Friday, September 22, 2017

Weekly Commentary: Q2 2017 Z.1 Report

I found the Fed’s latest (Q2) Z.1 report particularly interesting. It brought back memories. In general, debt growth was steady and rather uninteresting. As such, it would be reasonable to equate the seemingly placid Credit backdrop with an extraordinarily long period of low securities market volatility. Yet there’s another dynamic to contemplate (and carefully monitor). Below the surface the financial sector is turning increasingly unstable. Latent financial instability has begun to surface. And, sure enough, acute monetary disorder ensured that securities markets succumbed to speculative blow-off dynamics.

Q2 2017 Non-Financial Debt (NFD) expanded at a 3.8% rate, up from Q1’s 1.7% and Q4’s 3.1%. Household Debt growth increased from a 3.4% rate to 3.7%. Home Mortgage Debt expanded at a 2.8% rate, down from Q1’s 3.4%. Consumer Credit slowed to 4.6% from 5.2%. Total Business Debt growth slowed to 5.3% from Q1’s 6.1%. After contracting at a 2.6% rate during Q1, Q2 saw Federal borrowings increase at a 3.6% rate.

With system debt having inflated for decades now, today’s percentage changes don’t do justice. Plus, with interest rates so low, interest compounds much less than in the past – thus working to restrain overall debt expansion. But let’s examine nominal data. On a seasonally-adjusted and annualized (SAAR) basis, Non-Financial Debt expanded at a $1.813 TN pace during Q2 (up from Q1’s $794bn). This compares to annual growth of $2.095 TN in 2016, $1.958 TN in 2015, $1.792 TN in 2014 and $1.547 TN in 2013.

Total Household borrowings increased SAAR $542 billion during Q2. For comparison, Household borrowings expanded $510 billion in 2016, $403 billion in ‘15, $400 billion in ‘14, $241 billion in ’13 and $265 billion in ‘12. Household borrowings contracted in 2011 ($51bn) and 2010 ($60bn).

Total Business borrowings slowed to SAAR $724 billion, down from Q1’s $817 billion. Borrowings nonetheless remain robust, tracking above 2016 annual borrowings of $711 billion and not far below 2015’s $820 billion (strongest since 2007).

On a year-on-year basis, Federal government borrowings have shown the largest slowdown. This won’t last. Federal Government Liabilities ended Q2 at a record $18.651 TN, up from $8.056 TN to end 2007. Over this period as a percentage of GDP, Federal Liabilities have increased from 55% to 97%. Outstanding Treasury securities ended Q2 at $15.798 TN, up 160% from 2007's $6.051 TN. Somehow there is still talk of “deleveraging” in the face of one of the great bouts of government indebtedness.

Meanwhile, outstanding Agency- and GSE-Backed Securities ended Q2 at a record $8.667 TN. One of these decades there may even be GSE “reform.” GSE Securities increased $95 billion during the quarter, $343 billion over the past year and $888 billion over three years. Amazingly, with Fannie and Freddie remitting (accounting) profits back to the Treasury, the government sponsored enterprises these days have no meaningful capital base (Z.1 has GSE assets less liabilities at a paltry $6.0bn).

Complacency may come easy to those viewing relatively modest annual percentage growth in household, corporate and federal debt. Indeed, most at this point completely dismiss the Credit Bubble hypothesis. Yet there is plenty of support for The Bubble Thesis buried throughout the Fed’s Z.1 report.

Let’s start with the Fed’s “Financial Sector” category. Total Financial Assets expanded nominal $1.411 TN during the quarter to $93.61 TN, this following Q1’s gain of $1.997 TN (strongest since Q1 2012). Financial Sector growth is on pace for the largest gain since 2007. Notable expansions included the SAAR $797 billion gain in “Federal Funds and Security Repos,” SAAR $899 billion rise in “Loans”, and SAAR $1.573 TN jump in Financial Sector “Miscellaneous Assets.”

The Security Broker/Dealers expanded Financial Assets SAAR $567 billion during Q1. The quarter saw the strongest growth since Q1 2010. “Security Repurchase Agreements” jumped SAAR $263 billion, with Debt Securities up SAAR $154 billion. On the Liability side, Security Repurchase Agreements surged SAAR $329 billion and Corporate Debt Securities rose SAAR $144 billion.

The explosive growth of the ETF complex runs unabated, as detailed in Fed data. ETF assets surged a nominal $170 billion during the quarter (24% annualized) to a record $2.944 TN. Total assets were up $715 billion y-o-y, or 32%. Interestingly, when ranked by “investment objective,” World Equities led the way during Q2. World Equities assets expanded $77 billion (53% annualized) during Q2 and were up $195 billion, or 42%, y-o-y. U.S. Equities gained $55.6 billion during Q2 and were up $429 billion, or 33% y-o-y. Taxable Bond funds attracted $34 billion during the quarter, with assets up $95 billion y-o-y.

