Friday, September 28, 2018

Weekly Commentary: Portending an Interesting Q4

"Those who do not learn history are doomed to repeat it." I'll add that those that learn the wrong lessons from Bubbles are doomed to face greater future peril. The ten-year anniversary of the financial crisis has generated interesting discussion, interviews and scores of articles. I can't help but to see much of the analysis as completely missing the critical lessons that should have been garnered from such a harrowing experience. For many, a quite complex financial breakdown essentially boils down to a single flawed policy decision: a Lehman Brothers bailout would have averted - or at least significantly mitigated - crisis dynamics.

I was interested to listen Friday (Bloomberg TV interview) to former Treasury Secretary Hank Paulson's thoughts after a decade of contemplation.

Bloomberg's David Westin: "It's been ten years, as you know, since the great financial crisis that you stepped into. Tell us the main way in which the financial system is different today than what you faced when you came into the Treasury?"

Former Treasury Secretary Hank Paulson: "Well, it's very, very different today. So, let's talk about what I faced. What I faced was a situation where going back decades the government had really failed the American people, because the financial system had not kept pace with the modern financial markets. The protections that were put in place after the Great Depression to deal with panics were focused on banks - protecting depositors with deposit insurance. Meanwhile, the financial markets changed. And when I arrived (2006), half or more of the Credit was flowing outside of the banking system. And we didn't have the oversight we needed. We didn't have the regulatory authorities to deal with a run, and this was a situation where there was a great deal of leverage. There was a great deal of risk. Today, when you look at it, we see a situation where the banks are better capitalized. We have much better regulatory oversight. I think there are fewer gaps. I think we have a better set of authorities. There is less of what I would call 'dry tinder' - there's less excesses. So, I think there is less risk, although these things are unpredictable of having any kind of a major financial crisis, on the one hand. And there are some important new authorities. But some of the things we relied very heavily on have been taken away. So, I wish we had a few more protections."

"…The thing I would be most concerned about are some of the authorities we used to stop the panic. The Exchange Stabilization Fund at Treasury we used to guarantee the money markets. Remember there was a run on the three and one-half trillion money markets, and the money markets were funding short-term borrowings for many of the biggest companies in the world. So when the money markets began to implode, the commercial paper market dried up. If these big companies started cutting back on their funding, this would have moved very quickly to their suppliers, to smaller industrial companies. It could have been disastrous. We stepped in and we used the Exchange Stabilization Fund to guarantee the money markets. We no longer have that authority."

Mr. Paulson is surely accurate in stating the government "really failed the American people," though I doubt future historians will see this failure having concluded with the 2008 crisis. Finance had fundamentally changed, and the regulatory framework failed to adapt. As Paulson said, Credit expansion (and finance more generally) had moved outside of traditional bank lending, but Washington had not constructed adequate safeguards and resolution mechanisms in the event of a panic.

While not inaccurate, this line of analysis misses the greater point - the critical lesson that went unheeded: It was "activist" government policy-making over an extended period that played a decisive role in the rapid expansion of non-traditional finance. Federal Reserve policymaking evolved to aggressively incentivize risk-taking and leveraged speculation. The government-sponsored enterprises (GSE) evolved from guarantors of mortgages to massive quasi-central banks, with unlimited access to cheap money market finance supporting enormous balance sheets and market backstop operations. Between the Fed and GSEs, unprecedented Washington "activism" created a backdrop conducive to a "wild west" derivatives marketplace ballooning to the hundreds of Trillions.

It is true that "we didn't have the oversight we needed." But the much greater issue was that Washington had become actively involved in promoting cheap Credit, abundant liquidity, and inflated securities and asset markets. Washington partnered with Wall Street to fundamentally and momentously change system-wide risk intermediation and resource allocation.

What's missing in the 10-year crisis anniversary dialogue is a more comprehensive discussion of several decades of serial booms and busts, including the factors behind the 1987 stock market crash; the late-eighties boom and bust; the S&L crisis; the 1994 bond market rout; the 1995 Mexico collapse; the 1997 "Asian Tiger" collapse; the 1998 implosion of Russia and Long-Term Capital Management; the 2000 collapse of the "tech" Bubble; the 2001 crisis in Brazil; the 2002 U.S. corporate debt crisis; the 2002 collapse of the Argentine peso and so on.

