Friday, April 28, 2017

Weekly Commentary: Unsound Finance

With Emanuel Macron and Marine Le Pen moving on to next Sunday’s (May 7) runoff French presidential election, first-round results proved right in line with the polls. One would typically expect “as expected” results to elicit minimal market reaction. But we live in the age of derivatives, hedging and speculation. Markets – especially European – were buoyed, once again, this week by the reversal of hedges and short positions.

In Europe, the French CAC 40 index surged 4.1%. Italian stocks (MIB) jumped 4.4%, with Spanish equities (IBEX) up 3.3%. Germany’s DAX rose 3.2%. European bank stocks (STOXX 600) advanced 4.8%, with Italian banks up 7.6%. French sovereign CDS collapsed 22 to a five-month low 33 bps. Italian CDS declined 18 to a one-month low 168 bps. Here at home, the S&P500 gained 1.5%, trading Wednesday within a whisker of all-time highs. The week saw record highs for the Nasdaq composite, the Nasdaq 100, the Morgan Stanley High Tech index, the small cap Russell 2000 and the large-cap Russell 3000. The VIX collapsed to a near three-year low. With the yen sinking 2.2%, Japan’s Nikkei 225 jumped 3.1%.

I start with a simple definition: “A Bubble is a self-reinforcing but inevitably unsustainable inflation.” Bubble terminology is used in various contexts and means different things to different folks. To most analysts, talk of a “Bubble” connotes something that is about to burst. I take a different approach, working to identify initial factors and characteristics that are favorable for Bubble formation - and then monitoring and analyzing developments and ramifications. I covered the mortgage finance Bubble from every angle on a weekly basis for over six years, after initially warning of its development in early-2002. It’s now been over eight years analyzing the global government finance Bubble – the “Granddaddy of All Bubbles.”

There’s an interesting dynamic that I’ve lived through a few times now. These Bubbles inflate for years – much longer than would seem reasonably possible. And the longer they survive the more dismissive conventional analysts (and the business media) become to Bubble analysis. At the same time, over time as a Bubble gains momentum there becomes overwhelming evidence and analytical support for the Bubble view. My feelings these days recall 1999 and 2007 experiences: I have great conviction in the analysis, while conventional analysis turns increasingly bullish and dismissive of what have become increasingly conspicuous (and precarious) market distortions and excesses.

Unsound Finance gets to the heart of the issue. Looking back historically to early economic thought, the recurring issue that perplexed deep thinkers was how an economy that appeared robust could suddenly run so amuck. Economic busts would invariably focus analytical attention to “money,” debt and banking.

While discerned by few, Credit turns progressively less stable over the course of an economic upcycle. Especially during the late-cycle boom phase, there would be a huge divergence between general confidence and the underlying deterioration in the quality of rapidly expanding Credit. At some point the boom begins to falter, resulting in a tightening of bank lending. Latent fragilities were soon exposed, traditionally leading to fear, panic, bank runs and such.

My fundamental premise is that we’re in the late-stage of a historic global experiment in unfettered finance. From a historical and analytical perspective, Credit is inherently unstable. Today’s Credit is acutely unstable on a global basis as never before. The bullish counter argument holds that central bankers will ensure financial and economic stability. And with central banks willing to employ negative rates and limitless massive monetization, confidence in the bullish view is higher than ever. As such, today’s divergence between confidence and the underlying soundness of finance has never been as wide – ever. The bullish view holds that central banks are the solution. They’re undoubtedly the problem.

Especially with the view that the Trump Administration will aggressively pursue tax cuts and deregulation, optimism is running high that pent up real economy potential is about to be unleashed. Despite a weak Q1, some forecasts call for 3% GDP growth in Q2. Monitoring increasingly overheated real estate markets and stubbornly low bond yields, I would not be surprised by a decent economic uptick. Yet there are myriad fault lines that could bring this party to an abrupt end.

The Dilemma of Unsound Finance prevails just about everywhere – most notably China, Japan, Europe, EM, Canada, the U.S, Australia, etc. There are numerous potential flashpoints – where Unsound Finance has turned acutely vulnerable. While central bankers talk employment and CPI, I believe fear of global financial instability has been the true impetus behind “whatever it takes.”

April 28 – Bloomberg: “New shadow banking measures may be unveiled and China’s central bank will probably continue to raise money-market rates after President Xi Jinping met with the country’s top officials over risks to the financial system this week, according to Nomura Holdings Inc. Xi gathered with members of the Communist Party Politburo and the chiefs of China’s four financial regulators April 25, ordering them to prevent systemic risks. Concern over a regulatory crackdown has whipsawed Chinese assets over the past two weeks. ‘We expect stricter financial regulatory measures to be rolled out, which we believe should be seen as targeted tightening, particularly in the shadow banking system, to de-leverage financial speculation and reduce capital outflows,’ Nomura analysts Zhao Yang and Wendy Chen wrote…”

Chinese officials are grappling with an epic Credit Bubble and the resulting greatest expansion of finance in history. This week saw further pressure on Chinese stocks and bonds (See China Watch below). Last year’s measures to stabilize the country’s collapsing stock market, slow enormous capital flight and juice the faltering economy pushed China’s housing Bubble (and shadow banking) to ridiculous extremes. Chinese officials will now attempt to impose more strenuous measures to rein in financial excess without slowing the economy or bursting Bubbles. Global markets for the most part remain sanguine – not that they anticipate policymaker success but rather because they are confident that Beijing will not risk bursting Bubbles. Markets believe they have time.

