Friday, August 4, 2017

Weekly Commentary: Data and a Carefree Bond Market

July non-farm payrolls gained 209,000 versus estimates of 180,000. June payrolls were revised 9,000 higher to 231,000. It’s worth noting that manufacturing added 16,000 jobs (est. 5,000) in July, the strongest gains since March. So far in 2017, manufacturing employment has been expanding at the briskest pace in years, with y-t-d gains of 82,000 dwarfing comparable 2016’s zero and 2015’s 12,000. The unemployment rate dipped a tenth in July to 4.3%. Unemployment bottomed at 4.4% during the previous cycle low back in 2007. In fact, the unemployment rate has not been lower than the July level since February 2001.

The recent narrative holds that the economy has been in an extended “soft patch”. In general, economic data have somewhat missed expectations. “US Car Sales Continue to Skid, Drop 5.7% in July.” The decline in automobile sales was viewed as confirmation of a slowing manufacturing sector. Ongoing travails in retail also support the view of economic stagnation. The labor participation rate remains a dismal 62.9%.

The narrative of a weakening in both economic activity and inflationary pressures serves the markets well. With Fed funds now near the Federal Reserve’s “neutral rate,” rate normalization has apparently about run its course. Even after Friday’s stronger-than-expected job gains, the market places the probability of another 2017 hike at less than 40%. What could be more bullish than so-called rate “normalization” that avoids any tightening of financial conditions whatsoever? The Carefree Bond Market has been cruising along the PCH with the top down in a slick new autonomous sports car.

It’s my view that U.S. and global economic maladjustment has become extreme after years of policy-induced monetary disorder. The U.S. economy is structurally unsound, though this grim reality remains well-masked by the artistry of low rates, liquidity over-abundance, inflated securities markets and record household net worth. More succinctly, deep structural impairment ensures central bankers remain wedded to loose financial conditions.

On a more cyclical basis, however, economic activity is not that weak. Data aggregation definitely smooths an extraordinarily unbalanced economy, with some segments booming and others mired in stagnation. And, importantly, ongoing monetary stimulus will do anything but resolve imbalances and structural maladjustment. At this point in the cycle – after nine years of historic monetary stimulus - the Fed should focus policy attention on cyclical indicators and err on the side of reducing accommodation. There are perilous risks associated with pushing a structurally marred economic system to the limits.

July average earnings were up 0.3% m-o-m, with one-year gains of 2.5%. Tepid wage growth is viewed as a major factor keeping inflation (CPI) stubbornly below the Fed’s 2.0% target. Yet stagnant wages are clearly a structural issue. U.S. manufacturing workers must compete against labor from around the globe. Less appreciated, the massive U.S. service sector – that flourished in the backdrop of deindustrialization, aggressive monetary stimulus and asset inflation – has created tens of millions of low skill jobs. Moreover, it is increasingly difficult for the overbuilt service sector (i.e. retail, restaurant, hotels, etc.) to afford higher compensation expenses. And let’s not forget the enormous cost – and ongoing inflation – in healthcare and insurance.

Over recent months, there has been some focus on the divergence between robust “soft” and lagging “hard” data. The Bloomberg Consumer Comfort Index rose last month to 49.6, a level just below the previous cycle peak in 2006/07. One must go all the way back to 2001 to beat 2017 readings for the Bloomberg Weekly National Economy Index. July’s 113.4 reading for the University of Michigan Current Economic Conditions Index was the highest since July 2005 - and the second highest going all the way back to November 2000. Last month’s 147.8 reading for the Conference Board Consumer Confidence Present Situation Index was the highest since July 2001. The CEO Confidence Index has declined only slightly from the March level - which was the highest going back to December 2004.

These various confidence indices - in conjunction with a 4.3% unemployment rate and stock prices surging further into uncharted record territory - would have traditionally been viewed as indications of loose monetary conditions. But the Yellen Fed has hung its hat on the consumer price index (and, to a lesser extent, wage growth). And it matters little to the Fed that inflation is clearly a global structural issue – one arguably associated with a prolonged period of monetary mismanagement.

And it’s not as if “hard” data is all that weak. July’s 56.3 reading in the PMI Manufacturing Index compares to 52.3 from one year ago. Looking back to 2007, the high that year was 52.6 – with the 2006 peak (February) at 55.8. June Durable Goods Orders (up 6.5%) surprised on the upside. And Q2 GDP rose to 2.6%, up from Q1’s 1.2%. The Atlanta Fed forecasts 4% Q3 GDP growth.

And despite all the talk of heightened disinflationary pressures, the ISM Manufacturing Price Index jumped seven points in July to 62. The ISM Non-Manufacturing Price index rose 3.6 points in July to 55.7. Crude and most commodities have rallied sharply over the past six weeks, certainly bolstered by dollar weakness.

