Friday, June 16, 2017

Weekly Commentary: Peak Stimulus Has Passed

Bloomberg Radio/Television’s Tom Keene, Wednesday June 14, 2017: “Professor, what is the question you want to ask chair Yellen at the press conference here in six minutes?”

Narayana Kocherlakota, former president of the Minneapolis Fed: “I think the question to ask is ‘Why are you continuing to hike rates in such a low inflation environment?’. There doesn’t seem to be any risk to keeping rates low and lots of benefits to it.”

Torsten Slok, chief international economist at Deutsche Bank: “What are their arguments why this move down in inflation is only temporary?”

Bloomberg’s Keene: “Krishna, what do you want to know? Please keep the stock markets up?”

Krishna Memani, chief investment officer of Oppenheimer Funds: “I want to know what would it take for you to get off the path of tightening? What would the data have to show you to get off the path you have set the Fed on?”

Bloomberg’s Keene: “Do you agree with vice chairman Fischer that we are still ultra-accommodative even with the low inflation…?”

Memani: “Yes we are, and there’s no downside because despite ultra-accommodative policies there’s no uptick in inflation. So we can press on the pedal as much as we want without it effecting the economy negatively.”

Bloomberg’s Keene: “Professor, do we have a good understanding of where we are in our technological economy – do you have a belief in the data that the good PhDs at the Fed are coming up with on productivity, on the measurement of price change, on GDP? Do you have faith in the numbers?”

Kocherlakota: “I have faith. It’s definitely a difficult job to be doing – to be measuring productivity in the kind of changing economy that we’re in. But I have faith in that. I look at the data, I try to keep track of not just what’s going on at the aggregate level but individual price changes and I think we’re living in a low inflation world and that gives the Fed a lot more room to stay accommodative.”

Bloomberg’s Scarlet Fu: “Is there any central bank that's doing it right, Torsten? You’re an international economist. Is the ECB doing it better? Is the BOE doing better? Is the Bank of Canada doing it better?”

Slok: “There are important nuances, but I actually think that central banks have done extremely well. They have supported the economy as good as they can; they have invented new tools and instruments. We can debate if they were the right tools at the right time - the right dose. But I still will argue, at the end of the day, that what else should they have done, if we had been sitting in their chairs? I think we would have done the same thing. You can’t invent new tools and [do] Monday morning quarterbacking again without having another framework that's better. This has proven again and again that this was the right way to look at. And you need to come up with some other reason or some other model, and there really is no convincing model other than what the Fed is saying.”

It’s not as if we don’t learn from history. It’s just that more recent history has such a predominant effect on our thinking and perspectives. Nowhere is this truer than in the financial markets.

It’s been going on nine years since the “worst financial crisis since the Great Depression.” We’re now only two months from the 10-year anniversary of the Fed’s August 17, 2007 extraordinary measures: “To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 bps reduction in the primary credit rate to 5-3/4%.”

This extraordinary inter-meeting response to a faltering market Bubble marked the beginning of unprecedented global central bank stimulus that continues to this day. It’s worth noting that the Fed’s August 2007 efforts did somewhat prolong the Bubble. The S&P500 traded to a then record 1,562 on October 12, 2007 (Nasdaq peaked in November). Extending “Terminal Phase” mortgage finance Bubble excess, 30-year mortgage rates dropped below 5.7% by early-2008, down about 100 bps from early-August 2007. And trading at about $72 a barrel in August, crude oil then went on a moonshot to surpass $140 by June 2008.

Memories of the devastating effects of Credit and asset Bubbles have faded from memory. The disastrous aftermath of the Fed aggressively stimulating mortgage Credit - as the centerpiece of its post-“tech” Bubble reflation strategy - has been wiped away by the cagey hand of historical revisionism. The consequences of loose financial conditions – i.e. speculation, malinvestment, maladjustment, deep structural economic impairment, financial system fragility, wealth redistribution – no longer even merit consideration. Instead, it’s accepted as fact that central bank stimulus has been a huge and undeniable success. With inflation so low, central banks “can press on the pedal as much as we want without it effecting the economy negatively.” “There doesn’t seem to be any risk to keeping rates low and lots of benefits to it.” This never has to end.

These folks are “charlatans” and “monetary quacks”, terminology pulled from analysis of the long and sordid history of monetary booms and busts. Today's central bankers are destroying the sanctity of money with no meaningful pushback. And while they risk calamity, pundits claim there’s little risk in zero rates and creating Trillions of new “money.” So long as securities prices are high, all must be well in the markets and with policy.

I am reminded of a parable coming out of the late-eighties commercial real estate boom and bust. A developer walks into a bank hoping for a loan to finance a wonderful new development idea. The loan officer thinks to herself, “This guy is a visionary and surely must know what he’s doing or he wouldn’t be here.” Sitting across the table from the loan officer, the developer is thinking “she’s a whiz with the numbers and wouldn’t think of lending me a dime if this plan doesn’t make financial sense.” So the relationship is cemented, the loan is made and everyone is happy – for a while.

These days, securities markets have raged on the notion of “enlightened” central bank monetary management. Meanwhile, central bankers have viewed robust markets as validation of the ingenuity of both their measures and overall policy frameworks. Everyone is happy - for now.

