Friday, June 15, 2018

Weekly Commentary: The Great Fallacy

A big week in the world of monetary management: The Federal Reserve raised rates 25 bps, the ECB announced plans to wind down its historic QE program, and the Bank of Japan clung to its "powerful monetary easing" inflationist scheme. A tense People's Bank of China left rate policy unchanged, too weary to follow the Fed's path.

The renminbi declined a notable 0.5% versus the dollar this week. More dramatic, the euro was hammered 1.9% on Draghi's game plan. Also on Thursday's dollar strength - and even more dramatic - the Argentine peso sank another 6.2% (down 34% y-t-d). The session saw the Brazilian real drop 2.2%, the Hungarian forint 2.6%, the Czech koruna 2.2%, the Polish zloty 2.0%, the Bulgarian lev 1.9%, the Romanian leu 1.9% and the Turkish lira 1.7%.

The FOMC, raising rates and adjusting "dot plots" higher, was viewed more on the hawkish side. The ECB, while announcing plans to conclude asset purchases by the end of the year, was compelled to add dovish guidance on rate policy ("…expects the key ECB interest rate to remain at present levels at least through the summer of 2019…"). Blindsided, the market dumped the euro. The Fed and ECB now operate on disparate playbooks, each focused on respective domestic issues. Anyone these days focused on faltering emerging market Bubbles, global contagion and the rising risk of market illiquidity?

June 13 - Financial Times (Sam Fleming): "Jay Powell put his personal stamp on the Federal Reserve on Wednesday, as the new chairman vowed to speak in plain English and hold more regular press conferences as he fosters 'a public conversation' about what the US central bank is up to. The Fed's statement after the Federal Open Market Committee meeting, which detailed its decision to raise rates 0.25% and set a course for two more increases this year, also bore his imprint, as Mr Powell stripped away some of the economic verbiage that cluttered its communications in recent years. Mr Powell's break from the approach of his predecessor… was more a stylistic one than a radical change of monetary policy strategy."

It may be subtle, but Chairman Powell appears ready to break from both his predecessors and fellow global central bankers. So far, there's been the envisioned continuity, along with a traditional element of caution when it comes to adjusting central bank doctrine. There are, however, indications that Powell is ready to distance his committee from the Fed's recent radical monetary experiment.

Mr. Powell's plain-speaking approach is refreshing. He is the antithesis of "Greenspeak." The new Chairman is clear, concise and devoid of obfuscation. He's no ideologue. There are no glaring idiosyncrasies, for a change. Powell appears the adept and confident leader, yet he demonstrates an admirable humility when it comes to pontificating about today's exceedingly complex backdrop. The Chairman has also abandoned much of the academic narrative that too often ensures economic analysis and discussion turn hopelessly convoluted and divorced from reality.

June 14 - Bloomberg (Jeanna Smialek): "Federal Reserve Chairman Jerome Powell doesn't claim to have all of the answers, but when it comes to where unemployment can settle in the long run, he and his colleagues are especially stumped. 'No one really knows with certainty what the level of the natural rate of unemployment is,' Powell told reporters… Later, pressed about whether the Fed's long-run estimate, now at 4.5%, could come down, he indicated that it's possible. 'We can't be too attached to these unobservable variables.' It's a crucial uncertainty, because the natural jobless rate is a linchpin of Fed policy."

The Fed Chairman is also moving to a press conference following each FOMC meeting. I suspect there's more to this move than a desire for greater transparency. The markets have been assuming that significant policy moves would only occur during meetings with scheduled press conferences. Powell would prefer the markets not make such presumptions. Every meeting is live. Data matter. There are financial stability risks when the Fed pre-commits on policy or becomes hamstrung by market expectations.

The past few Fed chairs were keen to use forward guidance as part of their strategies to manipulate market expectations, prices and economic outcomes. Powell, in what would be a major departure, appears to want the Fed out of the guidance and manipulation business. It's an uncertain world, and financial markets must be reacquainted with the capitalistic principle of markets standing on their own. He appreciates the extraordinary uncertainty in the economic, market, policy, and geopolitical backdrops. Powell views the economy as strong and ongoing monetary policy normalization as appropriate. Of course, there are downside risks. But in contrast to Draghi, Powell shows little predilection to dangle the carrot of monetary stimulus and liquidity backstops in front of a craving marketplace.

With his background in finance, I'll assume the Chairman appreciates the speculative nature of current market dynamics. He is well aware of the powerful role the Greenspan/Bernanke/Yellen puts have played within the financial markets. Cognizant of market distortions, Powell would rather the markets not revel in the certitude of a Fed ready and willing to sprint immediately to the markets' defense. On the surface, adjustments in the Powell Fed's rate and communications policies appear less than far-reaching. But on the critical issue of the Federal Reserve's approach to market-pandering policy guidance and market-bolstering liquidity backstops, I believe Powell is breaking with the progressively radical policy course that unfolded under Drs. Greenspan, Bernanke and Yellen.

Over in Frankfurt, Mario Draghi is having a devil of a time shedding "whatever it takes." He stated the ECB's intention to end QE at the end of the year. This is, however, "subject to incoming data confirming the Governing Council's medium-term inflation outlook." Markets hear Draghi discussing an exit, while seeing ECB forward guidance as virtually ensuring ongoing liquidity operations. Viewing unfolding developments in EM, Italy, the European periphery and vulnerable global markets more generally, markets see fragilities that create a high likelihood of future "whatever it takes" QE measures.

The pressing issue for global markets goes far beyond widening interest-rate differentials. Markets anticipate a future with the Draghi ECB eager to expand QE and, across the pond, the Powell Fed reluctant to redeploy QE - in a world increasingly vulnerable to a globally systemic market liquidity event. Markets see a stimulus-driven overheated ("Core") U.S. economy distancing itself from faltering ("Periphery") Bubbles in EM and Europe. Recalling how cracks in subprime worked to extend "Terminal Phase Excess" in prime U.S. mortgages right into the 2008 crisis, serious issues today at the global "periphery" ensure financial conditions remain dangerously loose for the late-cycle U.S. boom.

