Friday, June 1, 2018

Weekly Commentary: Italian Drama

As I see it, cracks are opening in the greatest Bubble of all time. Serious fissures have developed in EM, Europe and China. Meanwhile, the stimulus-driven U.S. economic boom runs unabated. Global fragilities place downward pressure on U.S. market yields, while faltering Bubbles elsewhere stoke (self-reinforcing) outperformance - and speculative excess - within the U.S. equities market. The Fed faces a difficult challenge of weighing buoyant U.S. economic data and inflating asset prices against heightened global market fragilities.

Let's begin with U.S. data. May non-farm payrolls increased a stronger-than-expected 223,000. The Unemployment Rate declined a tenth to 3.8%, matching the low going all the way back to 1969. Average hourly earnings were up 0.3% in May and 2.7% y-o-y. The ISM Manufacturing Index increased 1.4 points to a stronger-than-expected 58.7. There have been only nine stronger monthly readings looking all the way back to August 2004. Prices Paid rose slightly to 79.5, the high since April 2011. ISM New Orders jumped 2.5 points to 63.7, the high since February. The Employment component rose 2.1 points to a solid 56.3. The Chicago Purchasing Managers index surged 5.1 points to 62.7, the high since January. The Dallas Manufacturing Outlook recovered five points to the high since February. A Friday afternoon CNBC (Jeff Cox) headline: "The US economy suddenly looks like it's unstoppable."

April Construction Spending was up a much stronger-than expected 1.8% (strongest since January), led by an 8.7% y-o-y increase in residential construction. This followed stronger-than-expected S&P CoreLogic house price inflation (up 6.79% y-o-y). May Conference Board Consumer Confidence gained 2.4 points to 128, just below February's 130, the strongest reading going all the way back to November 2000. The Conference Board Present Situation component jumped 4.2 points to 161.7, the high back to March 2001. Also indicative of boom time conditions, Personal Spending jumped 0.6% in April. May auto sales almost across the board surpassed expectations, with sales estimated up 5% from a year ago.

In most backdrops, such robust data would have the markets fretting both a more diligent Federal Reserve and surging market yields. Yet 10-year Treasury yields traded as low as 2.76% during Tuesday's session, before closing the week down three bps to 2.90%. Interestingly - and reflective of rapidly shifting expectations for Fed policy - after beginning the week at 2.48%, two-year yields dropped to 2.29% on Tuesday before reversing course and ending the week little changed.

Global markets, of course, were buffeted this week by developments in Italy. Italian 10-year yields surged 47 bps Tuesday to a four-year high 3.13%. At that point, Italy's 10-year yields were up more than 100 bps in six sessions. The spike at the front end of the yield curve was even more dramatic. Italian two-year yields jumped an extraordinary 181 bps Tuesday to 2.64%, the highest level since the 2012 European crisis. Panic buying saw German 10-year yields drop to 18 bps, after trading as high as 58 bps on May 21. Incredibly, German two-year yields dropped to negative 82 bps after ending the previous week at negative 63 bps.

Tuesday's mayhem followed the Italian President's veto of the Five Star and League coalition government. With the rejection of the coalition's first choice for Finance Minister, it appeared Italian voters would be heading back to the polls in an election that could have evolved into a referendum on the EU and the euro. The crisis backdrop spurred political compromise. By week's end, a new - and seemingly less hostile to the euro - Finance Minister had been proposed and a new coalition populist government formed. In a big relief for the markets, the need to call a snap election had been averted.

May 29 - Bloomberg (Nikos Chrysoloras and Helene Fouquet): "A surging dollar and a capital flight from emerging markets may lead to another 'major' financial crisis, investor George Soros said, warning the European Union that it's facing an imminent existential threat. The 'termination' of the nuclear deal with Iran and the 'destruction' of the transatlantic alliance between the EU and the U.S. are 'bound to have a negative effect on the European economy and cause other dislocations,' including a devaluing of emerging-market currencies, Soros said in a speech… 'We may be heading for another major financial crisis.'"

May 31 - Bloomberg: "Morgan Stanley Chief Executive Officer James Gorman said that investor George Soros's contention another major global crisis may be in store is unrealistic, and that the Federal Reserve will probably hike interest rates three more times in 2018 despite recent volatility. 'Honestly I think that's ridiculous,' Gorman said in an interview… when asked about Soros's comments this week, which included a warning that the European Union is at risk of breaking up amid Italy's challenges. 'I don't think we're facing an existential threat at all,' Gorman said of the EU."

I regret that George Soros has become such a polarizing political figure. My analytical framework owes considerable debt to his analysis and philosophy with respect to Credit, the markets and finance more generally. Soros' decades of experience, analysis and success navigating global markets are unequaled. I would not dismiss his warnings.

I hold the view that the euro monetary experiment has been deeply flawed in both its structure and implementation. European nations sacrificed sovereignty for the considerable benefits provided by a common currency that would compete globally against the U.S. dollar. Sharing the euro with Germany and others dramatically lowered borrowing costs and loosened Credit Availability more generally. Regrettably, there was no mechanism to effectively regulate Credit expansion, especially for members at the "periphery" that rather suddenly enjoyed access to cheap global finance like never before.