The crisis put the fear of God into Central bankers back in 2008/09 – and there have been a few unnerving reminders since. It’s difficult to believe most buy into the notion that low inflation ensures there’s little risk associated with sticking with extreme accommodation. Surely they’re familiar with the history of the late-twenties. And I believe there is a consensus view taking shape within the global central banker community that monetary policy should be moving in the direction of normalization. The Fed raised rates Wednesday, and the week was notable as well for less than dovish comments out of the Bank of England and Bank of Canada. And while the Bank of Japan left monetary policy unchanged, there has been a recent notable reduction in the quantity of bonds purchased. This week also saw Finance Minister Schaeuble (among other German officials) urging the ECB to prepare to reverse course.

I do think central bankers would prefer to remove some accommodation – and they won’t this time around be as disposed to flinch at the first sign of a market hissy fit. The Fed has now raised the fed funds rate four times, and financial conditions are as loose as ever. Securities markets have grown convinced that central bankers will not tighten policy to the point of meddling with the great bull market. Such market assurance then works to sustain loose financial conditions, a backdrop that will prod central bankers to move forward with accommodation removal.

I believe passionately in the moral and ethical grounds for sound money. It is a policy obligation at least commensurate with national defense. From my perspective, one can trace today’s disturbing social, political and geopolitical circumstance right back to the consequences of decades of unsound “money” and Credit. At this point, downplaying the risks of ultra-loose central bank policy measures is farcical.

Beyond morality and ethics, there are a more concrete practical issues that seems to escape conventional analysts. Desperate central bankers resorted to a massive “money printing” (central bank Credit) operation at the very heart of contemporary finance. Not surprisingly, years later they remain trapped in this inflationary gambit. They have manipulated interest rates, imposed zero rates on savings and forced savers into the risk markets. After nurturing a $3.0 TN hedge fund industry, monetary policymaking then promoted at $4.0 TN ETF complex. Near zero rates have accommodated an unprecedented expansion of global government and government-related debt. In China, ultra-loose global finance helped push a historic Bubble to unbelievable extremes.

History will look back at these measures as a most regrettable end game to a runaway multi-decade Credit and financial Bubble. When confidence wanes – in the moneyness of electronic central bank “money”; in the ability of central banks to manipulate market yields and returns; in the perception of money-like liquid and low-risk equities and corporate debt; in China – global policymakers will have lost the capacity to control financial and economic developments. It was a epic mistake to embark on almost a decade of central bank liquidity injections to reflate and then backstop global securities markets. To believe that structurally low consumer price inflation justifies ongoing aggressive monetary stimulus is foolhardy.

We’ve entered a dangerous period for the securities markets. Highly speculative markets have diverged greatly from underlying economic prospects. Unstable markets have been fueled by central bank liquidity and the belief that central bankers will not risk removing aggressive stimulus. At the minimum, there is now considerable uncertainty regarding the remaining two main sources of global QE (ECB and BOJ) out past a few months. Meanwhile, the Fed continues on a path of rate normalization, a course other central banks expect to follow. The monetary policy backdrop is in the process of changing. Peak Stimulus Has Passed.

Bull markets create their own liquidity. Especially late in the cycle, speculative leveraging spawns self-reinforcing liquidity abundance. Even with a diluted punch bowl, the party can still rave for a spell. Yet these days the changing backdrop significantly boosts the odds that the next risk-off episode sparks a problematic liquidity issue. It’s been awhile since the markets experienced de-risking/de-leveraging without the succor of a powerful QE liquidity backdrop.

According to JPMorgan’s Marko Kolanovic (via zerohedge), an incredible $1.3 TN of S&P500 options expired during Friday’s quarterly “quad witch” expiration. I have always been of the view that derivative trading strategies played a prevailing role in the final speculative blow-off in the big Nasdaq stocks back in Q1 2000. Coincidence that the Nasdaq 100 (NDX) peaked around March 2000 “triple witch” option expiration? After trading at a record high 4,816 on March 24, 2000, the NDX sank below 1,100 in August 2001 before hitting a cycle low 795 on October 8, 2002. Let this be a reminder of how quickly euphoria can vanish; how abruptly greed is transformed into fear; and how rapidly company, industry and economic fundamentals deteriorate when Bubbles burst.

The S&P500 traded to new all-time highs Wednesday, before a resumption of the technology selloff pressured major indices lower. After trading above 12 on Monday and Wednesday, the VIX retreated into Friday’s close (10.38). Such a low VIX reading doesn’t do justice to the volatility that is coming to life below the market’s veneer. The bank stocks (BKX) traded as high as 94.85 at Monday’s open and then retreated to a low of 93.24 before lunch, then traded to 94.93 Tuesday morning and then to 92.59 mid-session Wednesday - before rallying back to 94.78 Thursday and concluding the week at 93.94. The NDX traded as low as 5,633 Monday, then rallied to 5,774 Wednesday’s then as low as 5,635 early-Thursday - before closing the week down 1.1% at 5,681.

Thursday trading was the most interesting of the week. At one point, the S&P500 was approaching a 1% decline, with larger losses for the broader indices. The NDX was down as much as 1.6%. Yet despite weak equities, Treasury yields were grinding higher (up 4bps for the session). Both investment-grade and high-yield bonds were under modest selling pressure. Meanwhile, the currencies were trading wildly. The yen reversed abruptly lower, trading in an almost 2% range during the session. It was a market day that seemed to provide an inkling of what a more generally problematic de-risking episode might look like. But it was not to be this time, not with “quad witch” approaching. A significant amount of market “insurance” (put options) purchased over the past month (Trump/Comey/investigation uncertainties) expired worthless.

