Friday, October 13, 2017

Weekly Commentary: Arms Race

Bloomberg: “Treasuries Surge as December Hike Odds Drop After CPI Miss.” Year-over-year CPI was up 2.2% in September, with consumer inflation above 2% y-o-y for six of the past 10 months. The Producer Price Index gained 2.6% y-o-y in September. Yet, apparently, the focus will remain on core CPI (along with core personal consumption expenditure inflation) that, up 1.7% y-o-y, missed estimates by one tenth and remained below 2% for the sixth straight month. Notably – analytically if not in the markets – the preliminary October reading of University of Michigan Consumer Confidence jumped six points to the high since January 2004. Or taking a slightly different view, Consumer Confidence has been stronger for only one month in the past 17 years. Current Conditions rose to the highest level since November 2000.

Data notwithstanding, from Bloomberg: “Bond Shorts Experience the Agony of Defeat Yet Again.” Ten-year Treasury yields declined nine bps this week to 2.27%, though I’m not sure this qualifies as “defeat.” In stark contrast to the fanatical gathering on the opposing side of the field, not a single central banker was spotted on the bond bears’ sideline.

October 12 – Financial Times (Sam Fleming): “Worries about the risk of stubbornly low inflation hung over the Federal Reserve’s most recent policy meeting, even as the central bank held its course for a further rate rise as soon as the end of the year. Many of the US central bank’s policymakers declared at its latest rate-setting meeting that a further increase is likely to be needed ‘later this year’ as long as the economy stays on track. But minutes of the Fed’s gathering on September 19-20 revealed a body of policymakers who are troubled by this year’s doggedly weak inflation readings and divided over how best to respond. Many expressed worries that poor price growth could reflect entrenched factors following a half-decade of sub-target readings on the Fed’s favoured measure of core inflation. Several insisted they wanted to see economic data that ‘increased their confidence’ that inflation would move towards the Fed’s 2% objective before they acted again.”

October 13 – Reuters (Balazs Koranyi): “European Central Bank policymakers are homing in on extending their stimulus programme for nine months at their next meeting while scaling it back, five people with direct knowledge of discussions told Reuters. The ECB’s asset purchases are due to expire at the end of the year, and policymakers are set to decide on Oct. 26 whether to prolong them. They will have to reconcile the bloc’s best growth run in a decade with an inflation rate expected to undershoot the bank’s target of almost 2% for years. The next move is still up for discussion, but there is a consensus that it should signal both the need to cut support in light of strong economic growth, while also committing to an extended period of monetary accommodation…”

October 13 – Reuters (Leika Kihara): “Bank of Japan Governor Haruhiko Kuroda on Thursday stressed the central bank’s resolve to maintain its ultra-loose monetary policy, even as its U.S. and European counterparts begin to dial back their massive, crisis-mode monetary stimulus. Kuroda offered an upbeat view of Japan’s economy, saying it was expanding moderately with rising incomes leading to higher corporate and household spending. But he said inflation and wage growth were disappointingly low, despite such improvements in the economy.”

Goldman Sachs reduced its probability of a December Fed rate hike to 75%, as dovish comments from Fed officials and dovish minutes from the September FOMC meeting allay concerns that the Fed was leaning “normalization.” So global markets take comfort that the Fed is largely on hold with rate hikes; a rate increase may be at least a year away in the euro zone as the ECB sticks to its max leisurely path to winding down QE; and, best yet, the Bank of Japan is gratified to wait and see how the others get along without aggressive stimulus before contemplating its own course.

The S&P500 gained 0.2% this week to new record highs, increasing y-t-d gains to 14%. Indicative of the froth that has taken hold throughout EM, bastions of stability South Korea (up 22% y-t-d) and Turkey (up 36%) gained 3.3% and 2.0%, respectively. Meanwhile, Bitcoin (U.S. spot) surged $1,275 this week (29%!) to $5,615, with 2017 gains of a cool 480%. If central bankers have any concern with acute asset price inflation and speculation it was not apparent this week. And, sure enough, no sooner than Fed officials reiterate below-target inflation angst the commodities pop. The GSCI Commodities index jumped 2.8% this week to a six-month high. Copper rose 2.8% this week, increasing y-t-d gains to 25%. Crude jumped 4.4%, silver 3.7% and Gold 2.2%.

Markets these days have attained that late-nineties feel. Manic 1999 had those crazy Internet stocks. Manic 2017 has the even crazier cryptocurrencies – with biotech (up 39% y-t-d) and semiconductor (up 35%) stocks straining to keep up with the insanity. In the face of conspicuous speculative excess, the Fed in 1999 held firm with its baby-step “tightening” approach that worked only to promote a further loosening of financial conditions. The 1998 crisis was fresh in central bankers’ minds, while markets delighted in the fear central bankers harbored over Y2K. As for central banks here in 2017, apparently the 2008 crisis will remain forever top of mind. Markets have never been as reassured that central bankers are loving the party.