The boom was spectacular; the subsequent bust is proving rather everlasting. Since 2012, Draghi's "whatever it takes" collapsed borrowing costs and market yields, while stoking asset inflation and economic recovery. Historic monetary inflation has not, however, changed economic structure, history or distinctive cultures. ECB policies, along with central bank reflationary policies globally, have only exacerbated wealth inequalities, economic maladjustment and financial Bubbles. This is an especially intractable problem for the eurozone.

In an interview on German television, the EU's budget chief made a headline-grabbing assertion about the prospects for another Italian election: "My concern and my expectation is that the coming weeks will show that markets, that government bonds, that Italy's economic development could be [affected in a manner so] drastic that this could be a possible signal to voters not to choose populists from the left and right."

Understandably, this type of rhetoric doesn't sit well in Italy or in other countries that see outside political bodies holding a gun to their heads. It is, however, a view held as the gospel in the markets. As financial markets have evolved to command the world, there are two unassailable truths: First, central banks will do whatever it takes to ensure strong markets and economic expansion. And, second, markets are prepared to dish out sufficiently brutal punishment to ensure that politicians and voters fall in line. The electorate may be disgruntled and openly hostile, but they're not suicidal.

Eventually, fed up electorates will refuse being held hostage by the securities markets. I expect the euro system will at some point badly falter, and I suspect this view is quietly shared within the marketplace. This helps explain why things can so abruptly go haywire in the markets. As I have posited in the past, I don't believe the Germans and Italians will share a common currency forever. As cultures, societies and governments, they grow only more discordant. So, there will come a time when savers, investors and speculators choose not to wait and see how the inevitable destabilizing transition plays out. The genie was almost out of the bottle back in 2012.

There are, as well, sophisticated market operators with plans to be among the first wave out, appreciating that ECB and Italian government support will go only so far in stabilizing a hopelessly unstable arrangement. Expect more attention to ECB "Target2" balances (assets/liabilities to the euro financial system created from surpluses/deficits in trade and financial flows). Italy's accumulated Target2 liabilities ended April at an astounding $426 billion, much of it owed to Germany. This obligation will likely expand rapidly as flows exit Italian banks for refuge elsewhere. Perhaps the latest Italian Drama will spur an upswell of German support for Bundesbank President Jens Weidmann taking the helm of the ECB when Draghi's term ends in November 2019.

I have long admired Bill Gross. His long-term performance speaks for itself. Mr. Gross is struggling in this market environment, not unlike other seasoned market operators. The appearance of markets operating normally is only superficial. I'm compelled to mention the extraordinary 3% loss experienced by Bill Gross' unconstrained bond fund in wild Tuesday trading. Many public funds of this ilk posted notably large losses Tuesday, and I'll assume there were scores of hedge funds that were hit as hard or harder.

For the almost four-year period June 2, 2014, to May 7, 2018, the Italian to German two-year sovereign yield spread averaged 49.5 bps. The high for this period was 98 bps briefly back in February 2017. This spread had averaged about 30 bps for 2018 through early-May. Well, the Italian to German two-year yield spread blew out to 353 bps in chaotic Tuesday trading. After trading last week as high as 58 bps, ten-year German yields sank Tuesday to as low as 18 bps. At Tuesday's highs, Italian 10-year yields were 288 bps higher than bund yields, widening 113 bps in a week. Derivatives and leveraged speculation run amuck.

Wild market gyrations were not limited to European bonds. Ten-year Treasury yields, after trading as high as 3.13% the previous week, sank to 2.76% in Tuesday trading. In just five sessions, two-year yields dropped 30 bps to Tuesday morning's low of 2.29%.

May 29 - Financial Times (Robert Smith): "Yields on Italian bank bonds surged dramatically on Tuesday, as increasing political turmoil in the eurozone's third-biggest economy put heavy selling pressure on the debt of the country's lenders. Riskier forms of bank debt that count towards financial institutions' capital ratios have seen the sharpest sell-off. These bonds are more exposed to losses when banks need to be rescued, as seen when Spanish lender Banco Popular's additional tier 1 and tier 2 bonds were wiped out last year. Monte dei Paschi di Siena's €750m 10-year tier 2 bond plummeted as much as seven cents to 81.5 cents on the euro… This equates to a yield of more than 9.5%, a sharp increase from the 5.375% the bond was originally sold at in January."

A semblance of calm returned to Italian (and periphery) markets with Friday's swearing in of political novice Giuseppe Conte as Italy's new prime minister. Meanwhile in Madrid, socialist Pedro Sanchez appears poised to replace Mariano Rajoy who suffered a humiliating vote of no confidence after members of his People Party were convicted in a widespread political corruption scandal. The immediate risk to the euro may have subsided, but the political instability that has erupted in the eurozone's periphery will overhang increasingly fragile European financial markets. A Friday evening Financial Times headline: "Italy's new government: Europe on edge after palace takeover."

If messy European politics weren't enough, there were the Trump Tariffs.

May 30 - Reuters (Jason Lange and Ingrid Melander): "Canada and Mexico retaliated on Thursday after Washington imposed tariffs on steel and aluminum imports while the European Union had its own reprisals ready to go, reviving investor fears of a global trade war. Germany's Economy Minister said early on Friday the EU might look to coordinate its response with Canada and Mexico. The tariffs, announced by Commerce Secretary Wilbur Ross, ended months of uncertainty about potential exemptions and suggested a hardening of the U.S. approach to trade negotiations. The measures, touted by President Donald Trump in March, drew condemnation from Republican lawmakers and the country's main business lobbying group and sent a chill through financial markets."

