policy. Markets were supposed to begin “normalizing.” As central banks pulled back from market dominance, stock picking and active management were to grab some of their advantage lost to the passive index Crowd. We’ll wait to see the percentage of hedge fund and mutual fund managers that beat the SPY for the quarter.

As a market analyst, I saw during Q1 the unprecedented Crowded Trade Phenomenon deepen further. Way too much “money” playing the securities market game – became only more so. And while a strong quarterly gain in the indexes is celebrated by the bullish Crowd, the undercurrents must be troubling to many.

The reality is that too much “money” spoils the game. When everyone is Crowded on one side of the king dollar trade, the boat rocks over. When the Crowd gets short the yen, it’s squeeze higher. Short the metals, here comes a squeeze. Heavily long the banks (slam dunk trade), watch out below. Underweight the emerging markets, the Crowd is forced to chase a big rally. Long the small caps versus the big caps, and the Crowd has no choice but to unwind the trade and jump aboard the S&P500 index. Run long/short strategies with similar factors to everyone else, and the Crowd is left pulling its hair out. Most importantly, focus on risk and you had no chance of outperforming the market or the passive “investing” Crowd.

And it’s “funny” how this all works nowadays. Inflation has turned up, while central bank monetary stimulus is being turned down. Shorting Treasuries (and sovereign debt) should be a Sure Bet. Yet there’s this Lurking Financial Fragility issue, the Elephant in the Market. So, the bigger global Bubbles inflate, the greater the systemic vulnerability to rising market yields (among other things). Yet the more susceptible risk market Bubbles become to trouble the greater the safe haven bid - and the more downward pressure on market yields. Artificially low yields then work to spur speculation and excess, exacerbating global Bubbles and associated fragilities.

All the “money” slushing around in markets dominated by Deviant Market Dynamics continues to make it difficult for most active managers to perform. And the biggest consequence of this troubling market dilemma? Just more enormous self-reinforcing Bubble flows into ETF index products. For the most part, investors are pleased with Q1 returns. What’s not appreciated is the amount of risk that must be accepted to continue playing this game.

March 27 – Financial Times (Miles Johnson): “Hedge fund managers may be criticised for their recent returns but they have consistently displayed a razor sharp sense of timing when it comes to picking when to sell their own businesses. When Och-Ziff, the… hedge fund founded by the former Goldman Sachs trader Daniel Och, decided to sell equity to the public markets it did so near the top of the market in late 2007. Investors in that pre-crisis deal… have since lost more than 90% of their money… So what is to be made of the timing of last week’s news that Eric Mindich has decided to shut his $7bn Eton Park hedge fund and return money to investors from what he called a ‘position of relative strength’? The closure of Eton Park has a symbolic resonance on Wall Street. Once the youngest partner in the history of Goldman Sachs, Mr Mindich left the bank in 2004 to set up Eton Park. It became one of the largest launches in the history of the hedge fund industry and, emboldened by his and others’ success, a whole generation tried to follow him.”

And thanks for checking out our final of four short videos, Tactical Short Episode IV, “The Time is Now" at

For the Week:

The S&P500 increased 0.8% (up 5.5% y-t-d), and the Dow added 0.3% (up 4.6%). The Utilities fell 1.3% (up 5.0%). The Banks recovered 1.3% (up 0.3%), and the Broker/Dealers rallied 2.0% (up 5.2%). The Transports jumped 2.1% (up 0.8%). The S&P 400 Midcaps rose 1.5% (up 3.6%), and the small cap Russell 2000 rallied 2.3% (up 2.1%). The Nasdaq100 gained 1.3% (up 11.8%), and the Morgan Stanley High Tech index rose 1.2% (up 13.5%). The Semiconductors increased 0.7% (up 11.6%). The Biotechs advanced 1.6% (up 16.0%). Though bullion gained $6, the HUI gold index declined 1.0% (up 8.2%).

Three-month Treasury bill rates ended the week at 74 bps. Two-year government yields were unchanged at 1.26% (up 7bps y-t-d). Five-year T-note yields slipped two bps to 1.92% (down 1 bp). Ten-year Treasury yields declined two bps to 2.39% (down 6bps). Long bond yields were unchanged at 3.01% (down 6bps).

Greek 10-year yields sank 41 bps to 6.9% (down 12bps y-t-d). Ten-year Portuguese yields dropped 15 bps to 3.98% (up 23bps). Italian 10-year yields jumped nine bps to 2.32% (up 51bps). Spain's 10-year yields declined three bps to 1.67% (up 29bps). German bund yields dropped eight bps to 0.33% (up 12bps). French yields declined two bps to 0.97% (up 29bps). The French to German 10-year bond spread widened six to 64 bps. U.K. 10-year gilt yields fell six bps to 1.14% (down 10bps). U.K.'s FTSE equities index slipped 0.2% (up 2.5%).