By 1999, a policy-induced prolonged technology boom had fostered a veritable Arms Race, especially in anything Internet and PC. Finance was flooding into the sector, ensuring massive mal- and over-investment. The upshot was the rapid propagation of negative cash-flow enterprises that would turn unviable the minute the Bubble burst. The New Age hype had one thing right: Exciting new technologies changed the world. This did not, however, prevent painful busts and a pair of powerful financial crises.

There’s complacency along with a lack of appreciation for the long-term structural impact associated with late-nineties excesses. I continue to read of the “mild recession” after the bursting of the “tech” Bubble. In reality, collapse ensured depression throughout a segment of the economy. And let’s not forget the 2002 corporate debt crisis.

The Fed held powerful reflationary tools at its discretion. Rates were slashed from 6.5% in December 2000 all the way to 1.00% by June 2003. There was also a strong inflationary bias throughout mortgage finance and housing. This provided the Federal Reserve a robust avenue in which to promote record Credit growth and an attendant Bubble of sufficient scope to more than emerge from the technology bust. No nineties boom and bust then no mortgage finance Bubble reflation and resulting 2008 collapse – and no ongoing global government finance Bubble. Open the central bank crisis-fighting tool kit today and there’s a single slot for QE. Markets are elated with the virtually barren apparatus.

The current “tech” Bubble absolutely dwarfs the late-nineties period. Arms Races now proliferate across various industries, technologies and products on a global basis. Recalling 1999, media these days are filled with ads from scores of upstarts promoting new products and services. How many will ever generate positive cash-flow and earnings? The big global tech firms – flush with extraordinary boom-time profits – spend lavishly in an Arms Race for primacy over the cloud, artificial intelligence and myriad new services. Alternative energies, another Arms Race. Media, telecom, entertainment and programming – more Arms Races. Pharmaceuticals, biotech and biopharma…

And then there’s the massive Arms Race gathering momentum in electric vehicles. “British Vacuum Maker Dyson Plans Electric Car Assault” – with, it’s worth noting, a $2.0 billion investment. From the Seattle Times, “In Race for an Electric-Car Future, China Seeks the Lead.” With a blank checkbook and the power to ban the combustion engine, China will invest hundreds of billions in electric car and battery development. Will anyone ever earn a profit?

One can do worse than ponder the work of the great economist Joseph Schumpeter. Known most for the concept “creative destruction,” Schumpeter was an eminent thinker on economic development and Credit. He believed innovation often evolves in “swarm like clusters,” where development in one sector spurs innovation and development in other areas. Entrepreneur success in one field motivates entrepreneurship more generally. Moreover, innovation fuels - and is fueled by - Credit. The interplay of the entrepreneur and finance plays a fundamental role in boom and bust cycles. Eventually over-production, waning profits and Credit issues lead to cyclical downturn.

Schumpeter’s analysis would occasionally enter the discussion back in the late-nineties. Some of us would compare the proliferation of new technologies to that of the “Roaring Twenties” period (automotive, production line, electricity, radio & entertainment, refrigeration, household appliances, science & medicine, etc.). There’s no doubt that innovation and speculation tend to become kindred spirits.

The Greenspan Fed, Wall Street strategists and most economists argued during the nineties that new technologies had raised the economy’s “speed limit.” This meant less impetus to tap on the monetary brakes to subdue the boom. I saw things differently: Periods of breakneck innovation, technological advancement and resulting economic transformation beckon for a commitment to sound “money.” Especially in our age of unbounded market-based finance, captivating innovation in the real economy over time spurs precarious self-reinforcing excess in “money,” Credit, the securities markets and derivatives.

It’s my view that prolonged cycles of economic and financial innovation turn progressively more perilous. The key analysis from the “Roaring Twenties” period was one of spectacular economic and financial innovation commencing even before the outbreak of the first World War. As the Twenties progressed, our fledgling central bank misread the downward pressure on consumer prices. Technological advances, new production methods, a proliferation of new products, and booming international trade – all empowered by loose finance - were generating downward pressure on prices.

The Fed accommodated escalating financial excess and was later unwilling to risk bursting the Bubble (in the face of mounting late-cycle fragilities). At the heart of financial and economic excess was the prevailing view that the Federal Reserve possessed the tools to underpin uninterrupted financial and economic prosperity. The perception of adept central banking had become integral to a transformative change in inflation dynamics – massive investment spurring disinflation in the real economy in the face of powerful inflation dynamics raging in asset markets. What was viewed as an extraordinarily favorable fundamental backdrop was in reality an unsustainable boom, with an acutely unsound financial Bubble at its core. The many parallels to today are too obvious to ignore.