A lot of attention has been paid recently to weakening auto sales. July sales were reported at a weaker-than-expected (seasonally adjusted and annualized) 16.69 million units. This compares unfavorably to the year ago pace of 17.75 million. But before we get too carried away, sales averaged 16.35 million annualized during the 2006-2007 period. In fact, July sales were just slightly below the monthly average from the eight-years 2000-2007. Sure, sales have moderated from the 2015-2016 boom – a period stoked by booming subprime lending. But, for now, I don’t see the slowing auto sector as part of a general downturn in economic activity.

Housing starts jumped back in June to a stronger-than-expected 1.215 million pace. This was the strongest reading since February and compares to the year earlier 1.190 million. Over recent months, housing starts have been running at the strongest level since 2007. Building permits also popped higher in June. Existing Home Sales are running at the highest level since early 2007. At $263,800, June Median Existing Home Prices were a record and compare to the year ago $247,600. The supply of inventory at 4.3 months of sales, while up from January’s extreme 3.5 reading, remains significantly below the average 6.0 months over the period going back to 1999. The Case-Shiller National Price index increased to a record 190.61 in May (up 5.6% y-o-y).

Friday’s smaller-than-expected Trade Deficit was the result of a 1.2% m-o-m jump in exports (up 5.8% y-o-y), to the strongest level since December 2014. U.S. exports have recovered strongly from the 2015/16 pullback, reflecting a global trade revival. The jump in U.S. exports is consistent with recent data from China, Europe, Japan and elsewhere.

For now, it’s difficult for me to take a negative short-term view on U.S. economic activity so long as the housing and export sectors continue to boom. It’s remains a Bubble Economy and, while vulnerable, the Bubble is still expanding.

At this point, the bond market is content to disregard a lot of data, that is, so long as there are no upside surprises in consumer price indices or wages (the two data sets stuck deepest in the structural muck). This works to keep market yields artificially depressed – and mortgage rates extraordinarily low. With after-tax borrowing costs remaining significantly below the rate of housing appreciation (in many areas), the backdrop is favorable for a strengthening of an already potent housing market inflationary bias. The unusually low levels of housing inventory – and an expanding list of overheated local markets – coupled with the Fed’s fixation on CPI sow the seeds for Housing Bubble 2.0.

August 1 – Bloomberg (Alfred Liu): “China has made progress in slowing leverage in the economy, but still needs to do more with the total amount of financing expected to rise 13% this year, according to Autonomous Research analyst Charlene Chu. Total outstanding credit is expected to grow to 223 trillion yuan ($33 trillion) by December from 196.8 trillion yuan at the end of 2016, analysis by Chu shows. The estimated increase will be lower than last year’s 19% gain as the government’s campaign against leverage starts to bite, she said. Her estimates are far higher than the latest official figure of 167 trillion yuan in June, which she says doesn’t accurately represent the true state of financing as it doesn’t include items like local government bond issuance and some forms of off-balance sheet lending.”

Charlene Chu is one of the preeminent analysts of Chinese Credit. She currently forecasts almost $4.0 TN of Chinese Credit growth this year, with total Credit approaching 300% of GDP. It’s somewhat of a challenge to be negative on short-term global GDP trends with record Chinese Credit expansion, enormous ongoing global QE and booming securities markets. At the same time, there’s a strong case that we’re getting awfully close to peak QE, peak Chinese Credit and peak global securities Bubble. Things would get more interesting if economic data begins to surprise on the upside, forcing the Fed and other central banks to again rethink the meaning of “normalization”. That would awaken bonds. July payrolls could have been a start.

For the Week:

The S&P500 added 0.2% (up 10.6% y-t-d), and the Dow gained 1.2% (up 11.8%). The Utilities rose 1.3% (up 9.8%). The Banks jumped 2.1% (up 5.9%), and the Broker/Dealers added 0.2% (up 14.2%). The Transports increased 0.5% (up 2.6%). The S&P 400 Midcaps declined 0.6% (up 5.5%), and the small cap Russell 2000 fell 1.2% (up 4.1%). The Nasdaq100 slipped 0.2% (up 21.3%), while the Morgan Stanley High Tech index was unchanged (up 25.4%). The Semiconductors declined 1.2% (up 19.1%). The Biotechs fell 1.0% (up 28.4%). With bullion down $11, the HUI gold index dropped 2.3% (up 5.2%).

Three-month Treasury bill rates ended the week at 105 bps. Two-year government yields were unchanged at 1.35% (up 16bps y-t-d). Five-year T-note yields slipped two bps to 1.82% (down 11bps). Ten-year Treasury yields declined three bps to 2.26% (down 18bps). Long bond yields fell five bps to 2.84% (down 22bps).

Greek 10-year yields rose eight bps to 5.41% (down 161bps y-t-d). Ten-year Portuguese yields fell six bps to 2.87% (down 88bps). Italian 10-year yields dropped 10 bps to 2.02% (up 21bps). Spain's 10-year yields declined four bps to 1.48% (up 10bps). German bund yields dropped seven bps to 0.47% (up 26bps). French yields fell six bps to 0.75% (up 7bps). The French to German 10-year bond spread widened one to 28 bps. U.K. 10-year gilt yields declined four bps to 1.18% (down 6bps). U.K.'s FTSE equities index rallied 1.9% (up 5.2%).