Further indications of “Hot Money” On the Move: Bank “Holding Companies” saw Financial Assets jump SAAR $903 billion during the quarter. Financial Assets of “Funding Corporations” dropped SAAR $492 billion during Q2. Net Interbank Assets dropped SAAR $663 billion during Q2, after surging SAAR $1.582 TN during Q1 and declining SAAR $649 billion in Q4 2016. While Financial Sector Debt Securities holdings were relatively flat (up SAAR $31bn), a “risk on” dynamic was apparent with a SAAR $403 billion decline in Treasuries largely offset by a SAAR $308 billion increase in Corporate & Foreign Bonds. On the Liability side, “Federal Funds & Repo” jumped SAAR $698 billion and “Miscellaneous Liabilities” rose SAAR $662 billion.

Speaking of “hot money”… Rest of World (ROW) saw “Net Acquisition of (U.S.) Financial Assets” surge SAAR $1.916 TN, this following Q1’s gain of SAAR $1.515 TN. In nominal dollars, ROW holdings of U.S. Financial Assets surged $1.336 TN during the first-half to a record $25.559 TN. At this pace, the growth in ROW holdings will easily surpass 2006’s record $2.143 TN. By category during Q2, ROW Debt Securities holdings jumped SAAR $1.214 TN, with U.S. Corporate bonds up SAAR $584 billion. Foreign Direct Investment increased SAAR $299 billion, a significant slowdown from the 2015/2016 pace.

September 17 – Reuters (Saikat Chatterjee): “Global debt may be under-reported by around $13 trillion because traditional accounting practices exclude foreign exchange derivatives used to hedge international trade and foreign currency bonds, the BIS said… Bank for International Settlements researchers said it was hard to assess the risk this ‘missing’ debt poses, but that the main worry was a liquidity crunch like the one that seized FX swap and forwards markets during the financial crisis. The $13 trillion unaccounted-for exposure exceeds the on-balance-sheet debt of $10.7 trillion that data shows was owed by firms and governments outside the United States at end-March. The fact these FX derivatives do not appear on financial and non-financial institutions’ balance sheets under current accounting rules means little is known about where the debt lies. ‘The debt remains obscured from view,’ Claudio Borio, head of the BIS’s monetary and economic department…”

I hold the view that nontransparent derivative trading and associated leverage have been integral to the global government finance Bubble. QE and currency devaluation strategies created extraordinary opportunities for “carry trade” leveraged speculation. I believe enormous amounts of finance have been created in the process of shorting select currencies, most notably near-zero rate euro and yen securities. A large chunk of “money” flowed to “king dollar” U.S. securities markets, easily offsetting the (late-2014) termination of Federal Reserve QE. It is likely that huge flows are not being captured in Fed data – the Rest of World Z.1 data in particular. It was helpful to see the BIS put a $13 TN estimate on debt/leverage associated with unaccounted for foreign-exchange derivatives.

Recall that 10-year Treasury yields traded as low as 1.36% in July 2016, only to reverse sharply to as high as 2.60% near year-end. I believe fear of a disorderly unwind of leveraged holdings was behind the Fed’s decision to back away from rate “normalization.” When the Fed then signaled that rate hikes had largely run their course, the veritable speculation floodgates were pushed wide open.

The value of U.S. Equities jumped a nominal $1.50 TN during Q2 to a record $42.23 TN. Over the past four quarters U.S. Equities have jumped $6.182 TN, or 17.1%. For perspective, Equities rose about $3.9 TN in 1999 and $3.5 TN in 2006. The Q2 value of Equities was 67% higher than at the close of 2007. Equities ended Q2 2017 at a record 219% of GDP. Equities had cycle peaks of 181% of GDP during Q3 2007 and 202% to end Q1 2000. Equities were at 50% of GDP in 1975 and ended the eighties at 67%.

Total Debt Securities ended Q2 at a record $41.502 TN, up $85 billion for the quarter and $977 billion y-o-y. Debt Securities-to-GDP slipped a basis point to 216% (began the ‘90s at 130% and ended the decade at 157%). This puts Total (Debt & Equities) Securities at $83.733 TN, or a record 435% of GDP. Previous cycle peaks were 379% in Q3 2007 and 359% during Q1 2000.