October 12 – ANSA: “European Central Bank President Mario Draghi defended quantitative easing at a conference with former Fed chief Ben Bernanke, saying the policy had helped create seven million jobs in four years. Bernanke chided the idea that QE distorted the markets, saying ‘It's not clear what that means’.”

October 11 – Financial Times (Chris Giles): “Central bankers usurped the titans of Wall Street as the masters of the universe almost a decade ago. They rescued the global economy from the financial crisis, flooding the world with cheap money. They used their powers effectively to get banks lending again. Their actions raised asset prices, keeping business and consumer confidence up. Financial markets and populations hang on their words. But never have they been so vulnerable. As they gather in Washington for the annual meetings of the International Monetary Fund, there is a crisis of confidence in central banking. Their economic models are failing and there are doubts whether they understand the effects of interest rates and other monetary policies on the economy. In short, the new masters of the universe might not understand what makes a modern economy tick and their well-intentioned actions could prove harmful. While there have long been critics of the power of central bankers on the left and the right, such profound doubts have never been so present within their narrow world.”

For those interested, McAlvany Wealth Management’s Tactical Short Q3 Update conference call will be next Wednesday, October 18th at 4:30 pm EST.   For more information please visit:

For the Week:

The S&P500 added 0.2% (up 14.0% y-t-d), and the Dow increased 0.4% (up 15.7%). The Utilities gained 1.2% (up 11.0%). The Banks dropped 1.9% (up 7.7%), and the Broker/Dealers slipped 0.6% (up 20.1%). The Transports added 0.5% (up 9.9%). The S&P 400 Midcaps were unchanged (up 9.5%), while the small cap Russell 2000 dipped 0.5% (up 10.7%). The Nasdaq100 increased 0.5% (up 25.3%). The Semiconductors jumped 2.3% (up 34.5%). The Biotechs declined 0.5% (up 38.6%). With bullion rallying $28, the HUI gold index increased only 0.3% (up 11.2%).

Three-month Treasury bill rates ended the week at 105 bps. Two-year government yields slipped a basis point to 1.50% (up 30bps y-t-d). Five-year T-note yields declined six bps to 1.90% (down 3bps). Ten-year Treasury yields fell nine bps to 2.27% (down 17bps). Long bond yields dropped nine bps to 2.81% (down 26bps).

Greek 10-year yields declined six bps to 5.49% (down 153bps y-t-d). Ten-year Portuguese yields fell eight bps to 2.33% (down 141bps). Italian 10-year yields declined six bps to 2.08% (up 27bps). Spain's 10-year yields dropped 10 bps to 1.61% (up 23bps). German bund yields fell six bps to 0.40% (up 20bps). French yields rose eight bps to 0.82% (up 14bps). The French to German 10-year bond spread widened 14 bps to 42 bps. U.K. 10-year gilt yields were little changed at 1.37% (up 13bps). U.K.'s FTSE equities added 0.2% (up 5.5%).

Japan's Nikkei 225 equities index jumped 2.2% (up 10.7% y-t-d). Japanese 10-year "JGB" yields added one basis point to 0.06% (up 2bps). France's CAC40 slipped 0.2% (up 10.1%). The German DAX equities index increased 0.3% (up 13.2%). Spain's IBEX 35 equities index rallied 0.7% (up 9.7%). Italy's FTSE MIB index was little changed (up 16.5%). EM equities were mostly higher. Brazil's Bovespa index gained 1.2% (up 27.8%), while Mexico's Bolsa declined 0.6% (up 9.5%). India’s Sensex equities index rose 1.9% (up 21.8%). China’s Shanghai Exchange gained 1.2% (up 9.2%). Turkey's Borsa Istanbul National 100 index rose 2.0% (up 35.9%). Russia's MICEX equities index increased 0.2% (down 6.0%).

Junk bond mutual funds saw inflows rise to $967 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose six bps to a 10-month high 3.91% (up 44bps y-o-y). Fifteen-year rates gained six bps to 3.21% (up 45bps).  Five-year hybrid ARM rates slipped two bps to 3.16% (up 34bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 4.18% (up 54bps).

Federal Reserve Credit last week slipped $1.2bn to $4.419 TN. Over the past year, Fed Credit was little changed. Fed Credit inflated $1.608 TN, or 57%, over the past 257 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt fell $5.7bn last week to $3.360 TN. "Custody holdings" were up $214bn y-o-y, or 6.8%.

