Friday, May 18, 2018

Weekly Commentary: Crisis Watch

Where to begin? Contagion… The Argentine peso dropped another 5.0% this week, bringing y-t-d losses to 23.7%. The Turkish lira fell 3.9%, boosting 2018 losses to 15.4%. As notable, the Brazilian real dropped 3.7% (down 11.5% y-t-d), and the South African rand sank 4.0% (down 3.0% y-t-d). The Colombian peso fell 3.0%, the Chilean peso 2.7%, the Mexican peso 2.7%, the Hungarian forint 2.3%, the Polish zloty 2.1% and the Czech koruna 2.0%.

EM losses were not limited to the currencies. Yields continued surging throughout EM. Notable rises this week in local EM bonds include 54 bps in Brazil, 27 bps in South Africa, 34 bps in Hungary, 36 bps in Lebanon, 25 bps in Indonesia, 28 bps in Peru, 14 bps in Turkey, 20 bps in Mexico and 11 bps in Poland.

Dollar-denominated EM debt was anything but immune. Turkey's 10-year dollar bond yields spiked 41 bps to 7.16%, the high going back to May 2009. Brazil's dollar bond yields surged 29 bps to 5.58%, the highest level since December 2016. Mexico's dollar yields jumped 18 bps to 4.64%, the high going all the way back to February 2011. Dollar yields rose 19 bps in Chile, 28 bps in Colombia, 19 bps in Indonesia, 14 bps in Russia, 14 bps in Ukraine and 167 bps in Venezuela (to 32.80%). Losses are mounting quickly for those speculating in EM debt.

Developed bonds were under pressure as well. We'll begin with Italy:

May 17 - UK Guardian (Jon Henley): "Italy's new government, likely to be formally confirmed within the next few days, sets a perilous precedent for Brussels: it marks the first time a founding member of the EU has been led by populist, anti-EU forces. From the EU's perspective, the coalition of the anti-establishment Five Star Movement (M5S) and the far-right League looks headstrong and unpredictable, possibly even combustible. Leaked drafts of their government 'contract' include provision for a 'conciliation committee' to settle expected disagreements. Mainly it looks alarming. Both parties toned down their fiercest anti-EU rhetoric during the election campaign, dropping previous calls for a referendum on eurozone membership… But as they approach power, the historical Euroscepticism of the M5S and the League is resurfacing. An incendiary early version of their accord called for the renegotiation of EU treaties, the creation of a euro opt-out mechanism, a reduction in Italy's contribution to the EU budget and the cancellation of €250bn (£219bn) of Italian government debt."

Italian 10-year yields surged 36 bps this week to 2.23%, the high since the spike last July. Perhaps even more dramatic, after ending last week at negative 29 bps, Italian 2-year yields surged 37 bps to a near 22-month high eight bps. The Italian to German two-year yield spread widened 36 bps this week to a 13-month high 68 bps.

Bonds throughout the euro zone periphery were under pressure. Greek 10-year yields surged 50 bps to a 2018 high 4.50%. Portuguese yields jumped 19 bps to 1.87%, and Spanish yields gained 17 bps to 1.44%. Elsewhere, Australian 10-year yields rose 12 bps to 2.90%, and New Zealand yields rose 14 bps to 2.86%.

Even with Friday's six bps decline, 10-year Treasury yields ended the week up eight bps to 3.06%. Thursday's 3.13% yield was the high going back to July 2011. With two-year yields adding a basis point this week, the two to 10-year spread widened seven bps to 51 bps. It's worth noting that 30-year yields jumped 10 bps this week to 3.21%, the high since June 2015, and benchmark MBS yields rose 10 bps to 3.76%, a high going back to July 2011.

May 17 - Bloomberg (Selcuk Gokoluk): "Debt levels that quadrupled in a decade have made emerging markets vulnerable to tightening financial conditions in the era of rising U.S. interest rates, Fitch Ratings said. Outstanding debt securities from developing nations have ballooned to $19 trillion from $5 trillion a decade earlier... Despite the development of local-currency bond markets, borrowers will be hobbled by higher external borrowing costs, a stronger dollar and slowdown of capital inflows, it said… 'If easy financial conditions tighten more sharply than expected, EM debt would come under pressure,' said Monica Insoll, the head of the credit market research team at Fitch. 'If investor appetite for EM risk reverses, issuers may face refinancing challenges even in their home markets, while capital outflows could put pressure on exchange rates or foreign exchange reserves.'"

It's worth repeating (from above): "Outstanding debt securities from developing nations have ballooned to $19 trillion from $5 trillion a decade earlier." Analysts this week were keen to note that EM market tumult has been less disruptive than the (soon passing) 2016 episode. Give it time. We're still in just the initial phase of Risk Off. Only a few weeks back, universal bullishness held sway over the emerging markets and economies. Buy one ETF and own them all!

It's worth recalling that the 2016 de-risking/de-leveraging episode was nipped in the bud by an upsurge in global QE (especially courtesy the ECB and BOJ) and a corresponding extension of easy money by the Federal Reserve. And let us not forget the commanding contribution from Beijing policymaking. After a modest slowdown in 2015, China's Credit growth surged in 2016 and that acceleration continued well into 2017. Two additional fateful years of surging global Credit and financial flows are now coming home to roost.

Today's backdrop is more conducive to a protracted EM crisis backdrop, along with, I would argue, an especially destabilizing global market liquidity crunch. For one, the overheated U.S. economy has the Fed rather hamstrung. Their timid baby-step approach has worked to sustain excessively loose financial conditions. And while central bankers dilly-dallied, extreme fiscal stimulus coalesced with extreme monetary stimulus - creating a most potent concoction way too late in the economic cycle. Between fiscal stimulus, a capital investment boom and reenergized housing inflation, the Fed today confronts extraordinary uncertainty as it attempts to gauge the amount of economic stimulus and inflationary juice in the pipeline.