Policy-induced asset inflation has profoundly impacted Household Net Worth – or what I would refer to as “perceived wealth.” Indeed, the bloated Household balance sheet remains a primary Bubble manifestation. Household (& Nonprofits) assets ended Q2 at a record $111.4 TN, up $1.844 TN for the quarter and $8.660 TN (8.4%) over four quarters. Liabilities increased $146 billion during the quarter and $467 billion y-o-y – to $15.219 TN. Fundamental to the ongoing Bubble, Household Net Worth (assets less liabilities) jumped $1.698 TN during Q2 to a record $96.196 TN. Net Worth surged a staggering $8.193 TN over the past year (now 42% higher than the 2007 peak). For perspective, Net Worth jumped $4.894 TN during 1999 and dropped $10.240 TN during 2008. As a percentage of GDP, Household Net Worth reached 500% for the first time during Q2, up from cycle peaks of 473% in 2007 and 435% in 1999.

I’ll have more comments about the Fed meeting next week. It was interesting to see chair Yellen refer to an inflation “mystery.” There was nothing too surprising with the Fed’s plan to reduce its balance sheet holdings. For good reason, the markets assume the Federal Reserve won’t get too far into balance sheet “normalization” before it suffers a change of heart. Recall that our central bank more than doubled holdings after scrapping its 2011 “exit strategy” before it even got started.

I would add that bull markets create their own liquidity. And so long as “risk on” is fueled by self-reinforcing speculative leveraging, the marketplace would easily accommodate small portfolio sales from the Federal Reserve. It’s an altogether different story, however, when “Risk Off” materializes. De-risking/de-leveraging dynamics would rather abruptly emerge from hiding. That’s when the markets will sorely miss – and beckon for more - QE.

For the Week:

The S&P500 was little changed (up 11.8% y-t-d), while the Dow added 0.4% (up 13.1%). The Utilities dropped 2.7% (up 9.0%). The Banks jumped 3.4% (up 5.7%), and the Broker/Dealers rose 3.0% (up 14%). The Transports gained 1.7% (up 7.3%). The S&P 400 Midcaps rose 0.8% (up 6.5%), and the small cap Russell 2000 increased 1.3% (up 6.9%). The Nasdaq100 declined 0.9% (up 22%).The Semiconductors added 0.3% (up 26.8%). The Biotechs slipped 0.3% (up 35.5%). With bullion down $23, the HUI gold index fell 3.6% (up 9.4%).

Three-month Treasury bill rates ended the week at 100 bps. Two-year government yields jumped five bps to a nine-year high 1.43% (up 24bps y-t-d). Five-year T-note yields rose five bps to 1.86% (down 7bps). Ten-year Treasury yields gained five bps to 2.25% (down 19bps). Long bond yields added a basis point to 2.78% (down 29bps).

Greek 10-year yields rose 10 bps to 5.50% (down 152bps y-t-d). Ten-year Portuguese yields sank 37 bps to 2.44% (down 131bps). Italian 10-year yields increased three bps to 2.11% (up 30bps). Spain's 10-year yields increased two bps to 1.63% (up 25bps). German bund yields added a basis point to 0.45% (up 24bps). French yields gained two bps to 0.73% (up 5bps). The French to German 10-year bond spread widened one to 28 bps. U.K. 10-year gilt yields rose five bps to 1.36% (up 12bps). U.K.'s FTSE equities index rallied 1.3% (up 2.3%).

Japan's Nikkei 225 equities index jumped 1.9% (up 6.2% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.03% (down 1bp). France's CAC40 gained 1.3% (up 8.6%). The German DAX equities index added 0.6% (up 9.7%). Spain's IBEX 35 equities index was little changed (up 10.2%). Italy's FTSE MIB index jumped 1.4% (up 17.1%). EM equities were mixed. Brazil's Bovespa index declined 0.5% (up 25.2%), while Mexico's Bolsa gained 0.8% (up 10.2%). South Korea's Kospi was about unchanged (up 17.9%). India’s Sensex equities index fell 1.1% (up 19.9%). China’s Shanghai Exchange was unchanged (up 8.0%). Turkey's Borsa Istanbul National 100 index dropped 3.4% (up 33.3%). Russia's MICEX equities index was little changed (down 8.1%).

Junk bond mutual funds saw inflows of $866 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose five bps to 3.83% (up 35bps y-o-y). Fifteen-year rates gained five bps to 3.13% (up 37bps). The five-year hybrid ARM rate added four bps to 3.17% (up 37bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up nine bps to 4.09% (up 46bps).

Federal Reserve Credit last week expanded $7.5bn to $4.425 TN. Over the past year, Fed Credit declined $1.3bn. Fed Credit inflated $1.614 TN, or 57%, over the past 254 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $4.0bn last week to $3.376 TN (near 2015 high). "Custody holdings" were up $226bn y-o-y, or 7.2%.