Returning to earlier, “There doesn’t seem to be any risk to keeping rates low…”, I would point directly to the incredible explosion in options trading (thought it was enormous before!). The VIX is indicative of one of the more conspicuous market distortions nurtured by low rates and central bank liquidity backstops. Anyone not seeing derivatives markets - the epicenter of central bank-induced risk misperceptions and price deviance - as one gigantic accident in the making hasn’t been paying attention.

Clearly, the (distorted) low cost of “market insurance” promotes destabilizing risk-taking and speculative leveraging. Moreover, derivative-related market leverage – in sovereign debt, corporate Credit, equities and commodities – is surely instrumental in what has evolved into a self-reinforcing global liquidity and price Bubble. Furthermore, these dynamics are integral to what has evolved into a major divergence between ultra-loose financial conditions in the markets and a central bank preference for marginally less accommodation.

I have little confidence that central bankers are on top of market developments. I do, however, suspect that they have become increasingly concerned by the markets’ general disregard for economic fundamentals and policy normalization measures. Central bankers over recent years have grown increasingly confident in their extraordinary control over securities markets. At least from the Fed’s vantage point, there must be some reflecting that perhaps markets have left them behind. Fed officials still talk the inflation and employment mandate along with “data dependent.” But they’ve now got at least one eye fixed on the markets.

In contrast to Dr. Kocherlakota, I doubt central bankers have a “good understanding of where we are in our technological economy.” There must be some nagging feelings creeping in – “Are we even measuring GDP correctly? Ditto productivity? Inflation dynamics have changed profoundly – so what effect do our policies really exert these days on consumer prices? Are our economic models even valid? It’s increasingly difficult to maintain faith in what we’ve been doing – this monetary experiment...”

In a period of such profound uncertainties, there’s one thing that is certain by now: central bank accommodation exerts powerful inflationary effects upon securities and asset prices. And for the first time in a while, unstable asset market Bubbles pressure central bankers to remove accommodation. Sure, they don’t want to be in the Bubble popping business, though when it comes to market Bubbles the sooner they pop the better. Surreptitiously, tremendous amounts of structural damage occur during late-cycle excess. Markets are indicating an initial recognition of structural issues.

For the Week:

The S&P500 was little changed (up 8.7% y-t-d), while the Dow increased 0.5% (up 8.2%). The Utilities jumped 1.6% (up 10.9%). The Banks were about unchanged (up 2.1%), while the Broker/Dealers added 0.7% (up 8.9%). The Transports gained 0.9% (up 4.1%). The S&P 400 Midcaps slipped 0.2% (up 5.6%), and the small cap Russell 2000 declined 1.1% (up 3.7%). The Nasdaq100 fell 1.1% (up 16.8%), and the Morgan Stanley High Tech index lost 0.8% (up 20.4%). The Semiconductors dropped 2.1% (up 17.7%). The Biotechs gained 0.9% (up 20.1%). With bullion down $13, the HUI gold index dropped 5.2% (up 2.1%).

Three-month Treasury bill rates ended the week at 99 bps. Two-year government yields slipped two bps to 1.32% (up 13bps y-t-d). Five-year T-note yields dipped two bps to 1.74% (down 18bps). Ten-year Treasury yields fell five bps to 2.15% (down 29bps). Long bond yields dropped eight bps to 2.78% (down 29bps).

Greek 10-year yields sank 32 bps to 5.63% (down 141bps y-t-d). Ten-year Portuguese yields dropped 10 bps to 2.92% (down 83bps). Italian 10-year yields fell 10 bps to 1.99% (up 17bps). Spain's 10-year yields added a basis point to 1.46% (up 8bps). German bund yields increased one basis point to 0.28% (up 7bps). French yields declined two bps to 0.63% (down 5bps). The French to German 10-year bond spread narrowed three to 35 bps. U.K. 10-year gilt yields added a basis point to 1.02% (down 22bps). U.K.'s FTSE equities index declined 0.8% (up 4.5%).

Japan's Nikkei 225 equities index slipped 0.3% (up 4.3% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.056% (up 2bps). France's CAC40 dipped 0.7% (up 8.2%). The German DAX equities index declined 0.5% (up 11.1%). Spain's IBEX 35 equities index dropped 2.0% (up 15%). Italy's FTSE MIB index declined 0.9% (up 8.9%). EM equities traded lower. Brazil's Bovespa index fell 0.9% (up 2.3%), while Mexico's Bolsa added 0.3% (up 7.8%). South Korea's Kospi lost 0.8% (up 16.5%). India’s Sensex equities index declined 0.7% (up 16.6%). China’s Shanghai Exchange fell 1.1% (up 0.6%). Turkey's Borsa Istanbul National 100 index declined 0.8% (up 25.7%). Russia's MICEX equities index sank 3.2% (down 18.4%).

Junk bond mutual funds saw inflows of $198 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates increased two bps to 3.91% (up 37bps y-o-y). Fifteen-year rates gained two bps to 3.18% (up 37bps). The five-year hybrid ARM rate rose four bps to 3.15% (up 41bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.00% (up 33bps).