With the small caps ending the week at all-time highs, that's a rather balmy market chill. Believing strong equities remain presidential Priority One, markets now scoff at administration trade threats. Surely, tariffs are but a negotiating ploy to extract favorable trade concessions. But if markets don't take the administration's trade threats seriously, why would our trading partners/adversaries? And that we are negotiating trade terms with various parties concurrently, why wouldn't these countries be motivated to all covertly band together in a strategy to forcefully nip Trump's Tariffs in the bud. Reuters: "U.S. isolated at G7 meeting as tariffs prompt retaliation."

I understand market complacency with respect to steel and aluminum tariffs. It's the unfolding trade confrontation with China with the distinct potential to rattle markets. More than trade, it's a brewing battle royale pitting the world's lone superpower against the aspiring superpower. And as fissures continue to surface in Chinese Credit, I can envisage Beijing contriving scenarios where they will lay blame upon the U.S. and other foreigners. It's worth mentioning that the Shanghai Composite dropped 2.1% this week, trading Wednesday at a one-year low. China's currency declined 0.45% vs. the dollar to a four-month low.

Largely overlooked as attention turned to Italy, stress continued to mount in EM. The Brazilian real dropped 3.0% this week, pushing one-month losses to 6.9%. The Mexican peso fell 2.0%, and the Argentine peso declined 1.6%, with one-month losses of 5.0% and 17.8%. The South African rand lost 1.6% this week, with the Chilean peso down 1.2%. The beleaguered Turkish lira sank 2.6% in Friday trading, quickly wiping out much of the recovery from earlier in the week. Turkish 10-year dollar yields surged 20 bps this week to 6.73%. Brazil's dollar bond yields surged 39 bps to a two-year high 5.68%, and Mexico's dollar yields rose 16 bps to near multi-year highs at 4.53%. Local currency bond yields surged 25 bps in Brazil (11.45%) and 18 bps in Mexico (7.62%).

It was another week of important corroboration of the Global Bubble Thesis. Market historians might look back at Tuesday's Italian debt "flash crash" and sovereign bond dislocation as another warning of impending illiquidity and general market mayhem. How much leverage and systemic risk are embedded in perceived low-risk derivative trading strategies? Keep in mind that it's not unusual for U.S. equities to go on their merry way right into trouble. The S&P500 rallied to record highs after the subprime eruption in 2007. U.S. stocks advanced strongly right into July 1998 - only weeks from near Financial Armageddon. Q1 2000. 1987. 1929.

For the Week:

The S&P500 increased 0.5% (up 2.3% y-t-d), while the Dow declined 0.5% (down 0.3%). The Utilities slipped 0.6% (down 5.5%). The Banks fell 1.3% (up 0.7%), and the Broker/Dealers lost 1.3% (up 9.4%). The Transports were little changed (up 2.7%). The S&P 400 Midcaps added 0.6% (up 3.0%), and the small cap Russell 2000 jumped 1.3% (up 7.3%). The Nasdaq100 advanced 1.8% (up 10.7%).The Semiconductors rose 1.5% (up 12.6%). The Biotechs surged 3.0% (up 14.2%). With bullion down $8, the HUI gold index dipped 0.6% (down 6.8%).

Three-month Treasury bill rates ended the week at 1.87%. Two-year government yields were little changed at 2.47% (up 59bps y-t-d). Five-year T-note yields slipped two bps to 2.75% (up 54bps). Ten-year Treasury yields declined three bps to 2.90% (up 50bps). Long bond yields fell four bps to 3.05% (up 31bps). Benchmark Fannie Mae MBS yields dipped two bps to 3.62% (up 62bps).

Greek 10-year yields jumped 10 bps to 4.47% (up 39bps y-t-d). Ten-year Portuguese yields fell seven bps to 1.88% (down 6bps). Italian 10-year yields surged 23 bps to 2.69% (up 67bps). Spain's 10-year yields declined two bps to 1.44% (down 13bps). German bund yields dipped two bps to 0.39% (down 4bps). French yields were unchanged at 0.71% (down 8bps). The French to German 10-year bond spread widened two to 32 bps. U.K. 10-year gilt yields declined four bps to 1.28% (up 9bps). U.K.'s FTSE equities index declined 0.4% (up 0.2%).

Japan's Nikkei 225 equities dropped 1.2% (down 2.6% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.05% (unchanged). France's CAC40 fell 1.4% (up 2.9%). The German DAX equities index lost 1.7% (down 1.5%). Spain's IBEX 35 equities index sank 2.0% (down 4.1%). Italy's FTSE MIB index dropped 1.3% (up 1.2%). EM equities were mixed. Brazil's Bovespa index fell 2.1% (up 1.1%), and Mexico's Bolsa slipped 0.2% (down 8.8%). South Korea's Kospi index declined 0.9% (down 1.2%). India’s Sensex equities index gained 0.9% (up 3.4%). China’s Shanghai Exchange dropped 2.1% (down 7.0%). Turkey's Borsa Istanbul National 100 index sank 3.9% (down 14.0%). Russia's MICEX equities declined 0.5% (up 8.8%).

Investment-grade bond funds saw inflows of $849 million, and junk bond funds had outflows of $18 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates dropped 10 bps to 4.56% (up 62bps y-o-y). Fifteen-year rates fell nine bps to 4.06% (up 87bps). Five-year hybrid ARM rates declined seven bps to 3.80% (up 69bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 14 bps to 4.56% (up 54bps).