Japan's Nikkei 225 equities index dropped 1.8% (down 1.1% y-t-d). Japanese 10-year "JGB" yields added about a basis point to 0.07% (up 3bps). The German DAX equities index rose 2.1% (up 7.2%). Spain's IBEX 35 equities index advanced 1.5% (up 11.9%). Italy's FTSE MIB index gained 1.5% (up 6.5%). EM equities were mixed. Brazil's Bovespa index rallied 1.8% (up 7.9%). Mexico's Bolsa lost 1.1% (up 6.4%). South Korea's Kospi slipped 0.4% (up 6.6%). India’s Sensex equities index added 0.7% (up 11.2%). China’s Shanghai Exchange declined 1.4% (up 3.8%). Turkey's Borsa Istanbul National 100 index dropped 1.6% (up 13.8%). Russia's MICEX equities index sank 2.2% (down 10.6%).

Junk bond mutual funds saw outflows of $249 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates sank nine bps to 4.14% (up 43bps y-o-y). Fifteen-year rates declined five bps to 3.39% (up 41bps). The five-year hybrid ARM rate fell six bps to 3.18% (up 28bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.23% (up 47bps).

Federal Reserve Credit last week was little changed at $4.436 TN. Over the past year, Fed Credit fell $8.2bn (down 0.2%). Fed Credit inflated $1.626 TN, or 58%, over the past 229 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $4.8bn last week to $3.207 TN. "Custody holdings" were down $53.4bn y-o-y, or 1.6%.

M2 (narrow) "money" supply last week increased $2.5bn to a record $13.405 TN. "Narrow money" expanded $834bn, or 6.6%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits dropped $11.5bn, while Savings Deposits gained $6.8bn. Small Time Deposits were little changed. Retail Money Funds rose $5.1bn.

Total money market fund assets were about unchanged at $2.654 TN. Money Funds fell $112bn y-o-y (4.0%).

Total Commercial Paper jumped $18.2bn to $983.7bn. CP declined $117bn y-o-y, or 10.6%.

Currency Watch:

March 27 – Wall Street Journal (Ira Iosebashvili): “The dollar fell to its lowest level Monday since November amid rising doubts that the White House will be able to push through promised tax cuts and infrastructure spending after failing to repeal the Affordable Care Act last week. The Wall Street Journal Dollar Index, which gauges the U.S. currency against a basket of 16 others, was recently down 0.4% to 89.65, its lowest level since November 11.”

The U.S. dollar index rallied 0.7% to 100.35 (down 2.0% y-t-d). For the week on the upside, the British pound increased 0.6%, the Canadian dollar 0.5%, the South Korean won 0.4%, the Mexican peso 0.2%, the Singapore dollar 0.1% and the Australian dollar 0.1%. For the week on the downside, the South African rand declined 7.3%, the Swedish krona 1.8%, the euro 1.4%, the Norwegian krone 1.2%, the Swiss franc 1.1%, the Brazilian real 0.5% and the New Zealand dollar 0.3%. The Chinese yuan was little changed versus the dollar this week (up 0.84% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index rallied 2.7% (down 2.6% y-t-d). Spot Gold added 0.5% to $1,249 (up 8.4%). Silver jumped 2.7% to $18.26 (up 14.2%). Crude recovered $2.63 to $50.60 (down 6%). Gasoline surged 6.1% (up 2%), and Natural Gas rose 3.7% (down 15%). Copper increased 0.8% (up 6%). Wheat added 0.4% (up 5%). Corn gained 2.2% (up 4%).

Trump Administration Watch:

March 30 – Reuters (Susan Cornwell and Amanda Becker): “U.S. President Donald Trump lashed out… at Republican conservatives who helped torpedo healthcare legislation he backed, escalating a feud within his party that jeopardizes the new administration's legislative agenda. Trump threatened to try to defeat members of the Freedom Caucus - a bloc of conservative Republicans in the House of Representatives - in next year's congressional elections if they continued to defy him. ‘The Freedom Caucus will hurt the entire Republican agenda if they don't get on the team, & fast. We must fight them, & Dems, in 2018!’ Trump wrote on Twitter… He later singled out three Freedom Caucus members by name…”

March 31 – CNBC (Matthew J. Belvedere): “The United States will no longer bow to the rest of the world on trade because President Donald Trump plans to act, Commerce Secretary Wilbur Ross told CNBC… ‘We are in a trade war. We have been for decades. The only difference is that our troops are finally coming to the rampart. We didn’t end up with a trade deficit accidentally,’ he said, warning about the consequences of doing nothing. Ross…argued… that the shortfalls are the result of bad trade deals and other countries actively seeking surpluses. ‘Our trade deficit overall is about $500 billion a year,’ Ross said. ‘Quite miraculously, that also equals the net trade surplus with the rest of the world.’”