M2 (narrow) "money" supply last week rose $12.2bn to a record $13.709 TN. "Narrow money" expanded $681bn, or 5.2%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits declined $1.0bn, while Savings Deposits added $7.7bn. Small Time Deposits gained $2.0bn. Retail Money Funds increased $2.3bn.

Total money market fund assets were little changed at $2.741 TN. Money Funds increased $93bn y-o-y, or 3.5%.

Total Commercial Paper declined $5.4bn to $1.064 TN. CP gained $161bn y-o-y, or 17.6%.

Currency Watch:

The U.S. dollar index declined 0.8% to 93.091 (down 9.1% y-t-d). For the week on the upside, the South African rand increased 3.6%, the British pound 1.7%, the Australian dollar 1.5%, the South Korean won 1.5%, the Norwegian krone 1.4%, the New Zealand dollar 1.2%, the Singapore dollar 1.2%, the euro 0.8%, the Japanese yen 0.7%, the Swiss franc 0.5%, the Canadian dollar 0.5%, the Brazilian real 0.3% and the Swedish krona 0.1%. For the week on the downside, the Mexican peso declined 2.0%. The Chinese renminbi gained 1.11% versus the dollar this week (up 5.55% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index surged 2.8% (up 1.1% y-t-d). Spot Gold rallied 2.2% to $1,305 (up 13.2%). Silver jumped 3.7% to $17.411 (up 9.0%). Crude surged $2.16 to $51.45 (down 4%). Gasoline jumped 4.1% (down 3%), and Natural Gas rose 4.8% (down 20%). Copper advanced 3.4% (up 25%). Wheat declined 0.9% (up 8%). Corn gained 0.8% (unchanged).

Trump Administration Watch:

October 13 – Bloomberg (Zachary Tracer): “President Donald Trump said he is moving “step by step” on his own to remake the U.S. health care system because Congress won’t act on his demand to repeal Obamacare. The Trump administration took its most drastic measure yet to roll back the Affordable Care Act Thursday evening, announcing it would cut off a subsidy to insurers hours after issuing an executive order designed to draw people away from the health law’s markets. The moves -- which critics call deliberate attempts to undermine the law -- come just weeks before Americans begin to sign up for coverage in 2018. ‘You saw what we did yesterday with respect to health care,’ Trump said at a Washington event… ‘It’s step by step by step. That was a big step yesterday.’”

October 13 – CNN (Stephen Collinson, Kevin Liptak and Dan Merica): “President Donald Trump on Friday threatened to pull out of a deal freezing and reversing Iran's nuclear program if Congress and US allies do not agree to strengthen it, as he unveiled a tough and comprehensive new policy toward the Islamic Republic. ‘As I have said many times, the Iran deal was one of the worst and most one-sided transactions the United States has ever entered into,’ Trump said in a major speech at the White House.”

October 11 – Politico (Burgess Everett): “Senate Republicans are imploring President Donald Trump and Sen. Bob Corker to end their increasingly ugly feud, fretting that it's threatening to further hobble the party's flagging agenda. But the public tit-for-tat has shown no sign of abating… On Tuesday, Trump took to Twitter to lambaste ‘Liddle Bob Corker,’ after the Tennessee Republican said he worried that Trump’s belligerent foreign policy rhetoric could ignite ‘World War III.’ Former Trump strategist Steve Bannon called on Corker to resign…”

October 11 – Wall Street Journal (Jacob M. Schlesinger): “The Trump administration has honed its strategy for remaking the North American Free Trade Agreement in recent weeks as it prepared for a critical round of talks that started Wednesday—by proposing a number of specific ways to water down the pact and reduce its influence on companies. U.S. trade officials have made that theme clear in recent days, prompting a backlash from Mexico and Canada and from business groups in all three countries, casting new uncertainty over the talks… One provision designed with that objective is a ‘sunset’ clause that would force Nafta’s expiration in five years unless all three countries act to renew it…”

October 8 – BBC: “‘Only one thing will work’ in dealing with North Korea after years of talks with Pyongyang brought no results, US President Donald Trump has warned. ‘Presidents and their administrations have been talking to North Korea for 25 years,’ he tweeted, adding that this ‘hasn't worked’. Mr Trump did not elaborate further.”

October 9 – Financial Times (Bryan Harris): “A trove of classified military documents, including the joint South Korea-US wartime operational plans for conflict with Pyongyang, was stolen by North Korean hackers, a lawmaker in Seoul said. Lee Cheol-hee… said hackers had broken into a defence data centre in September last year. He said stolen documents included Operational Plan 5015, the most recent blueprint for war with North Korea. The plans reportedly includes detailed procedures for a decapitation strike against the North Korean regime, a proposal that has infuriated Kim Jong Un… The development comes amid growing anxiety in South Korea that US President Donald Trump intends to use military action to curb North Korea’s rapidly developing nuclear and ballistic missiles programmes.”