The risk of an upside dollar market dislocation is rising. That, at least, was how markets seemed to trade on Friday. The GSCI Commodities index fell 2.2%, with crude sinking $2.55, or 3.8%, in Friday trading. Silver (COMEX) was slammed 4.0%, gold 1.8% and Platinum 1.9%. Copper fell 2.5% and Nickel dropped 2.2%. Even in U.S. equities, it was sell industrials and materials and buy defensive. Treasury yields followed European yields lower, focused more on international developments than U.S. GDP or the trajectory of short-term interest rates. Despite the U.S. boom, there are rising concerns for the global economy. China ok?

June 13 - Bloomberg: "China's broadest measure of new credit slumped in May to the lowest in almost two years, as a campaign to rein in the shadow banking sector gained traction. Aggregate financing stood at 760.8 billion yuan ($118.8bn) in May…, compared with an estimated 1.3 trillion yuan in a Bloomberg survey and 1.56 trillion yuan in April. The change was driven by a fall in off-balance sheet lending of 421.5 billion yuan, the most since data began in 2006… New yuan loans stood at 1.15 trillion yuan, versus a projected 1.2 trillion yuan, and broad M2 money supply increased 8.3%, compared with a forecast 8.5%"

China's CNY 761 billion ($119bn) May increase in Total Social Financing not only badly missed estimates, it was the smallest monthly increase since July 2016. Y-t-d growth of CNY 17.990 TN ($1.235 TN) is running 16% below comparable 2017 - and was even below comparable 2016 Credit growth.

Beijing's crackdown on shadow banking has had a dramatic impact. Major shadow bank components (i.e. trust loans, entrusted loans and undiscounted bankers' acceptances) all contracted for the month. Corporate debt financings also declined during May (about $7bn).

At $180 billion, New Bank Loans were slightly below estimates and just below the May 2017 level. Importantly, lending (mostly mortgages) to the Household sector continues to grow at a rapid clip. May Household lending of CNY 614.3 billion ($96bn) expanded at 17.2% annual rate, with y-t-d growth at a 17.3% pace. This helps to explain an increasingly unbalanced Chinese economy.

June 14 - Reuters (Yawen Chen and Ryan Woo): "China's home prices in May logged their fastest growth in nearly a year, suggesting buyers are targeting smaller cities even as the government steps up measures to clamp down on speculation. Average new home prices in China's 70 major cities rose 0.7% in May from the previous month - the best pace since June 2017 - compared with a 0.5% increase in April…"

With real estate-directed lending booming, the resilience in the apartment price Bubble is easily explained. Related wealth effects are behind much stronger-than-expected May Imports (up 15.6% vs. expectations of 8.6%) - and China's rapidly shrinking Trade Surplus. I would argue that China's runaway mortgage finance and apartment Bubbles at this late stage of the cycle significantly increase the risk of systemic crisis.

In important sectors of the Chinese economy, there are indications that tighter Credit conditions are having an impact. Industrial Production (up 6.8%) and Fixed Investment (up 6.1%) both slowed and missed forecasts in May.

From Thursday's NYT (Keith Bradsher): "Gary Liu, the president of the China Financial Reform Institute, a Shanghai-based research group, said on the sidelines of the Lujiazui Forum that China's private-sector companies of all sizes, even large ones, had long faced challenges in obtaining loans. But the credit squeeze on them this spring has been particularly painful. 'It's very bad, and we see not just small and medium-sized enterprises defaulting but even big companies defaulting,' he said."

With the Trump administration Friday announcing $50 billion of tariffs on Chinese goods - supposedly with a list of an additional $100 billion ready to go - and China retaliating with its own tariffs on $34 billion, there are concerns for an escalating trade war. Returning to the potential for an upside dollar dislocation, China is today unusually financially and economically vulnerable.

A surging U.S. dollar would find Beijing in a difficult quandary. Maintaining China's soft peg to the dollar would leave Chinese manufacturers in a disadvantageous position, right as Credit and liquidity conditions tighten and growth slows.

Chinese devaluation fears would reemerge, spurring capital flight and the unwind of leveraged holdings of higher-yielding Chinese Credit instruments. With China's banks and corporations having over recent years borrowed aggressively in dollars, currency instability could quickly develop into Credit worries and market illiquidity. The Shanghai Composite dropped 1.5% this week, increasing y-t-d losses to 8.6%. The small cap CSI 500 index sank 3.3% (down 12.3% y-t-d), and China's growth stock ChiNext index was slammed 4.1% (down 6.3%). It's worth adding that Hong Kong's Hang Seng Financials index fell 2.3% this week, trading near 2018 lows. Bank stocks traded poorly almost around the globe this week.

Here at home, the NFIB Small Business Optimism Index jumped three points in May to the highest reading since 1983. Preliminary June Michigan Consumer Confidence rose to a stronger-than-expected 99.3, with Current Conditions rising to the second-highest reading going back to 2000. Up a blistering 0.8% for the month, May Retail Sales blew away estimates. The Empire Manufacturing Index jumped to an eight-month high. May CPI was up 2.8% y-o-y, with PPI gaining 3.1% y-o-y. The Atlanta Fed's growth forecasting model has real GDP expanding at a 4.8% clip.

The U.S. economy has grown too hot and markets too speculative. U.S. rates and market yields remain inappropriately low. The Powell Fed has set a course for rate normalization. Meanwhile, fissures open in the global Bubble. Global imbalances are coming home to roost. Resulting dollar strength has a very real possibility of becoming self-reinforcing and increasingly destabilizing. The Argentine peso sank 10.3% this week. The Turkish lira fell 5.4%, the South African rand 2.7%, the Hungarian forint 2.2%, the South Korean won 2.0% and the Mexican peso 1.6%. Yields rose again this week in Brazil, Argentina and Turkey. International markets seem to have a solid grasp of the immediately vulnerable countries. In short, the unfolding global crisis thesis remains on track.

Objectively, global markets indicating such fragility in the face of extraordinarily low rates and about $100 billion of ongoing monthly QE portends difficult challenges ahead. The notion that you can inflate your way out of Bubbles is The Great Fallacy of contemporary central bankers. They've inflated only bigger Bubbles.