Federal Reserve Credit last week declined $5.5bn to $4.428 TN. Over the past year, Fed Credit slipped $3.9bn. Fed Credit inflated $1.617 TN, or 58%, over the past 240 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $11.8bn last week to $3.270 TN. "Custody holdings" were up $32bn y-o-y, 1.0%.

M2 (narrow) "money" supply last week declined $11.7bn to $13.508 TN. "Narrow money" expanded $747bn, or 5.5%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits fell $36.7bn, while Savings Deposits rose $23.4bn. Small Time Deposits added $1.7bn. Retail Money Funds slipped $2.3bn.

Total money market fund assets fell $25bn to $2.634 TN. Money Funds fell $72.9bn y-o-y (2.7%).

Total Commercial Paper dropped $28.2bn to $969bn. CP declined $75bn y-o-y, or 7.2%.

Currency Watch:

The U.S. dollar index slipped 0.1% to 97.164 (down 5.1% y-t-d). For the week on the upside, the Canadian dollar increased 2.0%, the Mexican peso 1.5%, the Australian dollar 1.3%, the South African rand 1.0%, the New Zealand dollar 0.6%, the Norwegian krone 0.5%, the British pound 0.3%, the Singapore dollar 0.1% and the Brazilian real 0.1%. For the week on the downside, the South Korean won declined 1.0%, the Japanese yen 0.5% and the Swiss franc 0.4%. The Chinese renminbi declined 0.18% versus the dollar this week (up 1.97% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 1.5% (down 8.6% y-t-d). Spot Gold lost 1.0% to $1,254 (up 8.8%). Silver sank 3.3% to $16.66 (up 4.3%). Crude dropped $1.09 to $44.74 (down 17%). Gasoline fell 3.1% (down 13%), while Natural Gas was little changed (down 19%). Copper dropped 2.7% (up 3%). Wheat surged 4.7% (up 18%). Corn gained 1.1% (up 11%).

Trump Administration Watch:

June 14 – Politico (Rachel Bade and Sarah Ferris): “House GOP efforts to write a fiscal 2018 budget are deadlocked amid Republican infighting, a divide that threatens to undermine President Donald Trump’s agenda by stalling tax reform and delaying progress on appropriations. The House Budget Committee is months behind its usual timeline in releasing and marking up its annual fiscal blueprint. While the panel said it hoped to release the budget by early June, conference-wide bickering over priorities and spending levels have all but ground the process to a halt.”

June 13 – Reuters (Pete Schroeder and Lisa Lambert): “The U.S. Treasury Department unveiled a sweeping plan… to upend the country's financial regulatory framework, which, if successful, would grant many items on Wall Street's wishlist. The nearly 150-page report suggested more than 100 changes, most of which would be made through regulators rather than Congress, Treasury Secretary Steven Mnuchin said… ‘We were very focused on, what we can do by executive order and through regulators,’ he said. ‘We think about 80% of the substance in the report can be accomplished by regulatory changes, and about 20% by legislation.’ Republican President Donald Trump has gradually been nominating heads of financial agencies to carry out his agenda…”

China Bubble Watch:

June 14 – Bloomberg: “China’s broadest measure of new credit slowed in May as policy makers moved to contain excessive borrowing, while M2 money supply increased at the slowest pace on record. Aggregate financing stood at 1.06 trillion yuan ($156bn)…, versus a median estimate of 1.19 trillion yuan… and 1.39 trillion yuan in April. New yuan loans rose to 1.11 trillion yuan, compared to the estimated 1 trillion yuan. The broad M2 money supply increased 9.6%, versus the 10.4% forecast…”

June 14 – Wall Street Journal (Anjani Trivedi): “China’s banking regulator should know better by now: loosen the reins and debt soon piles up. While Beijing is carrying out a high-profile campaign to reduce leverage in its financial markets with one hand, with the other it is encouraging more potentially reckless borrowing. This week, the regulator put pressure on the country’s big banks to lend more to small companies and farmers, while the government announced tax breaks for financial institutions that lend to rural households… If the goal of lending to poorer customers sounds noble, the concern is that the execution will only worsen Chinese banks’ existing problems, namely high levels of bad loans and swaths of mispriced credit. Bank lending to small companies is already growing pretty fast, with non-trivial sums involved: It jumped 17% in the year through March to 27.8 trillion yuan ($4.084 trillion). That compares favorably with the 7% rise in loans to large- and medium-size companies over the same period.”

June 14 – Bloomberg: “Only a year ago he was hailed as one of the boldest dealmakers in China. But on Wednesday, with scant explanation, Wu Xiaohui was said to be unable to perform his duties as chairman of Anbang Insurance Group Co… The development added another layer of intrigue to the story of Anbang, whose overseas acquisition spree has slowed in recent months amid increased scrutiny at home and abroad. China’s central bank was said to look into suspected breaches of anti-money laundering rules at the insurer late last year, while authorities temporarily banned Anbang’s life insurance unit from selling new products in May. High-profile bids for American hotels, insurance assets and a Manhattan office tower owned by the family of U.S. presidential adviser Jared Kushner have all fallen through over the past 18 months.”