October 11 – Reuters (Idrees Ali): “A U.S. Navy destroyer sailed near islands claimed by China in the South China Sea on Tuesday…, prompting anger in Beijing, even as President Donald Trump’s administration seeks Chinese cooperation in reining in North Korea’s missile and nuclear programs.”

October 8 – Reuters (Babak Dehghanpisheh and William Maclean): “Iran warned the United States against designating its Revolutionary Guards Corp as a terrorist group and said U.S. regional military bases would be at risk if further sanctions were passed. The warning came after the White House said… that President Donald Trump would announce new U.S. responses to Iran’s missile tests, support for ‘terrorism’ and cyber operations as part of his new Iran strategy. ‘As we’ve announced in the past, if America’s new law for sanctions is passed, this country will have to move their regional bases outside the 2,000 km range of Iran’s missiles’” Guards’ commander Mohammad Ali Jafari said…”

Federal Reserve Watch:

October 10 – CNBC (Jeff Cox): “The contest for who will become the next head of the Federal Reserve appears to be coming down to two pretty different choices. In recent days, market participants have become more focused on former Fed Governor Kevin Warsh and current Governor Jerome ‘Jay’ Powell. While Warsh has long been considered a front-runner to head the central bank, Powell has emerged only lately as a compromise candidate who may just get the nod. Fed watchers are keeping a close eye on PredictIt, a predictions market site… He has met with both Powell and Warsh, as well as Yellen and Gary Cohn, the president's chief economic advisor. As of Tuesday morning, PredictIt puts Powell in the lead, with a 40% chance, while Warsh had a 30% likelihood.”

October 10 – Reuters (Ann Saphir): “Dallas Federal Reserve Bank President Robert Kaplan said… he wants to see more signs of upward inflation before raising interest rates again, but that low long-term borrowing costs may limit how far and fast rates can be raised. The Fed has raised rates twice this year, and is widely expected to do so again in December. But even as the short-term interest rate targeted by the Fed has climbed, the yield on the benchmark 10-year Treasury has fallen, a reversal of what usually happens and a development that Kaplan said he sees as ‘a little ominous.’ ‘I view that as a comment on future economic growth,” Kaplan said... ‘And what I don’t want to see us do is raise rates so fast that we get an inverted yield curve because history has shown an inverted yield curve has tended to be a precursor to a recession.’”

U.S. Bubble Watch:

October 10 – Bloomberg (Jeanna Smialek): “A buoyant and complacent stock market is worrying Richard H. Thaler, the University of Chicago professor who this week won the Nobel Prize in economics. ‘We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,’ Thaler said…’I admit to not understanding it.’”

October 11 – CNBC (Fred Imbert): “BlackRock, the world's largest asset manager, reported better-than-expected third-quarter results… Total assets under management rose 17% to nearly $6 trillion as net inflows easily beat Wall Street expectations… Total assets under management: $5.977 trillion vs StreetAccount's projected $5.94 trillion. Net inflows: $96 billion vs $71.62 billion expected.”

October 11 – Wall Street Journal (Sarah Krouse): “Investors plowed nearly $300 billion into Vanguard Group funds in the first nine months of this year, nearly matching flows into the firm for all of 2016 in the latest affirmation of the primacy of low-cost ‘passive’ investing. The torrent of investor money extends a winning streak for the... firm, which has emerged as one of the chief beneficiaries of Americans’ unprecedented embrace of index funds during an eight-year-old U.S. stock bull market.”

October 8 – Financial Times (Joe Rennison and John Authers): “The head of the fourth-largest exchange traded fund provider has warned that investors are blindly pouring money into highly concentrated stock indices, putting them at risk of outsized losses if markets tumble. Martin Flanagan, president and chief executive of Invesco… said that relying on indices that weight stocks according to their market value could inflate losses if stock markets take a nosedive. So-called ‘cap-weighted’ indices direct money to the largest companies and to stocks with higher valuations. There has been an age-old debate within the passive asset management industry about the high concentrations these products can produce. The S&P 500, the index tracked by the most widely held ETF, is currently dominated by five large technology companies — Apple, Google’s holding company Alphabet, Microsoft, Amazon and Facebook — which make up 11.7% of the total index… ‘Too many people have created their total portfolios with cap-weighted indexes thinking they are safe and cheap,’ said Mr Flanagan. ‘The reality is they are turning more and more into momentum plays. You are ending up with a disproportionate amount of your portfolio in the biggest stocks.’”