For the Week:

The S&P500 was little changed (up 4.0% y-t-d), while the Dow declined 0.9% (up 1.5%). The Utilities rallied 2.1% (down 6.4%). The Banks lost 2.1% (up 0.9%), and the Broker/Dealers declined 1.2% (up 9.9%). The Transports rose 1.2% (up 4.4%). The S&P 400 Midcaps slipped 0.4% (up 4.8%), while the small cap Russell 2000 added 0.7% (up 9.7%). The Nasdaq100 advanced 1.4% (up 13.4%). The Semiconductors increased 0.7% (up 13.5%). The Biotechs jumped 1.8% (up 16.9%). With bullion down $20, the HUI gold index declined 0.5% (down 7.5%).

Three-month Treasury bill rates ended the week at 1.88%. Two-year government yields rose five bps to 2.55% (up 66bps y-t-d). Five-year T-note yields added a basis point to 2.80% (up 59bps). Ten-year Treasury yields declined three bps to 2.92% (up 52bps). Long bond yields fell four bps to 3.05% (up 31bps). Benchmark Fannie Mae MBS yields declined four bps to 3.65% (up 66bps).

Greek 10-year yields dropped 20 bps to 4.45% (up 38bps y-t-d). Ten-year Portuguese yields fell 23 bps to 1.82% (down 12bps). Italian 10-year yields sank 52 bps to 2.61% (up 59bps). Spain's 10-year yields dropped 17 bps to 1.30% (down 27bps). German bund yields declined five bps to 0.40% (down 2bps). French yields fell nine bps to 0.73% (down 5bps). The French to German 10-year bond spread narrowed four to 33 bps. U.K. 10-year gilt yields declined six bps to 1.33% (up 14bps). U.K.'s FTSE equities index slipped 0.6% (down 0.7%).

Japan's Nikkei 225 equities index increased 0.7% (up 0.4% y-t-d). Japanese 10-year "JGB" yields declined one basis point to 0.04% (down one bp). France's CAC40 gained 0.9% (up 3.6%). The German DAX equities index jumped 1.9% (up 0.7%). Spain's IBEX 35 equities index rose 1.1% (down 1.9%). Italy's FTSE MIB index rallied 3.9% (up 1.5%). EM equities were mostly lower. Brazil's Bovespa index sank 3.0% (down 7.4%), while Mexico's Bolsa gained 2.2% (down 4.9%). South Korea's Kospi index dropped 1.9% (down 2.6%). India’s Sensex equities index added 0.5% (up 4.6%). China’s Shanghai Exchange fell 1.5% (down 8.6%). Turkey's Borsa Istanbul National 100 index lost 1.4% (down 18.0%). Russia's MICEX equities dropped 1.3% (up 6.1%).

Investment-grade bond funds saw inflows of $2.038 billion, and junk bond funds had inflows of $324 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates jumped eight bps to 4.62% (up 71bps y-o-y). Fifteen-year rates rose six bps to 4.07% (up 89bps). Five-year hybrid ARM rates gained nine bps to 3.83% (up 68bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 4.66% (up 66bps).

Federal Reserve Credit last week increased $3.0bn to $4.282 TN. Over the past year, Fed Credit contracted $146bn, or 3.3%. Fed Credit inflated $1.471 TN, or 52%, over the past 293 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $3.2bn last week to $3.402 TN. "Custody holdings" were up $131bn y-o-y, or 4.0%.

M2 (narrow) "money" supply rose $13.8bn last week to a record $14.080 TN. "Narrow money" gained $568bn, or 4.2%, over the past year. For the week, Currency increased $3.0bn. Total Checkable Deposits surged $43.9bn, while savings Deposits fell $39bn. Small Time Deposits added $2.0bn. Retail Money Funds gained $3.9bn.

Total money market fund assets dropped $22.8bn to $2.855 TN. Money Funds gained $221bn y-o-y, or 8.4%.

Total Commercial Paper expanded $11.2bn to $1.109 TN. CP gained $140bn y-o-y, or 14.5%.

Currency Watch:

The U.S. dollar index jumped 1.3% to 94.788 (up 2.9% y-t-d). For the week on the downside, the South African rand declined 2.7%, the Australian dollar 2.1%, the South Korean won 2.0%, the Canadian dollar 1.9%, the Mexican peso 1.6%, the euro 1.4%, the Norwegian krone 1.3%, the New Zealand dollar 1.2%, the Swiss franc 1.2%, the Singapore dollar 1.1%, Japanese yen 1.0%, the British pound 1.0%, the Swedish krona 0.8% and the Brazilian real 0.6%. The Chinese renminbi declined 0.50% versus the dollar this week (up 1.21% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.6% (up 4.8% y-t-d). Spot Gold declined 1.5% to $1,280 (down 1.8%). Silver fell 1.6% to $16.48 (down 3.9%). Crude declined 68 cents to $65.06 (up 8%). Gasoline sank 4.0% (up 13%), while Natural Gas rose 4.6% (down 3%). Copper dropped 4.7% (down 4.7%). Wheat lost 1.3% (up 20%). Corn gained 1.3% (up 9%).

Market Dislocation Watch:

June 13 - Bloomberg (Liz Capo McCormick): "The Treasury yield curve from 5 to 30 years flattened to levels last seen in August 2007 after Federal Reserve officials hiked rates and signaled a faster pace of tightening ahead. The spread narrowed to as little as 24.4 bps, falling below the previous low for 2018, touched in May. The gap between 2- and 10-year yields also slid to the smallest since 2007, touching 39.1 bps, before rebounding to just above 40 bps."¬

June 13 - Bloomberg (James Hirai): "The sharp sell-off in Italy's government bonds on May 29 was driven as much by technical factors as fundamentals and the lack of liquidity at such times implies that increased 'left tail risk in liquid asset prices' might be understated, economist Charles Himmelberg writes… Sell-off triggered 'largest 1-day spike in 2-year yields in at least 20 years' along with bid-ask spreads widening by more 'than at any time during the European sovereign-debt crisis in 2012."

June 11 - Financial Times (Philip Stafford and Kate Allen): "The gyrations in the Italian government bond market have revealed how Europe's liquidity-starved sovereign debt markets are being heavily tested by even short bouts of political instability. The rapid rise and fall in yields in the eurozone's largest debt market in recent weeks has been exacerbated by thin sovereign debt liquidity. During the most intense price swings some primary dealers - banks which deal directly with the national central bank to distribute its bonds into the wider market - reported that the electronic screens they used were showing fewer potential deals than normal. This made it difficult for them to carry out their traditional role of market-makers - providing liquidity to reduce price volatility."