M2 (narrow) "money" supply last week jumped $25.5bn to a record $13.694 TN. "Narrow money" expanded $682bn, or 5.2%, over the past year. For the week, Currency increased $4.3bn. Total Checkable Deposits gained $8.9bn, and Savings Deposits expanded $10.9bn. Small Time Deposits rose $2.9bn. Retail Money Funds slipped $1.5bn.

Total money market fund assets declined $14.6bn to $2.724 TN. Money Funds increased $54bn y-o-y, or 2.0%.

Total Commercial Paper jumped $20.3bn to a one-year high $1.044 TN. CP gained $101bn y-o-y, or 10.7%.

Currency Watch:

The U.S. dollar index gained 0.3% to 92.171 (down 10.0% y-t-d). For the week on the upside, the Norwegian krone increased 0.7%, the New Zealand dollar 0.4% and the euro 0.1%. On the downside, the Canadian dollar declined 1.1%, the Japanese yen 1.0%, the Swiss franc 0.9%, the South African rand 0.7%, the British pound 0.7%, the Australian dollar 0.5%, the Mexican peso 0.5%, the Brazilian real 0.4%, the South Korean won 0.4%, the Swedish krona 0.2% and the Singapore dollar 0.1%. The Chinese renminbi declined 0.57% versus the dollar this week (up 5.39% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index added 0.5% (down 0.1% y-t-d). Spot Gold declined 1.7% to $1,297 (up 12.6%). Silver sank 4.1% to $16.984 (up 6.3%). Crude gained 77 cents to $50.66 (down 6%). Gasoline increased 0.4% (unchanged), while Natural Gas dropped 2.1% (down 21%). Copper slipped 0.2% (up 17%). Wheat was little changed (up 10%). Corn declined 0.4% (unchanged).

Trump Administration Watch:

September 18 – Reuters (Steve Holland and Jeff Mason): “U.S. President Donald Trump escalated his standoff with North Korea over its nuclear challenge…, threatening to ‘totally destroy’ the country of 26 million people and mocking its leader, Kim Jong Un, as a ‘rocket man.’ In a hard-edged speech to the United Nations General Assembly, Trump offered a grim portrait of a world in peril, adopted a more confrontational approach to solving global challenges from Iran to Venezuela, and gave an unabashed defense of U.S. sovereignty. ‘The United States has great strength and patience, but if it is forced to defend itself or its allies, we will have no choice but to totally destroy North Korea,’ Trump told the 193-member world body… As loud, startled murmurs filled the hall, Trump described Kim in an acid tone, saying, ‘Rocket man is on a suicide mission for himself and his regime.’”

September 22 – CNN (Joshua Berlinger and Zahra Ullah): “North Korea could test a powerful nuclear weapon over the Pacific Ocean in response to US President Donald Trump's threats of military action, the country's foreign minister has warned. Ri Yong Ho spoke to reporters in New York shortly after North Korean leader Kim Jong Un made an unprecedented televised statement, accusing Trump of being ‘mentally deranged.’”

September 17 – Axios (Jonathan Swan): “Forget DACA or tax reform. One topic consumes the vast majority of President Trump's inner circle: North Korea. Contrary to the president's breezy tweet this morning, in which he refers to Kim Jong-un as ‘Rocket Man,’ top administration officials have a dark view of how this plays out. They believe the confrontation with Pyongyang's portly dictator will define Trump's first term in office. The consensus view among Trump, Mattis and McMaster, according to several officials…, is that this conflict is heading towards two options, both with high risks: escalated confrontation with China and the military option.”

September 18 – Bloomberg (Ben Steverman and Suzanne Woolley): “Here’s what we know about the details of the tax reform plan: almost nothing. Powerful lawmakers are promising at least a framework for the overhaul by the end of the month. The broad goals are lower rates for corporations and individuals, a simpler tax code with fewer brackets, and the elimination of the estate tax and the alternative-minimum tax. Sound good? Beware. If you save for retirement or itemize your tax deductions, you could end up paying thousands of dollars more after tax reform than you do now. To help pay for promised cuts, President Donald Trump and Republicans in Congress are trying to raise revenue elsewhere. And the best place to get this money may be the millions of Americans who use deductions and other such strategies to lower their tax bills. Upper-middle-class taxpayers in particular could face a triple whammy. On the table are limits on—or even the elimination of—three of their favorite tax perks: deductions for mortgage interest and for state and local taxes and the ability to make pre-tax 401(k) retirement contributions.”