October 8 – Financial Times (Eric Platt): “As President Donald Trump touched down at San Juan airport last week, 36-year-old Tanya Diaz was heading in the opposite direction. Although she has no job to go to Ms Diaz, her two sons and grandmother flew to California to escape the aftermath of Hurricane Maria… Some estimates suggest that more than 400,000 of the country’s 3.4m population will follow Ms Diaz in the coming years as the Caribbean island, which has already defaulted on its debt obligations, now confronts something that could be even more devastating to its economic recovery — losing thousands of its most talented people.”

October 10 – Bloomberg (Claire Boston): “Working-class Americans devoted a growing percentage of their income toward paying their debts last year, the first increase since 2010 and a shift that is likely contributing to rising default rates, Moody’s… said. The families’ debt burdens are still relatively low compared with earnings-- less than they’ve been for most of the last three decades… But the borrowers are accumulating more debt even as the economy continues its recovery, which could create problems for lenders if U.S. growth slows, said Jody Shenn, a senior analyst at the bond grader. ‘We are seeing signs of the credit cycle turning,’ Shenn said… It’s important to look out for signs of stress ‘and think about the implications when the economy does hit a rough patch.’”

China Bubble Watch:

October 9 – Financial Times (Tom Mitchell): “China’s outgoing central bank governor has called for an urgent return to his stalled capital account reforms, warning his country’s leaders that the opportunity to further open the economy ‘must be seized’. ‘No country can achieve an open economy with strict foreign exchange controls,’ Zhou Xiaochuan said… ‘Time windows are very important for reforms and must be seized. If missed, the cost of reform will be higher in future.’ Mr Zhou, who has run the People’s Bank of China since 2002, was speaking ahead of a Chinese Communist party congress next week that will mark the start of President Xi Jinping’s second five-year term.”

October 12 – Wall Street Journal (Aaron Back): “The Chinese government is pushing some of its biggest tech companies—including Tencent, Weibo and a unit of Alibaba—to offer the state a stake in them and a direct role in corporate decisions. Wary of the increasing power of private businesses, internet regulators have discussed taking 1% stakes with social-media powers Tencent Holdings Ltd. and Weibo Corp. and with Youku Tudou… While the authoritarian government already exerts heavy sway over businesses through regulation, a management role would give Beijing a direct hand in innovative companies that service hundreds of millions of Chinese.”

Central Banker Watch:

October 8 – Wall Street Journal (Josh Zumbrun): “A synchronized global economic expansion is leading to a big shift in monetary policy around the world—toward central banks shrinking rather than growing—with implications for markets, inflation and the outlook for growth. Following the financial crisis from 2007-2009, the world’s big central banks had been net buyers of financial assets in global markets, expanding their portfolios of government bonds, mortgage debt and corporate securities by 1% to 3% of global economic output per year for much of the past six years. Now that’s changing. The Bank of England announced in February it would mostly end its bond purchases, the Fed stopped buying bonds at the end of 2014 and announced in September it would move ahead with a plan to gradually shrink its holdings, and the European Central Bank is expected to announce at the end of October it will slow its pace of purchases.”

October 8 – Bloomberg (Adam Haigh): “Financial markets may be underpricing global risks, leaving them vulnerable to a major correction, …European Central Bank Governing Council member Klaas Knot warned. As global stocks surge, measures of volatility suggest unprecedented calm even as crises around the world -- including the Catalan separatists in Spain, Turkey’s diplomatic row with the U.S., North Korea’s missile tests and the danger of a hard Brexit -- make political headlines. ‘It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,’ said Knot, who is also the president of the Dutch Central Bank.”

Global Bubble Watch:

October 11 – Wall Street Journal (Carolyn Cui and Manju Dalal): “Investors’ thirst for income is enabling governments and companies in some of the world’s poorest countries to sell debt at lower and lower interest rates. And the global bond boom has even reached Tajikistan. The central Asian country last month raised $500 million in its first-ever international bond sale, paying just 7.125% in annual interest… Greece, which was on the brink of default a few years ago, issued new bonds this past summer, and the National Bank of Greece launched a bond sale Tuesday, marking the first visit of a Greek bank to the credit markets since the country’s sovereign-debt crisis. And June saw the bond-market debut of the Maldives, a tiny nation in the Indian Ocean that raised $200 million in a sale of five-year bonds with a 7% coupon. Speculative-grade bond issuance in the developing world has hit a record $221 billion this year, according to data from J.P. Morgan… and Dealogic, up 60% from the full-year total in 2016.”