Fed rate hikes, rising market yields and the resurgent dollar receive most of the attention when analysts contemplate EM vulnerabilities. Issues related to China are deserving of more prominence in the analysis. Chinese officials have finally become more assertive in cracking down on financial excess. China's system Credit growth has slowed meaningfully, and there are indications that tighter financial conditions have begun to bite.

May 18 - Bloomberg (Carrie Hong): "Zhongyuan Yuzi Investment Holding Group Co. became the second Asian investment-grade company that failed to price a dollar-denominated bond offering this week after the 10-year U.S. Treasury yield hit the highest level since 2011. The Chinese local government financial vehicle decided not to proceed with a plan to sell dollar bonds on Thursday because of unfavorable market conditions… A day earlier, developer China Overseas Grand Oceans Group Ltd. also postponed a sale of five-year bonds… With the global borrowing benchmark surging this week combined with rising Libor funding cost, appetite for Asian dollar new issues is weakening…"

May 16 - Bloomberg (Lianting Tu, Carrie Hong and Denise Wee): "A slump in prices of higher-yielding bonds sold by Chinese banks risks spurring margin calls that will exacerbate the declines. Capital instruments sold by Bank of Qingdao Co. and other small Chinese lenders sank below 90 cents on the dollar this month, tumbling faster than other securities as a rise in Treasury yields sent jitters through Asian credit markets. Because the notes were marketed to wealthy individuals as part of structured products and those investors tend to be heavily leveraged, buyers may face margin calls when prices decline to between 80 cents and 90 cents on the dollar, said three people familiar with the debt…"

May 17 - Bloomberg: "The days when only obscure Chinese companies defaulted on their debt are ending. Four of the five issuers that have defaulted for the first time in 2018 are companies with public listings, which used to be regarded as assuring better governance and information disclosure. That's as many by this type of firm as happened in 2014 through 2017… For investors, the change means it's dangerous to make assumptions. 'Our first and foremost task now is to avoid stepping on mines,' says Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management LLP, which oversees 12 billion yuan ($1.9bn) in assets. 'It's increasingly difficult to tell which one will default, which not.'"

China would not face today's degree of fragility had it not fatefully resuscitated Bubble Dynamics back in 2016. EM, as well, would be in a sounder position if it had begun to deal with excess and mounting vulnerabilities. Instead, for both China and EM it's been a case of extending Terminal Phase Excess, with an additional two years of rampant Credit expansion, extraordinary international "hot money" flows, and even deeper structural impairment.

May 17 - Bloomberg (Richard Frost and Emma Dai): "Hong Kong intervened to defend its currency peg for a second day after the city's dollar fell to the weak end of its trading band The Hong Kong Monetary Authority bought HK$9.5 billion ($1.2bn) of local dollars overnight, the third-biggest intervention since the defense began last month. The HKMA mopped up HK$1.57 billion on Wednesday. Lower rates than the U.S. have made the Hong Kong dollar an attractive target for shorting. The de facto central bank has now spent $7.95 billion protecting its currency system, which has the effect of tightening liquidity in a city that's grown fat on ultra-low borrowing costs."

From my vantage point, EM contagion has reached critical mass. There will be ebbs and flows, but we're now on Crisis Watch. De-risking/De-leveraging Dynamics have attained momentum, and the focus will be on waning global market liquidity and the next domino. The process of unwinding EM "carry trade" leverage has commenced. I ponder how much leverage has accumulated throughout Asian debt markets. Hong Kong's Monetary Authority has significant international reserves (over $400bn) to support its faltering currency peg. But I would expect the reversal of "hot money" flows to accelerate, pressuring central banks throughout Asia and EM more generally. To fund outflows, central bankers will be forced sellers of Treasuries (and other sovereign debt). It's worth noting that custody holdings held by the Fed for foreign Treasury holders have dropped $63bn over the past five weeks.

Back in 2015 and 2016, the monthly change in China's international reserves garnered significant market interest. Recall that after peaking at almost $4.0 TN in June 2014, reserves were down to about $3.0 TN by the end of 2016. But between January 2017 and January 2018, China's reserves recovered $160 billion, a significant quantity but still only a fraction of the previous decline. Hinting of a return of outflows, reserves have dropped $36 billion over the past three months.

Is there a big foreign "carry trade" component in Chinese debt instruments - in Hong Kong and the mainland? In the past, I posited "currency peg on steroids" - speculators could leverage in higher yielding Chinese instruments with confidence that Chinese officials would revalue the renminbi higher versus the dollar. The 2015/2016 renminbi devaluation corresponded with huge outflows and the drawdown of China's reserve holdings. Now, for almost 18 months the renminbi has enjoyed another period of managed appreciation - concurrent with a period of global exuberance for EM and Credit more generally. How much "hot money" and leverage was enticed by China's higher yields?

China appears increasingly vulnerable to EM contagion effects. Finance is tightening in EM, in China and globally. Over recent years, China has developed into the prevailing source of EM finance and trade. China and EM interdependency has been instrumental to their respective booms. Now comes the downside. I suspect "hot money" has begun exiting EM at least partially in anticipation of waning trade and financial flows from China. And a faltering EM Bubble certainly has negative ramifications for the increasingly fragile Chinese Bubble. If there is a big "carry trade" in Chinese Credit instruments, it's susceptible.

Previous problems have not gone away - they've instead festered and metastasized. EM debt, the China Bubble, Italy and euro monetary integration, to name just a few. This week was clearly an escalation in global de-risking/de-leveraging dynamics. How much speculative leverage has accumulated (since 2012) in Italian, Greek, Portuguese and Spanish debt? ECB rate manipulation and "money printing" stoked an artificial boom. It's come at a very steep price. Myriad problems associated with a deeply flawed monetary integration are waiting to resurface, as we're witnessing in Italy.

I know it sounds crazy - pure heresy - to most. But there's a shot that the world has commenced a crisis period that will unfold into something more comprehensive and challenging than 2008. And at least in the U.S., financial crisis is the furthest thing from people's minds. Not even on the radar. Not possible.