I have for a long time now argued that "unfettered" contemporary finance is dangerously unstable. I believe it has become only more unsound - and perilous - over time. Here in the U.S., it was easy to disregard the spectacular boom and bust dynamics that were wreaking havoc throughout numerous overseas economies (heck, they worked to keep U.S. rates and market yields low!). "The Maestro" and his monetary magic had everything under control. Things, however, finally came home to roost in 2008. The mighty U.S. was not immune after all. Indeed, years of government interventions, manipulations and market backstops ensured the accumulation of excesses and structural maladjustment to the point of risking financial collapse.

To focus on Lehman as the critical factor in the crisis is to disregard the true culprit, the intoxicating amalgamation of contemporary finance and "activist" government monetary management. As always, Credit is self-reinforcing. I (among others) have argued that Credit is inherently unstable, with today's unconstrained contemporary Credit remarkably unstable. Asset inflation is the most dangerous form of inflation, as "Wall Street" market-based finance and modern central banking doctrine specifically champion rising securities and asset prices. What is more, government and central bank promotion of asset inflation guaranteed that leveraged speculation evolved into a dominant force throughout global finance.

For more than nine years, I've argued that responses (U.S. and international) to the 2008 crisis unleashed the "global government finance Bubble." I believe speculative leverage is a greater global issue today than even in 2008. This leveraging has become integral to global liquidity, liquidity that fueled precarious booms in China, throughout the emerging markets and even in Europe. Furthermore, this global liquidity has over the past decade been "recycled" into Bubble U.S. securities markets, illustrated by the massive (Fed's Z.1) "Rest of World" flows into U.S. financial assets.

The "global savings glut" thesis was popular back during the mortgage finance Bubble period. We were to believe a persistent surplus of "savings" over "investment" explained low market yields and overly abundant marketplace liquidity. Yet "savings" is not going to suddenly disappear. Liquidity created in the process of expanding speculative leverage, on the other hand, can evaporate almost instantly in the event of an acute bout of de-risking/deleveraging. And if this liquidity had evolved into a prevailing source of finance for the asset markets and real economy, an abrupt change in market perceptions will have profound ramifications for both financial and economic stability. Most critically, the longer speculation-related liquidity has fueled the markets and economy, the deeper the structural impact and the greater the subsequent dislocation when this liquidity source is interrupted.

It was imperative for policymakers to make fundamental post-crisis changes to their approach with incentive structures, incentives that had fomented progressively more systemic financial and economic Bubbles. That was the key lesson from the crisis - one that went unheeded. Policymakers instead moved aggressively in the opposite direction: Their market interventions and manipulations became only more extreme. The upshot has been historic Bubbles around the globe, stocks and bonds and across asset markets more generally.

The issue in 2008 was not Lehman as much as it was tens of Trillions of leveraged securities holdings and derivatives whose value had been inflated by a confluence of speculation, leverage, liquidity overabundance and market misperceptions. This self-reinforcing liquidity backdrop had not only inflated the value of mortgage-related securities, it had inflated the value of the underlying collateral (home prices). This liquidity was also being recycled through the securities markets more generally, in particular inflating the prices of U.S. equities and corporate Credit.

This powerful dynamic of liquidity excess and rising asset prices propelled an unprecedented degree of sophisticated risk intermediation and derivatives trading that worked to distort, disguise and inflate various risks. Market risk perceptions became utterly distorted. These factors fundamentally loosened mortgage Credit and system Credit Availability more generally. The resulting massive expansion of mortgage Credit, ultra-easy financial conditions and resulting asset inflation (inflated perceived wealth) stoked both spending and investment.

Importantly, the critical factors fomenting the mortgage finance Bubble were all made more powerful by post-crisis policy responses: The amount and impact of leveraged speculation and resulting liquidity excess; endemic asset inflation; derivatives-related masking and distorting of risk; deep-seated distortions to both the financial and economic structure. Similar dynamics to those that fueled previous U.S. market and economic Bubbles now encompass the world.