March 28 – Associated Press (Andrew Taylor): “The fundamentals of tax overhaul were strong some 30 years ago. A popular president, Republican Ronald Reagan, pushed the landmark 1986 measure. Powerful and experienced congressional leaders shepherded the legislation with bipartisan support. Key players had established, trusting relationships. The situation facing President Donald Trump features none of those advantages. His party is divided and his congressional leadership is weakened after the health care debacle. Key players are inexperienced. Trump has record low approval ratings. Republicans who control all of Washington are planning on going it alone, without help from Democrats. Now, there isn't even basic agreement on what revising the tax code is. Trump is promising ‘massive tax relief for the middle class.’”

March 27 – Wall Street Journal (Justin Lahart): “Any investors who think the failure of health-care reform was somehow a positive because it cleared the way for tax reform may be about to be rapidly disabused of that notion. Optimism on taxes is sharply at odds with the complexity and controversy that has met every effort of reform. Indeed, the rifts among congressional Republicans exposed by the health care battle might just get deeper. Ever since President Donald Trump was elected, investors have used a tax-reform plan House Republicans drew up last year as their lodestar. The plan, championed by Speaker Paul Ryan, calls for a reduction in the corporate tax rate to 20% from 35%. To help pay for that plan, it includes a border adjustment tax that would levy goods imported into the U.S.”

March 27 – Wall Street Journal (Kristina Peterson and Siobhan Hughes): “President Donald Trump and GOP leaders enter their next big battle facing stubborn opposition in both parties that increases Republicans’ worries that they will need more Democratic support than previously expected to avert a government shutdown by the end of April. It is a sign of the new reality in Washington after Mr. Trump and House Speaker Paul Ryan failed to persuade the House’s most conservative Republicans, as well as centrists, to back a bill to replace the Affordable Care Act. The failure derailed the GOP leadership and the new administration’s top legislative priority and has put unexpected questions before both parties about their paths forward. For Republicans leaders, the main challenge is the House Freedom Caucus, an alliance of the most conservative Republicans who successfully defied the White House to sink the health bill.”

March 28 – Bloomberg (Billy House and Erik Wasson): “Republican leaders are eager to avoid a government shutdown but the demise of their Obamacare repeal could leave some conservatives spoiling for a fight that raises the odds of a standoff. The House Freedom Caucus… says Republicans have yet to notch a significant victory, despite controlling both chambers of Congress and the White House. One top promise they and other conservatives had to hoped to deliver on with the Obamacare repeal was defunding Planned Parenthood over its provision of abortions. Now, their next chance comes with a spending measure needed to keep the government operating after April 28, when current funding runs out.”

March 29 – Wall Street Journal (William Mauldin): “The Trump administration appears poised to cement China’s unfavorable status in trade cases, making Chinese goods eligible for higher U.S. tariffs well into the future. U.S. officials are preparing a review of China’s ‘market-economy status’ under the World Trade Organization, according to official documents… The review is expected to be announced as early as this week, just days before a high-stakes meeting between President Xi Jinping and President Donald Trump.”

March 30 – Associated Press (Michael Cohen): “President Donald Trump is predicting ‘a very difficult’ meeting next week with Chinese President Xi Jinping, citing trade deficits and lost jobs. Hours after both governments announced an April 6-7 summit between the economic powerhouses in Florida, Trump sought to set expectations by tweeting: ‘The meeting next week with China will be a very difficult one in that we can no longer have massive trade deficits and job losses. American companies must be prepared to look at other alternatives.’”

March 31 – Wall Street Journal (Chun Han Wong): “China signaled little inclination to make concessions on trade with the U.S. after President Donald Trump warned of a difficult meeting with Chinese leader Xi Jinping at next week’s bilateral summit. ‘China doesn’t intentionally seek trade surpluses,’ Vice Foreign Minister Zheng Zeguang said… He said that imbalances in China-U.S. trade are mainly the result of global industrial trends, as well as disparities in the two countries’ economic structures and development.”