The VIX closed the week at 13.42. Blue skies as far as eyes can see. But to one that has been chronicling the "global government finance Bubble" now for over nine years, I really worry. Excess became systemic. Deep structural maladjustment - systemic. Global imbalances - unprecedented. The amount of global debt - previously unfathomable. And, deeply concerning, the world has become so much more divisive and hostile over the past decade.

Come the next international crisis, it will not be the U.S. and a group of likeminded global central bankers coordinating a unified policy response. Expect a disparate group of bankers, politicians and strongmen autocrats pointing fingers, making threats and demanding action from others. If they can't after months successfully negotiate trade deals, how are they to respond to crisis dynamics that they are wholly unprepared for.

But I'm getting ahead of myself. The U.S. economic boom has a head of steam. The small caps traded to record highs this week. To the naked eye, things look sound and sustainable. If only it weren't a Bubble Illusion. The NYT's Kevin Roose this week penned an insightful article, "The Entire Economy Is MoviePass Now. Enjoy It While You Can."

"I've got a great idea for a start-up. Want to hear the pitch? It's called the 75 Cent Dollar Store. We're going to sell dollar bills for 75 cents - no service charges, no hidden fees, just crisp $1 bills for the price of three quarters. It'll be huge. You're probably thinking: Wait, won't your store go out of business? Nope. I've got that part figured out, too. The plan is to get tons of people addicted to buying 75-cent dollars so that, in a year or two, we can jack up the price to $1.50 or $2 without losing any customers. Or maybe we'll get so big that the Treasury Department will start selling us dollar bills at a discount. We could also collect data about our customers and sell it to the highest bidder. Honestly, we've got plenty of options. If you're still skeptical, I don't blame you. It used to be that in order to survive, businesses had to sell goods or services above cost. But that model is so 20th century. The new way to make it in business is to spend big, grow fast and use Kilimanjaro-size piles of investor cash to subsidize your losses, with a plan to become profitable somewhere down the road. Over all, 76% of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to… Jay Ritter, a professor at the University of Florida's Warrington College of Business. That was the largest number since the peak of the dot-com boom in 2000, when 81% of newly public companies were unprofitable. Of the 15 technology companies that have gone public so far in 2018, only three had positive earnings per share in the preceding year… The rise in unprofitable companies is partly the result of growth in the technology and biotech sectors, where companies tend to lose money for years as they spend on customer acquisition and research and development… But it also reflects the willingness of shareholders and deep-pocketed private investors to keep fast-growing upstarts afloat long enough to conquer a potential winner-take-all' market."

We've created a Bubble economic structure that will function especially poorly come faltering markets and a tightening of financial conditions.

For the Week:

The S&P500 declined 0.5% (up 1.5% y-t-d), and the Dow dipped 0.5% (unchanged). The Utilities sank 3.1% (down 7.8%). The Banks fell 1.2% (up 2.6%), while the Broker/Dealers added 0.4% (up 11.2%). The Transports increased 0.2% (up 1.1%). The S&P 400 Midcaps added 0.2% (up 2.3%), and the small cap Russell 2000 jumped 1.2% (up 5.9%). The Nasdaq100 declined 1.2% (up 7.3%).The Semiconductors slipped 0.4% (up 7.4%). The Biotechs gained 0.9% (up 11.4%). With bullion sinking $26, the HUI gold index dropped 2.5% (down 7.6%).

Three-month Treasury bill rates ended the week at 1.85%. Two-year government yields added a basis point to 2.55% (up 66bps y-t-d). Five-year T-note yields gained five bps to 2.89% (up 68bps). Ten-year Treasury yields jumped eight bps to 3.06% (up 65bps). Long bond yields rose nine bps to 3.20% (up 46bps). Benchmark Fannie Mae MBS yields jumped 10 bps to 3.76% (up 76bps).

Greek 10-year yields surged 50 bps to 4.50% (up 42bps y-t-d). Ten-year Portuguese yields gained 19 bps to 1.87% (down 8bps). Italian 10-year yields jumped 36 bps to 2.23% (up 21bps). Spain's 10-year yields rose 17 bps to 1.44% (down 12bps). German bund yields added two bps to 0.58% (up 15bps). French yields gained four bps to 0.83% (up 5bps). The French to German 10-year bond spread widened two to 25 bps. U.K. 10-year gilt yields gained six bps to 1.50% (up 31bps). U.K.'s FTSE equities index increased 0.7% (up 1.2%).

Japan's Nikkei 225 equities gained 0.8% (up 0.7% y-t-d). Japanese 10-year "JGB" yields gained almost two bps to 0.06% (up 1bp). France's CAC40 rose 1.3% (up 5.7%). The German DAX equities index added 0.6% (up 1.2%). Spain's IBEX 35 equities index dropped 1.5% (up 0.7%). Italy's FTSE MIB index sank 2.9% (up 7.3%). EM equities were mostly lower. Brazil's Bovespa index dropped 2.5% (up 8.7%), and Mexico's Bolsa fell 2.3% (down 7.5%). South Korea's Kospi index declined 0.7% (down 0.3%). India’s Sensex equities index dropped 1.9% (up 2.3%). China’s Shanghai Exchange gained 0.9% (down 3.4%). Turkey's Borsa Istanbul National 100 index recovered 0.5% (down 11.2%). Russia's MICEX equities declined 0.8% (up 10.3%).

Investment-grade bond funds saw inflows of $3.069 billion, while junk bond funds posted outflows of $542 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped six bps to 4.61% (up 59bps y-o-y). Fifteen-year rates gained seven bps to 4.08% (up 81bps). Five-year hybrid ARM rates rose five bps to 3.82% (up 69bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up a basis point to 4.72% (up 64bps).