Japan's Nikkei 225 equities index was unchanged (up 4.4% y-t-d). Japanese 10-year "JGB" yields slipped a basis point to 0.065% (up 3bps). France's CAC40 gained 1.4% (up 7.0%). The German DAX equities index recovered 1.1% (up 7.1%). Spain's IBEX 35 equities index gained 1.2% (up 14%). Italy's FTSE MIB index surged 2.4% (up 14%). EM equities were mostly higher. Brazil's Bovespa index rose 2.1% (up 11.1%), and Mexico's Bolsa added 0.2% (up 12.5%). South Korea's Kospi slipped 0.2% (up 18.2%). India’s Sensex equities index was unchanged (up 21.4%). China’s Shanghai Exchange increased 0.3% (up 5.1%). Turkey's Borsa Istanbul National 100 index gained 0.8% (up 38.9%). Russia's MICEX equities index rose 0.8% (down 12.5%).

Junk bond mutual funds saw inflows of $195 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates added a basis point to 3.93% (up 50bps y-o-y). Fifteen-year rates slipped two bps to 3.18% (up 44bps). The five-year hybrid ARM rate declined three bps to 3.15% (up 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down six bps to 4.05% (up 43bps).

Federal Reserve Credit last week declined $9.2bn to $4.426 TN. Over the past year, Fed Credit contracted $8.7bn. Fed Credit inflated $1.615 TN, or 58%, over the past 247 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $8.0bn last week to $3.333 TN. "Custody holdings" were up $113bn y-o-y, or 3.5%.

M2 (narrow) "money" supply last week rose $12.2bn to a record $13.620 TN. "Narrow money" expanded $727bn, or 5.6%, over the past year. For the week, Currency increased $1.4bn. Total Checkable Deposits jumped $55.9bn, while Savings Deposits slumped $44.9bn. Small Time Deposits gained $2.6bn. Retail Money Funds declined $2.9bn.

Total money market fund assets jumped $20.47bn to $2.660 TN. Money Funds fell $78.3bn y-o-y (2.9%).

Total Commercial Paper declined $8.2bn to $969.6bn. CP declined $57bn y-o-y, or 5.5%.

Currency Watch:

August 1 – Financial Times (Jennifer Hughes): “The Hong Kong dollar has fallen to its weakest level since the China-inspired turmoil of January 2016 as abundant liquidity continues to create a widening interest rate gap with the US. The move pushed the Hong Kong currency further into the weaker half of its tightly pegged trading range against the US dollar — in a shift from its position for most of the past decade of trading near the stronger end. Wednesday’s weakness took the currency to HK$7.8171 against the greenback — a level not seen since January 2016 when fears about China’s weakening economy sent shockwaves through global markets.”

The U.S. dollar index recovered 0.3% to 93.542 (down 8.7% y-t-d). For the week on the upside, the euro increased 0.2%. On the downside, the South African rand declined 3.1%, the Canadian dollar 1.7%, the New Zealand dollar 1.4%, the Australian dollar 0.8%, the British pound 0.7%, the Mexican peso 0.6%, the Swiss franc 0.4%, the Norwegian krone 0.4%, the Swedish krona 0.3%, the Singapore dollar 0.3%, and the South Korean won 0.2%. The Chinese renminbi added 0.12% versus the dollar this week (up 3.21% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.5% (down 3.5% y-t-d). Spot Gold declined 0.9% to $1,259 (up 19.2%). Silver dropped 2.7% to $16.252 (up 1.7%). Crude slipped 13 cents to $49.58 (down 8%). Gasoline fell 1.8% (down 2%), and Natural Gas sank 5.7% (down 26%). Copper added 0.3% (up 15%). Wheat sank 5.5% (up 12%). Corn lost 1.8% (up 8%).

Trump Administration Watch:

August 3 – Wall Street Journal (Del Quentin Wilber and Byron Tau): “Special Counsel Robert Mueller has impaneled a grand jury in Washington to investigate Russia’s interference in the 2016 elections, a sign that his inquiry is growing in intensity and entering a new phase, according to people familiar with the matter. The grand jury, which began its work in recent weeks, signals that Mr. Mueller’s inquiry will likely continue for months. Mr. Mueller is investigating Russia’s efforts to influence the 2016 election and whether President Donald Trump’s campaign or associates colluded with the Kremlin as part of that effort.”

August 1 – New York Times (Keith Bradsher): “The Trump administration is preparing a broad move against China over trade, according to people with knowledge of its plans, amid growing worries in the United States over a Chinese government-led effort to make the country a global leader in microchips, electric cars and other crucial technologies of the future. The move, which could come in the next several days, signals a shift by the administration away from its emphasis on greater cooperation between Washington and Beijing, in part because administration officials have become frustrated by China's reluctance to confront North Korea over its nuclear and ballistic missile programs. The two sides have also struggled in trade negotiations despite claiming modest progress earlier this year, while American companies have complained they face pressure to share trade secrets with Chinese partners. The trade case will focus on alleged Chinese violations of American intellectual property, according to three people with a detailed knowledge of the administration's plans.”