Trump Administration Watch:

June 15 - Wall Street Journal (Bob Davis, Vivian Salama and Lingling Wei): "Beijing retaliated against planned U.S. tariffs on Chinese goods by targeting high-value American exports-including farm products, cars, and crude oil-bringing the world's two biggest economies closer to an all-out trade war. Shortly after the Trump administration unveiled plans Friday to impose tariffs of 25% on $50 billion in Chinese products, China's State Council announced it would levy penalties of the same rate on the U.S. goods of the same value. The U.S. is 'provoking the trade war,' China's Foreign Ministry spokesman Lu Kang said Friday, while pledging to defend the country's interests."

June 10 - Bloomberg (Mark Niquette): "President Donald Trump's disavowal of a joint statement after the Group of Seven meeting was made to avoid looking weak going into the North Korea summit after 'sophomoric' comments by Canada's Justin Trudeau, a top aide said. Trudeau 'really kind of stabbed us in the back,' White House economic adviser Larry Kudlow said on CNN's "State of the Union"…, calling on the Canadian to apologize. Trudeau's office, in turn, said what the Canadian leader said on Saturday was nothing new… Speaking on 'Fox News Sunday,' Navarro doubled down on Kudlow's rhetoric and said Trudeau's post-conference comments were in bad faith. 'There's a special place in Hell for any foreign leader that engages in bad faith diplomacy with President Donald J. Trump and then tries to stab him in the back on the way out the door,' Navarro said."

June 12 - Reuters (Matt Spetalnick and David Brunnstrom): "U.S. President Donald Trump… kept up his feud with America's closest allies over trade, saying he could not allow them to continue taking advantage of the United States… 'We are being taken advantage of by virtually every one of those countries,' Trump told a news conference… 'Look, countries cannot continue to take advantage of us on trade.'"

June 10 - Reuters (Matt Spetalnick and David Brunnstrom): "U.S. President Donald Trump fired off a volley of tweets on Monday venting anger on NATO allies, the European Union and Canadian Prime Minister Justin Trudeau in the wake of a divisive G7 meeting over the weekend… 'Fair trade is now to be called fool trade if it is not reciprocal,' said Trump… 'Sorry, we cannot let our friends, or enemies, take advantage of us on trade anymore. We must put the American worker first!'"

June 11 - Wall Street Journal (Paul Vieira and Sara Schaefer Muñoz): "A backdrop of new hostility is hurting chances for Washington and Ottawa to successfully overhaul the North American Free Trade Agreement, say people close to the talks… Before this past weekend's Group of Seven leaders' summit, the fate of Nafta was on shaky footing following the U.S. decision to impose tariffs on Canadian- and Mexican-made steel and aluminum products on national-security grounds. Both Canada, the largest foreign supplier of both metals to the U.S., and Mexico unveiled retaliatory tariffs, and former trade negotiators warned the levies would only strengthen Canadian and Mexican resolve not to give in to unconventional U.S. demands in Nafta. A successful outcome for the trade pact now seems even more tenuous after President Donald Trump abruptly withdrew U.S. support for a G-7 final communiqué and he and advisers issued a series of highly personal attacks on Twitter and in interviews against Canada's prime minister…"

June 10 - New York Times (Ana Swanson): "At the rockiest annual meeting of major Western powers in decades, President Trump criticized the tariffs imposed on American goods as 'ridiculous and unacceptable' and vowed to put an end to being 'like a piggy bank that everybody is robbing.' Behind Mr. Trump's outrage is his belief that the United States is at a disadvantage when it comes to global trade and is on the losing end of tariffs imposed by other nations. But to many of the country's trading partners, the president's criticisms ring hollow given that the United States places its own tariffs on everything from trucks and peanuts to sugar and stilettos."

June 10 - Financial Times (Chris Giles): "Relations between the US and its closest allies plunged to new depths on Sunday after the most acrimonious G7 summit in a generation ended with the American president lashing out at fellow leaders and backtracking on a pledge to sign the G7 communiqué. The west was in disarray after Donald Trump left the summit early, instructed his officials to tear up the bland G7 statement, threatened to impose more tariffs and called the Canadian prime minister 'very dishonest and weak'…"

June 14 - Politico (Adam Behsudi and Nancy Cook): "President Donald Trump wants his staff to push forward with plans to slap 25% tariffs on foreign cars before the midterm elections in a bid to score points with his political base, according to administration and auto industry officials. The president believes a promise to tax cars, trucks and auto parts coming from U.S. competitors like Europe and Japan would allow him to present a concrete win to workers, the officials said. 'Trump sees the auto tariffs as part of his midterm strategy, a way to position Republicans and the White House as pro-worker,' said one senior administration official. 'He views it as part of the broader story about to helping to revitalize the American-based economy.' Raising the price of foreign cars would be the latest in a series of aggressive trade moves by Trump, who is betting that his supporters will be more focused on the protection of local jobs than on the increased costs for consumers…"

June 9 - Reuters (Christian Shepherd and Shu Zhang): "Chinese President Xi Jinping, whose country is locked in a high-stakes trade dispute with the United States, …said China rejects 'selfish, shortsighted' trade policies, and called for building an open global economy… 'We reject selfish, shortsighted, closed, narrow policies, (we) uphold World Trade Organisation rules, support a multi-lateral trade system, and building an open world economy,' Xi said…"

June 14 - Reuters (Philip Blenkinsop): "European Union countries on Thursday unanimously backed a plan to impose import duties on 2.8 billion euros ($3.3bn) worth of U.S. products after Washington hit EU steel and aluminum with tariffs at the start of June, EU sources said… The European Commission has proposed setting 25% duties on U.S. goods such as orange juice, bourbon, jeans, motorcycles in response to what it is sees as illegal U.S. action affecting 6.4 billion euros of its exports."

June 10 - Reuters (Paul Carrel and Michael Nienaber): "International Monetary Fund chief Christine Lagarde led an attack by global economic organizations on U.S. President Donald Trump's 'America First' trade policy on Monday, warning that clouds over the global economy 'are getting darker by the day'… The… IMF is sticking to its forecast for global growth of 3.9% both this year and next, she said, before adding: 'But the clouds on the horizon that we have signaled about six months ago are getting darker by the day, and I was going to say by the weekend.'"