Bubble markets remained largely oblivious to risk heading right into the 2008 crisis. There was no appreciation for how vulnerable the liquidity backdrop had become to abrupt change. After all, the GSEs and Fed had for years cultivated the perception of impenetrable market liquidity backstops. And this misperception incentivized risk-taking - aggressive speculation, leveraging, risk intermediation and derivative strategies - that basically ensured acute vulnerability to a bout of de-risking/deleveraging. Sure, Lehman could have been bailed out. But that would have only ensured an even more extended period of ("terminal") excess and a more perilous crisis.

I appreciate Hank Paulson's focus on the critical role played by non-bank Credit in the crisis. But when discussing how the system has become sounder post-crisis, he falls back on the standard "the banks are better capitalized." We are to have faith that system stability has benefitted from better oversight and regulation - that policymakers learned from history.

Market were blindsided in 2008. There was a complete lack of appreciation for how distortions at the "periphery" - in particular Trillions of risky mortgage loans, securities, derivatives and speculative leverage - had late in the cycle come to provide the marginal source of finance fueling increasingly maladjusted financial and economic structures. There was no understanding of how unstable finance had nurtured acute fragility - no appreciation for how the inevitable eruption of risk aversion at the "periphery" would over time imperil stability at the "core."

There are today ominous parallels. In 2007 and well into 2008, it was "subprime doesn't matter." Today, "EM doesn't matter. China doesn't matter. Tariffs don't matter. Debt doesn't matter." Corporate earnings, tax cuts, deregulation and technological prowess ensure the robust U.S. economy will remain immune to global financial and economic issues. The powerful "core" is invulnerable to a weak "periphery," much as the highly liquid and resilient market in "AAA" was (right into the fall of 2008) perceived unaffected by faltering lower-tier securities. There is the current misperception that global "whatever it takes" ensures liquid and robust securities markets.

I have posited that the global Bubble has been pierced at the "periphery." Global financial conditions have tightened, although there is the typical ebb and flow between risk aversion and risk embracement (fear and greed). It's my view that unprecedented speculative leverage has accumulated throughout global markets and that the destabilizing process of "de-risking/deleveraging" has commenced in the emerging markets. The first phase of this process has seen faltering liquidity at the "periphery" spur additional speculative flows to the "core." Increasingly, however, I would expect global de-leveraging to have negative ramifications for risk-taking and liquidity more generally.

It's worth noting Friday's 26 bps surge in Italian 10-year yields. Italy's yields were up as much as 35 bps intraday (to a four-year high 3.26%) before settling somewhat lower. Italian bank stocks sank 3.7% in Friday trading, this after Italy's populist government appeared to agree on a 2019 budget deficit of 2.4% (above the anticipated 2.0% ceiling). Why such a forceful reaction (considering U.S. deficits will likely soon approach 5% of GDP)?

I'm thinking back to when subprime issues began afflicting the "Alt A" (less than prime) mortgage market. Current market focus has turned to Italy - a heavily indebted sovereign borrower increasingly vulnerable to a tightening of global financial conditions; a prime beneficiary of loose finance on the upside, now at risk as a marginal borrower in a shifting liquidity backdrop. From my analytical perspective, Italy is a key player as we monitor for crisis dynamics gravitating from the "Periphery" to the "Periphery of the Core."

The ECB's "whatever it takes" policy approach has incentivized leveraged speculation, especially at the Eurozone's relatively higher-yielding periphery. A Friday Bloomberg headline: "Sovereign-Bank 'Doom Loop' Haunts Rattled Italian Markets." Italy's banks are not alone in holding leveraged bets on Italian debt. It's been too easy for the leveraged speculating community to borrow at negative rates (i.e. short German two-year debt at negative 54 bps) and profit from the spread. Italian debt has surely been one of the most popular "carry trade" speculations in the world, perhaps also financed with interest-free borrowings from Japan. Meanwhile, funds have likely flowed into Italian debt from Japan, with savers and institutions alike reaching for yields. And, now remembering back 20 years, leveraged derivatives bets on Italian debt played a role in the 1998 (Russia/LTCM) crisis.