April 23 – Wall Street Journal (Carolyn Cui, Ian Talley and Ben Eisen): “Emerging-market companies are binging on U.S. dollar debt and that could become a source of trouble in some parts of the world if growth slows, interest rates rise or the dollar resumes its ascent. Governments and companies in the developing world sold $179 billion in dollar-denominated debt in the first quarter, the most dollar debt ever raised in the first quarter and more than double the amount raised during the same period last year, according to… Dealogic. In all, U.S. dollar debt stood at $3.6 trillion in emerging markets through the third quarter of 2016, an all-time high... Including local currency debt, and emerging-market companies have increased their borrowing by a staggering $17 trillion since 2008, according to the Institute of International Finance.”

I have argued for a while now that EM Finance is Unsound. Over the past year, Chinese reflation coupled with global QE spurred a major short squeeze followed by an onslaught of (performance-chasing) EM inflows. As always, EM economies show alluring potential – so long as international inflows boost asset prices, lending and investment. To have EM binging again on dollar-denominated debt should be a troubling development for anyone paying attention.

It’s worth noting that Germany’s DAX index has gained 8.3% y-t-d, increasing one-year gains to 20.5%. Booming European equities are not limited to Germany. France’s CAC 40 has risen 8.3% so far this year (18.9% 1-yr), Spanish stocks 14.6% (15.6%) and Italian 7.2% (8.6%). Euro zone consumer price inflation has rebounded to about 2% annualized, while corporate risk premiums have declined to near three-year lows. Meanwhile, March broad money supply (M3) jumped to 5.3% y-o-y, the strongest monetary expansion since 2009. Yet the ECB Thursday held firm with about $65bn monthly QE and short-rates at zero or lower. European bank stocks jumped 4.8% this week, increasing 2017 gains to 8.0%.

European periphery debt spreads narrowed this week. French to German 10-year yield spreads collapsed 16 bps. Spanish bond spreads narrowed 11 bps, and Portuguese spreads narrowed 26 bps. Notably, Italian spreads narrowed only 4 bps, remaining close to multi-year wides. European debt markets have evolved into huge Bubbles. How much speculative finance has shorted German bunds to fund higher-yielding bonds from Italy, Spain and Portugal? How large is the “carry trade” – short zero-yielding Japanese instruments to leverage in higher-yielding European periphery corporate and sovereign debt?

The yen dropped 2.2% this week. The yen continues to provide an intriguing “Risk On vs. Risk Off” indicator. Not only has the Bank of Japan’s (BOJ) open-ended QQE created massive amounts of liquidity to bolster Japanese and global securities markets. BOJ policy has incentivized speculators to short yen instruments for cheap finance to acquire higher-yielding bonds around the globe – likely including European, Chinese and EM instruments.

My opening paragraph noted that we live in the age of derivatives. To what extent these “carry trades,” and leveraged speculation more generally, are accomplished through derivative transactions is an important issue. Not only would such imbedded leverage create latent fragilities, it also ensures transparency issues. There is ample evidence that huge amounts of finance have exited Europe, Japan, China and EM over recent years to participate in king dollar. Yet I believe such flows are not adequately reflected in Fed data. Could the explanation be that the proliferation of derivative strategies has distorted traditional flow data?

I go down this path because I was asked this week by an astute observer of the world how the bursting of the global Bubble might play out. I contemplate various scenarios and tend to look at this most extraordinary backdrop and think “expect the unexpected.” Nevertheless, I’ll throw out a possible scenario.

After years of astounding expansion, China’s leading banks occupy the top four spots in the list of the world’s largest banks (by assets). Chinese finance has become hopelessly Unsound, with a Credit Bubble fueling epic malinvestment, asset Bubbles, fraud and deep financial and economic structural impairment.

A bursting Bubble would rather quickly see a crisis of confidence throughout China’s opaque financial system, certainly including “shadow banking” and “repo” finance more generally. I would expect collapsing real estate prices and economic dislocation to spur capital flight. There would be enormous pressure to unwind “carry trades,” greatly pressuring the Chinese currency. A collapsing currency would further impair Chinese borrowers, especially those (banks) exposed to dollar-denominated debt. Chinese officials would see no alternative than to impose strict capital control. The Chinese crisis would spur global “Risk Off” – de-risking, de-leveraging dynamics that I would expect to be particularly problematic for Europe and EM.