September 19 – Reuters (David Morgan): “U.S. Senate Republicans have reached a tentative budget deal that could allow tax reform legislation to eliminate as much as $1.5 trillion in revenues over 10 years through tax cuts, raising the odds that their planned tax overhaul would expand the federal deficit. Two members of the Senate Budget Committee, Republicans Pat Toomey and Bob Corker, announced the formal agreement late on Tuesday, but their joint news release did not provide dollar figures for revenue reduction or tax cuts. The prospective tax cuts are part of closed-door talks among 12 Senate Budget Committee Republicans who are drafting a fiscal 2018 budget measure needed to help the 100-member Senate pass a tax overhaul with as few as 51 Republicans votes and prevent Democrats from blocking the legislation.”

September 19 – Politico (Adam Cancyrn): “Republicans hoping to jam a last-minute Obamacare repeal plan through the Senate are confronting a rising tide of opposition as health care groups, patient advocates and even some red-state governors join forces against a bill they worry would upend the nation’s health care system. The wide-ranging backlash threw the GOP’s repeal push into fresh doubt on Tuesday, even as White House officials and Senate Republican leaders insist they are on the verge of winning the 50 votes needed to dismantle Obamacare under a reconciliation bill that expires in two weeks.”

September 21 – Reuters (Bozorgmehr Sharafedin): “Iran will strengthen its missile capabilities and will not seek any country’s permission, President Hassan Rouhani said… in a snub to demands from U.S. President Donald Trump. Rouhani was speaking at a military parade where an Iranian news agency said one of the weapons on display was a new ballistic missile with range of 2,000 km (1,200 miles), capable of carrying several warheads.”

China Bubble Watch:

September 17 – Bloomberg (Ben Steverman and Suzanne Woolley): “Home prices rose in fewer Chinese cities last month and declined in some of the nation’s hottest markets... New-home prices… gained in 46 of 70 cities tracked by the government in August, compared with 56 in July, the National Bureau of Statistics said… That was the smallest number of increases since January. Prices fell in 18 cities from the previous month and were unchanged in six. Developers’ stocks rose on the prospect that Chinese leaders would feel less pressure to roll out additional property restrictions…”

September 19 – Bloomberg: “Chinese property developers face a wall of local bonds that investors can force them to pay off next year ahead of schedule, just as rising interest rates raise the risk that more note holders may opt to do so. Investors have an option to offload 250 billion yuan ($38bn) of such notes in 2018… As China’s government pushes companies to trim excessive borrowing, financing costs in the nation’s credit markets have jumped this year. That’s left about 72% of the 137 local real estate bonds with put options that can be exercised next year in the money, meaning their current secondary-market yields are higher than coupon rates…”

September 19 – Bloomberg: “China’s most indebted developer is the latest firm to feel the heat amid a drive by regulators to rein in risks in the financial system. China Huarong Asset Management Co., a state-owned entity…, asked units to temporarily suspend new project financing to Sunac China Holdings… While Huarong says it’s not acting on instructions from regulators, the email noted authorities are paying more attention to Sunac’s high debt load and aggressive acquisition strategy. Sunac shares closed 2.8% lower… The shares have advanced 467% this year to rank among the world’s top performing stocks.”

September 21 – Bloomberg (Enda Curran and Alfred Liu): “Foreigners predicting doom for China’s banks have got it all wrong, according to James Stent, who spent more than a decade serving on the boards of two Chinese lenders. Instead of falling into a debt-fueled crisis, China’s banks are able to stave off trouble because of the willingness of the government to throw money at problems in order to ensure financial stability, Stent argues. ‘As one Chinese banker who works for an American bank said to me: ‘In the West, money flees problems; in China, money flows to problems to solve them,’ said Stent…”

Central Bank Watch:

September 19 – Bloomberg (Fergal O'Brien): “Brexit, which prompted Mark Carney to cut U.K. interest rates for the first time in seven years in 2016, is now pushing in the other direction. In a speech in Washington…, the Bank of England governor said while the decision to leave the European Union has slowed growth, it’s also cut the economy’s potential. That reduced ‘speed limit’ -- as he has described it -- increases the chance of overheating and partly explains why the Monetary Policy Committee now says it may need to raise rates soon.”

Global Bubble Watch:

September 17 – Reuters (Marc Jones): “The conundrum of stubbornly low inflation despite a pick-up in global growth and continued monetary stimulus is a ‘trillion dollar’ question, the umbrella body for the world’s leading central banks said… The Bank for International Settlements (BIS) said in its latest quarterly report that cheap borrowing rates and the rare simultaneous expansion of advanced and developing economies are driving financial markets higher, with signs of ‘exuberance’ starting to re-emerge. U.S. corporate debt is much higher than before the financial crisis and a drop in the premiums investors demand for riskier lending has boosted sales of so-called covenant-lite bonds offering high yields. The BIS said this raises a question over the potential for another crisis if there is a significant rise in interest rates.”