If, as I suspect, the global risk-taking and liquidity backdrop is changing, "marginal" borrowers such as Italy will be viewed in different light. Yields are rising, which means the value of EM and Italian debt is declining. When these securities offered rising prices and stable spreads, risk embracement saw self-reinforcing speculative leveraging and attendant liquidity abundance. And as wonderful and enduring as this dynamic appears on the upside, speculative leverage is inevitably problematic on the downside. Lower bond prices (higher yields) force a reduction in leverage, which can lead to a self-reinforcing "Risk Off" contraction of marketplace liquidity.

Interestingly, the euro declined 1.2% this week, with the Swiss franc down a notable 2.3%. Key Eastern European currencies (Czech koruna, Bulgarian lev, Romanian leu and Hungarian forint) fell between 1% and 2%. The week provided a reminder of how Italian debt worries can spark worry for Italian banks, European banking, the euro and Eastern European economies.

Worries about Europe spur the U.S. dollar, with a stronger American currency reminding the world of festering EM issues. The Argentine peso sank 9.9% this week. For the most part, however, global markets ended the third quarter with a semblance of stability.

A bloody Friday in Italian debt certainly wasn't going to tarnish a big quarter for U.S. equities. The S&P500 returned 7.7% for the quarter, lagging the Nasdaq100's 8.6%. The Nasdaq Telecom index jumped 11.7%, and the Biotechs (BTK) surged 13.2%. The NYSE Healthcare Index gained 12.7%. The Dow Transports rose 10.0%, with the DJIA up 9.0%.

It may have been subtle, but there was some quarter-end market action that might just portend an interesting Q4. There was the 32 bps one-week surge in Italian yields, along with the 8.3% drop in Italian bank stocks. The European (STOXX600) Bank index was down 3.0% in the final week of the quarter, with Japan's TOPIX Bank Index dropping 2.0%. Curiously, especially with Treasury yields trading at highs for the quarter, U.S. Bank stocks (BKX) sank 4.7% this week. The Broker/Dealers were down 3.1%. There was, as well, the return of concern for tightening global dollar funding markets. The fourth quarter starts Monday, with various indicators pointing toward an important tightening of financial conditions.

As I chronicle history's greatest financial Bubble, I'll take note of this week's developments in the Judge Kavanaugh Supreme Court confirmation hearings. Thursday's hearings were nothing short of incredible - incredibly dramatic, emotional, tragic and disturbing. Our country is being torn apart - and the tearing has turned more unambiguous and heinous. Ramifications for what is unfolding in society, politics and geopolitics are as profound as they are far-reaching. But with stocks right at all-time highs, what's to fret about…

It was a week that pitted Democrats and Republicans in Washington, with vitriol and differences that appear more irreconcilable than ever before. There was also President Trump speaking at the United Nations, with world representatives either laughing "with" or "at" the leader of the free world. And it's this confluence of division, contempt and hostility in the face of an increasingly fragile global Bubble that has me deeply concerned. A global crisis in the current backdrop would make 2008 seem like a walk in the park.

I'll conclude with an astute observation from Bloomberg's David Westin:

Westin: "You lost some of the legal provisions that you described. What about political? Because one of the things you had going for you - and I know it was difficult and was not all in a straight line - but through that crisis you got Congress, you had a President, even with low approval ratings, to really back you. Do we still have that same political capital - or political competence - given what happened last time?"

Paulson: "That's really a key question…"

For the Week:

The S&P500 slipped 0.5% (up 9.0% y-t-d), and the Dow declined 1.1% (up 7.0%). The Utilities fell 0.8% (down 0.4%). The Banks sank 4.7% (down 1.7%), and the Broker/Dealers fell 3.1% (up 0.2%). The Transports declined 1.3% (up 7.2%). The S&P 400 Midcaps fell 1.1% (up 6.3%), and the small cap Russell 2000 lost 0.9% (up 10.5%). The Nasdaq100 advanced 1.3% (up 19.2%). The Semiconductors declined 1.2% (up 9.1%). The Biotechs surged another 3.4% (up 27.4%). With bullion down $7, the HUI gold index fell 1.3% (down 26.6%).