A “Risk Off” spike in European periphery yields and a widening of spreads would be a major issue for the thinly capitalized European banks. And with the European banking organizations having become such major players in derivatives, securities finance and EM, a crisis of confidence in European finance would quickly become a systemic issue globally.

This scenario could be viewed as positive for king dollar – and perhaps, to some, even favorable for U.S. securities markets and the American economy more generally. The perception is that U.S. finance is sound and the economy stable. I have serious doubts, believing deeply unsound finance has inflated a U.S. Bubble economy with latent fragilities.

I would expect global “Risk Off” to illuminate enormous amounts of speculative leverage throughout U.S. securities markets, most notably in corporate Credit. I would not be surprised if global markets freeze up – a “flash crash” that would be more than a flash in the pan. Illiquid global markets would be perilous to derivative players that rely on dynamic trading strategies to hedge portfolio exposures. This would curtail sales of cheap market “insurance” that have been instrumental in bolstering risk-taking throughout the securities markets. A resulting sharp tightening of financial conditions would expose the degree to which uneconomic enterprises have flourished in the almost nine years of free “money.” Corporate America would have huge exposure to a faltering global economy, with the major financial institutions all caught up in the global crisis of confidence in derivatives and counter-party issues. And there’s the issue of Trillions that have flowed into perceived safe and highly liquid ETFs. Now that’s some Unsound Finance.

But it’s not necessary to ponder the future to see how Unsound Finance comes back to haunt the system. This week the Trump Administration released a broad outline of its plan for tax cuts and reform. Eight years of zero rates, ultra-low Treasury yields, record stock prices and booming asset markets have fed the dangerous delusion that deficits don’t matter. The central bank blank checkbook has salivating politicians believing they enjoy a similar luxury. And while one article raised the “bond vigilante” issue, for the most part markets remain happy to oblige.

It’s not difficult to present analysis showing 3% (why not 4 or 5%?) growth creating ample revenues to offset major tax cuts. But after eight years of egregious monetary stimulus, one can easily envisage a scenario where growth surprises to the downside. And it is not a totally crazy notion to ponder growth faltering concurrent with a rise in Treasury borrowing costs. Such a scenario would likely see a bursting of assets Bubbles and a resulting collapse in revenues throughout the government sector. There’s as well all the entitlements and unfunded pension plans. When things turn sour globally, we’ll be spending a lot more on national defense. Unsound Finance always comes back to bite. The worrying part is that the world has never experienced anything comparable to the past 30 years.

For the Week:

The S&P500 gained 1.5% (up 6.5% y-t-d), and the Dow jumped 1.9% (up 6.0%). The Utilities slipped 0.2% (up 5.7%). The Banks rose 1.8% (down 0.6%), and the Broker/Dealers surged 2.8% (up 5.3%). The Transports dipped 0.4% (up 0.6%). The S&P 400 Midcaps increased 0.9% (up 4.3%), and the small cap Russell 2000 rose 1.5% (up 3.2%). The Nasdaq100 gained 2.6% (up 14.8%), and the Morgan Stanley High Tech index advanced 3.0% (up 14.8%). The Semiconductors increased 1.3% (up 10.9%). The Biotechs surged 4.5% (up 18.3%). With bullion declining $16, the HUI gold index sank 6.6% (up 5.3%).

Three-month Treasury bill rates ended the week at 78 bps. Two-year government yields jumped eight bps to 1.26% (up 7bps y-t-d). Five-year T-note yields gained four bps to 1.82% (down 11bps). Ten-year Treasury yields increased three bps to 2.28% (down 16bps). Long bond yields rose five bps to 2.95% (down 11bps).

Greek 10-year yields fell 30 bps to 6.25% (down 77bps y-t-d). Ten-year Portuguese yields dropped 20 bps to 3.55% (down 20bps). Italian 10-year yields increased two bps to 2.28% (up 47bps). Spain's 10-year yields dipped five bps to 1.65% (up 27bps). German bund yields rose six bps to 0.32% (up 11bps). French yields dropped 10 bps to 0.84% (up 16bps). The French to German 10-year bond spread narrowed 16 to 52 bps. U.K. 10-year gilt yields gained five bps to 1.09% (down 15bps). U.K.'s FTSE equities index rallied 1.3% (up 0.9%).

Japan's Nikkei 225 equities index surged 3.1% (up 0.4% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.02% (down 2bps). The German DAX equities index rallied 3.2% (up 8.3%). Spain's IBEX 35 equities index jumped 3.3% (up 14.6%). Italy's FTSE MIB index surged 4.4% (up 7.1%). EM equities were mostly higher. Brazil's Bovespa index rose 2.6% (up 8.6%). Mexico's Bolsa added 0.6% (up 7.9%). South Korea's Kospi rose 1.9% (up 8.8%). India’s Sensex equities index gained 1.9% (up 12.4%). China’s Shanghai Exchange slipped another 0.6% (up 1.6%). Turkey's Borsa Istanbul National 100 index advanced 2.4% (up 21.1%). Russia's MICEX equities index recovered 3.7% (down 9.7%).