Federal Reserve Credit last week declined $3.1bn to $4.314 TN. Over the past year, Fed Credit contracted $125bn, or 2.8%. Fed Credit inflated $1.504 TN, or 53%, over the past 289 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $9.4bn last week to a five-month low $3.387 TN. "Custody holdings" were up $153bn y-o-y, or 4.7%.

M2 (narrow) "money" supply rose $16.0bn last week to a record $13.971 TN. "Narrow money" gained $511bn, or 3.8%, over the past year. For the week, Currency increased $0.5bn. Total Checkable Deposits sank $64.8bn, while savings Deposits surged $70.9bn. Small Time Deposits added $2.1bn. Retail Money Funds gained $7.2bn.

Total money market fund assets rose $11.5bn to $2.818 TN. Money Funds gained $173bn y-o-y, or 6.6%.

Total Commercial Paper jumped $9.6bn to $1.069 TN. CP gained $82.3bn y-o-y, or 8.3%.

Currency Watch:

The U.S. dollar index jumped 1.2% to 93.637 (up 1.6% y-t-d). For the week on the upside, the Swiss franc increased 0.2%. For the week on the downside, the South African rand declined 4.0%, the Brazilian real 3.7%, the Mexican peso 2.7%, the Swedish krona 1.7%, the Norwegian krone 1.5%, the euro 1.4%, the Japanese yen 1.3%, the New Zealand dollar 0.9%, the South Korean won 0.8%, the Canadian dollar 0.7%, the British pound 0.5%, the Singapore dollar 0.5% and the Australian dollar 0.4%. The Chinese renminbi declined 0.72% versus the dollar this week (up 1.99% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 1.0% (up 10.6% y-t-d). Spot Gold fell 1.9% to $1,293 (down 0.8%). Silver dropped 1.8% to $16.455 (down 4.0%). Crude gained 58 cents to $71.28 (up 18%). Gasoline jumped 2.0% (up 24%), and Natural Gas rose 1.5% (down 4%). Copper declined 1.5% (down 7%). Wheat rallied 3.9% (up 21%). Corn jumped 1.5% (up 15%).

Market Dislocation Watch:

May 16 - Bloomberg (Robert Burgess): "Ask most any smart investor what could cause the next crisis in markets and the likely answer would be a sharp rise in borrowing costs brought on by a selloff in the bond market. But the thing about markets is that the pain usually originates in places where it's least expected. That may be the case now with emerging markets. The fact is, investors have had a few years now to prepare for the inevitable rise in bond yields that is currently underway. That's seen in the record bets against U.S. Treasuries. What hasn't been expected is the big slump in EM, which attracted a record $315 billion in non-resident portfolio debt flows in 2017…"

Trump Administration Watch:

May 18 - Bloomberg (Eric Martin, Josh Wingrove and Jenny Leonard): "President Donald Trump's chief Nafta negotiator said the U.S., Canada and Mexico are 'nowhere near close to a deal' to update the region's 24-year-old free-trade pact as U.S. lawmakers warn that time is almost up to reach a agreement that can pass the current Congress. 'There are gaping differences on intellectual property, agricultural market access, de minimis levels, energy, labor, rules of origin, geographical indications, and much more,' U.S. Trade Representative Robert Lighthizer said… 'We of course will continue to engage in negotiations, and I look forward to working with my counterparts to secure the best possible deal for American farmers, ranchers, workers, and businesses.'"

May 16 - Reuters (Doina Chiacu and David Lawder): "The United States is still pushing for a deal to revise the North American Free Trade Agreement (NAFTA), the White House said…, while a top Mexican official held out the possibility of an agreement in the coming weeks. President Donald Trump is committed to getting a better agreement with Canada and Mexico, White House press secretary Sarah Sanders told Fox News. 'We still want to see something happen and we're going to continue in those conversations. They're ongoing now and we're pushing forward and hopeful that we can get something done soon,' said Sanders."

May 16 - Reuters (John Irish): "China's foreign minister on… took a swipe at the United States' trade policy and defended international free trade on the basis of World Trade Organisation regulations. 'Trade unilateralism goes against the current of history,' Wang-Yi said… 'We must preserve international free trade on the basis of WTO rules.'"¬¬

May 16 - Bloomberg: "The Trump administration is delivering the World Trade Organization 'three hard blows' that could destroy the body's ability to regulate global commerce, China's ambassador to the Geneva-based body said. 'The U.S. is blocking selection of new Appellate Body members, taking restrictive trade measures under Section 232 and threatening to impose tariff measures of $50 billion of goods imports from China under Section 301 of U.S. domestic law,' said Zhang Xiangchen, China's envoy to the WTO since last year. 'Any one of these, if left untreated, will fatally undermine the functioning of the WTO.'"

May 16 - Politico (Andrew Restuccia, Nancy Cook and Doug Palmer): "Tensions between Trump administration moderates and hard-liners on trade with China are boiling over ahead of talks with Chinese negotiators in Washington this week - and as President Donald Trump seems increasingly eager to reach a deal. Peter Navarro, a Beijing critic and the standard-bearer of the president's harsh campaign rhetoric on China, had a screaming match with Treasury Secretary Steven Mnuchin, a moderate, during an initial round of talks in Beijing two weeks ago. On Wednesday, his name wasn't on a Treasury Department list of U.S. officials who will meet with Chinese Vice Premier Liu He and the rest of the Beijing delegation at Treasury on Thursday and Friday."

May 17 - Bloomberg (Toluse Olorunnipa): "John Bolton's desire to turn North Korea into the next Libya isn't going over so well in Pyongyang, where Kim Jong Un's government has threatened to cancel upcoming talks with the U.S. in part because of the U.S. national security adviser's remarks. Bolton drew the ire of the North Korean government for saying that the country's nuclear disarmament should follow the 'Libya model' embraced by Muammar Qaddafi, who was later overthrown and killed in a U.S.-backed uprising."