September 21 – Financial Times (Jennifer Hughes): “Mention the creation of the eurodollar market these days and be prepared to feel like a financial fossil. International markets as we know them are so established that referring to their development from dollars held overseas in the 1960s feels quaint. But the reason to bring up such a piece of ancient history is to ask whether Asia-Pacific is having an equivalent ‘Asiadollar’ moment. Sales of dollar bonds in the region have rocketed this year, with $359bn issued so far, according to Dealogic, already surpassing 2016’s full-year record. Sales are also more than double their levels in 2010, which was arguably the last time when Asia’s largely emerging market bonds were an international investor darling.”

September 19 – Bloomberg (Mikael Holter and Sveinung Sleire): “Norway’s sovereign wealth fund hit $1 trillion for the first time…, driven higher by climbing stock markets and a weaker U.S. dollar… ‘I don’t think anyone expected the fund to ever reach $1 trillion when the first transfer of oil revenue was made in May 1996,’ Yngve Slyngstad, chief executive officer of the fund, said… ‘Reaching $1 trillion is a milestone, and the growth in the fund’s market value has been stunning.’”

Fixed-Income Bubble Watch:

September 19 – Bloomberg (Sid Verma): “Beneath the tranquil surface of U.S. credit markets, bearish winds are blowing. Issuer and sector-specific risks are increasing while the pile of debt trading at distressed levels is rising -- evidence the post-crisis debt bull-run is peaking. That’s the alarm sounded by Wall Street arch-bears Morgan Stanley after a deep dive into the shifting credit landscape in recent months… One warning sign: The face-value of high-yield debt trading at distressed levels has risen by about $30 billion from March to mid-September… Another: The dispersion between credit spreads -- the degree to which bonds are priced according to issuer and sector-specific risks -- is slowly rising. That underscores increasing credit concerns that are masked at the index level…”

September 18 – Bloomberg (Tracy Alloway): “What’s in a word? A lot when it comes to the term ‘liquidity.’ For years, academics, investors and regulators have sparred over the meaning of liquidity, and the degree to which it’s said to have deteriorated in the marketplace. For many, it’s simply the ability to sell an asset without significantly affecting its price. To others it’s the hallmark of a healthy market, or the symptom of a disease brought on by ‘easy money’ provided by central banks… To Aleksander Kocic, derivatives strategist at Deutsche Bank AG, it’s something that has turned the world of fixed income on its head -- transmuting an age-old principle of debt and converting the world’s biggest market into something theoretically far more risky. ‘Liquidity transforms the risk of default (the ability that the debtor may not be able to pay back his debt) into the risk that the securities representing the debt find no purchasers,’ he wrote… ‘It replaces responsibility with salability.’”

Federal Reserve Watch:

September 19 – CNBC (Jeff Cox): “The Federal Reserve is on the cusp of reversing the most ambitious monetary stimulus program in world history amid questions over how much impact it really delivered. There's little question that the program, known as quantitative easing or ‘money printing,’ boosted the stock market. The three iterations of QE between November 2008 and October 2014 each saw big boosts to the market, with a cumulative S&P 500 gain from beginning to end, including the various down periods between each leg, of about 140%. The economic impacts, though, are less clear… In fact, one of the Fed's own economists recently penned a report indicating that QE has come up short of its goals. ‘Evaluating the effects of monetary policy is difficult, even in the case of conventional interest rate policy,’ St. Louis Fed economist Stephen D. Williamson wrote. ‘With respect to QE, there are good reasons to be skeptical that it works as advertised, and some economists have made a good case that QE is actually detrimental.’”

September 21 – CNBC (Patti Domm): “Kevin Warsh, a former Fed governor, is increasingly seen as the replacement for Fed Chair Janet Yellen, who has not been shy about putting herself at odds with President Donald Trump's views on banking deregulation. ‘It makes sense … [Warsh] has some ties to the Trump people,’ said Horizon Investment's chief global strategist Greg Valliere. ‘I would say that Yellen's chances have faded because of that speech at Jackson Hole. I think Trump wants somebody that's anti-regulation, and she's clearly not.’ … Warsh, long seen as a candidate for Fed chair, has been gaining momentum in the betting markets, and in the minds of Fed watchers, after White House top economist Gary Cohn fell out of the top slot.”