Junk bond mutual funds saw inflows of $291 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose six bps to 4.03% (up 37bps y-o-y). Fifteen-year rates gained four bps to 3.27% (up 38bps). The five-year hybrid ARM rate increased two bps to 3.12% (up 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up seven bps to 4.14% (up 38bps).

Federal Reserve Credit last week declined $3.9bn to $4.440 TN. Over the past year, Fed Credit declined $5.0bn (down 0.1%). Fed Credit inflated $1.620 TN, or 58%, over the past 232 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $4.5bn last week to $3.211 TN. "Custody holdings" were down $28bn y-o-y, or 0.9%.

M2 (narrow) "money" supply last week jumped $30.7bn to a record $13.439 TN. "Narrow money" expanded $815bn, or 6.5%, over the past year. For the week, Currency increased $1.7bn. Total Checkable Deposits gained $7.4bn, and Savings Deposits rose $19.7bn. Small Time Deposits were little changed. Retail Money Funds added $1.1bn.

Total money market fund assets expanded $15.4bn to $2.642 TN. Money Funds fell $66.5bn y-o-y (2.5%).

Total Commercial Paper gained $5.3bn to $980.2bn. CP declined $129bn y-o-y, or 16.1%.

Currency Watch:

The U.S. dollar index fell 0.9% to 99.05 (down 3.3% y-t-d). For the week on the upside, the Swedish krona increased 1.6%, the euro 1.6%, the British pound 1.1%, the Norwegian krone 1.0%, and the Swiss franc 0.2%. For the week on the downside, the New Zealand dollar declined 2.2%, the Japanese yen 2.2%, the South African rand 1.9%, the Canadian dollar 1.1%, the Brazilian real 0.9%, the Australian dollar 0.7%, the South Korean won 0.3% and the Mexican peso 0.1%. The Chinese renminbi slipped 0.11% versus the dollar this week (up 0.75% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index was little changed (down 3.9% y-t-d). Spot Gold declined 1.2% to $1,268 (up 10.1%). Silver sank 3.8% to $17.26 (up 8%). Crude slipped 29 cents to $49.33 (down 8%). Gasoline dropped 5.9% (down 7%), while Natural Gas rallied 5.6% (down 12%). Copper recovered 2.2% (up 4%). Wheat gained 2.7% (up 6%). Corn added 0.8% (up 4.1%).

Trump Administration Watch:

April 27 – Bloomberg (Brian Chappatta and Liz McCormick): “The Trump administration’s tax plan -- and its disregard for the effect it would have on the federal budget deficit -- is certain to pique the interest of a long-dormant segment of bond investors. So-called bond vigilantes, once feared for enforcing restraint on spendthrift governments, have struggled to flex their muscles in recent years as global central banks stepped in to buy a glut of sovereign debt. Now may be the time for a comeback, with the Federal Reserve talking about trimming its Treasury holdings while the administration’s tax plan could spur more borrowing to cover a shortfall (assuming the projected economic growth doesn’t materialize).”

April 25 – Financial Times (Sam Fleming and Barney Jopson): “In seeking to scythe the corporate tax rate to 15% Donald Trump can claim to be pursuing longstanding campaign pledges to make the US more competitive and revive economic growth. But whether the president’s expected tax-cutting demand will bolster the chances of reform actually happening this year in Congress is a very different question. Attempting such a steep cut in the key rate would raise a host of procedural questions within Congress if the headline-grabbing reduction is not offset with revenue-raising measures elsewhere. It would also sound alarm bells among deficit hawks in the GOP, given that the US is facing a renewed ballooning of its budget deficit.”

April 26 – New York Times (Peter Baker): “A white cloth napkin, now displayed in the National Museum of American History, helped change the course of modern economics. On it, the economist Arthur Laffer in 1974 sketched a curve meant to illustrate his theory that cutting taxes would spur enough economic growth to generate new tax revenue. More than 40 years after those scribblings, President Trump is reviving the so-called Laffer curve as he announces the broad outlines of a tax overhaul… What the first President George Bush once called ‘voodoo economics’ is back, as Mr. Trump’s advisers argue that deep cuts in corporate taxes will ultimately pay for themselves with an explosion of new business and job creation.”

April 28 - Reuters (Stephen J. Adler, Steve Holland and Jeff Mason): “U.S. President Donald Trump said… a major conflict with North Korea is possible in the standoff over its nuclear and missile programs, but he would prefer a diplomatic outcome to the dispute. ‘There is a chance that we could end up having a major, major conflict with North Korea. Absolutely,’ Trump told Reuters… Nonetheless, Trump said he wanted to peacefully resolve a crisis that has bedeviled multiple U.S. presidents… ‘We'd love to solve things diplomatically but it's very difficult,’ he said.”