May 13 - Reuters (Valerie Volcovici and Richard Cowan): "The United States threatened on Sunday to impose sanctions on European companies that do business with Iran, as the remaining participants in the Iran nuclear accord stiffened their resolve to keep that agreement operational. White House national security adviser John Bolton said U.S. sanctions on European companies that maintain business dealings with Iran were 'possible,' while Secretary of State Mike Pompeo said he remained hopeful Washington and its allies could strike a new nuclear deal with Tehran."

May 11 - Wall Street Journal (Louise Radnofsky, Stephanie Armour and Joseph Walker): "President Donald Trump unveiled dozens of initiatives aimed at curbing high drug prices Friday, a raft of modest moves that left the pharmaceutical industry relieved and buoyed their stocks. 'We're going to take on one of the biggest obstacles to affordable medicine: the tangled web of special interests,' Mr. Trump said… 'The drug lobby is making an absolute fortune at the expense of American consumers.'"

May 13 - Reuters (Valerie Volcovici and Michael Martina): "U.S. President Donald Trump pledged on Sunday to help ZTE Corp 'get back into business, fast' after a U.S. ban crippled the Chinese technology company, offering a job-saving concession to Beijing ahead of high-stakes trade talks this week. Trump's unexpected announcement was a stunning reversal, given Washington's tough stance on Chinese trade practices that have put the world's two largest economies on course for a possible trade war… 'Too many jobs in China lost. Commerce Department has been instructed to get it done!' Trump wrote on Twitter…"

May 14 - Politico (Andrew Restuccia and Doug Palmer): "Wilbur Ross has largely been sidelined in high-stakes trade negotiations with China in the latest signal that President Donald Trump is losing confidence in his commerce secretary… Ross - whom Trump once affectionately called a 'killer,' a high compliment in the president's lexicon - has steadily become a bit player, with the president regularly leaning on Treasury Secretary Steven Mnuchin, U.S. Trade Representative Robert Lighthizer and White House trade adviser Peter Navarro. The commerce secretary's standing took another hit this week when the president tweeted criticism of the department's recent decision to block the Chinese phone-maker ZTE from accessing U.S. technology…"

Federal Reserve Watch:

May 15 - Reuters (Howard Schneider and Ann Saphir): "Federal Reserve Chair Jerome Powell's top deputies are edging toward a clash that could shape the pace of interest-rate hikes in coming months, as well as how the Fed should prepare for and combat the next economic downturn. The fault lines are technical as well as philosophical and include a debate over whether the economy has shifted into a higher gear, giving the Fed room for more interest-rate hikes and perhaps reducing the need for controversial tools like bond-buying to fight future recessions. They come as tax cuts and government spending boost growth and inflation, giving policymakers the breathing room to debate whether to retool the Fed's basic policy approach to give themselves more firepower even if slower future economic growth is unavoidable."

May 14 - CNBC (Natasha Turak): "The U.S. should keep its debt-to-GDP in mind before things 'get out of hand,' Federal Reserve Bank of Cleveland President Loretta Mester said… Asked by CNBC's Joumanna Bercetche if she was worried about the outlook for rising U.S. debt, Mester was measured but encouraged monitoring the debt level, which is at its highest since just after World War Two. 'I think we have to be taking into account the health of U.S. economy, in terms of are we on a sustained fiscal path?' Mester replied. 'And I do think that's something we should be thinking of now as we go forward, and not waiting till things get too far out of hand.'"

U.S. Bubble Watch:

May 14 - CNBC (Jeff Cox): "America's budget deficit and unemployment rate are heading in opposite directions - something that's never happened during post-World War II peacetime and could cause a significant jump in interest rates. Goldman Sachs projects, for instance, that the 10-year Treasury note could be yielding 3.6% next year. The deficit increase is coming due to the recent barrage of fiscal stimulus from Congress, including a $1.5 trillion tax cut approved in December 2017 and a $1.3 trillion spending bill aimed at keeping the government operating through the end of the fiscal year. Normally such moves would come in the early stages of an economic recovery. The U.S. economy, though, is in the eighth year of its post-financial crisis expansion…"

May 11 - Reuters (Richard Leong): "The U.S. economy is likely growing at a 2.97% annualized pace in the second quarter, little changed from the 2.96% rate calculated a week earlier, the New York Federal Reserve's Nowcast model showed…"

May 15 - CNBC (Diana Olick): "A sharp sell-off in the bond market is sending mortgage rates to the highest level in seven years. The average contract rate on the 30-year fixed will likely end the day as high as 4.875% for the highest creditworthy borrowers and 5% for the average borrower… Mortgage rates, which loosely follow the yield on the 10-year Treasury, started the year right around 4% but began rising almost immediately. They then leveled off in March and early April, only to begin rising yet again."

May 15 - Wall Street Journal (Akane Otani, Ben Eisen and Chelsey Dulaney): "U.S. companies are ramping up spending on their businesses at the fastest pace in years, a long-awaited development after years of tepid growth. Spending on factories, equipment and other capital goods by companies in the S&P 500 is expected to have risen to $166 billion in the first quarter, up 24% from a year earlier, according to Credit Suisse…. It is on track for the fastest pickup since 2011 and a record for the first quarter of a year. The jump has been aided by the U.S. tax-code overhaul, which is putting more cash in companies' coffers."