March 27 – Politico (Ben White and Nancy Cook): “The fight for the direction of Donald Trump’s presidency between the Goldman Sachs branch of the West Wing and hardcore conservatives is spilling into the Treasury Department, threatening Trump’s next agenda item of overhauling the tax code. Conservatives inside and outside Treasury say the new secretary, former Goldman Sachs banker, movie producer and Democratic donor Steven Mnuchin, is assembling a team that is too liberal and too detached from the core of Trump’s ‘Make America Great Again’ platform of ripping up trade deals, gutting the Dodd-Frank banking rules and generally rejecting ‘globalism’ in all its forms. The ideological divide has been brewing for weeks inside the White House as a result of appointing a raft of top advisers with radically different worldviews. The battle at Treasury is simply an extension of that brutal fight…”

March 27 – Financial Times (Shawn Donnan and Sam Fleming): “Conservative economist Allan Meltzer has railed against the World Bank and the International Monetary Fund for decades and in Donald Trump’s nomination of a former protegee he sees hope that Washington may finally be heeding his calls for reform. While Mr Trump’s naming this month of Adam Lerrick as the next assistant secretary for international finance at the Treasury has yielded a nervous reaction inside both the IMF and the World Bank, Mr Meltzer is effusive. ‘There is not to my knowledge a person in the world better qualified for that job,’ he says. Mr Lerrick, a former investment banker, served as Mr Meltzer’s top adviser on a 1990s congressional commission examining the role of the two institutions in the global economy. The ‘Meltzer Commission’ report that Mr Lerrick went on to help draft called for a more limited IMF that focuses exclusively on plugging the short-term liquidity needs of countries facing crises rather than protracted bailouts. It also recommended that the World Bank scale back its activities…”

March 30 – Reuters (David Shepardson): “U.S. Transportation Secretary Elaine Chao said the Trump administration would unveil a $1 trillion infrastructure plan later this year, but she did not offer details of funding for projects. Chao said… the infrastructure initiative would include ‘a strategic, targeted program of investment valued at $1 trillion over 10 years. The proposal will cover more than transportation infrastructure, it will include energy, water and potentially broadband and veterans hospitals as well.’”

China Bubble Watch:

March 29 – Wall Street Journal (Shen Hong): “Money markets are often described as the financial system’s plumbing: When they work—which is most of the time—hardly anyone notices, but when they get blocked up, it creates quite a stink. That’s why China’s massive money market—where banks and other financial institutions borrowed some $6.4 trillion from each other last month alone to fund their daily needs—is becoming one of the world’s most important markets to watch. China’s central bank has raised key interest rates twice since early February. That immediately pushed funding costs to the highest in two years, hitting smaller banks that have come to rely on the market particularly hard. Last week, some small rural banks failed to make good on short-term loans from other lenders… The volume of interbank lending, usually uncollateralized, hit a record with the equivalent of $34 trillion in loans last year, nearly 100 times the amount of lending in 2002… Turnover in the repo market surged to the equivalent of $216 trillion last year, around 24 times its volume a decade ago.”

March 31 – Bloomberg: “Chinese banks are taking on an unprecedented amount of short-term financing. Yield-starved investors are lapping it up amid assumptions of state support, unperturbed by a lack of collateral and warnings from rating companies. That’s fueling concern among some analysts that government backing for the nation’s lenders is distorting one of the world’s largest debt markets and increasing risks in the event of cash crunches, even after Premier Li Keqiang vowed to give market forces greater sway. Banks have issued a record 5.2 trillion yuan ($754.6bn) this quarter of so-called negotiable certificates of deposit (NCDs) that mostly mature within a year, up 44% from the three months ended Dec.31…”

March 31 – Bloomberg (Robin Ganguly): “China’s short-term money-market rates climbed across the board, with the one-week cost rising to the most expensive level in almost two years. The seven-day repurchase rate jumped 36 bps to 3.17%, the highest since April 7, 2015. The 14-day cost added 20 bps to 4.94%, extending its advance after reaching the highest since March 2015 on Thursday. The rates rose as the People’s Bank of China refrained from conducting reverse-repurchase agreements for the sixth day in a row, saying that there is a high level of liquidity in the banking system.”

March 28 – Bloomberg: “Turmoil at a small Chinese dairy company is shedding rare light on the final destination for some of the country’s estimated $8 trillion of shadow banking loans. Jilin Jiutai Rural Commercial Bank Corp., a major creditor to embattled China Huishan Dairy Holdings Co., said… it has extended a total of 1.35 billion yuan ($196 million) in credit to the dairy producer, including 750 million yuan through the purchase of investment receivables from a finance lease company. Investment receivables -- a category that can include using wealth-management products, asset-management plans and trust-beneficiary rights to disguise what are in effect loans -- allow banks to reduce the amount of cash they need to set aside for capital and provisions for loan losses.”

March 30 – Reuters (Meg Shen and Lee Chyen Yee): “China's economy, the world's second largest, will likely expand 6.8% in the first quarter of 2017, the official Xinhua agency quoted a government think tank as saying… The expected pace is on par with the 6.8% growth logged in the fourth quarter, which was better than market expectations due to higher government spending and record bank lending.”