April 28 – Bloomberg (Jeff Mason, Steve Holland and Stephen J. Adler): “President Donald Trump’s pledge to repeal Obamacare ran into a Republican buzz saw. Now, his ambitious proposal to cut taxes is again encountering GOP opposition -- from lawmakers in Democratic-leaning states. Within a day of Trump’s top economic adviser Gary Cohn and Treasury Secretary Steven Mnuchin releasing a dozen bullet points outlining the administration’s tax goals, at least three House Republicans criticized one of the key provisions -- eliminating the deductibility of state and local taxes -- estimated to raise $1.3 trillion over a decade.”

April 28 – Bloomberg (Jeff Mason, Steve Holland and Stephen J. Adler): “President Donald Trump downplayed the severity of a potential government shutdown on Thursday, just two days shy of a deadline for Congress to reach a spending deal to avert temporary layoffs of federal workers. ‘We'll see what happens. If there's a shutdown, there’s a shutdown,’ Trump told Reuters…, adding that Democrats would be to blame if the federal government was left unfunded. Congress has until 12:01 a.m. ET on Saturday to pass a bill to fund the government or face a shutdown, which would temporarily lay off hundreds of thousands of federal workers.”

April 25 – Bloomberg (Jennifer Epstein and Joe Light): “U.S. President Donald Trump intensified a trade dispute with Canada, slapping tariffs of up to 24% on imported softwood lumber in a move that drew swift criticism from the Canadian government, which vowed to sue if needed… ‘We’re going to be putting a 20% tax on softwood lumber coming in -- tariff on softwood coming into the United States from Canada,’ Trump said…”

April 26 – CNBC (Ed Lane): “U.S. Secretary of Commerce Wilbur Ross told the Wall Street Journal that trade actions on aluminum, semiconductors and shipbuilding are under review as well as plans to start free-trade talks directly with Japan, the United Kingdom and European Union even as plans to look at existing free-trade pacts with South Korea and the North America free Trade Agreement (NAFTA). In a wide ranging interview, Ross, 79, pledged to look at issues as diverse as providing support to Westinghouse Electric Co., the nuclear-reactor company owned by Japan's Toshiba that filed for bankruptcy protection in the U.S. last month.”

China Bubble Watch:

April 28 – Bloomberg: “Chinese companies’ borrowing costs have surged to a two-year high relative to the government’s, with an intensifying crackdown on leverage persuading investors to cut holdings of riskier assets. The yield premium that investors demand to hold top-rated bonds over the sovereign surged to a two-year high of 1.5 percentage points this week, the most since April 2015. The gap was driven mainly by a tumble in company notes, with the three-year, AAA rated yield surging 42 bps in the nine days through Tuesday… China’s bond market is feeling the heat of increased scrutiny on the use of borrowed money to invest in financial assets…”

April 23 – Bloomberg: “China’s boom in wealth-management products worth trillions of dollars, under scrutiny from regulators because of potential threats to financial stability, is slowing for now. Outstanding products issued by banks stood at 29.1 trillion yuan ($4.2 trillion) as of March 31, up 18.6% from a year earlier… The growth rate slumped from 53% during the same period last year, CBRC said. WMPs -- popular among individual and corporate investors for their high yields -- have almost tripled in value over the past three years, dominating China’s shadow-banking sector. Regulators have recently stepped up efforts to clamp down on the potential risks.”

April 24 – Bloomberg: “Rising defaults in China are unearthing hidden debt at companies across the country. Small firms that can’t get loans by themselves have been winning banks over by getting other companies to guarantee their borrowings. The companies making those pledges exclude them from their balance sheets, leaving creditors in the dark. Borrowers often extend the guarantees for each other, raising the risk that failures could ricochet, at a time when increasing borrowing costs have already added to strains. China’s banking regulator has ordered checks of such cross-guaranteed loans, Caixin reported… Scrutiny is mounting after a corn oil producer in the eastern province of Shandong said last month it had guaranteed debt of a neighboring aluminum product manufacturer which is now stuck in a cash crunch. Just days before that, a local government financing vehicle in China’s southwest had to repay an auto parts maker’s loans it had guaranteed after the latter defaulted.”

April 24 – Bloomberg: “A $1.7 trillion source of inflows into Chinese markets has suddenly switched into reverse, roiling the nation’s money management industry and sending local bonds and stocks to their biggest losses of the year. The turbulence has centered on so-called entrusted investments -- funds that Chinese banks farm out to external asset managers. After years of funneling money into such investments, banks are now pulling back in response to a series of regulatory guidelines over the past three weeks that put a spotlight on the risks. Critics have blamed entrusted managers for adding leverage to China’s financial system and reducing transparency. The banks’ withdrawals helped erase $315 billion of stock market value over the past six days and sent bond yields to the highest level in nearly two years…”

April 25 – New York Times (Keith Bradsher): “In China, it’s all about whom you owe. That precise question — who owes what to whom? — shook the Chinese industrial town of Zouping in recent weeks. Some businesses closed. City officials engineered a desperate corporate takeover. An executive was detained by the police. The problem: Local companies had agreed to guarantee hundreds of millions of dollars of one another’s loans. When some of those loans went bad, the impact rippled across the city. Zouping’s plight offers a sobering example of the problems that could lurk within China’s vast and murky debt load. A nearly decade-long Chinese lending spree drove growth but burdened the economy with one of the world’s heaviest debt loads, equal to $21,600 worth of bank loans, bonds and other obligations for every man, woman and child in the country. Debt in China has expanded twice as fast as the overall economy since 2008.”