Federal Reserve Credit last week declined $10.2bn to $4.289 TN. Over the past year, Fed Credit contracted $132bn, or 3.0%. Fed Credit inflated $1.478 TN, or 53%, over the past 291 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt recovered $12.0bn last week to $3.394 TN. "Custody holdings" were up $157bn y-o-y, or 4.8%.

M2 (narrow) "money" supply expanded $14.8bn last week to a record $14.013 TN. "Narrow money" gained $490bn, or 3.6%, over the past year. For the week, Currency increased $5.4bn. Total Checkable Deposits added $3.0bn, while savings Deposits dipped $6.9bn. Small Time Deposits gained $1.6bn. Retail Money Funds jumped $11.7bn.

Total money market fund assets rose $14.5bn to $2.840 TN. Money Funds gained $187bn y-o-y, or 7.0%.

Total Commercial Paper jumped $16.1bn to $1.108 TN. CP gained $114bn y-o-y, or 11.5%.

Currency Watch:

The U.S. dollar index was little changed at 94.156 (up 2.2% y-t-d). For the week on the upside, the New Zealand dollar increased 0.9%, the Swiss franc 0.3%, the Australian dollar 0.3%, the British pound 0.3%, the South Korean won 0.3%, the Singapore dollar 0.2%, the Canadian dollar 0.2%, and the euro 0.1%. For the week on the downside, the Brazilian real declined 3.0%, the Mexican peso 2.0%, the South African rand 1.5%, the Swedish krona 0.6%, the Norwegian krone 0.2% and the Japanese yen 0.1%. The Chinese renminbi declined 0.45% versus the dollar this week (up 1.34% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.9% (up 7.8% y-t-d). Spot Gold slipped 0.6% to $1,294 (down 0.7%). Silver dipped 0.5% to $16.441 (down 4.1%). Crude fell $1.69 to $65.81 (up 9%). Gasoline declined 1.2% (up 19%), while Natural Gas gained 1.1% (unchanged). Copper increased 0.7% (down 6%). Wheat dropped 3.6% (up 23%). Corn sank 3.6% (up 12%).

Market Dislocation Watch:

May 29 - Reuters (Dhara Ranasinghe and Abhinav Ramnarayan): "A deepening political crisis in Italy, the euro zone's third biggest economy, fuelled a selloff in Italian assets and the euro on Tuesday that was reminiscent of the euro zone debt crisis of 2010-12. Short-term Italian bond yields suffered the biggest one-day jump since 1992, while Italian and wider euro zone banking stocks saw their worst day since August 2016."

May 30 - Wall Street Journal (James Mackintosh): "Market reporting can be prone to hyperbole, but Tuesday's Italian bond selloff and Wednesday's partial recovery was truly astonishing. Short-dated bonds that can usually be treated as a close proxy for cash turned toxic, and bond prices suggested a full-blown panic, then the relief of a rescue. Prices fell, and yields on short-dated bonds rose as much or more than when the euro was fighting for survival in 2011 and 2012, before a massive reverse. The reaction of other markets was muted by comparison. Sure, stocks and the flakier end of European government bonds sold off, and there was a flight to the safety of U.S. Treasurys. But this wasn't much more than a run-of-the-mill bad day, mostly reversed on Wednesday."

May 29 - Bloomberg (Samuel Potter): "Reports of the death of the sovereign-bank 'doom loop' are greatly exaggerated. Italian government bonds have blown up, with the yield on two-year notes skyrocketing by as much as 192 bps on Tuesday to the highest level since 2012. Spreads on subordinated debts from euro-area financial companies, meanwhile, have jumped in sympathy as Rome's political turmoil reverberates across markets. The Markit iTraxx Europe Subordinated Financial Index, a gauge of credit default swaps tied to junior debt sold by the region's lenders, has surged to the highest in more than a year."

May 29 - Bloomberg (Jana Randow): "Italy's political stalemate is forcing investors to once again contemplate the survival of the euro. A gauge measuring the likelihood of Italy leaving the currency union within the next 12 months jumped to 11.3% in May from 3.6% in April, according to research group Sentix. That's pushed an index for the entire euro area to 13%, the highest level in more than a year.

May 29 - Financial Times (Kate Allen and Miles Johnson): "Until this weekend, many investors thought eurozone politics were inevitably messy but no longer had the power to trigger volatile and disorderly markets. Italy has forced a rapid and painful reappraisal. Those exposed to eurozone markets, and Italy in particular, are nursing heavy paper losses after near unrelenting selling in bonds and equities since Friday. The shift in markets has been profound, ensnaring the debt of other peripheral countries such as Portugal and hurting banks as investors contemplate the possibility of Italy's political turbulence escalating into another eurozone crisis. The scale of the moves in Italian debt has stunned some. Italy's two-year government bond price has plunged over the past three trading days, sending its yield soaring from 0.27% to as high as 2.72% on Tuesday. The 10-year bond yield has jumped from 2.4% to a high of 3.39% over the same period."

June 1 - Bloomberg (Sridhar Natarajan, Yalman Onaran and Sonali Basak): "Deutsche Bank AG just ended a roller-coaster week. June doesn't look any less harrowing. Shares of Europe's largest investment bank are trading near a record low, as short sellers pile on and credit derivative traders once again signal doubts about the firm's health. It's part of a painful pattern for the bank and its investors: Another spate of bad headlines keeps outweighing the good."