March 31 – Bloomberg: “China’s official factory gauge climbed to the highest in almost five years, the latest evidence of increasing momentum in the world’s second-largest economy. The manufacturing purchasing managers index increased to 51.8 in March…”

March 30 – Reuters: “Growth in China’s services sector accelerated in March at the fastest pace in nearly three years, an official survey showed… The official non-manufacturing Purchasing Managers' Index (PMI) stood at 55.1, compared with the previous month's reading of 54.2…”

March 28 – Reuters (Jun Yang): “The ever-closer relationship between Chinese companies and banks can be a toxic mix. A growing number of companies in the People's Republic are buying into local lenders that need to raise capital. The interdependence is risky. One danger is that banks lend to their corporate shareholders on more lenient terms than to regular borrowers, regardless of credit risks. That concern sparked a selloff in Jilin Jiutai Rural Commercial Bank’s stock on Monday, the first trading day following an 85% plunge in the market value of shareholder China Huishan Dairy. The milk group’s chairman controls the company through an entity that also owns more than 15% of Jilin Jiutai's Hong Kong-listed stock. The lender in turn is Huishan’s second-largest creditor, with some $262 million on the line, according to Caixin.”

Global Bubble Watch:

March 31 – Financial Times (Katie Martin): “Investors might need to chuck out their text books, because markets seem set to move in unpredictable and potentially painful ways. That’s the warning from Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, in his widely-read quarterly market wrap. ‘It ain’t a normal cycle,’ he and Jared Woodward write. After all, central banks around the world have cut interest rates 679 times and bought $14.2bn since the collapse of Lehman Brothers. ‘Normalization’ from a 5,000-year low in rates, 70-year low in G7 fiscal stimulus, 35-year high in the US-German rate differential, an all-time high US stocks vs. [the rest of the world], a 75-year low in bank stocks is unlikely to be peaceful; long gold in anticipation of potential manias, panics, crashes.’”

March 26 – Financial Times (Gavyn Davies): “One of the most dramatic monetary interventions in recent years has been the unprecedented surge in global central bank balance sheets. This form of ‘money printing’ has not had the inflationary effect predicted by pessimists, but there is still deep unease among some central bankers about whether these bloated balance sheets should be accepted as part of the ‘new normal’. There are concerns that ultra large balance sheets carry with them long term risks of inflation, and financial market distortions. In recent weeks, there have been debates within the FOMC and the ECB Governing Council about balance sheet strategy, and it is likely that there will be important new announcements from both these central banks before the end of 2017. Meanwhile, the PBOC balance sheet has been drifting downwards because of the large scale currency intervention that has been needed to prevent a rapid devaluation in the renminbi. Only the Bank of Japan seems likely to persist with policies that will extend the balance sheet markedly further after 2017.”

March 28 – Bloomberg (Andrea Wong): “A high-risk corner of the $5.1 trillion-a-day currency market has become the collateral damage of the dollar selloff. Whipsawed by the greenback and confronted by U.S. policy confusion, carry trades were supposed to be a rare bright spot for investors who want to stay away from the world’s biggest reserve currency. Under the strategy, you borrow in low-rate alternatives such as the yen, and buy high-yielding peers like the Mexican peso… Practitioners of the carry trade are learning there’s no hiding from the dollar’s influence. Growing doubts about the outlook for U.S. policy following the failed attempt at health-care reform not only led to a weaker dollar, it also caused investors to pile into havens such as the yen and the euro -- the funding currencies carry traders sell as part of the strategy. The Japanese currency gained 2.2% against the dollar this month, while the euro rose 2.7%.”

March 28 – Bloomberg (Narae Kim and Sid Verma): “Talk about risk-on: the demand for higher-yielding securities is proving so strong that Papua New Guinea, one of Asia’s poorest nations, is contemplating a debut issue of dollar bonds. The southwest Pacific nation plans to raise $500 million in five-year bonds… The country would join Mongolia among sub-investment grade issuers in 2017. Sales of high-yield bonds total almost $15 billion so far this year… It’s part of a broader trend of enduring strength in emerging markets that are weathering the U.S. Federal Reserve’s monetary tightening cycle with aplomb. Concerns about trade wars and the potential renewed decline of commodity prices have been set aside for now, with the long-awaited end of the global bond bull market seeming to be on hold.”

Fixed Income Bubble Watch:

March 27 – Reuters (Nick Carey): “As U.S. auto sales have peaked, competition to finance car loans is set to intensify and drive increased credit risk for auto lenders, Moody’s… said… ‘The combination of plateauing auto sales, growing negative equity from consumers and lenders' willingness to offer flexible loan terms is a significant credit risk for lenders,’ Jason Grohotolski, a senior credit officer at Moody’s… told Reuters. Motor vehicle sales have boomed in the years since the Great Recession.”