April 23 – Reuters (Josephine Mason and Yawen Chen): “China's insurance regulator said on Sunday it will ramp up its supervision of insurance companies to make sure they comply with tighter risk controls and threatened to investigate executives who flout rules aimed at rooting out risk-taking. The China Insurance Regulatory Commission said… it had told companies to strengthen controls in 10 areas, including liquidity risk and capital management, and implement 39 measures to stamp out risky investments and behavior.”

April 28 – Bloomberg: “A bond market rout in China has triggered the most bond sales to be canceled in a year. Chinese firms have scrapped 120 billion yuan ($17.4bn) of note offerings so far this month, the most since April 2016, according to Bloomberg-compiled data. China Vanke Co., the nation’s second-biggest residential developer, canceled 3 billion yuan in debt sales scheduled for Wednesday, citing changes in market conditions…”

Europe Watch:

April 24 – Wall Street Journal (William Horobin and Stacy Meichtry): “Centrist Emmanuel Macron and far-right politician Marine Le Pen led the first round of voting in France’s presidential election as voters redrew the political map, placing the European Union at the center of a new divide. Mr. Macron won the first round with 23.8% of the vote, …ahead of Ms. Le Pen with 21.5%. The vote marks a stunning rebuke of France’s mainstream political forces. For more than four decades, a duopoly of conservative and socialist presidents has alternated in the Élysée Palace, squeezing out fringe parties as well as mavericks seeking to end the country’s political and economic sclerosis.”

April 26 – Bloomberg (Jean-Michel Paul): “With such high turnout in Sunday’s first-round presidential vote, one thing that would seem to be working in France is democracy. But a recent survey revealed that 70% of French voters believe that democracy does not work well in France. Only 11% trust political parties and 24% trust the media… In this context, the big question facing the next French president is whether he -- as it almost certainly will be Emmanuel Macron -- can keep the social peace in a country that is seething with divisions and has a long history of airing them on the streets. The signs of pent-up social discontent are everywhere. Some 63% of young French claim to be ready for a ‘large-scale revolt.’ The head of France’s general directorate for internal security warned, in a parliamentary commission deposition last year, that the country was ‘on the verge of civil war.’ The numbers of days lost to strike action is the largest among comparable countries; 40,000 cars are set ablaze annually in France’s often ghettoized suburbs.”

April 28 – Bloomberg (Jana Randow): “Euro-area inflation bounced back to a level in line with the European Central Bank goal and underlying price growth surged, setting up a debate about an exit from unconventional stimulus that may lead to a policy signal in June. Consumer prices rose an annual 1.9% in April after gaining 1.5% in March… Core inflation, a measure that excludes volatile components such as food and energy prices, jumped to 1.2%, the most in almost four years and stronger than anticipated.”

April 24 – Bloomberg (Piotr Skolimowski): “German business sentiment rose to the strongest level in almost six years in a sign that the momentum in Europe’s largest economy is set to continue. The… Ifo institute’s business climate index increased to 112.9 in April from a revised 112.4 in March.”

Global Bubble Watch:

April 25 – Bloomberg: “The Chinese and U.S. stock markets are going in opposite directions. An intensifying crackdown against leverage in Asia’s biggest economy has rocked the hither-to unflappable Shanghai Composite Index over the past week, sending it to a three-month low last session. In the U.S., the largest equity market is embracing a risk rally spurred by the French election, with the S&P 500 Index continuing to build on reflation-trade gains ignited by Donald Trump’s November victory. The divergence means the two markets are the least in tune since August 2008 -- just before the collapse of Lehman Brothers Holdings Inc. unleashed chaos on the global financial system.”

April 25 – Financial Times (Robin Wigglesworth): “There goes the fear – again. Wall Street’s ‘fear gauge’ is heading towards its lowest closing level in three years, after the first round of the French presidential election calmed investor nerves over another populist upset, and US President Donald Trump promised to cut the US corporate tax rate to 15%. The Chicago Board Options Exchange’s Volatility Index, known as Vix…, tracks the prices of short-term options on the S&P 500. It is designed to reflect how turbulent investors think the US stock market will be over the next 30 days.”

April 24 – Bloomberg (Greg Quinn): “Optimism about home prices reached an all-time high in Canada just as policy makers stepped in to curb runaway prices in the country’s largest city. The share of respondents in the weekly Bloomberg Nanos Canadian Confidence Index who see home prices rising in the next six months climbed to 48.5 percent, the most in records back to mid-2008… ‘Bullish sentiment on real estate in Canada continues to drive consumer confidence,’ said Nanos Research Group Chairman Nik Nanos.”