June 11 - Financial Times (Anne-Sylvaine Chassany and Tobias Buck): "This time, there was no kissing, hugging or planting trees. Less than two months after Donald Trump and Emmanuel Macron displayed mutual affection in Washington, their encounter at the G7 meeting in Canada during the weekend was marked by angry rhetoric on US trade tariffs and a white thumbprint left on Mr Trump's hand by a firm squeeze from the French leader. Mr Trump's weekend onslaught on the postwar multilateral order has cooled his bromance with Mr Macron and reinforced the French president's determination that the EU should stand its ground on trade, seen by the EU as a defining transatlantic issue. For Mr Macron and German chancellor Angela Merkel, who described the G7 outcome as 'sobering' and 'depressing', the Québec debacle also emphasised how much the EU's two dominant leaders will have to rely on each other in a colder multilateral era. 'Flattery has had no effect, we are now in a more confrontational phase,' said François Heisbourg, a geopolitical analyst."

Federal Reserve Watch:

June 13 - Bloomberg (Craig Torres, Christopher Condon and Jeanna Smialek): "Federal Reserve officials raised interest rates for the second time this year and upgraded their forecast to four total increases in 2018, as unemployment falls and inflation overshoots their target faster than previously projected. The so-called 'dot plot' …showed eight Fed policy makers expected four or more quarter-point rate increases for the full year, compared with seven officials during the previous forecast round in March… The median estimate implied three increases in 2019 to put the rate above the level where officials see policy neither stimulating nor restraining the economy. Chairman Jerome Powell told reporters following the decision -- which lifted the Fed's benchmark rate by a quarter percentage point to a range of 1.75% to 2% -- that the main takeaway was that 'the economy is doing very well.' Powell also announced he plans to start holding a press conference after every meeting in January…"

June 13 - Wall Street Journal (Nick Timiraos): "Federal Reserve officials signaled… they could pick up the pace of interest-rate increases this year and next to keep a rapidly expanding economy on an even keel. Central bank officials voted unanimously to raise their benchmark federal-funds rate by a quarter-percentage point to a range between 1.75% and 2%. It is their second rate rise this year, and they penciled in a total of four increases for 2018, up from a projection of three at their March meeting. 'The decision you see today is another sign that the U.S. economy is in great shape,' said Fed Chairman Jerome Powell… 'Growth is strong. Labor markets are strong. Inflation is close to target.' Eight of 15 Fed officials now expect at least four rate increases will be needed this year, up from seven in March and four in December."

U.S. Bubble Watch:

June 12 - Reuters (Lindsay Dunsmuir): "The U.S. government had a $147 billion budget deficit in May, an increase of 66% from the same month last year as the ledger took a hit from declining revenue and higher spending… The deficit for the fiscal year, which began last October, was $532 billion, compared to a deficit of $433 billion in the same period of fiscal 2017. On an adjusted basis, the gap was $584 billion compared with $473 billion in the prior period. Unadjusted receipts last month totaled $217 billion, down 10% from May 2017, while unadjusted outlays were $364 billion, a rise of 11% from the same month a year earlier."

June 14 - Bloomberg (John Gittelsohn): "The soaring U.S. budget deficit at a time interest rates are increasing may be setting the stage for fiscal trouble, according to Jeffrey Gundlach, chief investment officer of DoubleLine Capital. 'Here we are doing something that almost seems like a suicide mission,' Gundlach said… 'We are increasing the size of the deficit while we're raising interest rates.'"

June 13 - Bloomberg (Liz Capo McCormick): "The Treasury yield curve from 5 to 30 years flattened to levels last seen in August 2007 after Federal Reserve officials hiked rates and signaled a faster pace of tightening ahead. The spread narrowed to as little as 24.4 bps, falling below the previous low for 2018, touched in May. The gap between 2- and 10-year yields also slid to the smallest since 2007, touching 39.1 bps, before rebounding to just above 40 bps."

June 12 - Reuters (Lucia Mutikani): "U.S. consumer prices rose marginally in May amid a slowdown in increases in the cost of gasoline and the underlying trend continued to suggest moderate inflation in the economy… The Consumer Price Index increased 0.2% last month… That followed a similar gain in the CPI in April. In the 12 months through May, the CPI increased 2.8%, the biggest advance since February 2012, after rising 2.5% in April."

June 13 - Reuters (Lucia Mutikani): "U.S. producer prices increased more than expected in May, leading to the biggest annual gain in nearly 6-1/2 years, the latest sign of a gradual building up of inflation pressures… The producer price index for final demand rose 0.5% last month, boosted by a surge in gasoline prices and continued gains in the cost of services… The PPI edged up 0.1% in April. In the 12 months through May, the PPI increased 3.1%, the largest advance since January 2012. Producer prices rose 2.6% year-on-year in April."

June 14 - CNBC (Patti Domm): "Armed with new-found proceeds from the tax bill, American consumers went shopping in May, driving retail sales - and economic growth - sharply higher. The economy in the second quarter is tracking close to 4% growth - a level President Donald Trump raved about last December, just before the tax bill was approved. At the same time, he had also told reporters he was holding out for a doubling of growth to 6%. For now, his 4% forecast is close to coming true on a quarterly basis, after strong retail sales data pushed up tracking GDP growth for the second quarter to about double the first quarter's level. The economy grew by 2.2% in the first quarter. CNBC/Moody's Analytics Rapid GDP Update reported economists' estimates of tracking GDP show average growth at 3.8%..."

June 12 - Bloomberg (Scott Lanman): "A gauge of optimism among U.S. small-business owners rose to a 34-year high amid increasingly sunny expectations for sales and profits, a National Federation of Independent Business survey showed… Sentiment index rose 3 points to 107.8 (est. 105), second-highest in gauge's history behind reading of 108 in 1983. Net 31% expect sales to increase, up 10 points from prior month and highest since Nov. Record 34% of respondents said it's a good time to expand…"

June 13 - Wall Street Journal (Miriam Gottfried): "The animal spirits are returning to the leveraged-buyout business, and that's helping fuel a historic rise in merger activity. At $156 billion, this year is on pace to have the highest dollar volume of LBOs since 2007 and is about 44% above last year's comparable level, according to Dealogic… The pace of private-equity fundraising, including more than $500 billion raked in last year alone, has led to concern about their ability to spend all that cash profitably, especially with equity valuations running near all-time highs."