Brexit Watch:

March 29 – Bloomberg (Tim Ross and Jonathan Stearns): “U.K. Prime Minister Theresa May struck a conciliatory tone toward the European Union as she coupled her demand for divorce with a request for a sweeping free-trade deal encompassing financial services. In a six-page letter submitted… to EU President Donald Tusk, May formally triggered two years of likely contentious talks that will end with Britain breaking ties with its largest trading partner after more than four decades. May sought to smooth over tensions from the start by calling on both sides to negotiate ‘constructively and respectfully,’ saying that she wants the bloc to ‘succeed and prosper.’”

ECB Watch:

March 30 – Reuters (Thomas Escritt and Balazs Koranyi): “The European Central Bank needs to stick to its already laid out policy path, several policymakers argued…, although a top conservative urged them to leave the door open to a more rapid reduction in stimulus. Economic growth is gaining momentum and the euro zone may be on its best economic run in a decade. But inflation is still not moving decisively higher, the policymakers argued, hinting at little appetite for now to amend the ECB's policy stance. The comments gel with Reuters report on Wednesday that policymakers are wary of making any new change to their policy message after small tweaks this month upset investors… With inflation at a four-year high, critics of the ECB, particularly in Germany, have called on the bank to start winding down its unprecedented stimulus measures…”

March 29 – Wall Street Journal (Tom Fairless): “The European Central Bank’s recent moves mark the first steps in winding down its aggressive monetary stimulus and the bank could soon take fresh steps toward an exit if economic data remain strong, a top ECB official said. Klaas Knot, who sits on the ECB’s rate-setting committee as governor of the Dutch central bank, said policy makers were increasingly optimistic about the strength of the economic recovery under way in the 19-nation eurozone. He said the ECB would likely start winding down its massive bond-purchase program within the next 12 months, and suggested it could even raise interest rates in parallel.”

March 27 – Reuters (Balazs Koranyi, Andreas Framke and Francesco Canepa): “Germany’s two representatives on the European Central Bank's main policy-making body called… for it to prepare to wind down its aggressive stimulus policy as soon as economic conditions allow it. The comments by Bundesbank president Jens Weidmann and by Sabine Lautenschlaeger, who represents the ECB's supervisory arm on the bank's executive board, highlight Germany's impatience with the direction the ECB has taken under president Mario Draghi. They also reveal the rift between themselves and supporters of the ECB's current policy of ultra-low interest rates and massive bond buying, which was defended on Monday separately by the central bank's chief economist Peter Praet and by Belgian central bank governor Jan Smets. ‘I would like to see a less expansive stance,’ Jens Weidmann, who sits on the ECB's Governing Council, said…”

March 25 – Reuters (Francesco Canepa): “The European Central Bank’s next policy moves and the order they come in are still up in the air and might even include a rate hike or sales of bonds, a director at Germany's central bank said. Joachim Wuermeling's comments signal Germany’s impatience with the ECB's ultra-easy policy as inflation in the bloc rebounds and raise new questions about the bank's policy plan… The ECB has said it would keep buying bonds until at least the end of the year and keep interest rates at current record low levels or even cut them until ‘well past’ that point. ‘The forward guidance of the ECB council now presumes that interest rate hikes are currently to be expected at the earliest after the end of net monetary policy purchases,’ Wuermeling told an audience… ‘But here too, everything is in flux.’”

March 28 – Financial Times (Mehreen Khan): “The European Central Bank improperly veered into political activity during the eurozone crisis and should withdraw from the ‘troika’ of international bailout monitors, according to anti-corruption watchdog Transparency International. In a review of the central bank’s actions, carried out in co-operation with ECB officials, the report called on the ECB to be placed under greater scrutiny by EU institutions, saying its mandate to ensure price stability in the eurozone had been pushed to ‘breaking point’ in tackling the crisis. ‘The ECB’s accountability framework is not appropriate for the far-reaching political decisions taken by the governing council,’ said the report written by Benjamin Braun, an economist at Harvard.”

Europe Watch:

March 31 – Bloomberg (Carolynn Look and Stu Metzler): “German unemployment fell by the most since 2011, pushing joblessness to a record low as Europe’s largest economy powers ahead. The number of people out of work slid by a seasonally adjusted 30,000 to 2.6 million in March, and the rate dropped to 5.8% from 5.9%...”

March 28 – Wall Street Journal (James Mackintosh): “Politics has been a big driver of markets, but investors may be worrying about the wrong politics. Squabbling over health care hurts the chance of a big U.S. tax cut, and the neurotic can find plenty to fear in the French presidential election. Much less attention has been paid to the biggest political threat on the horizon for investors: Italy. Italian elections are events investors have learned to disregard after 44 governments in 50 years. The next election might be different, thanks to the potential for a nasty three-way feedback loop between populist politics, the European Central Bank and the bond market.”