April 26 – Bloomberg (Michael Heath): “Australia’s annual core inflation accelerated last quarter to just shy of the bottom of the central bank’s target range… Slight misses in other inflation gauges pushed the currency a little lower. Quarterly headline CPI rose 0.5% vs estimated 0.6%; annual gained 2.1%...”

Fixed Income Bubble Watch:

April 27 – Bloomberg (Tom Beardsworth): “Europe’s leveraged loan market is on pace for the busiest year since the financial crisis as borrowers take advantage of investor demand for income that moves with benchmark rates. Companies… have agreed about 56 billion euros ($61 billion) of leveraged loans in Europe this year… That’s the most for the same period since 2013 and set for the biggest annual total since 2007 if the pace continues.”

Federal Reserve Watch:

April 24 – Bloomberg (Matthew Boesler): “The so-called neutral U.S. interest rate fell in the final three months of 2016, according to a widely-cited estimate produced by Fed economist Thomas Laubach and San Francisco Fed President John Williams. The theoretical rate -- which is adjusted for inflation and would neither stimulate nor restrict an economy growing on trend -- declined to roughly zero from 0.2%. The drop, which reverses a slightly rising trend in the last three quarters, suggests the Fed may not be providing as much stimulus as officials previously thought. Its benchmark rate, adjusted for core inflation, is currently -0.8%.”

U.S. Bubble Watch:

April 25 – Bloomberg (Sid Verma): “Markets are taking sides when it comes to the direction of the U.S. economy. In the green corner are stocks. The Standard & Poor’s 500 index is just 0.2% away from a record high reached in March on bets that Donald Trump’s administration will push through tax-code changes to spark growth. In the red corner sit U.S. government bonds, where benchmark 10-year Treasury yields have unwound almost half of their post-election increase, suggesting a far more pessimistic view the economy. ‘The increasing divergence between global equity market performance and bond markets has raised questions as to whom is right,’ Jefferies… analysts led by Sean Darby wrote…”

April 26 – Wall Street Journal (Laura Kusisto): “The U.S. housing market’s red-hot recovery from the depths of the crash five years ago is fueling concerns among economists and real-estate brokers that home prices are overheating. A dearth of new construction and strong demand from buyers are pushing up prices twice as fast as the rate of income growth... The S&P CoreLogic Case-Shiller U.S. National Home Price Index… showed that in February home prices rose 5.8% from the same month a year earlier. That put prices nearly 40% above their level at the bottom of the housing crash in February 2012. At the same time, incomes rose 3% in February from the same month a year earlier, and are up 12% since February 2012… Some local markets have experienced extreme swings. Home prices in San Francisco have vaulted 98% from their low point during the bust and now stand nearly 7% above their earlier record in 2006… In Dallas, home prices have risen by nearly 53% from their low during the recent bust and are now 35.5% above their previous high. In Denver, prices are now 59% above their previous lows and 36.5% above their previous high.”

April 26 – Bloomberg (Vincent Del Giudice and Wei Lu): “America’s working class is falling further behind. The rich-poor gap -- the difference in annual income between households in the top 20% and those in the bottom 20% -- ballooned by $29,200 to $189,600 between 2010 and 2015… Computers and robots are taking over many types of tasks, shoving aside some workers while boosting the productivity of specialized employees, contributing to the gap.”

April 27 – Bloomberg (Charles Stein): “Exchange-traded funds are ‘weapons of mass destruction’ that have distorted stock prices and created the potential for a market selloff, according to the managers of the FPA Capital Fund. ‘When the world decides that there is no need for fundamental research and investors can just blindly purchase index funds and ETFs without any regard to valuation, we say the time to be fearful is now,’ Arik Ahitov and Dennis Bryan… said… The flood of money into passive products is making stock prices move in lockstep and creating markets increasingly divorced from underlying fundamentals, the managers said.”

April 24 – CNBC (Diana Olick): “Spring homebuyers are pounding the pavement at a furious pace, but the pickings are getting ever slimmer. Even as more homes come on the market for this traditionally popular sales season, they're flying off fast, with bidding wars par for the course. Home prices have now surpassed their last peak, and at the entry level, where demand is highest, sellers are firmly in the driver's seat. ‘I've been selling real estate for 25 years and this is the strongest seller's market I have ever seen in my entire real estate career,’ said David Fogg, a real estate agent with Keller Williams in Burbank, California. ‘A lot of our sellers are optimistically pricing their homes in today's market, and I have to say in most cases we're getting the home sold anyway.’”