June 14 – Bloomberg (Keith Zhai and Ting Shi): “China’s billionaires are learning yet again that wealth and power are no longer enough to keep them out of trouble. Anbang Insurance Group Co. said… that Wu Xiaohui -- its chairman, and one of China’s most aggressive overseas dealmakers -- was unable to perform his duties for personal reasons. Caijing Magazine, a reputable finance and business publication, said he was taken away for questioning. Wu is the latest example of the new reality in Xi Jinping’s China: Almost anyone could be hauled away at any time, regardless of cash or connections. Since Xi became party chief in 2012, billionaires and senior Communist Party members alike have been among those rounded up for questioning over corruption, financial crimes or other misdeeds.”

June 12 – Reuters (Stella Qiu and Jake Spring): “Chinese auto sales slipped in May from a year ago, registering two straight months of declines for the first time since 2015, with the automakers' association saying the weakness may drag on as the rollback of a tax incentive continues to hurt. The world's biggest auto market got a shot in the arm in 2016, growing at its fastest pace in three years, after Beijing halved the purchase tax on smaller-engined vehicles. But buyers have shied away since taxes climbed to 7.5%, from 5%, at the start of this year. Auto sales in China fell 0.1% in May from a year ago to 2.1 million vehicles…”

June 13 – Bloomberg (Kana Nishizawa): “The Hong Kong dollar may be sliding into the weak end of its trading band, yet money managers see no reason for stock investors to turn bearish just yet. Unlike previous bouts of weakness in the pegged currency… this time around there’s plenty of liquidity in the system, and no shortage of buyers. Foreign and mainland Chinese investors alike have been piling into Hong Kong-listed shares, lifting the benchmark index to a two-year high last week, even as the local currency retreated to a 17-month low.”

Europe Watch:

June 13 – Bloomberg (Rainer Buergin, Birgit Jennen, and Patrick Donahue): “German Finance Minister Wolfgang Schaeuble called for central banks to end ‘ultra loose’ monetary policy to avoid stoking global imbalances, saying that while they were beginning to take steps in that direction it was harder for the European Central bank to do so. ‘The Federal Reserve has already begun this process and even the ECB has made some communications that you could feel that, in a medium-term time, they will continue to think about -- in this direction,’ Schaeuble said… at the Bloomberg Germany G-20 Day conference in Berlin. ‘It’s not easy for the ECB, with all due respect.’”

June 14 – Reuters (Balazs Koranyi and Toby Sterling): “Top critics of the European Central Bank's asset purchase scheme expressed fresh doubts about the effectiveness of the program…, laying down their arguments just as the bank prepares for a debate on extending the measures. With its unprecedented 2.3 trillion euro ($2.6 trillion) bond buying scheme set to run until year's end, the ECB will have to decide this autumn whether to keep on buying to prop up a still weak inflation rate or start winding down the program. Conservative countries led by Germany, the bloc's biggest economy, have long opposed the scheme arguing that its effect is questionable while risks are underestimated… Jens Weidmann, president of the powerful Bundesbank, argued that the ECB, now a top creditor to euro zone governments, is at risk of coming under political pressure because any hint of policy tightening poses the risk of pushing yields higher and blowing a hole in national budgets. ‘At the end of the day, this can lead to political pressure being exerted on the Eurosystem to maintain the very accommodative monetary policy for longer than appropriate from a price stability standpoint,’ Weidmann told a conference…”

Central Bank Watch:

June 11 – Bloomberg: “Investors who fret about when and how global central banks will run down their crisis-era balance sheets can be relaxed about the biggest of them all -- China’s. Whereas the Federal Reserve’s $4.5 trillion asset pile is set to be shrunk and the European Central Bank’s should stop growing by the end of this year as the outlook brightens, China’s $5 trillion hoard is here to stay for the time being -- and could even still expand, according to the majority of respondents in a Bloomberg survey of People’s Bank of China watchers. The PBOC balance sheet is a fundamentally different beast from its global peers -- run up through years of capital inflows and trade surpluses rather than hoovering up government bonds -- but it still matters for the global economy. Changes in the amount of base money in the world’s largest trading nation are having a bigger impact than ever, making the variable key for stability in a year when political transition in Beijing is in the cards.”

June 15 – Reuters (Michael Nienaber): “Germany continued its push against European Central Bank policy…, when a senior member of Chancellor Angela Merkel's conservatives asserted the ECB has damaged the European project with its bond buying programme and could only regain trust by scaling back its ultra-loose monetary policy. The comments by Werner Bahlsen, head of the economic council of Merkel's CDU conservatives, came after Finance Minister Wolfgang Schaeuble… urged the ECB to change its policy ‘in a timely manner’, warning that very low interest rates had caused problems in some parts of the world. Germany is heading towards a federal election in September.”

June 14 – Reuters (Toby Sterling): “The impact of the European Central Bank's 2.3 trillion asset purchase program on inflation has been disappointing, Dutch central bank chief Klaas Knot, a long-time critic of the bond buying scheme, said… The purchases… have taken longer to work than the bank has anticipated. But other ECB officials argue that the benefits are now clear. ‘I think the effect (of asset buys) has been there in keeping the economic recovery going,’ Knot told Dutch lawmakers. ‘But the effect on inflation has just been what you'd call disappointing, full stop…If you look at core inflation... then actually inflation has been flat for four years, flat as a pancake, and so you can barely observe any effect,’ Knot said.”