July 31 – Wall Street Journal (Gerald F. Seib): “When folks here in Washington end a summer filled with White House hijinks and an epic but inconclusive health-care debate, they will look up and discover something unsettling: The world has become a more dangerous place while everybody has been distracted. That’s most obviously true in North Korea, where its rogue weapons program has leapt so far forward that the nation now has a missile with the range to reach much of the U.S…. Meanwhile, American relations with China, the country most able to cooperate in slowing down Pyongyang, are deteriorating amid presidential recriminations—delivered via Twitter—about Beijing’s behavior. Relations with Russia are sliding backward as well… Both sides agree that ties now are at their lowest point since the Cold War.”

July 30 – Wall Street Journal (Siobhan Hughes and Thomas M. Burton): “President Donald Trump’s tumultuous past week has widened rifts in his party, between those who vocally support the president’s combative style and others who bridle at it, according to interviews… Mr. Trump has long been a polarizing force among members of his party, but for the first several months of his tenure, the GOP was largely united by a shared desire to make the most of his election and the party’s total control of the government for the first time in a decade. After a week that included the president attacking his attorney general, the collapse of a GOP health bill, a surprise effort to bar transgender people in the military and a White House staff shakeup, divisions that were largely set aside at the start of 2017 have emerged anew.”

August 2 – Reuters (David Lawder and Lesley Wroughton): “Three top Democratic senators, in a rare show of bipartisanship, on Wednesday urged U.S. President Donald Trump to stand up to China as he prepares to launch an inquiry into Beijing's intellectual property and trade practices in coming days. Senate Democratic leader Chuck Schumer pressed the Republican president to skip the investigation and go straight to trade action against China. ‘We should certainly go after them,’ said Schumer in a statement. Senators Ron Wyden of Oregon and Sherrod Brown of Ohio also urged Trump to rein in China.”

July 30 – Wall Street Journal (Kate Davidson): “Republicans are leaving town for an August recess after a failed attempt to repeal the Affordable Care Act. When they return in September, they’ll have just 12 working days to avert another big problem. In a letter to lawmakers Friday, U.S. Treasury Secretary Steven Mnuchin said the federal borrowing limit, or debt ceiling, needed to be raised by Sept. 29 or the government risked running out of money to pay its bills. The Treasury Department has been employing cash-conservation measures since March, when borrowing hit the formal ceiling of nearly $20 trillion.”

China Bubble Watch:

July 30 – New York Times (Chris Buckley): “China’s president, Xi Jinping, has opened a public campaign to deepen his grip on power in a coming leadership shake-up, using a huge military parade on Sunday, speeches and propaganda, along with a purge in the past week, to warn officials to back him as the nation’s most powerful leader in two decades. Wearing his mottled green uniform as commander in chief of the People’s Liberation Army, Mr. Xi watched as 12,000 troops marched and tanks, long-range missile launchers, jet fighters and other new weapons drove or flew past in impeccable arrays. Mao famously said political power comes from the barrel of a gun, and Mr. Xi signaled that he, too, was counting on the military to stay ramrod loyal while he chooses a new leading lineup to be unveiled at a Communist Party congress in the autumn.”

August 2 – Bloomberg: “President Xi Jinping’s top economic adviser commissioned a study earlier this year to see how China could avoid the fate of Japan’s epic bust in the 1990s and decades of stagnation that followed. The report covered a wide range of topics, from the Plaza Accord on currency to a real-estate bubble to demographics that made Japan the oldest population in Asia… While details are scarce, the person revealed one key recommendation that policy makers have since implemented: The need to curtail a global buying spree by some of the nation’s biggest private companies. Communist Party leaders discussed Japan’s experience in a Politburo meeting on April 26… State media came alive afterward, with reports trumpeting Xi’s warning that financial stability is crucial in economic growth.”

August 1 – BloombergBusinessweek (Kevin Hamlin): “For the past couple of years, Chinese companies roamed the world in an unprecedented $343 billion cross-border takeover spree. Among the splashiest deals: Dalian Wanda Group, whose founder, Wang Jianlin, is China’s second-richest executive, bought Hollywood production and finance company Legendary Entertainment for $3.5 billion in 2016. Anbang Insurance Group bought the Waldorf Astoria. Fosun International Ltd. purchased Club Méditerranée SA and Cirque du Soleil. But as the binge seemed ready to go on, China’s banking regulator in June ordered lenders to scrutinize their exposure to four high-­flying private conglomerates that have announced $75 ­billion-plus in deals at home and abroad since the start of 2016: Dalian Wanda, Anbang, Fosun, and aviation and shipping giant HNA Group Co.”

August 1 – Bloomberg: “China’s crusade against capital outflows and leverage has ensnared some of the nation’s largest property investors, including Anbang Insurance Group Co… The crackdown is rippling across the world, and will likely spur an 84% slump in Chinese overseas property investment this year, and a further 18% drop in 2018, according to… Morgan Stanley. The most vulnerable real-estate markets are those in the U.S., U.K., Hong Kong and Australia, with office properties the most exposed, analysts including economist Robin Xing wrote. Manhattan is a particular worry, with about 30% of transactions in the borough that’s home to Wall Street involving Chinese parties in 2017.”