Three-month Treasury bill rates ended the week at 2.15%. Two-year government yields added two bps to 2.82% (up 94bps y-t-d). Five-year T-note yields were little changed at 2.95% (up 75bps). Ten-year Treasury yields were unchanged at 3.06% (up 66bps). Long bond yields added a basis point to 3.21% (up 47bps). Benchmark Fannie Mae MBS yields slipped a basis point to 3.81% (up 82bps).

Greek 10-year yields jumped 10 bps to 4.15% (up 8bps y-t-d). Ten-year Portuguese yields added a basis point to 1.88% (down 7bps). Italian 10-year yields surged 32 bps to 3.15% (up 113bps). Spain's 10-year yields were unchanged at 1.50% (down 7bps). German bund yields gained one basis point to 0.47% (up 7bps). French yields gained three bps to 0.80% (up 2bps). The French to German 10-year bond spread widened about two to 33 bps. U.K. 10-year gilt yields increased two bps to 1.57% (up 38bps). U.K.'s FTSE equities index increased 0.3% (down 2.3%).

Japan's Nikkei 225 equities index rose 1.0% (up 6.0% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.13% (up 8bps). France's CAC40 was little changed (up 3.4%). The German DAX equities index fell 1.5% (down 5.2%). Spain's IBEX 35 equities index dropped 2.1% (down 6.5%). Italy's FTSE MIB index sank 3.8% (down 5.2%). EM equities were mixed. Brazil's Bovespa index was little changed (up 3.8%), while Mexico's Bolsa increased 0.3% (up 0.3%). South Korea's Kospi index gained 0.2% (down 5.0%). India's Sensex equities index dropped 1.7% (up 6.4%). China's Shanghai Exchange rose 0.9% (down 14.7%). Turkey's Borsa Istanbul National 100 index jumped 2.0% (down 13.3%). Russia's MICEX equities index rose 2.0% (up 17.3%).

Investment-grade bond funds saw inflows of $1.781 billion, while junk bond funds had outflows of $1.569 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose seven bps to 4.72% (up 73bps y-o-y). Fifteen-year rates gained five bps to 4.16% (up 72bps). Five-year hybrid ARM rates increased five bps to 3.97% (up 50bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.81% (up 66bps).

Federal Reserve Credit last week declined $11.9bn to $4.161 TN. Over the past year, Fed Credit contracted $262bn, or 5.9%. Fed Credit inflated $1.351 TN, or 48%, over the past 308 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $12.5bn last week to $3.439 TN. "Custody holdings" were up $67bn y-o-y, or 2.0%.

M2 (narrow) "money" supply rose $18bn last week to $14.248 TN. "Narrow money" gained $554bn, or 4.0%, over the past year. For the week, Currency increased $2.3bn. Total Checkable Deposits dropped $44.8bn, while Savings Deposits rose $53bn. Small Time Deposits gained $3.7bn. Retail Money Funds added $3.0bn.

Total money market fund assets gained $18bn to $2.883 TN. Money Funds gained $143bn y-o-y, or 5.2%.

Total Commercial Paper rose $7.9bn to $1.082 TN. CP gained $23bn y-o-y, or 2.2%.

Currency Watch:

The U.S. dollar index rallied 1.0% to 95.132 (up 3.3% y-t-d). For the week on the upside, the South African rand increased 1.3%, the Mexican peso 0.6%, the South Korean won 0.6%, and the Canadian dollar 0.1%. For the week on the downside, the Swiss franc declined 2.3%, the euro 1.2%, the Swedish krona 1.1%, the New Zealand dollar 1.0%, the Japanese yen 1.0%, the Australian dollar 0.9%, the British pound 0.3% and the Singapore dollar 0.2%. The Chinese renminbi declined 0.17% versus the dollar this week (down 5.27% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index jumped 2.6% (up 9.9% y-t-d). Spot Gold slipped 0.5% to $1,193 (down 8.5%). Silver rallied 2.5% to $14.712 (down 14.2%). Crude surged another $2.47 to $73.25 (up 21%). Gasoline jumped 3.4% (up 16%), and Natural Gas gained 1.0% (up 2%). Copper fell 1.8% (down 15%). Wheat dropped 2.4% (up 19%). Corn slipped 0.3% (up 2%).