Trump Administration Watch:

May 30 - New York Times (Mark Landler and Ana Swanson): "President Trump, stung by criticism that he has gone soft on China and less worried about Beijing's ability to disrupt a potential summit meeting with North Korea, reversed course on Tuesday and declared that the United States would impose tariffs and other punitive measures on China. Barely a week after Treasury Secretary Steven Mnuchin said that the trade war was 'on hold' and that tariffs would be suspended as negotiations continued, the White House issued a statement saying the United States would move ahead with its plan to impose 25% tariffs on $50 billion worth of imported Chinese goods within the next month. Mr. Trump's reversal was yet another twist in a long-running ideological battle in the West Wing between economic nationalists, who channel Mr. Trump's protectionist instincts, and more mainstream advisers like Mr. Mnuchin, who worry that tariffs and investment restrictions will hurt the stock market and hobble long-term growth."

May 30 - Bloomberg (Jenny Leonard and Rich Miller): "White House trade adviser Peter Navarro criticized Treasury Secretary Steven Mnuchin for declaring the U.S.-China trade war was on hold, calling the remarks an 'unfortunate sound bite' and acknowledging there's a dispute that needs to be resolved. 'What we're having with China is a trade dispute, plain and simple,' Navarro said… 'We lost the trade war long ago' with deals such as Nafta and China's entry into the World Trade Organization, he said. The remarks from Navarro, a hard-liner on President Donald Trump's trade team, come just days before U.S. Commerce Secretary Wilbur Ross is scheduled to meet with his counterparts in Beijing to discuss ways to reduce the U.S. trade deficit with China."

May 29 - Wall Street Journal (William Mauldin and Lingling Wei): "The Trump administration sent a sudden, harsh message to its Chinese counterparts, saying the U.S. was moving forward with its threat to apply tariffs on Chinese imports and other actions to restrict Beijing from accessing sensitive U.S. technology. Tuesday's move surprised many observers after the White House had for days trumpeted the outlines of a deal in which any trade war with China would be put on hold while negotiators-led on the U.S. side by Treasury Secretary Steven Mnuchin -worked on a deal that would have China reduce its $375 billion annual trade advantage by buying more U.S. goods."

May 30 - Reuters (Michael Martina and Ben Blanchard): "China lashed out… at renewed threats from the White House on trade, warning that it was ready to fight back if Washington was looking for a trade war, days ahead of a planned visit by U.S. Commerce Secretary Wilbur Ross. In an unexpected change in tone, the United States said on Tuesday that it still held the threat of imposing tariffs on $50 billion of imports from China unless it addressed the issue of theft of American intellectual property. Washington also said it will press ahead with restrictions on investment by Chinese companies in the United States as well as export controls for goods exported to China."

May 28 - Reuters (Tom Miles): "Chinese and U.S. envoys sparred at the World Trade Organization… over U.S. President Donald Trump's claims that China steals American ideas, the subject of two lawsuits and a White House plan to slap huge punitive tariffs on Chinese goods. U.S. Ambassador Dennis Shea said 'forced technology transfer' was often an unwritten rule for companies trying to access China's burgeoning marketplace… China's licensing and administrative rules forced foreign firms to share technology if they wanted to do business, while government officials could exploit vague investment rules to impose technology transfer requirements, he said. 'This is not the rule of law. In fact, it is China's laws themselves that enable this coercion,' Shea told the WTO's dispute settlement body…"

May 30 - Reuters (Madeline Chambers and Edward Taylor): "A report that U.S. President Donald Trump has threatened to pursue German carmakers until there are no Mercedes-Benz rolling down New York's Fifth Avenue dented shares in the luxury car manufacturers on Thursday… The news and current affairs magazine said Trump had told French President Emmanuel Macron in April that he aimed to push German carmakers out of the United States altogether. Macron's administration in Paris declined to comment on the report."

May 31 - Reuters (Michael Nienaber): "German Chancellor Angela Merkel said… that the European Union would give a 'smart, determined and jointly agreed' response if the United States decides to impose tariffs on European steel and aluminum imports. 'We don't know the decision yet but if tariffs were to be imposed, then we have a clear stance within the European Union,' Merkel said…"

May 30 - Bloomberg (Bryce Baschuk): "President Donald Trump's unilateral tariff measures are necessary to fix a broken global trade system and the U.S., like other nations, should focus on its own interests, according to Commerce Secretary Wilbur Ross. 'Every country's primary obligation is to protect its own citizens and their livelihood,' Ross said at an Organisation for Economic Cooperation and Development conference… 'Maybe that's a populist saying but it's one we feel very strongly about.'"

EM Bubble Watch:

May 29 - Reuters (Simon Webb): "Brazilian President Michel Temer said… there was no chance that a nationwide truckers' protest that has paralyzed Latin America's biggest economy will spark a military coup and topple his government."

May 29 - Bloomberg (Mac Margolis): "After a week of anger and protests, Brazilian truck drivers agreed late Sunday to ease their strike. That's the good news. For more than a week, the truckers had all but staggered this country of 208 million people, jamming the highways with semis and strangling commerce from the grain silos to cargo ports. What's less heartening are the terms of the shaky truce, including cheaper fuel and a tax break for cargo transport workers, which emboldened a powerful pressure group at the expense of Brazilian taxpayers, may well encourage other aggrieved groups to do the same, and did nothing to address the fiscal disarray and ailing infrastructure sapping the region's biggest economy."