August 1 – Bloomberg: “China’s foreign-exchange regulator is examining how some of the country’s biggest dealmakers used their domestic assets as collateral to get loans overseas, people familiar with the matter said. The State Administration of Foreign Exchange recently began reviewing loan guarantees for Anbang Insurance Group Co., Dalian Wanda Group Co., Fosun International Ltd., HNA Group Co. and the Chinese owner of the AC Milan soccer team, the people said…”

July 31 – Reuters (Kevin Yao): “China's central bank will continue to force financial institutions to cut debt but ensure the process is smooth and orderly to limit its impact on market liquidity, an assistant central bank governor said… Higher short-term funding costs, driven by a regulatory crackdown on banks' riskier financing, have started to spill over into the real economy, a risk to economic stability ahead of a five-yearly leadership transition later this year. The drive to force financial institutions to deleverage… could affect the stability in market supply and demand of funding, Zhang Xiaohui wrote in the bank's China Finance magazine.”

July 31 – Reuters (Elias Glenn): “Growth in China's manufacturing quickened in July, a private survey showed on Tuesday, as output and new orders rose at the fastest pace since February on strong export sales. But even as firms boosted purchasing in anticipation of more business, employment levels at factories fell at the fastest pace in 10 months and a reading on business outlook was the lowest since last August… The Caixin/Markit Manufacturing Purchasing Managers' Index (PMI) rose to 51.1 in July… well ahead of the 50.4 in June which was also the median figure forecast…”

July 31 – Financial Times (Yuan Yang): “Multinationals in China are bracing to be cut off from the global internet as Beijing begins to shut down their only way of accessing uncensored foreign content. Companies offering virtual private network services, which bypass the country’s ‘Great Firewall’, have had their operations closed or obstructed in recent weeks — a blow to foreign groups that rely on VPN services to connect their staff to services such as Google-provided email and uncensored news. International companies are now preparing for an extended crackdown, according to Carolyn Bigg, senior lawyer at DLA Piper in Hong Kong. ‘The time for businesses to ignore these restrictions is over. The environment is changing weekly at the moment,’ she said.”

August 2 – Financial Times (Gabriel Wildau): “China’s finance ministry has acknowledged that public-private partnerships for infrastructure investment have become a vehicle for ‘disguised borrowing’ by local governments, as Beijing targets systemic risk from rising regional debt. The central government has sought to rein in runaway debt at local governments, a legacy of China’s post-2008 economic stimulus. But local officials have continued to exploit loopholes in local borrowing rules to keep infrastructure projects cashed up. The clampdown on PPP investment could add to growth headwinds for China’s economy. Infrastructure comprised 21.2% of urban fixed-asset investment in the first half — the highest share since 2010.”

July 30 – Financial Times (Louise Lucas and Sherry Fei Ju): “China’s pending regulatory crackdown on the $120bn peer-to-peer lending industry has claimed its first scalp before it has even begun, with one of the biggest players saying it will wind up its business in an industry full of bad loans and no profits. P2P lending, in which borrowers are matched with investors via online platforms, has mushroomed in the past five years, with China boasting more than 2,100 such platforms, but so too have scandals. Last year was marked by multibillion-dollar scams in China and a governance scandal that rocked New York-listed LendingClub. Beijing this month said it would delay regulations that will bar online lenders from guaranteeing principal or interest on loans they facilitate, cap the size of loans at Rmb1m for individuals and Rmb5m for companies, and force lenders to use custodian banks — a requirement only a fraction of the industry has met so far.”

Europe Watch:

July 29 – Reuters (Joseph Nasr): “The European Central Bank should start thinking about how it wants to return to normal monetary policy and when it wants to wind down it bond purchases, governing council member Sabine Lautenschlaeger said… ‘The expansionary monetary policy has both advantages and side effects. As time passes, the positive effects get weaker and the risks increase,’ she told the Mannheimer Morgen newspaper. ‘So it's important to prepare for the exit in good time. What's crucial in that context is a stable trend in the rate of inflation towards our objective of just under 2%. It's not quite there yet.’”

August 1 – Bloomberg (Catherine Bosley): “The euro-area economy expanded apace in the second quarter, a sign the bloc’s upswing is becoming increasingly robust and self-sustaining. Gross domestic product in the 19-country region rose 0.6% in the three months through June, after increasing 0.5% at the start of the year.”

August 3 – Bloomberg (Nikos Chrysoloras): “Public support for the euro rose to a 12-year high among citizens of the currency bloc, according to the… latest Eurobarometer survey… Almost three-quarters of respondents in the poll support the ‘economic and monetary union with one single currency, the euro,’ the highest reading since the fall of 2004. Adding to signs of increasing optimism, against the backdrop of a strengthening economic recovery, 56% of Europeans are now confident about the future of the EU -- an increase of six percentage points from fall 2016.”