June 10 - CNBC (Jeff Cox): "Corporate executives are using tax cuts and share buybacks to boost their own compensation, a top regulator said… Companies have announced a record-breaking level of share buybacks since Congress passed the Republican-backed tax reduction in December. Critics of the $1.5 trillion measure had worried that it would lead to big rewards for shareholders and only limited benefit to the broader economy. Robert Jackson Jr., a member of the Securities and Exchange Commission, said corporate bigwigs have been selling their shares after the buyback announcements hit, cashing in from the stock price surge that often happens after a repurchase notice."

June 9 - Financial Times (Owen Walker): "The asset management snowball is in full roll. The industry's largest funds are hurtling along, attracting billions of dollars of assets, while small competitors struggle to keep up. From mutual funds and exchange traded funds to private equity and other alternative vehicles, the story is the same: the biggest products are growing rapidly as assets are increasingly concentrated in the megafunds. The implications for the market and consumers are huge. 'As investors entrust their money to fewer products, assets come under the control of fewer individuals, who ultimately make fewer but larger decisions,' said Warren Miller, chief executive of Flowspring, a US data analysis group… According to Flowspring, the largest 1% of mutual funds manage 45% of industry assets. That figure is 72 times larger than all the assets managed by the bottom half. This is the highest concentration in two decades and has increased dramatically since the financial crisis. In 2009, the amount managed by the top 1% was just over 30 times that of the bottom half. The ratio was as low as 22:1 in 2006."

June 12 - Bloomberg (Joe Light): "Fannie Mae and Freddie Mac's regulator is proposing that the mortgage-finance giants have a combined capital buffer of as much as $180.9 billion should the companies be released from government control. The capital requirement, which the Federal Housing Finance Agency proposed…, would be suspended as long as the companies remain in federal conservatorship… FHFA Director Mel Watt first told the Senate Banking Committee last month that he was developing the rule…. 'We think it is important for FHFA, as the prudential regulator for Fannie Mae and Freddie Mac, to articulate our views on capital requirements and to start a healthy discussion about the amount of capital the enterprises should have to appropriately shield taxpayers,' Watt said…"

June 12 - Reuters (Diane Bartz and David Shepardson): "AT&T Inc won court approval… to buy Time Warner Inc for $85 billion, rebuffing an attempt by U.S. President Donald Trump's administration to block the deal and likely setting off a wave of corporate mergers. The deal, which could close next week, is seen as a turning point for a media industry that has been upended by companies like Netflix Inc and Alphabet Inc's Google which produce content and sell it online directly to consumers, without requiring a pricey cable subscription. Cable, satellite and wireless carriers all see buying content companies as a way to add revenue."

June 14 - Financial Times (Nicole Bullock): "Funds have been raised at a record rate in the US this year for shell companies that offer a 'blank cheque' to sponsors to pursue takeovers, providing further evidence of the rehabilitation of a controversial tool that waned in the wake of the financial crisis. The so-called special purpose acquisition companies, or spacs, have raised $4.5bn so far in 2018 - the largest amount for this type of fundraising in the period, according to Dealogic… That followed a brisk 2017, the second strongest year on record with nearly $10bn sold."

China Watch:

June 13 - Bloomberg: "China's broadest measure of new credit slumped in May to the lowest in almost two years, as a campaign to rein in the shadow banking sector gained traction. Aggregate financing stood at 760.8 billion yuan ($118.8bn) in May…, compared with an estimated 1.3 trillion yuan in a Bloomberg survey and 1.56 trillion yuan in April. The change was driven by a fall in off-balance sheet lending of 421.5 billion yuan, the most since data began in 2006… New yuan loans stood at 1.15 trillion yuan, versus a projected 1.2 trillion yuan, and broad M2 money supply increased 8.3%, compared with a forecast 8.5%."

June 13 - Wall Street Journal (Nathaniel Taplin): "China has spent the past 18 months tightening the screws on risky funding practices, but growth has mostly kept chugging along. Total financing in the economy-including municipal and corporate bond issuance, equity sales and shadow banking-grew just 11.5% in May from a year earlier, the slowest pace in more than a decade. Even so, factory-gate price inflation accelerated again. What exactly is going on? A big factor is the convoluted way that China's campaign against debt has unfolded-which implies that the real hit to growth could arrive soon."

June 14 - Financial Times (Edward White): "China's retail sales, investment growth and industrial output came in below forecasts in May… Retail sales growth showed a year-on-year increase of 8.5% last month, missing a 9.6% forecast from economists polled by Reuters and down almost 1 percentage point from 9.4% in April. Total fixed-asset investment growth slowed to 6.1%, compared to a 7% Reuters forecast. Commerzbank analyst Zhou Hao noted that the indicators 'illustrated a rather sluggish growth picture' with the sharp fall for fixed asset investment sending the marker to a new record low. 'After seasonal adjustment, all the indicators point to a rapidly slowing momentum,' he said. 'There is a clear spill-over effect from the financial deleveraging to the real sector.'"

June 13 - Reuters (Yawen Chen and Kevin Yao): "China's real estate investment growth slowed in May but remained firm, with sales growth hitting a near one-year high, defying fresh purchase curbs and higher financing costs and indicating resilience in one of the country's main economic drivers. Property investment rose 9.8% in May from the same period a year earlier, compared with a 10.2% rise in April... It grew 10.2% in the first five months of the year."

June 12 - Financial Times (James Kynge): "A moderate shock, perhaps caused by mounting trade frictions, could send China's current account into deficit this year for the first time since 1993, according to Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered. As the current account balance moves closer to zero, more movement in the value of the renminbi… against the US dollar is possible, Mr Ding said. A weakening renminbi has in the past fuelled outflows of capital from China and hit domestic equity and bond markets. Standard Chartered forecasts a narrowing surplus in the current account, which measures trade and services flows, to 1% of GDP this year and 0.5% in 2019, down from 1.3% in 2017."