May 26 - Reuters (Daren Butler): "Turkish President Tayyip Erdogan called on Turks… to convert their dollar and euro savings into lira, as he sought to bolster the ailing currency which has lost some 20 percent of its value against the U.S. currency this year. 'My brothers who have dollars or euros under their pillow. Go and convert your money into lira. We will thwart this game together,' Erdogan said at a rally…"

Federal Reserve Watch:

June 1 - Bloomberg (Nathan Crooks): "San Francisco Fed President John Williams says federal reserve should continue with gradual rate increases over next two years… Says Fed is about three rate hikes away from reaching a 'neutral' level, where interest rates are neither adding to or taking away from economic growth. Williams sees need for less forward guidance from fed as rates near neutral. Fed does not necessarily need to pause on rate hikes once rates reach neutral…"

U.S. Bubble Watch:

May 25 - Reuters (Noel Randewich): "S&P 500 companies have returned a record $1 trillion to shareholders over the past year, helped by a recent surge in dividends and stock buybacks following sweeping corporate tax cuts introduced by Republicans… In the 12 months through March, S&P 500 companies paid out $428 billion in dividends and bought up $573 billion of their own shares, according to S&P Dow Jones Indices analyst Howard Silverblatt. That compares to combined dividends and buybacks worth $939 billion during the year through March 2017…"

May 29 - CNBC (Diana Olick): "Home values have been rising for six straight years, and the gains have been accelerating for the past two years... 'The continuing run-up in home prices above the pace of income growth is simply not sustainable,' wrote Lawrence Yun, chief economist for the National Association of Realtors… 'From the cyclical low point in home prices six years ago, a typical home price has increased by 48% while the average wage rate has grown by only 14%.'"

May 29 - Wall Street Journal (Rachel Louise Ensign and Lillian Rizzo): "Faced with tepid loan growth and heated competition for clients, banks are sweetening their deals on loans to businesses, a development that is concerning regulators. Lenders are giving corporate borrowers lower rates and looser terms, even if they operate in industries that are under strain… The development is a boon to companies looking to borrow cheaply while the economy is doing well. But regulators are raising red flags, particularly since rising interest rates may make it harder for businesses to pay off the loans. The Office of the Comptroller of the Currency, or OCC, in a report last week identified the easing of commercial loan standards as a top risk in the industry."

May 31 - Reuters (Lucia Mutikani): "U.S. consumer spending increased more than expected in April, a further sign that economic growth was regaining momentum early in the second quarter, while inflation continued to rise steadily. …Consumer spending, which accounts for more than two-thirds of U.S. economic activity, jumped 0.6% last month, the biggest gain in five months. …March was revised up to show spending rising 0.5%... Prices continued to gradually rise. The personal consumption expenditures (PCE) price index excluding the volatile food and energy components increased 0.2% for the third straight month."

May 28 - CNBC (Jaden Urbi): "Retailers are facing a shipping squeeze, and the trucking industry just can't keep up. According to the American Trucking Associations, there's a shortage of roughly 50,000 truck drivers across the country. And it's hitting both businesses and consumers in the wallet. Companies are complaining about how the driver shortage is impacting their business. Meanwhile, the cost of convenient shipping is starting to catch up with consumers. Amazon recently hiked its Prime membership to $119 a year from $99 a year. The retail giant said one of the reasons for the price jump was increased shipping costs."

May 25 - CNN Money (Matt Egan): "Get ready for sticker shock at the gas station if you're one of the estimated 36 million Americans hitting the roads this Memorial Day weekend. Gone are the days of $2-a-gallon gasoline. A spike in crude oil prices has lifted the national average price of gas by 31% over the past year to an average of $2.97 a gallon… Prices at the pump haven't been this high heading into the biggest driving holiday of the year since 2014, when crude was sitting in triple-digit territory."

May 30 - Reuters (Jason Lange): "U.S. factories ramped up production in late April and early May despite the risk of a global trade war, but soft consumer spending kept the economy growing at a moderate rate, the Federal Reserve reported… In its periodic 'Beige Book'… the U.S. central bank pointed to strong output in fabricated metals, heavy machinery and electronics equipment. The assessment of growth across the economy represented a slight upgrade from the Fed's prior Beige Book report, which said economic activity was expanding at a 'modest to moderate pace.' 'Manufacturing shifted into higher gear,' the Fed said…"

May 31 - CNBC (Phil LeBeau): "There was a time when new car and truck buyers pushed hard to keep their monthly payment under $500. Those days are quickly fading away. In the first quarter of this year, the average monthly loan payment for a new vehicle climbed $15 compared with last year, hitting an all-time high of $523, according to Experian. The credit analysis company's review of new and open auto loans for the first three months of this year found buyers of new cars, trucks and SUVs borrowed an average of $31,453 - also a record high."

May 30 - Bloomberg (Lucy Meakin, Rich Miller and Catherine Bosley): "A staggering number of American homeowners remain under water on their mortgages a decade after the housing bubble burst. Almost 4.5 million households -- or 9.1% -- owed more than their homes are worth in the fourth quarter of 2017, according to data firm Zillow, with an estimated 713,000 owing at least twice as much as their property's value. While the percentage is declining, families in communities with stagnant property values are 'trapped in their homes with no easy options to regain equity other than waiting,' said Aaron Terrazas, a senior economist at Zillow."