Central Bank Watch:

August 3 – Bloomberg (David Goodman and Jill Ward): “Mark Carney said Brexit is casting the biggest shadow over the U.K.’s economic outlook, as his confidence in an orderly departure from the European Union starts to fade. The Bank of England governor’s comments follow slow progress in the initial round of exit talks after Prime Minister Theresa May lost her parliamentary majority in June. Carney said that there’s only so much monetary policy can do as the central bank cut its forecasts for economic growth and wages.”

Global Bubble Watch:

August 4 – Bloomberg (Theophilos Argitis): “Canada’s labor market continued its stellar performance in July, with the jobless rate falling to the lowest since before the financial crisis. The unemployment rate fell to 6.3%, the lowest since October 2008, as the labor market added another 10,900 jobs during the month, Statistics Canada reported from Ottawa. The total increase over the past year of 387,600 is the biggest 12-month gain since 2007.”

August 2 – Bloomberg (Katia Dmitrieva and Erik Hertzberg): “Home prices in Canada’s largest city posted their biggest monthly drop in at least 17 years in July and sales plunged as government efforts to cool the market and the near-collapse of a mortgage lender made buyers leery. The benchmark Toronto property price, which tracks a typical home over time, dropped 4.6% to C$773,000 ($613,000) from June.”

Fixed Income Bubble Watch:

August 2 – Wall Street Journal (Paul J. Davies): “The last financial crisis cleared out an alphabet soup of complex credit products. One type, however, has returned in droves in recent years, although popularity is now threatening their viability. This product is collateralized loan obligations, or CLOs, which buy portfolios of risky, leveraged loans often used by private-equity firms in buyouts. In the U.S., new CLO volumes have outstripped pre-crisis totals since 2014, while Europe is catching up to its previous levels fast. But returns from the loans they buy are getting squeezed as money from retail and institutional investors rushes in alongside CLOs to snap up loans. That could bring CLOs to a painful halt again.”

Federal Reserve Watch:

July 30 – Financial Times (Lena Komileva): “The US Federal Reserve raised rates for the third time in six months in June, even though inflation had stayed below its 2% target for much of the past decade. Why? The justification lies with the return to ‘economic normalisation’ (a more normal US growth and credit cycle), a reflationary global environment and easy financial conditions all combining to banish the extreme ‘tail risks’ of a deflationary slump that followed the financial crisis. Yet markets have been reluctant to heed the call of a return to more normal monetary conditions. Having lagged behind the Fed’s rate tightening and the discussion on shrinking its balance sheet this year, investors are still uncertain about the chances of another — well telegraphed — rate rise this year. A less than 40% probability is attached to this in the fed fund futures market. “

August 2 – Reuters (Richard Leong and Jonathan Spicer): “St. Louis Federal Reserve James Bullard is opposed to further U.S. interest rate increases by the central bank and warned that more hikes could hinder domestic inflation from achieving the Fed's 2-% goal… ‘Given the inflation outlook, which has deteriorated in 2017, I would not support further moves in the near term,’ Bullard told Market News… ‘It's possible data will turn around, but we'll have to see. I think for now we should remain on pause.’”

August 2 – Bloomberg (Christopher Condon): “Federal Reserve Bank of Cleveland President Loretta Mester is keeping the faith that weak inflation will bounce back, even as she lowers her estimate for where unemployment begins to trigger higher prices. ‘My suspicion is it’s the idiosyncratic factors, it’s transitory and that the factors pushing down inflation are going to dissipate over time,’ Mester told reporters… ‘I still have a forecast for a gradual increase in inflation back to 2% over time.’”

August 2 – Wall Street Journal (Nick Timiraos): “Eric Rosengren, president of the Federal Reserve Bank of Boston, said increasingly tight labor markets should keep the U.S. central bank on its path to gradually raise rates and start slowly shrinking its portfolio of bonds and other assets, despite a surprising pause in inflation pressures this spring. In an interview, Mr. Rosengren said he sees ‘some reasonable risk’ that the unemployment rate drops below 4% in the next two years. ‘In my own view, that would not be sustainable,’ he said.”

U.S. Bubble Watch:

August 1 – CNBC (Diana Olick): “Home price gains are accelerating again, and in some cities those values are overheating. Four of the nation's largest cities are now considered overvalued, according to CoreLogic. Home prices in Denver, Houston, Miami and the Washington, D.C., metropolitan area now exceed sustainable levels. To determine if a market is overvalued, CoreLogic compares current prices to their long-run, sustainable levels, which are supported by local economic fundamentals like disposable income… ‘With no end to the escalation in sight, affordability is rapidly deteriorating nationally,’ said Frank Martell, president and CEO of CoreLogic.”

August 1 – Wall Street Journal (Sarah Krouse): “The fortunes of Wall Street’s cheapest and priciest funds are diverging fast. Exchange-traded funds held $1 trillion more in investor money than hedge funds globally for the first time ever at the end of June… Assets in ETFs, which trade on exchanges like stocks, first surpassed the amount of money in hedge funds two years ago and have continued to swell. Market-mimicking funds like ETFs have been helped by fresh market highs… Those gains have prodded investors already losing faith in star stock and bond pickers to plow even more money into the ultra low-cost funds.”