September 18 – Financial Times (Sam Fleming): “Ron Paul, at least, has no regrets. The former Texas Congressman is one of the most prominent voices among those Americans who have long been deeply suspicious of the US central bank and its power to print money. When he ran for president in 2012, he assailed then Federal Reserve chairman Ben Bernanke for debasing the currency and risking an inflationary upsurge by pumping trillions of dollars into the financial system. ‘We don’t have prices in the consumer market going up like in the 1970s but we should not be surprised if that happens,’ says Mr Paul… Elsewhere, certainty is harder to come by. As the Fed meets in Washington tomorrow, US central bankers, and their counterparts across the world, are genuinely flummoxed by recent low inflation readings. Despite a recovery that is now the third-longest on record, America is trapped not in a 1970s-style, double-digit inflationary upsurge, but a slow-inflation quandary… The uncertain outlook has confounded Fed policymakers just as the central bank prepares for a leadership overhaul in the new year.”

U.S. Bubble Watch:

September 19 – Reuters (Lucia Mutikani): “The U.S. current account deficit jumped to its highest level since 2008 in the second quarter amid a decline in both secondary and primary income. …The current account deficit, which measures the flow of goods, services and investments into and out of the country, increased to $123.1 billion from a downwardly revised $113.5 billion in the first quarter. That was the highest level since the fourth quarter of 2008. Economists… had forecast the current account deficit slipping to $115.1 billion from a previously reported $116.8 billion shortfall.”

September 21 – Reuters (Barbara Kollmeyer): “Now that the Fed has finally started to peel off the quantitative-tightening Band-Aid, things should start getting back to normal. That's a good one, given no one really knows what normal is these days… We’re diving right into our call of the day, which comes from Jim Rogers. In a sweeping interview with RealVision TV, the veteran investor warns another bear market is coming, and that it will be ‘horrendous, the worst.’ It’s the level of debt across global economies that will be to blame, he says. And retail investors who have been piling into exchange-traded funds will be particularly vulnerable to that next big mauling. For those ETF owners — who are all in on easy S&P plays right now — here’s his message: ‘When we have the bear market, a lot of people are going to find that, ‘Oh my God, I own an ETF, and they collapsed. It went down more than anything else.’ And the reason it will go down more than anything else is because that’s what everybody owns,’ he says.”

September 18 – Bloomberg (Daniel Taub): “The typical student debt load for millennials in the U.S. is $41,200, surpassing their median annual income of $38,800. One impact of that burden: first-time home purchases are being delayed by seven years. That’s according to survey results released… by the National Association of Realtors and the nonprofit group American Student Assistance. Only a fifth of millennial respondents own a home, with 83% of non-owners citing student debt as the reason they aren’t buying.”

September 20 – Wall Street Journal (Heather Gillers): “When Aurora, Ill., closed its books in December, about $150 million disappeared from the city’s bottom line. The Chicago suburb of 200,000 people hadn’t become poorer. Instead, for the first time it recorded on its balance sheet the full cost of health care promised to public employees once they retire. States and cities around the country will soon book similar losses because of new, widely followed accounting guidelines that apply to most governments starting in fiscal 2018. The adjustments will show that U.S. states as a group have promised hundreds of billions more in retiree health benefits than they have saved up. The shortfall amounts to $645 billion, according to… The Pew Charitable Trusts based on 2015 data. That is in addition to the $1.1 trillion states need to pay for future pension benefits…”

September 19 – Reuters (Lucia Mutikani): “U.S. import prices recorded their biggest increase in seven months in August as the cost of petroleum surged and there were also signs of a pickup in underlying imported inflation. The Labor Department said… that import prices jumped 0.6% last month, the biggest gain since January, after a downwardly revised 0.1% dip in July.”

September 18 – Wall Street Journal (AnnaMaria Andriotis, Michael Rapoport and Robert McMillan): “On March 8, researchers at Cisco Systems Inc. reported an online security flaw that allowed hackers to break into servers around the internet. Cisco urged users to upgrade their systems immediately with a newly issued fix. Equifax Inc. was among the companies using the flawed software. On Friday, it said its technology experts at the time worked to identify and patch vulnerable systems… From about mid-May to July 30, hackers ransacked vast troves of information at the credit-reporting company. The breach potentially exposed about 143 million Americans’ personal information…”

Europe Watch:

September 22 – Reuters (Jonathan Cable): “Euro zone private businesses ended the third quarter with much stronger growth than predicted, bolstered by manufacturers, who had their best month since early 2011… IHS Markit’s euro zone Flash Composite Purchasing Managers’ Index for September, seen as a good guide to economic growth, bounced to 56.7 from August’s 55.7, comfortably above the 50 level that separates growth from contraction. September’s reading was above all expectations…”

September 20 – Reuters (Raquel Castillo and Sam Edwards): “Spanish police raided Catalan government offices and arrested officials… to halt a banned referendum on independence, an action the regional president said meant Madrid had effectively taken over his administration. Hundreds of protesters gathered outside the regional government offices in the center of Barcelona’s tourist district, waving the red-and-yellow Catalan flag and chanting ‘Occupying forces out’ and ‘Where is Europe?’. ‘The Spanish state has by all rights intervened in Catalonia’s government and has established emergency rule,’ Catalan President Carles Puigdemont said in a televised address.”