China Watch:

May 28 - Bloomberg: "Strains are spreading in China's $15 trillion shadow banking industry as investors pull back from the debt-like savings products that helped drive leverage to dangerous levels. Most affected are some $3.8 trillion of so-called trust products, until now the fastest-growing shadow banking segment and a popular way for debt-ridden property developers and local governments to raise funds from millions of ordinary Chinese. In recent weeks, at least two of the products have been forced to delay payments as the market started to freeze up, making it harder to refinance maturing issues with new ones. 'On the one hand you have cash-strapped borrowers scrambling for refinancing; on the other you have cash-rich investors not knowing where to put their money for fear of getting burned,' said James Yang, a sales manager at Shanghai Xiangyi Asset Management Co."

May 28 - Wall Street Journal (Manju Dalal and Shen Hong): "Less than seven months ago, an investor consortium led by an obscure Chinese energy conglomerate reached an ambitious deal to buy one of Hong Kong's landmark skyscrapers for a record-setting price. Not long after, the Beijing-based conglomerate known as China Energy Reserve and Chemicals Group backed out of the $5.2 billion deal, and this month it defaulted on a set of U.S. dollar bonds. A subsidiary of the group said in a regulatory filing that it failed to repay the principal amount on $350 million in three-year dollar bonds that matured on May 11. The missed payment triggered default provisions on $655 million in other debt securities that were due to mature in 2021 and 2022. The privately held group blamed a 'tightening in credit conditions' in China over the past two years…"

May 30 - Bloomberg: "The case for the People's Bank of China to cut the amount of cash lenders are required to hold is getting stronger. Chinese banks racked up 2.93 trillion yuan ($457bn) in medium-term loans extended by the PBOC scheduled for repayment during the rest of 2018. That has prompted some analysts to raise bets the PBOC may soon repeat a tactic used in April: cutting the Reserve Requirement Ratio to hand lenders liquidity so they can pay back the debt."

May 31 - Reuters (Stella Qiu and Ryan Woo): "China's vast manufacturing sector grew at the fastest pace in eight months in May, blowing past expectations and easing concerns about an economic slowdown even as risks from trade tensions with the United States and a crackdown on debt point to a bumpy ride ahead. The official Purchasing Managers' Index (PMI) released on Thursday rose to 51.9 in May, from 51.4 in April, and remained well above the 50-point mark that separates growth from contraction for the 22nd straight month."

Central Bank Watch:

May 30 - Bloomberg (Lucy Meakin, Rich Miller and Catherine Bosley): "Just when central bankers thought they were about to get out of the business of emergency economic stimulus, jittery financial markets are threatening to pull some of them back in. For the European Central Bank, the latest threat requiring vigilance is political turmoil in Italy that's reviving memories of the debt crisis that threatened to fracture the euro area. The Bank of England's path is complicated by Brexit and, across emerging markets, central banks are trying to push back against the strong dollar. The People's Bank of China recently eased liquidity conditions for banks, while Indonesia's central bank is forecast to hike rates at an extraordinary policy meeting on Wednesday."

Global Bubble Watch:

May 31 - CNBC (Evelyn Cheng): "The Federal Reserve has designated Deutsche Bank's U.S. business as being in 'troubled condition,' The Wall Street Journal reported… The downgrade to one of the lowest designations occurred about a year ago and has not been previously reported, the report said. The Financial Times also reported… that Deutsche Bank's U.S. subsidiary was added to the Federal Deposit Insurance Corporation's list of 'problem banks,' or those with weaknesses that threaten their financial survival."

Europe Watch:

May 29 - Bloomberg (Tommaso Ebhardt and John Follain): "Italy's Democratic Party signaled a return to campaign mode as it charged its rivals, the League and the Five Star Movement, with having prepared a plan to pull the country out of the euro if they had succeeded in forming a government together. The two parties gambled with the country's well-being 'with a project to take Italy out of the euro zone, and they did it in a ruthless way,' acting PD leader Maurizio Martina wrote on Twitter. League head Matteo Salvini and Five Star chief Luigi Di Maio have both denied any plan to leave the euro."

May 30 - Financial Times (Robin Wigglesworth): "For most of the past decade the main job of Doug Rediker, Washington's former top man at the International Monetary Fund, has essentially been to tell US investors to relax about Europe. Now he thinks they might not be nervous enough. Italy's political chaos has reawakened concerns over the country's future in the eurozone, but given its size, the crisis could dwarf that caused by Greece just a few years ago, Mr Rediker worries. 'My own anxiety level has increased significantly,' he admits. 'Italy is too big to save, and too big to fail.' Investors are therefore dusting off their old eurozone crisis playbooks."

May 30 - Bloomberg (John follain): "The Italian establishment is heading into a showdown against the populists with its armies in disarray. Former Prime Minister Silvio Berlusconi's center-right Forza Italia has been practically swallowed up by Matteo Salvini's League since the inconclusive election on March 4, while the center-left Democratic Party of outgoing premier Paolo Gentiloni is still casting around for a way forward after its worst-ever result. The League and its would-be coalition partner Five Star Movement, meanwhile, are increasingly setting the agenda. Efforts by former International Monetary Fund official Carlo Cottarelli to forge a short-term technocratic government stalled Tuesday with the populists baying for a fresh election… 'The pro-European ruling class is very weak,' said Giovanni Orsina, professor of government at Luiss University in Rome. 'Mattarella has picked the wrong fight.'"