May 17 - Axios (Steve LeVine and Chris Canipe): "At a time of rock-bottom joblessness, high corporate profits and a booming stock market, more than 40% of U.S. households cannot pay the basics of a middle-class lifestyle - rent, transportation, child care and a cellphone, according to a new study. Quick take: The study, conducted by United Way, found a wide band of working U.S. households that live above the official poverty line, but below the cost of paying ordinary expenses. Based on 2016 data, there were 34.7 million households in that group - double the 16.1 million that are in actual poverty…"

May 17 - Wall Street Journal (Janet Adamy): "American women are having children at the lowest rate on record, with the number of babies born in the U.S. last year dropping to a 30-year low… Some 3.85 million babies were born last year, down 2% from 2016 and the lowest number since 1987, according to the Centers for Disease Control and Prevention's National Center for Health Statistics. The general fertility rate for women age 15 to 44 was 60.2 births per 1,000 women-the lowest rate since the government began tracking it more than a century ago…"

China Watch:

May 14 - Reuters (Kevin Yao and Fang Cheng): "China reported weaker-than-expected investment and retail sales in April and a drop in home sales, clouding its economic outlook even as policymakers try to navigate debt risks and defuse a heated trade row with the United States. Fixed asset investment grew the slowest since 1999 while the pace of retail sales softened to a four-month low, suggesting a long-anticipated slowdown in the world's second-largest economy may finally be setting in even as protectionism is on the rise. The lone bright spot on Tuesday's activity data was industrial output, which jumped more than expected as automobile and steel production surged."

May 13 - Reuters (Shu Zhang and Engen Tham): "Chinese insurers are channeling funds through shadow lenders to real estate and local government infrastructure projects in a bid to boost returns, six insurance and trust sources told Reuters. The practice undermines Beijing's efforts to cut local debt risk and curb a property bubble, highlighting the difficulties regulators face in reining in shadow lending and applying regulations uniformly across China's $15 trillion asset management sector… The amount insurers have allocated to alternative assets - trusts, asset management plans and bank wealth management products - has surged rapidly since authorities relaxed investment rules in 2012. Analysts warn that the complex and opaque structure of such products makes it difficult for insurers to see the ultimate borrowers and to then gauge their real exposure - a risk magnified by the long investment periods involved."

May 18 - Bloomberg: "China's regulator is warning companies to be mindful of currency and interest-rate risks when issuing offshore notes as mainland firms aggressively tap the dollar-bond market amid tighter cash conditions onshore. Chinese companies planning to sell overseas notes with tenors of over one year need to explain the rationale and feasibility of the borrowing, according to a statement on National Development and Reform Commission's website... Companies should consider forex, interest rates and other factors before issuing debt, it said. Chinese companies sold a record $75.6 billion dollar bonds so far this year… Offshore issuance from Chinese borrowers has surged in the wake of tougher access to funding in the onshore market as the government reduces financial leverage."

May 14 - Reuters (Kevin Yao and Yawen Chen): "China's property investment growth slowed in April while sales marked their biggest fall in six months as higher borrowing costs and increased curbs on buyers weighed on demand, backing views that a key driver of the economy is losing some momentum. Real estate investment rose 10.2% in April from the same period a year earlier, compared with a 10.8% rise in March… New household loans, mostly mortgages, slowed to 528.4 billion yuan in April from 580 billion yuan in March…"

Central Bank Watch:

May 14 - Bloomberg (Piotr Skolimowski, Jana Randow and Alessandro Speciale): "European Central Bank policy maker Francois Villeroy de Galhau signaled that he expects bond purchases to end this year and an interest-rate hike could follow in 2019, putting him in the camp of officials who see the current euro-area slowdown as temporary. …The French central banker said inflation will resume its acceleration in coming months, with underlying price pressures set to strengthen… The ECB could say a rate increase will follow the halting of net asset purchases by 'at least some quarters, but not years' he said…"

Global Bubble Watch:

May 17 - Bloomberg (Sridhar Natarajan): "Warren Buffett once called them 'financial weapons of mass destruction.' Now Pope Francis, of all people, is taking aim at derivatives. In a sweeping critique of global finance released by the Vatican…, the Holy See singled out derivatives including credit-default swaps for particular scorn. 'A ticking time bomb,' the Vatican called them. The unusual rebuke -- derivatives rarely reach the level of religious doctrine - is in keeping with Francis's skeptical view of unbridled global capitalism. 'The market of CDS, in the wake of the economic crisis of 2007, was imposing enough to represent almost the equivalent of the GDP of the entire world. The spread of such a kind of contract without proper limits has encouraged the growth of a finance of chance, and of gambling on the failure of others, which is unacceptable from the ethical point of view,' the Vatican said in the document."

May 17 - Bloomberg (Sid Verma): "In credit markets, it's America first no longer. A wave of foreign selling of U.S. corporate bonds threatens to unhinge global debt markets from their bullish moorings, according to HSBC… After a multi-year binge, the largest owners of America Inc.'s debt -- overseas investors -- are paring their exposures as higher short-term U.S. rates drive up hedging costs, especially for Europeans. The accompanying pressure on the biggest corporate bond market risks hobbling credit bulls around the world. 'Our analysis of foreign investors in U.S. dollar and euro suggests major changes in global capital flows are underway,' strategists led by Jamie Stuttard wrote… While European issuers will benefit from repatriation flows, a 'disorderly' retrenchment from dollar debts would ensure no developed credit market escapes the 'bearish correlations.' Higher relative yields and the U.S. economic recovery lured a tide of capital inflows in recent years. Now short-term dollar rates are at crisis-era levels, increasing the cost for foreigners to hedge their exposures, and dimming the market's allure even as yields on U.S. investment-grade notes rise to seven-year highs."

May 15 - Bloomberg (Greg Quinn): "Canadian home sales fell to the lowest in more than five years in April, as tougher mortgage qualification rules deterred buyers. The number of homes sold last month declined 2.9% from March, the Canadian Real Estate Association said… Declines were recorded in about 60% of cities tracked including Vancouver, Calgary, Toronto and Montreal."

May 18 - Bloomberg (Frederik Balfour): "A rare bottle of 60-year-old Macallan whisky sold for HK$7.96 million ($1.01 million) at Bonhams Hong Kong on Friday, smashing the record for the most expensive bottle ever sold at auction. The bottle sold for more than twice the high estimate of HK$4.5 million."