July 31 – CNBC (Fred Imbert): “Investors may be in for disappointing market returns in the decade to come with valuations at levels this high, if history is any indication. Analysts at Goldman Sachs Asset Management pointed out that annualized returns on the S&P 500 10 years out were in the single digits or negative 99% of the time when starting with valuations at current levels. In a chart, they point out that the S&P's cyclically adjusted price-to-earnings ratio (CAPE) is currently around its highest historical levels. CAPE is a widely followed valuation metric developed by Nobel Prize winners John Campbell and Robert Shiller.”

August 1 – CNBC (Tae Kim): “Mutual funds are piling into technology stocks to a record level, according to… Bank of America Merrill Lynch. But the overweighting may not be bullish for the sector going forward. In July ‘large cap active managers have yet again increased their positioning in tech, setting another record overweight of 25% (+5.8 percentage points) relative to the benchmark,’ strategist Savita Subramanian wrote… ‘This record overweight has helped managers beat their benchmarks so far this year, as tech continues to outperform all other sectors.’”

August 1 – Reuters (Joseph White and Paul Lienert): “U.S. carmakers said… they continued to slash low-margin sales to daily rental fleets in July as the overall pace of U.S. car and light truck sales fell for the fifth straight month. The annualized pace of U.S. car and light truck sales in July fell to 16.73 million vehicles, down from 17.8 million vehicles a year earlier…”

July 31 – Wall Street Journal (AnnaMaria Andriotis): “Credit-card losses are mounting, a reversal from a six-year trend that could be a warning sign for markets and the broader economy. The average net charge-off rate for large U.S. card issuers—the percentage of outstanding debt that issuers write off as a loss—increased to 3.29% in the second quarter, its highest level in four years, according to Fitch Ratings. The quarter was also the fifth consecutive period of year-over-year increases in the closely watched rate. All eight large issuers… had increases for the quarter.”

EM Bubble Watch:

August 2 – Wall Street Journal (Julie Wernau and Carolyn Cui): “Investors have been bracing for a Venezuela debt default for more than a year, but fallout from the country’s widely criticized election last weekend could prove to be the tipping point. The government and state-owned oil company Petróleos de Venezuela SA, also known as PdVSA, together owe $5 billion in principal and interest payments due between now and the end of the year… The country has $725 million due this month alone… The problem: Venezuela only has about $3 billion of its foreign reserves in cash, according to S&P Global Ratings. That means the country is dependent on oil exports to make up the difference.”

July 31 – CNBC (Lucia Kassai, Laura Blewitt, and Nathan Crooks): “The specter of tighter U.S. sanctions is pushing up the perception that Venezuela is getting closer to defaulting on its bonds. Venezuela is awaiting possible further restrictions after the U.S., its largest trading partner, sanctioned President Nicolas Maduro after he held elections Sunday for a new assembly that will rewrite the constitution. U.S. Treasury Secretary Steven Mnuchin said in announcing the measures, including freezing Maduro’s assets in the U.S., that additional sanctions were ‘on the table.’”

July 29 – Reuters (Girish Gupta): “In a portend of steepening inflation in crisis-stricken Venezuela, money supply surged 10% in just one week earlier this month, its largest single-week rise in a quarter of a century. Venezuela is undergoing a major economic crisis, with millions suffering food shortages, monthly wages worth only the tens of U.S. dollars, and soaring inflation…”

August 2 – Bloomberg (Jeanette Rodrigues): “Business conditions in India have deteriorated the most since the global financial crisis as the roll out of a nationwide sales tax disrupted supply and distribution links just months after Prime Minister Narendra Modi’s cash ban roiled markets. The Nikkei India Composite PMI Output Index fell to 46 in July from 52.7 in June, the steepest drop since March 2009… Activity in the key services sector plunged to 45.9 from 53.1 -- the lowest since September 2013 -- after data showed manufacturing slumped the most since 2009.”

Leveraged Speculation Watch:

August 3 – Bloomberg (Simone Foxman): “Billionaire Paul Singer is warning of a growing and menacing threat: passive investing. ‘Passive investing is in danger of devouring capitalism,’ Singer wrote... ‘What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.’ Almost $500 billion flowed from active to passive funds in the first half of 2017. The founder of Elliott Management Corp. contends that passive strategies, which buy a variety of securities to match the overall performance of an index, aren’t truly ‘investing’ and that index fund providers don’t have incentive to push companies to change for the better and create shareholder value.”

August 3 – Bloomberg (Nishant Kumar, Javier Blas, and Suzy Waite): “If an oil trader so good that he was known as “God” can’t win in today’s markets, it’s hard to imagine who can. Andy Hall is closing down his main hedge fund after big losses in the first half of the year, according to people with knowledge of the matter. His flagship Astenbeck Master Commodities Fund II lost almost 30% through June… The capitulation of one of the best-known figures in the commodities industry comes after muted oil prices wrong-footed traders from Goldman Sachs Group Inc. to BP Plc’s in-house trading unit.”