Federal Reserve Watch:

March 31 – Reuters (Jonathan Spicer): “The Federal Reserve could begin shrinking its $4.5-trillion balance sheet as soon as this year, earlier than most economists expect, New York Fed President William Dudley said… in the central bank's most definitive comments on the question that looms over financial markets. The hawkish-sounding assertion temporarily pushed the dollar lower and raised yields on longer-dated bonds, and added Dudley's influential voice to at least three other officials at the Fed eyeing a prompt end to a crisis-era policy. ‘It wouldn't surprise me if some time later this year or some time in 2018, should the economy perform in line with our expectations, that we will start to gradually let the securities mature rather than reinvesting them,’ Dudley, a close ally of Fed Chair Janet Yellen, said…”

March 31 – Bloomberg (Matthew Boesler): “For two decades, William Dudley has led a charge to change the way central bankers think about how they steer their economies through the booms and busts of financial markets. As president of the Federal Reserve Bank of New York, he’s showing them during the current tightening cycle what he’s been talking about all along. Dudley’s contribution has been, in a nutshell, to get policy makers more focused on swings in the stock market and how they affect the economy. Inspired by the Bank of Canada in the mid-1990s, he’s been developing an idea ever since that could encourage the Fed to speed up -- or slow down -- the pace of interest-rate increases, depending on market movements. ‘I don’t think we are removing the punch bowl, yet. We’re just adding a bit more fruit juice,’ Dudley said Thursday…”

March 31 – Wall Street Journal (Eric Morath and Jeffrey Sparshott): “An important measure of inflation exceeded the Federal Reserve’s target for a 2% annual gain for the first time in nearly five years. The personal-consumption expenditures price index, which is the Fed’s preferred inflation gauge, rose a seasonally adjusted 0.1% in February from the prior month and climbed 2.1% from a year earlier… It was the strongest annual gain for the price measure since March 2012.”

March 30 – Reuters (Svea Herbst-Bayliss): “The U.S. Federal Reserve should raise interest rates three more times this year due to the strength of the economy, Boston Fed President Eric Rosengren said… ‘The base case (for 2017) would be four tightenings, reflecting the strength of the economy that I believe justifies more regular normalization of interest rates,’ Rosengren said…”

March 28 – Reuters (Jason Lange): “A Republican-controlled committee of lawmakers approved a bill… to allow a congressional audit of Federal Reserve monetary policy, a proposal Fed policymakers have opposed and which faces an uncertain path to final approval. Democrats uniformly spoke against the proposal during a meeting of the House of Representatives Committee on Oversight and Government Reform, suggesting the bill would face stronger resistance than in the past.”

U.S. Bubble Watch:

March 28 – Reuters (Lucia Mutikani and Dan Burns): “U.S. consumer confidence surged to a more than 16-year high in March amid growing labor market optimism while the goods trade deficit narrowed sharply in February, indicating the economy was regaining momentum after faltering at the start of the year… Robust consumer confidence and rising household wealth from the home price gains suggest a recent slowdown in consumer spending, which has hurt growth, is likely temporary. ‘We think that real consumption will firm moving forward,’ said Daniel Silver, an economist at JP Morgan…”

March 28 – Bloomberg (Michelle Jamrisko): “Home prices in 20 U.S. cities climbed in the 12 months through January at the fastest pace since July 2014, while nationwide the increase in property values also accelerated, according to S&P CoreLogic Case-Shiller… 20-city property values index rose 5.7% from January 2016 after increasing 5.5% in the year through December. National home-price gauge increased 5.9% in the 12 months through January…”

March 27 – Bloomberg (Vince Golle): “The paucity of houses on the market remains a nagging hurdle for those Americans interested in trading up or looking to take their first step into homeownership. With a limited number of property listings amid solid demand, sellers have little reason to reduce asking prices. From December through February, less than four months’ supply of existing houses were on the market, compared with a post-recession high of about 12 months’ worth in mid-2010… Yes, interested sellers take their homes off the market during the winter, but such a lean supply over a similar time frame has never been recorded in about two decades of data.”

Japan Watch:

March 30 – Bloomberg (Toru Fujioka and Keiko Ujikane): “Japan’s core consumer prices rose slightly for a second month in February, while the jobless rate dropped to the lowest level since 1994. Consumer prices excluding fresh food climbed 0.2% in February from a year earlier, registering the first back-to-back gains since late 2015.”

EM Watch:

March 30 – Reuters (Adam Haigh): “The first quarter is ending, and the tally is in: emerging markets are winning hands down. Developing-market equities have handed investors a 12.4% return this year, twice that of developed stocks, for their best start to a year since 2012. A gauge of local-currency emerging-nation bonds is up 7.4%, more than three times as much as the Bloomberg Barclays global fixed-income index.”