May 31 - Reuters: "Euro zone inflation jumped by far more than expected in May on higher energy costs, bringing relief to the European Central Bank after market turbulence that has jeopardized its planned exit from a lavish stimulus program. Inflation in the 19 countries sharing the euro rose to 1.9% from 1.2% in April…"

Fixed Income Bubble Watch:

May 30 - Bloomberg (Shelly Hagan and Adam Tempkin): "It's gotten a lot harder to borrow money from the raft of fintech firms looking to bring online lending into the mainstream. Besieged by a wave of defaults after several years of rapid growth, the biggest online-lending platforms have been forced by bond investors to tighten underwriting standards. Social Finance, Prosper, LendingClub and Avant now demand higher average credit scores and offer shorter maturities to boost the quality of loans they repackage into asset-backed securities. The shift in the $30 billion market comes after a swarm of borrower defaults in the past three years rattled ABS investors… 'They all had a pretty tough time and took losses a lot more than expected,' said Henry Song, a portfolio manager at Diamond Hill Capital Management…, a firm that invests in online-lending securitizations… 'Some dropped certain grades and the mentality of grabbing market share to be profitable has shifted.'"

Leveraged Speculator Watch:

May 27 - Financial Times (Lindsay Fortado): "The Wall Street star system is dominating hedge-fund launches this year, with a handful of better known managers raising billions of dollars for new investment vehicles. The four biggest hedge fund launches of 2018 have attracted more than $17bn… That compares with the $13.7bn investors have put in existing funds, according to data from eVestment."

Geopolitical Watch:

May 30 - Fox News (Lukas Mikelionis): "Defense Secretary Jim Mattis said… that the U.S. will continue to confront China's increasing militarization of islands in the South China Sea -- despite the U.S. angering Beijing over the weekend by sending two Navy ships to the region. Mattis rebuked China and said the country hasn't abided by its promise to stop militarization of the Spratly Islands, a disputed territory whose ownership is contested by Brunei, Malaysia, the Philippines, Taiwan and Vietnam. Mattis said U.S. ships are maintaining a 'steady drumbeat' of naval operations and will confront 'what we believe is out of step with international law.' 'You'll notice there is only one country that seems to take active steps to rebuff them or state their resentment [to] them, but it's international waters and a lot of nations want to see freedom of navigation,' Mattis told reporters…"

May 30 - Bloomberg (Keith Zhai and Jason Koutsoukis): "Tensions are rising between the U.S. and China ahead of Asia's biggest security conference this week, even as the two powers push for peace on the Korean Peninsula. Defense Secretary James Mattis said… he was planning to raise U.S. concerns about China's recent moves to 'militarize' the South China Sea. Meanwhile, China warned the U.S…. against expanding defense ties with the democratically run island of Taiwan, which Beijing views as a province. Such exchanges have occurred almost daily in recent weeks as old disputes flare up amid the Trump administration's efforts to counter Chinese influence on everything from security to trade."

May 28 - Reuters (Joseph Nasr, Michael Nienaber and Thomas Escritt): "Germany is worried by signs of weakening in the network of multilateral organizations and agreements designed to foster international cooperation, Chancellor Angela Merkel said… Merkel blamed the fraying of the multilateral order on a 'double transition' - the gradual fading of the direct memory of searing global conflict and the sheer pace and scale of technological change. 'The people who experienced World War Two, the last true global catastrophe, are dying out and are no longer there as eyewitnesses,' she told a conference in Berlin."

May 28 - Wall Street Journal (Benoit Faucon): "Chinese and Russian state-backed companies are maneuvering to profit from European firms leaving Iran, threatening the Trump administration's bid to raise economic pressure on Tehran. Their efforts show how Iran's business landscape has shifted since the Trump administration withdrew from the nuclear pact... Secretary of State Mike Pompeo has threatened the 'strongest set of sanctions in history' if Iran doesn't rein in its military activities across the Middle East and stop testing long-range missiles. European executives who tried to make inroads in Iran since the Obama administration struck the nuclear deal in 2015 are now concerned Beijing and Moscow will seize an insurmountable advantage in a large, growing market."

May 27 - Wall Street Journal (Chun Han Wong): "China criticized the U.S. for sending two warships into South China Sea waters that Beijing considers its territory, amid simmering bilateral tensions over trade and North Korea. …China's foreign and defense ministries each expressed 'firm opposition' to what they described as violations of Chinese sovereignty by the guided-missile destroyer USS Higgins and the guided-missile cruiser USS Antietam… 'The Chinese military took immediate action, deploying ships and aircraft to identify the U.S. vessels and issued warnings to drive them away,' Chinese Defense Ministry spokesman Wu Qian said…, which said that the two vessels made 'unauthorized' entry into Chinese waters."

Friday Evening Links

[BloombergQ] Stocks Rally, Led by Tech, as Jobs Give Fed Cover: Markets Wrap

[Reuters] U.S. isolated at G7 meeting as tariffs prompt retaliation

[CNBC] The US economy suddenly looks like it's unstoppable

[Reuters] Fed's Williams says rates may start to brake growth by next year

[Reuters] Italy's Conte sworn in as PM of anti-establishment government

[Reuters] Brazil strike boosts far right candidate's shot at presidency