August 1 – Bloomberg (Nishant Kumar and Suzy Waite): “Europe is on a mini-streak with hedge-fund investors as the prospect of faster economic growth and fading political risk help restore confidence in the region. Money pools investing across Europe attracted additional capital for the second straight month in June, following a 12-month stretch in which almost $16 billion was pulled out, according to… eVestment. The continent’s success contrasts with Asia and the U.S., where investors have pulled money from hedge funds.”

August 1 – Bloomberg (Saijel Kishan): “Paul Tudor Jones’ investors are increasingly deserting him. The billionaire macro manager who helped give rise to the hedge fund industry saw clients pull about 15% of their assets from his main fund in the second quarter… That’s left client assets at about $3.6 billion, almost half the value a year ago. The withdrawals are a blow to Jones… and exemplify the asset bleed hurting the biggest names in the business, including Alan Howard and John Paulson… Macro hedge funds have posted their worst first half since 2013, losing 0.7%, and on average returned about 1% annually in the past five years, according to Hedge Fund Research Inc.”

Geopolitical Watch:

July 31 – Reuters (Philip Wen and Ben Blanchard): “China loves peace but will never compromise on defending its sovereignty, President Xi Jinping said… while marking 90 years since the founding of the People's Liberation Army. China has rattled nerves around Asia and globally with its increasingly assertive stance in territorial disputes in the East and South China Seas and an ambitious military modernization plan. Relations with self-ruled Taiwan have also worsened since Tsai Ing-wen from the pro-independence Democratic Progressive Party won presidential elections there last year. China considers Taiwan a wayward province, to be brought under Beijing's control by force if necessary.”

August 2 – Financial Times (Emily Feng and Leo Lewis): “Xi Jinping has warned that China will not tolerate any infringement of its sovereignty or territory, in a speech delivered as the country finds itself embroiled in several territorial disputes with neighbours. ‘We will never seek aggression or expansion but we have the confidence to defeat all invasions,’ the Chinese president said in an hour-long speech on the 90th anniversary of the founding of the country’s army. ‘We will never allow any people, organisation or political party to split any part of Chinese territory out of the country.’ His comments came as Japan mounted a formal diplomatic protest to demand that China stop its renewed drilling operations in the East China Sea.”

August 4 – Associated Press: “Beijing is intensifying its warnings to Indian troops to get out of a contested region high in the Himalayas where China, India and Bhutan meet, saying China's ‘restraint has its limits’ and publicizing live-fire drills in Tibet. Indian troops entered the area in the Doklam Plateau in June after New Delhi's ally, Bhutan, complained a Chinese military construction party was building a road inside Bhutan's territory.”

July 31 – Reuters (Ben Blanchard and Elias Glenn): “China hit back on Monday after U.S. President Donald Trump tweeted he was ‘very disappointed’ in China following North Korea's latest missile test, saying the problem did not arise in China and that all sides need to work for a solution. China has become increasingly frustrated with American and Japanese criticism that it should do more to rein in Pyongyang. China is North Korea's closest ally, but Beijing, too, is angry with its continued nuclear and missile tests.”

July 29 – Reuters (James Pearson and Michelle Nichols): “The United States flew two supersonic B-1B bombers over the Korean peninsula in a show of force on Sunday and the U.S. ambassador to the United Nations said China, Japan and South Korea needed to do more after Pyongyang's latest missile tests. North Korea said it conducted another successful test of an intercontinental ballistic missiles (ICBM) on Friday that proved its ability to strike America's mainland, drawing a sharp warning from U.S. President Donald Trump. Trump's ambassador to the United Nations Nikki Haley said… that the United States was ‘done talking’ about North Korea, which was ‘not only a U.S. problem.’”

July 29 – Reuters (Babak Dehghanpisheh): “The Iranian Revolutionary Guards said… that U.S. Navy ships came close to their vessels in the Gulf and shot flares. The USS Nimitz and an accompanying warship drew close to a rocket-bearing Iranian vessel on Friday and sent out a helicopter near a number of Guards vessels… ‘The Americans made a provocative and unprofessional move by issuing a warning and shooting flares at vessels ...,’ the statement said. ‘Islam’s warriors, without paying attention to this unconventional and unusual behaviour from the American vessels, continued their mission in the area and the aircraft carrier and accompanying battleship left the area.’”

July 31 – Wall Street Journal (Julian E. Barnes, Laurence Norman and Felicia Schwartz): “The U.S. Pentagon and State Department have devised plans to supply Ukraine with antitank missiles and other weaponry and are seeking White House approval, U.S. officials said, as Kiev battles Russia-backed separatists and ties between Moscow and Washington fray. American military officials and diplomats say the arms, which they characterized as defensive, are meant to deter aggressive actions by Moscow, which the U.S. and others say has provided tanks and other sophisticated armaments as well as military advisers to rebels fighting the Kiev government.”

Friday Evening Links

[Reuters] Dow chalks up eighth record close in a row

[Reuters] Strong U.S. jobs report bolsters case for further Fed tightening