April 24 – Wall Street Journal (Laura Kusisto): “Mortgage rates dropped below 4% for the first time since November, providing more kindling to an already hot housing market as the crucial spring selling season gets under way. The average rate on a 30-year fixed-rate mortgage dropped to 3.97% for the week ended April 20, from 4.08% a week earlier and 4.3% in mid-March… The drop could help encourage buyers who had been put off by rising mortgage rates to dive into the market and prompt others to rush to buy homes before rates rise again. ‘We are in the spring, and people are out looking to buy homes,’ said Len Kiefer, deputy chief economist at Freddie Mac. ‘These low rates are really going to help out with affordability.’”

April 25 – Bloomberg (Michelle Jamrisko): “Home prices in 20 U.S. cities accelerated in the year through February for a fifth month, while nationwide property values also picked up, according to S&P CoreLogic Case-Shiller… 20-city property values index climbed 5.9% from February 2016 (forecast was 5.8%), the fastest since July 2014, after increasing 5.7% in the year through January. National home-price gauge rose 5.8% in the 12 months through February…”

April 25 – Bloomberg (Patricia Laya): “Purchases of new U.S. homes unexpectedly increased in March to an eight-month high, indicating housing demand remained strong at the start of the spring buying season… Single-family home sales increased 5.8% to a 621,000 annualized pace (median forecast… 584,000 rate). The median sale price of a new house rose 1.2% from March 2016 to $315,100. Supply of homes shrank to 5.2 months from 5.4 months.”

April 27 – Wall Street Journal (Laura Kusisto): “For the first time in a decade, more new U.S. households in the first quarter chose to buy homes than to rent, suggesting a long-term decline in homeownership rates might be coming to an end. Some 854,000 new-owner households were formed during the first three months of the year, more than double the 365,000 new-renter households formed during the period, the Census Bureau said… That is the first time since the third quarter of 2006 that the number of new homeowners outstripped that of new renters…”

April 28 – Bloomberg (Sho Chandra): “The U.S. economy expanded at the slowest pace in three years as weak auto sales and lower home-heating bills dragged down consumer spending, offsetting a pickup in investment led by housing and oil drilling. Gross domestic product, the value of all goods and services produced, rose at a 0.7% annualized rate after advancing 2.1% in the prior quarter…”

April 25 – Bloomberg (Josh Mitchell): “Millions of U.S. parents have taken out loans from the government to help their children pay for college. Now a crushing bill is coming due. Hundreds of thousands have tumbled into delinquency and default. In the process, many have delayed retirement, put off health expenses and lost portions of Social Security checks and tax refunds to their lender, the federal government… The problem is the government asks almost nothing about its borrowers’ incomes, existing debts, savings, credit scores or ability to repay. Then it extends loans that are nearly impossible to extinguish in bankruptcy if borrowers fall on hard times.”

April 28 – Bloomberg (Sho Chandra): “U.S. employment costs rose in the first quarter by the most since the final three months of 2007 as both worker pay and benefits accelerated, the Labor Department said… Employment cost index advanced 0.8% (forecast was 0.6%) after a 0.5% gain in the prior three months… Total compensation, which includes wages and benefits, rose 2.4% over the past 12 months.”

April 24 – Bloomberg (Kim Bhasin): “Retailers are filing for bankruptcy at a record rate as they try to cope with the rapid acceleration of online shopping. In a little over three months, 14 chains have announced they will seek court protection, according to… S&P Global Market Intelligence, almost surpassing all of 2016. Few retail segments have proven immune as discount shoe-sellers, outdoor goods shops, and consumer electronics retailers have all found themselves headed for reorganization.”

April 25 – Wall Street Journal (Deepa Seetharaman): “Yahoo Inc. Chief Executive Marissa Mayer is set to reap some $187 million from her shareholdings as a result of the internet company’s sale of its core business to Verizon… The hefty payout comes despite Ms. Mayer’s inability to accomplish what she was hired to do five years ago: revitalize the fading internet icon after its struggles with high employee and executive turnover and declines in ad revenue.”

EM Watch:

April 28 – Bloomberg (Bruce Douglas and David Biller): “Millions of Brazilians were stranded without public transport and faced shuttered banks and schools on Friday as labor unions staged a nationwide strike against President Michel Temer’s reform agenda. Buses and trains were down in several major cities, including Sao Paulo. The access road to airports in Rio de Janeiro and Brasilia were temporarily blocked by protesters but, barring some delays and cancellations, flights around the country continued to operate. Police cordoned off the main avenue crossing government quarters in the nation’s capital Brasilia in anticipation of protests later in the day.”

Geopolitical Watch:

April 26 – AFP: “China has launched its first domestically designed and built aircraft carrier, state media said…, as the country seeks to transform its navy into a force capable of projecting power onto the high seas. Adorned with colourful ribbons, the Type 001A ship ‘transferred from dry dock into the water at a launch ceremony’ in the northeastern port city of Dalian…’”

Friday Afternoon Links

[Reuters] Wall Street slips as weak GDP data weighs

[Bloomberg] Plunge in Election-Related Spending Dents U.S. GDP Growth: Chart

[Bloomberg] Fatter Paychecks Set to Perk Up U.S. Growth as Consumer Rebounds