June 15 – Bloomberg (Fergal O'Brien): “A split among Bank of England policy makers widened this month as two officials joined Kristin Forbes in her call for a rate increase, warning that inflation could rise more than previously thought. In the biggest division on interest rates in six years, the Monetary Policy Committee voted by five members to three to maintain the key interest rate at a record-low 0.25%. Michael Saunders and Ian McCafferty broke ranks to demand an immediate hike to 0.5%.”

June 12 – Bloomberg (Greg Quinn and Maciej Onoszko): “The Bank of Canada offered its strongest signal yet that it’s ready to raise interest rates as the economy gathers steam, in surprise comments that sent the Canadian dollar and bond yields soaring. In a speech Monday, Senior Deputy Governor Carolyn Wilkins highlighted how the nation’s recovery is broadening across regions and sectors, giving policy makers ‘reason to be encouraged.’ She downplayed worries about Toronto’s housing market and said policy makers need to keep their eye on the future evolution of growth, not only current economic conditions.”

Brexit Watch:

June 15 - CNN (Charles Riley): “Britain has three days to figure out its Brexit plan. The U.K. confirmed Thursday that official divorce talks with the European Union will start on June 19. But it's far from clear what its negotiating position will be when they get underway. Last week's general election wiped out Prime Minister Theresa May's parliamentary majority and raised big doubts about her hardline EU exit strategy. May is still trying to secure the support of a fringe party whose votes she needs to form a government, and it won't be clear until next Wednesday whether she commands a majority in parliament. Meanwhile, there is open debate about how Britain should approach talks with the EU, despite a year having passed since voters chose to pull the U.K. out of its most important export market.”

Global Bubble Watch:

June 11 – Bloomberg (Jonas Cho Walsgard): “The best returns are not in the riskiest stocks but in the least risky bonds. But you can’t get them without leverage. That philosophy helped Asgard Fixed Income Fund deliver a 19% return in the past year. ‘That’s the core of our strategy,’ Morten Mathiesen, 45, chief investment adviser at Copenhagen-based Moma Advisors A/S, said… ‘The best risk-adjusted returns are actually the low vol trades.’ …Mathiesen uses a proprietary model to forecast and pick the best risk premiums in short-term, high-quality bond markets. Most of the fund’s bonds are AAA rated, such as Danish mortgage bonds… To offset the interest rate risk the fund hedges the bonds with derivatives and is only exposed to the spread. The spread is usually small so the fund must borrow money to boost the return. Current leverage is about 11 times and has been as high as 25 times, according to Mathiesen. The volatility target is about 6%.”

June 14 – Wall Street Journal (Asjylyn Loder and Gunjan Banerji): “Wall Street’s ‘fear gauge’ has neared all-time lows this year. That hasn’t stopped retail investor Jason Miller from making a nice chunk of change betting it will go even lower. The Boca Raton, Fla., day trader says he has made $53,000 since the start of the year by effectively shorting the CBOE Volatility Index, nicknamed the VIX. That includes a white-knuckle day on May 17, when the VIX spiked 46% following reports that President Donald Trump had pressured former FBI Director James Comey to drop an investigation into former National Security Advisor Michael Flynn. As the 40-year-old Mr. Miller recalls, he rode out the storm, confident the market would revert to its torpid ways—which it did. ‘One person’s fear is another person’s opportunity,’ says Mr. Miller.”

June 11 – CNBC (Stephanie Landsman): “If David Stockman is right, Wall Street should hunker down. ‘This is one of the most dangerous market environments we’ve ever been in. It’s the calm before a gigantic, horrendous storm that I don't think is too far down the road,’ he recently said on ‘Futures Now.’ Stockman, who was director of the Office of Management and Budget under President Ronald Reagan, made his latest prediction after lawmakers grilled former FBI Director James Comey…”

June 14 – Bloomberg (Michael Heath): “Australian employment surged in May, led by a rebound in full-time positions, sending the jobless rate to the lowest level in more than four years. The currency surged. Employment jumped 42,000 from April, when it climbed an upwardly revised 46,100… Jobless rate fell to 5.5%, the lowest since Feb. 2013…”

Fixed Income Bubble Watch:

June 14 – Bloomberg (Luke Kawa and Robert Elson): “Combine the enduring search for yield with a renewed bull market in Treasuries and what do you get? Record high U.S. corporate debt holdings. Stone & McCarthy Research Associates’ weekly survey of fixed-income portfolio managers showed corporate debt allocations at an all-time high of 37%, matching levels last seen in August 2016. Money managers’ holdings of corporate bonds as a share of assets has oscillated between 32% and 37% over the past five years. Survey participants also reported reducing their allocation to Treasuries ahead of this week’s Federal Reserve meeting to 24.2%...”

June 11 – Bloomberg (Michelle Kaske and Steven Church): “Puerto Rico will likely need to fund government operations using sales-tax revenue claimed by warring factions of bondholders unless a legal dispute at the heart of the island’s bankruptcy is resolved by November. The federal oversight board charged with restructuring Puerto Rico’s $74 billion debt asked a judge to let the board appoint two independent agents to help litigate a dispute over who owns cash collected by the government’s sales tax agency…”

June 14 – Wall Street Journal (Ben Eisen): “Move over Benjamin Franklin. It’s all about the euros. American companies sold $107.3 billion of bonds in other currencies in 2017, the most for any comparable period in a decade, according to… Dealogic. U.S. companies have done hefty issuance of euro-denominated debt but have also sold bonds in Canadian dollars and British pounds this year, Bank of America Merrill Lynch data show.”