Europe Watch:

May 17 - Bloomberg (Alessandra Migliaccio): "Italy's populist parties are planning an overhaul of its banking system that would reverse years of national and international regulatory policy. A 39-page draft program published by Corriere della Sera and confirmed by Five Star and League officials contains plans including a strategy review for Banca Monte dei Paschi di Siena SpA, the lender that was nationalized last year… The program also laid out plans to reimburse retail shareholders of banks that have been wound down; review the Basel banking accords whose parameters 'threaten the existence of Italy's small and medium companies;' and separate investment banking from deposit-taking consumer banking."

May 14 - Reuters (Lisa Jucca): "Italy's impending radical government will be a headache for the European Union. After days of intense talks, the anti-establishment 5-Star Movement and the rightist League are closing in on a joint political programme and will report to President Sergio Mattarella on Monday afternoon. Both resent Brussels' fiscal oversight, and its failure to help with Italy's migration crisis. Their policies will likely stir up tensions with European partners… According to Italian media reports, 5-Star, which represents the poor constituencies of Italy's South, and the League, which draws support from the entrepreneurial North, have drawn up an agenda comprising tax cuts, looser early retirement rules and more handouts for Italy's jobless. If these are all implemented, Italy's fiscal bill could rise by 100 billion euros a year, local economists estimate, equivalent to almost 6% of gross domestic product."

May 16 - Bloomberg (Mark Gilbert): "It's Groundhog Day again for the euro. It doesn't really matter whether talks in Italy between the Five Star Movement and the League still include plans to seek a write-off of 250 billion euros ($295bn) of the nation's debts and secure an exit mechanism from the euro, as the Huffington Post reported. The fact that these ideas were even mooted shows that the common currency remains deeply flawed almost two decades after its introduction. On Wednesday, German Chancellor Angela Merkel called on the governments of the 19-member euro zone to accelerate efforts to integrate the bloc, including enhancing the European Stability Mechanism to create a 'common backstop' in the region. The idea of common debt obligations gets revived repeatedly in Brussels. But aren't such moves to ever-closer union exactly what Italian voters rejected by voting for populist anti-European parties in their most recent election?"

May 14 - Reuters (Piotr Skolimowski): "Economic growth slowed across Europe at the start of the year, with Germany seeing its pace of expansion cut in half amid weaker trade. The 0.3% increase in Europe's largest economy was softer than forecast and the weakest in more than a year. Dutch and Portuguese growth also cooled more than expected in the first quarter, while a similar trend was seen across central and eastern Europe. A deceleration in euro-area momentum to 0.4% was confirmed…"

Fixed Income Bubble Watch:

May 18 - Bloomberg (Sally Bakewell and Kiel Porter): "Buyout titans are benefiting as banks get less fearful about leveraged buyouts. When Leonard Green & Partners recently decided to buy a majority stake in SRS Distribution Inc., banks led by Bank of America Corp. and Barclays Plc sought loans and bonds to help finance the $3.6 billion buyout. Investors have so far been willing to increase debt for the building supply company to more than seven times a measure of earnings, a level that just a few years ago would have raised regulators' eyebrows. That deal isn't unusual. Debt in leveraged buyouts is creeping above the six times level that regulators said in 2013 was potentially too risky, after commitments to private equity deals scorched banks during and after the crisis. The average company in an LBO had borrowings equal to 6.4 times earnings before interest, taxes depreciation and amortization in 2018, according to Fitch… Last year it was 6.2 times Ebitda and in 2016, it was 5.9 times. The higher debt burdens are a symptom of memories getting shorter as the economic expansion grows longer."

May 13 - Wall Street Journal (Ryan Dezember and Peter Rudegeair): "KKR & Co. is raising its bet on high-interest, short-term home loans, the latest sign that Wall Street firms are aiming to cash in on the risky but lucrative house-flipping market. Borrowers of residential transitional loans-or flip loans, as they are better known-use the money to buy a property, renovate it and then try to quickly resell at a profit. They have become a lucrative and growing niche of finance in recent years. Nomura Holdings Inc. estimates that flippers will borrow some $15 billion this year, nearly 25% more than last year. KKR is the latest example of Wall Street's growing interest in the area."

EM Bubble Watch:

May 16 - Bloomberg (Ben Bartenstein): "While money managers from Goldman Sachs… to UBS Wealth Management still tout investing opportunities in emerging markets, the asset class has one notable critic: Harvard professor Carmen Reinhart. The… economist points to mounting debt loads, weakening terms of trade, rising global interest rates and stalling growth as reasons for concern. In fact, developing nations are worse off than during their two most recent moments of weakness: The 2008 global financial crisis and 2013 taper tantrum, when equities endured routs of 64% and 17% respectively. 'The overall shape they're in has a lot more cracks now than it did five years ago and certainly at the time of the global financial crisis,' Reinhart said… 'It's both external and internal conditions.'"

May 14 - Financial Times (Kate Allen): "Investors who bought some of the riskiest emerging market sovereign bond sales in the past year have been left nursing paper losses as a strengthening dollar has rattled sentiment for emerging markets. JPMorgan's emerging markets bond index has lost 5.1% since the start of this year. Some of the worst-hit bonds are those from countries that were rarely seen in debt markets until last year, when demand for sovereign debt paying attractive fixed yields was paramount among investors."

May 14 - Financial Times (Kate Allen): "Emerging economies with shorter debt maturities and less fiscal scope to accommodate rising debt costs are most vulnerable to a tightening of global financial conditions, according to… Moody's. The study singled out Egypt, Bahrain, Pakistan, Lebanon and Mongolia as particularly at risk; Sri Lanka and Jordan are also 'highly exposed' to an interest rate shock, Moody's said. With global interest rates rising and emerging market nations accumulating a rapidly-increasing debt pile, concerns are growing that they could be hit with a financing crisis. The IMF warned earlier this year that 40% of low-income developing countries face 'significant debt-related challenges'. Investors who bought some of the riskiest emerging market sovereign bond sales of the past year have in recent weeks been left nursing paper losses as a strengthening dollar rattles sentiment for emerging markets."