Trump Administration Watch:

September 23 - CNBC (Javier E. David): "With the world's two largest economies opening a new front in their multibillion dollar bilateral trade dispute, the risk has risen sharply that the U.S. will eventually slap tariffs on all imports from China, Goldman Sachs said… President Donald Trump ordered a new raft of surcharges on around $200 billion worth of Chinese goods last week, with China retaliating with $60 billion in U.S. goods. Last year, the world's largest economy absorbed more than $500 billion worth of goods from China… 'Following President Trump's threat of further escalation, we now think the probability that all imports from China will ultimately be subject to tariffs has risen to 60%,' the bank's analysts wrote…"

September 24 - Bloomberg (Joanna Ossinger): "JPMorgan… strategists are starting to make forecast and strategy changes around the potential that President Donald Trump gets so overconfident in the robust economy and markets that he makes a 'major miscalculation.' The worry is that 'U.S. economic and equity market resilience despite tariffs will embolden the President on all geopolitical fronts -- autos, Nafta and particularly Iran -- and thus risk a major miscalculation from sanctions that are tough to calibrate,' strategists led by John Normand wrote…"

September 23 - New York Times (Cecilia Kang): "President Trump says his trade war with China will protect America's dominance and derail Beijing's plan for technological and economic supremacy. But as the fight kicks into high gear this week, American tech and telecom companies are warning that the industry's growing reliance on products made and assembled in China means they are more likely to be casualties, not victors, in the skirmish. Mr. Trump's next round of tariffs on $200 billion worth of Chinese goods goes into effect on Monday, hitting thousands of consumer products from handbags to refrigerators to bicycles. The tariffs will also hit the tech and telecom companies that provide much of the gear that powers the internet, mobile networks, data storage and other technology. United States customs will begin collecting a tax on circuit boards, semiconductors, cell tower radios, modems and other products made and assembled in China and exported into America. Those tariffs, Intel warned in a letter last month, are 'a game changer for the American consumer.'"

September 25 - Wall Street Journal (Vivian Salama): "President Trump criticized international organizations and alliances as unaccountable and defended his administration's hard-line trade policies, urging fellow world leaders… to chart their own paths toward sovereignty. Mr. Trump, speaking to the United Nations General Assembly, offered a more subdued, but equally defiant performance to his first U.N. address last year, saying that he won't entertain trade deals that aren't fair and reciprocal, and don't stand to benefit the American people. 'We will not allow our workers to be victimized, our companies to be cheated and our wealth to be plundered and transferred,' he said. 'America will never apologize for protecting our citizens.'"

September 25 - Reuters (David Lawder): "U.S. President Donald Trump's top trade official said… that changing China's economic policies to become more market-oriented 'is not going to be easy' even with tariffs now in place on $250 billion worth of Chinese goods. U.S. Trade Representative Robert Lighthizer, in rare public remarks at the Concordia Summit, said 'endless dialogues' with the Chinese government over decades had 'failed miserably' in changing Beijing's policies, so the Trump administration decided to try direct pressure with tariffs… Lighthizer repeated his views that China's intellectual property practices and non-market industrial subsidies that have resulted in excess production capacity would put the future of the U.S. economy and its high-technology industries at risk. 'We changed the paradigm, we have tariffs in place, and the president is not going let this go long, where you take intellectual property where you have a forced transfer of intellectual property, where you treat American companies and farmers and ranchers poorly,' he added."