March 30 – Bloomberg (Michael Cohen): “South African President Jacob Zuma faced a widening public backlash from senior members of the ruling African National Congress including his deputy, Cyril Ramaphosa, the morning after he fired his finance minister and made sweeping cabinet changes. ‘I have made my views known and there are quite a number of other colleagues and comrades who are unhappy about the situation, particularly the removal of the minister of finance,’ Ramaphosa said… He called Zuma’s reasons for removing Pravin Gordhan ‘unacceptable.’”

March 31 – Bloomberg (Jonathan Spicer): “Venezuela lurched closer to full-blown crisis Friday when the nation’s top prosecutor, a long-time ally of the ruling socialist party, labeled unconstitutional the Supreme Court’s move to usurp the power of the opposition-led National Assembly. Small, sporadic protests flared up across the country, jittery investors dumped the government’s bonds and opposition leaders sought to capitalize on the chaos by calling on the military to ‘restore’ constitutional order.”

Leveraged Speculation Watch:

March 29 – Wall Street Journal (Saumya Vaishampayan): “Many of the trades that seemed sure bets at the start of 2017 have already flopped in the first quarter. Investors’ high expectations about what President Donald Trump would be able to achieve in office, reflected in the ‘Trump trade,’ have moderated. In addition, trades have been upended by surprisingly good global economic data. The Eurekahedge Macro Hedge Fund Index, which shows the performance of funds that wager on big economic trends, has returned 0.5% so far this year, versus 3.4% in all of 2016. ‘There’s been quite a shift in sentiment about what the U.S. administration will do,’ said Mitul Kotecha, head of Asia macro strategy at Barclays…”

Geopolitical Watch:

March 30 – Reuters (Ben Blanchard): “China's Defence Ministry said… it was futile for Taiwan to think it could use arms to prevent unification, as the self-ruled democratic island looks to fresh arms sales by the United States amid what it sees as a growing Chinese threat. China has never renounced the use of force to bring under its control what it deems a wayward province, and Taiwan's defense ministry says China has more than 1,000 missiles directed at the island. The Trump administration is crafting a big new arms package for Taiwan that could include advanced rocket systems and anti-ship missiles to defend against China…”

March 30 – Reuters (Ben Blanchard): “There was ‘no such thing’ as man-made islands in the disputed South China Sea, China's Defence Ministry said…, and reiterated that any building work was mainly for civilian purposes. China, which claims most of the resource-rich region, has carried out land reclamation and construction on several islands in the Spratly archipelago, parts of which are also claimed by Brunei, Malaysia, the Philippines, Taiwan and Vietnam. The building has included airports, harbors and other facilities…”

March 30 – Wall Street Journal (Yaroslav Trofimov): “Turkey expected a honeymoon with President Donald Trump. Instead, it increasingly looks like Ankara and Washington are heading for a squabble, if not a divorce. For now, President Recep Tayyip Erdogan has bitten his tongue and avoided attacking the Trump administration with the kind of inflammatory statements that he routinely hurls at European and regional leaders. The White House, too, has kept largely mum about Turkish affairs… Yet, on several key issues of this complicated relationship between the two North Atlantic Treaty Organization allies, a head-on collision with potentially unpredictable consequences seems more and more possible.”

March 29 – New York Times (Ben Hubbard and Michael R. Gordon): “The United States launched more airstrikes in Yemen this month than during all of last year. In Syria, it has airlifted local forces to front-line positions and has been accused of killing civilians in airstrikes. In Iraq, American troops and aircraft are central in supporting an urban offensive in Mosul, where airstrikes killed scores of people on March 17. Two months after the inauguration of President Trump, indications are mounting that the United States military is deepening its involvement in a string of complex wars in the Middle East that lack clear endgames… On display are some of the first indications of how complicated military operations are continuing under a president who has vowed to make the military ‘fight to win.’”

Friday Afternoon Links

[Bloomberg] U.S. Stocks Meander on Last Day of Stellar Quarter: Markets Wrap

[Reuters] Oil retreats, set to become worst-performing asset in first quarter

[Reuters] Fed signals it could promptly start shedding bonds from portfolio this year

[Bloomberg] Venezuela Crisis Deepens, Bonds Sink as Maduro Ally Pushes Back

[Reuters] Top Venezuela official breaks with government, protests escalate

[CNBC] The looming budget disaster, in four charts

[Forbes] Proof That Mr. Market Is Losing His Mind

[CNBC] From a $200,000 Aston Martin sports car to $1,000 an hour escorts, Wall Street spending is up

[NYT] Caution Signals Are Blinking for the Trump Bull Market

[FT] ‘It ain’t a normal cycle’, BAML reminds investors