June 14 – Bloomberg (Carrie Hong and Narae Kim): “Dollar bond deals in Asia are coming so fast and furious that buyers sometimes aren’t getting the chance for a thorough look under the hood. Yet with yields higher than available elsewhere, the pressure is on to buy nevertheless -- a situation that could see problems down the road… That’s the picture emerging from an analysis of the record $137 billion of bonds sold in the U.S. currency in Asia excluding Japan so far this year -- nearly double of what was priced in the same period last year.”

Federal Reserve Watch:

June 14 – Bloomberg (Christopher Condon and Craig Torres): “Federal Reserve officials forged ahead with an interest-rate increase and additional plans to tighten monetary policy despite growing concerns over weak inflation. Policy makers agreed to raise their benchmark lending rate for the third time in six months, maintained their outlook for one more hike in 2017 and set out some details for how they intend to shrink their $4.5 trillion balance sheet this year. In a press conference…, Fed Chair Janet Yellen said the unwinding plan could be put into effect ‘relatively soon’ if the economy evolves as the central bank expects. ‘Near-term risks to the economic outlook appear roughly balanced, but the committee is monitoring inflation developments closely,’ the Federal Open Market Committee said… ‘The committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.’”

June 11 – Wall Street Journal (David Harrison): “The Federal Reserve’s interest-rate increases aren’t having the desired effect of cooling off Wall Street’s hot streak. While Fed officials meeting this week will likely decide to raise short-term interest rates for a fourth time since December 2015, much of that tightening effort has yet to be felt in financial markets, where stocks have rallied to records this year and bond yields have fallen, developments that tend to prompt more borrowing, faster economic growth and more market speculation. The tech-heavy Nasdaq Composite stock index, despite a drop Friday afternoon, is still up 15% as it nears the midyear mark and the S&P 500 index a robust 9% so far in 2017. Yields on 10-year Treasury notes have dropped to their lowest levels since November, meaning borrowing costs are falling for many households and businesses even as the Fed tries to raise them. Broad financial conditions are as accommodative now as they were in early 2015, the point of maximum Fed stimulus, according to a closely watched Goldman Sachs index…”

June 14 – Bloomberg (Cameron Crise): “The Federal Reserve’s focus on consumer-price inflation, over which it exerts relatively little influence, means it’s ignoring asset prices that are veering dangerously close to bubble territory. The surge in prices this year for virtual currencies such as bitcoin is reminiscent of the technology-stock excess of the late 1990s, and even after a recent selloff, the biggest U.S. tech shares are still up more than 20%. Policy makers could rein in the speculation by speeding up the pace of interest-rate increases…”

June 14 – Bloomberg (Nick Timiraos and Kate Davidson): “The White House is set to launch its search for the next Federal Reserve chief, according to a senior official, and it will be managed by Gary Cohn, the former Wall Street executive who some market strategists believe could be a candidate for the post himself. Officials won’t publicly outline any timetable for their decision or shortlist of candidates. Fed Chairwoman Janet Yellen’s term runs through January… Ms. Yellen’s reappointment isn’t an outcome many observers expect because of Mr. Trump’s fierce criticism of her during the final weeks of last year’s presidential campaign. But his willingness to consider her speaks to the amicable relationship they have forged since Mr. Trump took office, observers say.”

U.S. Bubble Watch:

June 14 – Bloomberg (Sho Chandra): “U.S. retail sales fell in May by the most since the start of 2016, reflecting broad declines in categories including motor vehicles and electronics… Retail sales dropped 0.3% (est. unchanged) after a 0.4% increase in prior month. Sales excluding autos and gasoline were unchanged after a revised 0.5% advance…”

June 14 – Wall Street Journal (Jon Sindreu): “Desperate to increase returns, some of the world’s most conservative investors are taking bigger risks by aping banks and lending directly to companies. In recent years, there has been a surge in investments from pension funds and life insurers into specialist asset managers that lend to midsize firms who can’t get financing from banks… But now the flood of cash is pushing down returns, leading these funds to design riskier and more complex products, while increasing their leverage. Because ultralow interest rates and other monetary stimulus have pushed down yields across markets, pension funds and life insurers have struggled to match their long-dated liabilities. That has encouraged them to chase riskier assets, such as real estate, private equity and now direct lending to companies.”

June 13 – Bloomberg (Julie Verhage): “U.S. stocks are the most overvalued investment in the world. At least that’s what institutional investors say. A record 44% of fund managers polled in a monthly survey from Bank of America Merrill Lynch see equities as overvalued, up from 37% last month. The technology-heavy Nasdaq Composite Index was named the most crowded trade, with 57% of investors saying Internet stocks are expensive and 18% calling them ‘bubble-like.’ Still, analysts caution that these results don’t spell the end of the bull market.”

June 12 – Bloomberg (Luke Kawa): “The severity of the retreat from tech shares Friday can be seen in the amount of cash that fled the group. The Technology Select Sector SPDR Fund, ticker XLK, suffered its worst week of outflows in 18 months, shedding more than $737 million. Friday’s withdrawals of $560.5 million were the most among U.S.-listed equity products, and the third-highest for the ETF since the start of 2015.”