October 11 – Financial Times (Shawn Donnan): “The International Monetary Fund has warned that good times in the global economy mask longer-term risks, including a $135tn debt pile in G20 nations that companies and consumers are already finding difficult to service. A day after upgrading its global growth forecasts for this year and next the IMF warned… that benign economic conditions were fuelling an appetite for risk that, together with central banks’ response to the 2008 global crisis, appeared to be laying the ground for a new financial crunch. ‘While the waters seem calm, vulnerabilities are building under the surface [and] if left unattended, these could derail the global recovery,’ said Tobias Adrian, of the IMF’s financial stability watchdog… The US and China each accounted for about a third of the $80tn increase in debt since 2006, the IMF said.”

October 10 – CNBC (Evelyn Cheng): “The next global economic slowdown could come from rising risks outside the banking sector, according to the International Monetary Fund. Leverage in the nonfinancial sector for G-20 economies as a whole has surpassed its pre-crisis high, the IMF said… in its Global Financial Stability Report. Nonfinancial sector debt refers to borrowing by governments, nonfinancial companies and households. The total level of that debt for G-20 economies rose to $135 trillion, or about 235% of aggregate gross domestic product in 2016, surpassing the debt-to-GDP ratio of 210% in 2006, before the financial crisis…”

October 8 – Financial Times (Guy Chazan): “Wolfgang Schäuble has warned that spiralling levels of global debt and liquidity present a big risk to the world economy, in his parting shot as Germany’s finance minister. In an interview with the Financial Times, the Europhile who has steered one of the world’s largest economies for the past eight years, said there was a danger of ‘new bubbles’ forming due to the trillions of dollars that central banks have pumped into markets. Mr Schäuble also warned of risks to stability in the eurozone, particularly from bank balance sheets burdened by the post-crisis legacy of non-performing loans.”

October 11 – Bloomberg (Olga Kharif and Camila Russo): “Regulators worldwide are finding that it’s incredibly hard to control the explosive growth of money tied to no nation. Russian President Vladimir Putin is the latest to call for regulation of cryptocurrencies, saying there are ‘serious risks’ they can be used for money laundering or tax evasion. Finance Minister Anton Siluanov has called for regulating digital money as securities, while central bank officials vowed to work with prosecutors to block websites that allow retail investors access to bitcoin exchanges. ‘We think this is a pyramid scheme,’ said Sergey Shvetsov, first deputy governor of the central bank. Global efforts to regulate digital money have accelerated in the past month since China banned initial coin offerings and ordered all cryptocurrency exchanges to close, following inspections of more than 1,000 trading venues over a six-month period.”

October 12 – CNBC (Arjun Kharpal): “Bitcoin hit a new record high Thursday with rising investor interest causing a rally for the price of the cryptocurrency. Bitcoin climbed 11% to an all-time high of $5,364.10, according to… Coindesk. This surpassed the previous high of $5,013.91 hit on September 2. With Thursday's gains, bitcoin is now up around 454% year-to-date.”

October 12 – Wall Street Journal (Aaron Back): “China’s seemingly insatiable demand for foreign assets has driven up prices for everything from U.S. Treasury bonds to global companies to luxury real estate. Now, a combination of market forces and capital controls are choking off the flow of Chinese cash. Asset markets around the world will have to adjust.”

Fixed-Income Bubble Watch:

October 12 – Financial Times (Miles Johnson): “A boom in issuance of risky debt used to finance takeovers has resulted in a fee bonanza for investment bankers, with revenues generated this year from selling leveraged loans and high-yield bonds close to surpassing their post-crisis peak. Investment banks have made $10.5bn in revenues from selling leveraged finance deals so far this year, up from $6.9bn in 2016 and have hit the highest level since 2013… The surge in fees paid for arranging junk bond and leveraged loan deals reflects an explosion in demand for riskier debt from yield-starved institutional investors, such as pension funds, which have been among the largest buyers of $1.1tn of this debt so far this year. This appetite has helped private equity companies in Europe and the US finance an acquisition spree over the past 12 months larger than at any time since the financial crisis, with leveraged buyouts in Europe and the US this year surpassing $200bn.”

October 10 – Financial Times (Eric Platt): “With eight words last week, US president Donald Trump sent a tremor through Puerto Rico’s $74bn of debt and the broader municipal bond market, where states and local governments borrow to fund critical infrastructure projects and services. The president and former real estate mogul warned, in a heavily scrutinised interview, that ‘we’re going to have to wipe that out’ after Hurricane Maria devastated the island. That knocked the US’s $3.8tn municipal bond market. It suffered outflows in the seven days to October 4, the first redemptions since early July… Retail investors have pulled cash from muni bond funds every day since Mr Trump told investors to ‘say goodbye’ to the debt…”

Europe Watch:

October 11 – Bloomberg (Angeline Benoit, Todd White and Charles Penty): “Spanish Prime Minister Mariano Rajoy stepped up pressure on Catalonia to halt its drive for independence, taking the first step in a process that could strip the region’s separatist government of its limited autonomy and impose direct control from Madrid. Rajoy convened an emergency session of cabinet…, at which ministers agreed to issue a formal request to the Catalan government for confirmation of whether it had declared independence… Catalan President Carles Puigdemont’s response to the request will determine what happens next, Rajoy said… Rajoy’s request is a preamble to triggering Article 155 of the Spanish Constitution, a move that would enable him to suspend Catalonia’s devolved government and take over control of its affairs in what would represent an ultimate defeat of the Catalan leadership.”