May 15 - Bloomberg (Guy Johnson and James Hertling): "Turkish President Recep Tayyip Erdogan said he intends to tighten his grip on the economy and take more responsibility for monetary policy if he wins an election next month. With the Turkish lira at a record low against the dollar… Erdogan told Bloomberg… that after the vote transforms Turkey into a full presidential system, he expects the central bank will have to heed his calls for lower interest rates. The central bank's key rate is now 13.5%, compared with 10.9% consumer-price inflation. 'When the people fall into difficulties because of monetary policies, who are they going to hold accountable? …They'll hold the president accountable. Since they'll ask the president about it, we have to give off the image of a president who's influential on monetary policies.' That 'may make some uncomfortable,' he said. 'But we have to do it. Because it's those who rule the state who are accountable to the citizens.'"

May 15 - Financial Times (Roger Blitz, Jonathan Wheatley and Laura Pitel): "When banks and investment funds sent senior representatives to dine with Recep Tayyip Erdogan, they probably expected the Turkish president to deliver a reassuring message about investing in his country. But by the end of Monday's lunch at Bloomberg's London office, they were left wondering whether there was any longer an argument for risking their money in his country's currency, stocks and government bonds. The message was uncompromising. The Turkish president, seeking re-election next month, made clear that not only was he steadfastly opposed to raising rates, he was intent on taking control of monetary policy."

May 16 - Bloomberg (Ferdinando Giugliano): "Turkey's president Recep Tayyip Erdogan has issued a stark warning to his country's central bank. If he wins a presidential parliamentary election next month, he says he'll clamp down on central bank independence to keep interest rates low. This is obviously a terrible idea, and comes at the worst possible moment. The lira is in freefall and inflation on the rise. Turkey needs a strong monetary authority, not a stooge obeying the president's bizarre orders. Erdogan has long held wrong-headed views on the impact of interest rates. Unlike the vast majority of economists, he believes a tight monetary policy causes rather than tames inflation. In an interview with Bloomberg TV…, he went a step further, saying he was ready to interfere with the central bank if it didn't follow his advice. 'It's those who rule the state who are accountable to the citizen,' he said."

May 16 - Wall Street Journal (Richard Barley): "Who's next? The fear of contagion is stalking emerging markets again, but Argentina and Turkey have put themselves in the firing line while others have distanced themselves from it. The shakeout in emerging markets sparked by the 'taper tantrum' of 2013 put the spotlight on countries with relatively wide current-account deficits… Right now, the uncomfortable spotlight is on Argentina, where the peso has fallen more than 23% against the dollar this year and the country is seeking support from the International Monetary Fund, and Turkey, where the lira has fallen more than 15%. Both stand out for having current-account deficits estimated by the International Monetary Fund in 2018 at more than 5% of gross domestic product: the widest of the emerging-market members of the Group of 20 nations."

May 15 - Reuters (Dave Graham and Christine Murray): "Mexican presidential frontrunner Andres Manuel Lopez Obrador extended his lead to more than 12 points over his nearest rival ahead of the July 1 vote, according to a poll published on Tuesday. The survey by polling firm Consulta Mitofsky showed Lopez Obrador, running for the third time, had 32.6% of support, up from 31.9% in April. Second-placed Ricardo Anaya, the candidate of the 'For Mexico in Front' coalition of three parties from the right and left, saw his backing fall slightly to 20.5%..."

May 16 - Bloomberg (Liau Y-Sing and Kartik Goyal): "Mahathir Mohamad's return may spell more pressure on Malaysia's beleaguered bond market - almost a decade of efforts spent narrowing a fiscal deficit is at risk just when capital is flowing out of emerging markets. Already reeling from the impact of a stronger dollar and higher U.S. Treasury yields, ringgit sovereign securities may face a further blow as newly-elected Prime Minister Mahathir presses ahead with a plan to scrap a consumption tax and reinstate fuel subsidies. Bond investors and rating companies are worried that may hurt efforts to narrow a persistent budget shortfall."

Japan Watch:

May 16 - Bloomberg (Yuko Takeo): "Japan's first economic contraction in two years is expected to be only a speed bump on the road to further, yet slower growth. The economy shrank in the first quarter at an annualized rate of 0.6% due to capital investment unexpectedly falling 0.1% and flat private consumption. Growth is forecast to resume in the current quarter as global trade and Japanese exports regain traction."

Geopolitical Watch:

May 16 - Reuters (Gabrielle TĂ©trault-Farber): "Russian President Vladimir Putin and his Turkish counterpart Tayyip Erdogan, in a phone call, expressed serious concern over the number of casualties in the protests on the Gaza border, the Kremlin said…"

May 16 - CNBC (Natasha Turak): "Turkey's President Recep Erdogan and Israeli Prime Minister Benjamin Netanyahu went at each other's necks via Twitter, accusing each other of brutality and human rights abuses. The spat… went down in the wake of violence on the Israeli-Gaza border on Monday during which Israeli forces killed at least 60 Palestinian protesters, coinciding with the opening of the U.S. embassy in Jerusalem. Turkey's government loudly condemned the killings. 'Israel is wreaking state terror. Israel is a terror state,' Erdogan said in a speech for state television… 'What Israel has done is a genocide. I condemn this humanitarian drama, the genocide, from whichever side it comes, Israel or America.' In response, Netanyahu shared some choice words for the Turkish president on Twitter, saying, 'Erdogan is among Hamas's biggest supporters and there is no doubt that he well understands terrorism and slaughter. I suggest that he not preach morality to us.'"

May 13 - Reuters (Ahmed Aboulenein and Maher Chmaytelli): "Populist cleric Moqtada al-Sadr, a long-time adversary of the United States, has all but won Iraq's parliamentary election, the electoral commission said, in a surprise turn of fortune for the Shi'ite leader. In the first election since Islamic State was defeated in the country, Iran-backed Shi'ite militia chief Hadi al-Amiri's bloc was in second place, while Prime Minister Haider al-Abadi, once seen as the front-runner, trailed in third."