June 14 – Bloomberg (Matt Scully): “Two of the biggest online consumer lenders don’t always check whether borrowers are lying to them, and if they find errors in an application, they may still approve the loan. Prosper Marketplace Inc. doesn’t verify key information like income and employment for around a quarter of the loans it makes, according to documents... LendingClub Corp. said it only verified income about a third of the time for one of the most popular loans it made in 2016… If either lender finds mistakes in a borrower’s application, such as overstated income, they may still go ahead with the loan, according to disclosures…”

June 12 – Wall Street Journal (Kristen Grind): “Brokers willing to learn the lost art of making risky mortgages are in demand again. Brandon Boyd was a high school junior during the financial crisis. Now, the former Calvin Klein salesman is teaching mortgage brokers how to make subprime loans. Mr. Boyd, a 25-year-old account executive at FundLoans in a beach town outside of San Diego, is at the cusp of efforts to bring back an army of salespeople who once powered the mortgage industry and, some say, contributed to the housing crisis.”

June 12 – Bloomberg (Matt Scully): “Subprime auto bonds issued in 2015 are by one key measure on track to become the worst performing in the history of car-loan securitizations, according to Fitch Ratings. This group of securities is experiencing cumulative net losses at a rate projected to reach 15%, which is higher even than for bonds in the 2007, Fitch analysts Hylton Heard and John Bella Jr. wrote… ‘The 2015 vintage has been prone to high loss severity from a weaker wholesale market and little-to-no equity in loan contracts at default due to extended-term lending, a trend which was not as apparent in the recessionary vintages,’ said the analysts, referring to lenders’ stretching out repayment terms on subprime loans, sometimes to over six years, to lower borrowers’ monthly payment.”

Japan Watch:

June 14 – Wall Street Journal (Saumya Vaishampayan and Megumi Fujikawa): “Don’t look now, but Japan’s central bank is slowing its vast bond-buying exercise. The Bank of Japan bought just ¥7.89 trillion ($71.6bn) worth of Japanese government debt last month, according to J.P. Morgan. While that sounds like a lot, it is the least outright buying… since October 2014, when the central bank surprised markets by saying it would increase its asset purchases. The latest figure raises a question: Is the BOJ trying to rein in its ultraloose policies by stealth?”

EM Watch:

June 13 – Bloomberg (Archana Narayanan, Alaa Shahine, and Fiona Macdonald): “Some Qatari banks are boosting interest rates on dollar deposits to shore up liquidity as a Saudi-led campaign to isolate the gas-rich Arab state intensifies, people familiar with the matter said. The lenders are offering a premium of as much as 100 bps over the London interbank offered rate to attract dollars from regional banks… That compares with rates of 20 basis bps over Libor before the feud started on June 5.”

Leveraged Speculator Watch:

June 14 – Bloomberg (Evelyn Cheng): “Short-term investors should sell stocks and get ready for a drop in the market this summer, Jeffrey Gundlach, CEO and CIO of DoubleLine, said… ‘If you’re a trader or a speculator I think you should be raising cash today, literally today. If you're an investor you can easily sit through a seasonally weak period,’ Gundlach said… Gundlach reiterated his expectation for a summer correction in the U.S. stock market, while Treasury yields rise.”

June 13 – Bloomberg (John Gittelsohn): “Investors should be wary as low interest rates, aging populations and global warming inhibit real economic growth and intensify headwinds facing financial markets, according to Bill Gross. ‘Don’t be mesmerized by the blue skies,’ Gross, manager of the Janus Henderson Global Unconstrained Bond Fund, wrote... ‘All markets are increasingly at risk.’”

Geopolitical Watch:

June 13 – Reuters (Idrees Ali and Mike Stone): “U.S. Defense Secretary Jim Mattis said… that North Korea's advancing missile and nuclear programs were the ‘most urgent’ threat to national security and that its means to deliver them had increased in speed and scope. ‘The regime’s nuclear weapons program is a clear and present danger to all, and the regime’s provocative actions, manifestly illegal under international law, have not abated despite United Nations’ censure and sanctions,’ Mattis said… ‘The most urgent and dangerous threat to peace and security is North Korea… North Korea's continued pursuit of nuclear weapons and the means to deliver them has increased in pace and scope.’”

June 10 – Reuters (Maria Kiselyova): “Russia said… it had told the United States it was unacceptable for Washington to strike pro-government forces in Syria after the U.S. military carried out an air strike on pro-Assad militia last month. Russian Foreign Minister Sergei Lavrov relayed the message to U.S. Secretary of State Rex Tillerson… on Saturday initiated by the U.S. side, the Russian Foreign Ministry said…”

June 13 – Reuters (Jim Finkle): “Two cyber security firms have uncovered malicious software that they believe caused a December 2016 Ukraine power outage, they said…, warning the malware could be easily modified to harm critical infrastructure operations around the globe. ESET, a Slovakian anti-virus software maker, and Dragos Inc, a U.S. critical-infrastructure security firm, released detailed analyses of the malware, known as Industroyer or Crash Override, and issued private alerts to governments and infrastructure operators to help them defend against the threat.”