June 13 - Bloomberg: "China's two-year long deleveraging campaign is finally taking a toll on corporate financing, igniting concerns that defaults will accelerate as liquidity strains worsen. The nation's broadest measure of new credit slumped in May to the lowest in almost two years. Net financing by company bond sales turned negative for the first time since last June, with more debt maturing than was issued… 'Chinese companies face heavy bond redemption in the second half of the year,' said Jiang Chao, an analyst at Haitong Securities Co. 'So if new credit growth stays sluggish, default risk will keep rising.' China is grappling with a delicate balancing act to rein in the shadow banking sector without undermining investment and growth in the economy. At least 17 bond defaults have occurred this year, while investors have also become pickier. Since the start of April, 13 issuers rated AA or below and considered junk score in the nation, have called off bond sales, the most for any quarter in two years."

June 13 - Bloomberg (Christopher Balding): "You wouldn't know it from the government's optimistic pronouncements, but China's banks are still under significant stress. Although the latest plan to help them out won't solve any fundamental problems, it will buy time… By several measures, Chinese banks are strained. Their official loan-to-deposit ratio increased from 65.8% in June 2015 to 71.2% at the end of March. New deposits peaked in 2015 and have since failed to keep up with lending growth. Last year, new loans amounted to 100.1% of new deposits. Through the first five months of this year, they were running at 104%... Since 2015, the PBOC has boosted lending to banks by more than 300%, to $1.5 trillion. Beyond just providing liquidity, it's also pushing banks to change their lending patterns: In particular, by allowing short-term debt to expire and rolling it into loans of longer duration. Since January 2017, medium- and long-term loans have made up 85% of all new bank lending."

EM Watch:

June 10 - Financial Times (Jonathan Wheatley): "In the turmoil that has struck emerging market currencies over the past six weeks the headlines have been grabbed by the Turkish lira, the Argentine peso and, in the past week, the Brazilian real. But what of the Mexican peso, traditionally seen as a bellwether of sentiment towards emerging markets as a whole? It crashed to an all-time low against the US dollar after the election of Donald Trump to the US presidency in November 2016. After staging a comeback, it is heading back in that direction, shedding 12% of its dollar value since mid-April. Worse may lie ahead. Analysts say the Trump administration's renewed abrasive attitude to trade and a likely runaway victory in Mexico's July 1 election for the leftist Andrés Manuel López Obrador, known to all as Amlo, could send the peso into uncharted territory. 'Markets are too complacent,' said Win Thin, emerging market currency strategist at Brown Brothers Harriman. 'There could be a big overshoot if Amlo wins that would test the levels of January 2017.'"

June 14 - Financial Times (Adam Samson): "Recep Tayyip Erdogan has threatened to conduct an 'operation' against Moody's, less than two weeks after the ratings company placed Turkey on review for a downgrade, state-run media reported. The Turkish president was quoted by the Anadolu Agency as saying the operation would commence after elections scheduled for later this month… 'God willing, we will conduct an operation against Moody's after June 24. Moody's is making unnecessary statements despite the fact that we are not a member of it. What a shame,' AA quoted Mr Erdogan as saying. Mr Erdogan's comments came after Moody's on June 1 placed Turkey on review for a downgrade just months after it cut the country's rating."

June 12 - Financial Times (Henny Sender): "As real US interest rates and the dollar have risen, investors have been pulling money from emerging markets. There has been about $10bn of outflows from EM debt and shares over the past six weeks, according to analysts at Bank of America Merrill Lynch. Portfolio managers are detecting vulnerabilities in several Asian countries, including India and Indonesia. And despite investors feeling far more comfortable about China than they did at the start of 2016, the rebound in the dollar over the past six weeks has increased the scrutiny of the economy. For those starting to pay attention, the focus is on how much dollar-denominated debt corporate China has sold in recent years and, critically, how much of it will fall due next year and in 2020. Plenty of it comes from the country's property companies."

June 14 - Bloomberg (Andres R. Martinez): "Argentina's truck drivers began a one-day national strike, demanding wage increases to compensate for an unexpected surge in inflation and protesting President Mauricio Macri's economic policies. Workers want wage increases of 27%, as well as reductions in the price of fuel and other subsidized utilities. Workers began blocking streets in Buenos Aires early in the morning… The strike is a test for Macri as his government embarks on a series of unpopular measures amid a possible economic recession, an unexpected surge in inflation and a free-falling currency."

June 12 - Financial Times (Joe Leahy and Andres Schipani): "Brazil's central bank president Ilan Goldfajn is facing the test of his career as the country's currency has once more come under assault from foreign exchange traders. Mr Goldfajn… has warned speculators he has the firepower to see them off in the form of dollar swaps, in effect a bet against the dollar settled in the local currency, the real. During the last bout of volatility before he took over in 2016, the central bank issued $115bn of the instruments. This time, the central bank has sold only slightly more than one-third of this amount, leaving it with plenty of room for more, in addition to its $380bn in reserves. 'We can exceed the amount [of swaps] offered in the past,' Mr Goldfajn said… 'We will intensify their use in the near term.'"

June 14 - Reuters (Caroline Stauffer): "Consumer prices rose 2.1% in May in Argentina… That brought 12-month inflation to 26.3%, up from 25.5% in the 12 months through April. The central bank abandoned its 15% inflation goal for 2018 last week…"

June 10 - Reuters (Delphine Schrank): "Mexican presidential frontrunner Andres Manuel Lopez Obrador extended his lead to nearly 17 points over his nearest rival ahead of the July 1 vote… The polling reflects the unpopularity of the ruling Institutional Revolutionary Party (PRI) in the bloodiest presidential race of recent history. On Friday night, Fernando Puron, a congressional candidate for the PRI and a former mayor of Piedras Negras, Coahuila state, was shot in the back of the head as he was greeting supporters just after leaving a debate… Puron's death was the first for a candidate running at the federal level, bringing to 112 the number of candidates, politicians or office holders killed since nationwide campaigning began in September…"

June 10 - Reuters (Andreina Aponte): "Prices in Venezuela rose almost 24,600% in the 12 months ended May 31, the country's opposition-led National Assembly, whose numbers are broadly in line with those of independent economists, reported…"

Central Bank Watch:

June 14 - Bloomberg (Brian Swint, Piotr Skolimowski and Catherine Bosley): "Mario Draghi put the European Central Bank on the road to raising interest rates, though he may never get the chance to complete the journey himself. Sixteen months before his crisis-marked tenure at the central bank draws to a close, the president has shifted the ECB back toward the old norm of using borrowing costs as the main policy tool. For the past four years, bond-buying has been the flagship measure for reviving inflation and the economy after Draghi found that even negative rates couldn't do the job alone. The Governing Council used its June meeting to announce that asset purchases will phased out by the end of December… But it was a pledge to keep interest rates at current record lows 'at least through the summer of 2019' that caught investors by surprise…"

June 14 - Bloomberg (Piotr Skolimowski): "Mario Draghi said the euro-area economy is strong enough to overcome increased risk, justifying the European Central Bank's decision to halt bond purchases and end an extraordinary chapter in the decade-long struggle with financial crises and recession. Policy makers agreed to phase out the stimulus tool with 15 billion euros ($17.7bn) of purchases in each of the final three months of the year… The central bank also pledged to keep interest rates unchanged at current record lows at least through the summer of 2019."

Global Bubble Watch:

June 14 - Bloomberg (Suzanne Woolley): "The rich are getting a lot richer and doing so a lot faster. Personal wealth around the globe reached $201.9 trillion last year, a 12% gain from 2016 and the strongest annual pace in the past five years, Boston Consulting Group said… Booming equity markets swelled fortunes, and investors outside the U.S. got an exchange-rate bonus as most major currencies strengthened against the greenback. The growing ranks of millionaires and billionaires now hold almost half of global personal wealth, up from slightly less than 45% in 2012… In North America, which had $86.1 trillion of total wealth, 42% of investable capital is held by people with more than $5 million in assets. Investable assets include equities, investment funds, cash and bonds."

June 10 - Wall Street Journal (Richard Rubin): "Multinational companies shift about 40% of the profits they earn outside their home countries into tax havens, eluding tax-collection efforts, according to an analysis that points to persistent gaps in government revenue collection. U.S. companies are among the most aggressive users of profit-shifting techniques, which often relocate paper profits without bringing jobs and wages, according to the study by economists Thomas Torslov and Ludvig Wier of the University of Copenhagen and Gabriel Zucman of the University of California, Berkeley. Mr. Zucman said the research suggests the global trend toward lower corporate tax rates in major countries-including the recent U.S. reduction to 21% from 35%-won't by itself cause companies to alter their tax-avoidance moves. Companies can still lower their tax bills significantly by shifting profits to places with effective tax rates between zero and 10%."

June 11 - Bloomberg (Michael Heath and Garfield Reynolds): "Australia's east-coast property bubble is showing signs of deflating at a faster clip as home-lending data recorded the longest losing streak in almost a decade. Housing finance fell 1.4% in April, the fifth straight monthly drop and the longest stretch of declines since September 2008… The downturn is most prominent in Sydney where prices slid 4.2% in May from a year earlier, when they were rising at an annual pace of 17%. Sales at auctions -- a popular way of marketing houses Down Under - have slumped to the lowest since early 2016 in Australia's biggest city, with only around half of properties successfully selling."

Europe Watch:

June 13 - Financial Times (Kate Allen): "Bond investors demanded significantly higher returns from Italian debt at auctions on Wednesday, highlighting the lasting scar left by last month's market ructions. The country raised €2bn in three-year paper at a gross yield of 1.16%, some 1.09 percentage points higher than the last time Italy sold three-year paper. It also sold seven-, 28- and 30-year debt with higher yields across the board to issue a total of €5.6bn. According to Reuters these are the highest prices paid for fresh Italian debt since 2014."

Japan Watch:

June 14 - Bloomberg (Leika Kihara and Izumi Nakagawa): "Japan's 'Abenomics' stimulus program is sputtering just as the government and the central bank wanted to tap the brakes, heightening the chance they will be forced to fight the next economic downturn with a near-empty policy arsenal. Analysts say Japan will avoid a recession… and suggest the first-quarter slump was a soft patch caused by temporary factors like bad weather and weak stock markets. But there are signs growth is moderating after two years of expansion. Factory output slowed and inventory rose in April, a sign firms may have overestimated global demand."

Fixed Income Bubble Watch:

June 11 - Bloomberg (Christopher DeReza): "Sales of the riskiest subprime auto bonds are on pace for a record year, according to Barclays Plc. Companies have sold more than $150 million of B rated subprime auto ABS bonds this year, compared with nothing last year, and an annual average of about $20 million since the financial crisis, Barclays analyst Alin Florea wrote… Meanwhile, BB rated debt in the sector has already exceeded $500 million and looks set to pass last year's total of $950 million. 'Despite the volatility earlier in the year, 2018 is shaping up to be a banner year for subprime, auto ABS high yield issuance,' Florea wrote. Subprime auto ABS issuers have started to sell more BB- and B rated bonds to meet investor demand for riskier slices of the debt."

Leveraged Speculator Watch:

June 13 - Bloomberg (Elena Popina): "Signs of gathering economic strength are throwing the best thinking of short sellers out the window. A basket of 50 heavily shorted companies -- stocks that speculators bet will fall -- has jumped 16% since May 1, according to… Goldman Sachs… That's twice the return of a separate collection of companies favored by hedge-fund longs… While firms targeted by short sellers have often done well during the bull market, rarely has their performance been this dominating… Versus the hedge-fund VIP picks, the rally in the bear basket is currently two standard deviations wider than normal in the past 10 years."

Geopolitical Watch:

June 12 - Reuters (Mohammed Ghobari and Mohamed Mokhashef): "A Saudi-led alliance of Arab states launched an attack on Yemen's main port city on Wednesday in the largest battle of the Yemen war, aiming to bring the ruling Houthi movement to its knees at the risk of worsening the world's biggest humanitarian crisis. Arab warplanes and warships pounded Houthi fortifications to support ground operations by foreign and Yemeni troops massed south of the port of Hodeidah in operation 'Golden Victory'."

Friday Afternoon Links

[Reuters] Wall Street ends lower; trade war fears resurface

[BloombergQ] Argentine Peso Resumes Slide; Yield on Century Bonds Tops 9%

[CNBC] China announces retaliatory tariffs on $34 billion worth of US goods, including agriculture products

[NYT] Trade Skirmish or War? Who Gets Hurt?