October 11 – Bloomberg (Alessandro Speciale, Piotr Skolimowski and Carolynn Look): “European Central Bank policy makers are poised to preserve their commitment to ultra-low interest rates even as they wrangle over how long to keep their bond-buying program going. Members of President Mario Draghi’s Governing Council will meet this month amid discord over whether a strengthening economy means now is the time to plot an end to more than 2 1/2 years of quantitative easing or whether to keep it going until inflation accelerates. Where there is agreement is on keeping a pledge to not raise interest rates until ‘well past’ the end of bond buying, according to euro-area central bank officials… Maintaining that promise would remove one potential point of contention in the debate while offering reassurance to investors that higher borrowing costs won’t be imminent when purchases slow.”

Brexit Watch:

October 12 – Bloomberg (Ian Wishart and Tim Ross): “The European Union said talks hit an impasse over what the U.K. owes when it leaves, increasing the chances of a messy departure as time is running out to clinch a deal. The pound fell to the weakest in a month after chief EU negotiator Michel Barnier said there had been no discussions over the all-important bill that the U.K. has to agree it will pay before the EU will start trade talks. Barnier put the onus firmly on the U.K.’s squabbling government to find the political will to move the talks forward, while both sides raised the prospect of talks breaking down without an agreement -- throwing businesses into a chaotic legal limbo.”

Emerging Market Watch:

October 8 – Bloomberg (Adam Haigh): “Emerging-market investors were handed a timely reminder that political risk is never very far away. The lira briefly tumbled to a record low on Monday morning against a basket of currencies including the euro and the dollar as tensions between Turkey and the U.S. escalated. It’s the last thing the country needs -- with widening twin deficits in Turkey already dampening sentiment together with concern many emerging-market assets will be weakened in a climate of higher U.S. interest rates. Investors this year have already had to cope with President Recep Tayyip Erdogan’s state of emergency and the nation’s companies continue to grapple with vast financing needs… And the yield-hunting global wave of money means that appetite for lira-denominated assets has remained strong and may continue to be so if this latest political spat can be cooled quickly.”

Geopolitical Watch:

October 10 – Reuters (Christine Kim and Eric Beech): “The U.S. military flew two strategic bombers over the Korean peninsula in a show of force late on Tuesday, as President Donald Trump met top defense officials to discuss how to respond to any threat from North Korea. Tensions have soared between the United States and North Korea following a series of weapons tests by Pyongyang and a string of increasingly bellicose exchanges between Trump and North Korean leader Kim Jong Un.”

October 12 – Wall Street Journal (Yaroslav Trofimov): “Here’s one measure of where Turkey stands in today’s world. Russian and Iranian citizens are free to enter the country without a visa. Americans, following the recent spat over the detention of a U.S. consulate employee, are essentially barred from traveling to their fellow North Atlantic Treaty Organization ally. The unfolding breakup between Turkey and the U.S. goes far beyond that dispute. It is fueled by increasing frustration on both sides—and is encouraged by countries most interested in such a separation, especially Russia and Iran. Even in the Syrian war, Turkey now has found itself in a new convergence of aims with Moscow and Tehran—and opposing American goals.”

October 10 – NBC (Andrea Mitchell and Ken Dilanian): “The cybersecurity company FireEye says in a new report to private clients, obtained exclusively by NBC News, that hackers linked to North Korea recently targeted U.S. electric power companies with spearphishing emails.

The emails used fake invitations to a fundraiser to target victims, FireEye said. A victim who downloaded the invitation attached to the email would also be downloading malware into his or her computer network…”

Friday Evening Links

[Bloomberg] Stocks, Bonds Rally as Inflation Debate Lingers: Markets Wrap

[Reuters] Oil rallies nearly 2 percent on China import boost, U.S.-Iran tensions

[Bloomberg] What’s at Stake for Oil Markets After Trump’s Iran Move

[Reuters] Trump strikes blow at Iran nuclear deal in major U.S. policy shift

[Reuters] BOJ's Kuroda does not see excesses building up in markets