September 21 – Reuters (Julien Toyer and Sam Edwards): “The Catalan regional leader… said he would press on with an Oct. 1 referendum on a split from Spain, flouting a court ban, as tens of thousands gathered for a second day on the streets of Barcelona demanding the right to vote. Catalan leader Carles Puigdemont said he had contingency plans in place to ensure the vote would go ahead, directly defying Madrid and pushing the country closer to political crisis. Spain’s Constitutional Court banned the vote earlier this month after Prime Minister Mariano Rajoy said it violated Spain’s 1978 constitution…”

September 16 – Reuters (Karolina Tagaris): “Greece should not put off agreed bailout reforms or it could ‘complicate’ an upcoming bailout review by its foreign creditors, a European Central Bank official said… Greece’s third bailout review is expected to begin in October with bad loans, the 2018 budget, the energy market and privatizations among the main issues, the ECB’s mission chief in Greece, Francesco Drudi, told Greek newspaper Proto Thema. ‘If any major backtracking or delays occur in the implementation of the key deliverables due so far, this could complicate the completion of the review,’ Drudi said. ‘Unfortunately, a number of parliamentary bills adopted after the conclusion of the second review may not be in line with program commitments and will have to be assessed by our teams,’ he said.”

Brexit Watch:

September 19 – Bloomberg (Cat Rutter Pooley and Jill Ward): “Bank of England Governor Mark Carney has 200 billion reasons to keep an eye on consumer borrowing and he’s about to find out just how concerned he should be. With household credit rising five times faster than earnings, alarm bells are ringing and regulators have fast-tracked part of their annual stress tests to get an insight into the resilience of banks to a sharp jump in defaults. Carney and his Financial Policy Committee will have that crucial information when they gather for their quarterly meetings this week. Unsecured debt totaled 202 billion pounds ($274bn) in July, the highest since 2008, having risen by almost 10% over the past year.”

Japan Watch:

September 19 – Bloomberg (Chikako Mogi and Saburo Funabiki): “After spending a year trying to prevent benchmark yields from rising above zero percent, the Bank of Japan now faces the challenge of stopping them from falling too low. Japan’s 10-year yield has gone from a one-year high in February to slipping below the BOJ’s targeted zero percent level earlier this month amid a bout of global risk aversion stemming from North Korea tensions. While the central bank has cut back on its debt purchases three times since mid-August, strategists question if that will be enough should global bonds keep rallying. ‘I am worried about yields falling too low, which would be risky,’ said Yusuke Ikawa, Japan strategist at BNP Paribas… ‘The more the BOJ owns bonds, the more downward pressure it puts on yields. The bank will likely continue gradually scaling back purchases, but it can’t reduce outstanding debt holdings under its monetary base expansion policy.’”

September 19 – Bloomberg (Connor Cislo): “Japanese exports and imports surged in August, with both beating expectations as a recovery in trade appeared to gain momentum. Exports rose 18.1% from a year earlier (forecast +14.3%), the biggest increase since November 2013.”

EM Bubble Watch:

September 20 – Bloomberg (Ksenia Galouchko): “Investors sold the foreign debt of Russia’s private banks on Wednesday as the prospect of the second bailout of a major lender in less than a month fanned concern that cracks in the industry are spreading. The yield on Credit Bank of Moscow’s October 2027 Eurobond jumped 57 bps to 8.93%, the most since the debt was sold in March… The rescue appeal to regulators by B&N Bank, owned by billionaire Mikhail Gutseriev and his nephew, comes on the heels of Otkritie Bank’s bailout, where officials have warned that subordinated debt may be written off.”

Geopolitical Watch:

September 19 – Reuters (Ben Blanchard): “Stability is an absolute principle that needs to be dealt with using ‘strong hands’, Chinese President Xi Jinping has told security officials ahead of next month’s key Congress of the ruling Communist Party. The stability-obsessed party brooks no challenge to its rule and always steps up security ahead of important meetings. Those working in the public security sector should improve their political awareness and maintain the authority and unified leadership of the party, Xi said…”

Friday Evening Links

[Bloomberg] Stocks Bounce, Treasuries Rise on Korea Tensions: Markets Wrap

[Reuters] Fed officials in muddle over permanent vs temporary inflation lull

[Reuters] Trump, Republicans to showcase tax cut for businesses

[Reuters] Shorting volatility: Rising risks mean itchier trigger fingers