September 24 - CNBC (Kate Rooney): "Establishing a new trade deal with China could be significantly tougher than it was with Mexico, according to one of President Trump's top advisors. 'The challenge is, they've engaged in so many egregious practices that it's far more difficult to make a deal with China than it would be with Mexico,' Peter Navarro, director of the National Trade Council at the White House, said… The former economics professor and author of 'The Coming China Wars,' has been notoriously hawkish on trade. Navarro said the goal now is structural realignment where all countries the U.S. trades with engage in 'free, fair, and reciprocal' agreements."

September 26 - Reuters (Yara Bayoumy and Michelle Nichols): "U.S. President Donald Trump… accused China of seeking to meddle in the Nov. 6 U.S. congressional elections, saying Beijing did not want his Republican Party to do well because of his pugnacious stance on trade. 'China has been attempting to interfere in our upcoming 2018 election, coming up in November. Against my administration,' Trump told a U.N. Security Council meeting…"

September 22 - Reuters (Christopher Bing): "The White House has drafted an executive order that would push federal antitrust and law enforcement agencies to probe the business practices of social media and other internet companies, according to Bloomberg. It is unclear whether the order will be signed by President Donald Trump. The order has yet to be reviewed by other government agencies and remains in its preliminary stages…"

September 26 - Bloomberg (Jenny Leonard, Jennifer Jacobs and Jennifer Epstein): "President Donald Trump announced he has reached an agreement with Japanese Prime Minister Shinzo Abe to open trade talks between the two nations. Trump said he expected the talks will come to a 'satisfactory conclusion' as he spoke to reporters… 'It can only be better for the United States, because it couldn't get any worse than what has happened over the years' Trump added… The U.S. and Japan want to address bilateral trade in goods during the first phase of the talks over the next few months, U.S. Trade Representative Robert Lighthizer said…"

Federal Reserve Watch:

September 26 - Bloomberg (Christopher Condon and Craig Torres): "Federal Reserve officials raised interest rates and cemented expectations for another hike this year as they reaffirmed that a strong U.S. economy will probably warrant further gradual increases well into 2019. The quarter-point hike boosted the benchmark federal funds rate to a target range of 2% to 2.25%. The move reflected an upbeat assessment of the economy that was identical to the central bank's last policy statement eight weeks ago… 'This gradual return to normal is helping to sustain this strong economy,' Chairman Jerome Powell told reporters Wednesday following a two-day meeting of the Federal Open market Committee…"

September 26 - Bloomberg (Craig Torres and Jeanna Smialek): "The White House's latest pick for the Federal Reserve Board was deliberately chosen for her financial stability expertise and knowledge of the Fed system to round out a board of monetary policy experts and Wall-Street savvy lawyers. President Donald Trump plans to nominate Nellie Liang, a Ph.D. economist who ran the Fed's financial stability unit until her retirement last year. It's a timely choice as some credit markets are showing signs of aggressive risk-taking. Liang's long study of that topic was a key factor in the winning the nod… The news of her intended nomination broke Sept. 20. Financial conditions are heating up with some credit markets showing signs of overheating. The Fed's gradual pace of interest rate increases, combined with low interest rates globally, has supported a reach for yield that has weakened standards among some lenders."

September 25 - New York Times (Binyamin Appelbaum): "One of the most perplexing questions about the nation's economic recovery is why a tight labor market has not translated into faster wage growth. Part of the answer appears to be that American workers are receiving a growing share of compensation in the form of benefits rather than wages. The average worker received 32% of total compensation in benefits including bonuses, paid leave and company contributions to insurance and retirement plans in the second quarter of 2018. That was up from 27% in 2000… The rising cost of health insurance accounts for only about one-third of the trend. And the data do not include the increased prevalence of non-monetary benefits like flexible hours or working from home, or perks like gyms and 'summer Fridays.'"

U.S. Bubble Watch:

September 25 - New York Times (Nelson D. Schwartz): "The federal government could soon pay more in interest on its debt than it spends on the military, Medicaid or children's programs. The run-up in borrowing costs is a one-two punch brought on by the need to finance a fast-growing budget deficit, worsened by tax cuts and steadily rising interest rates that will make the debt more expensive. With less money coming in and more going toward interest, political leaders will find it harder to address pressing needs like fixing crumbling roads and bridges or to make emergency moves like pulling the economy out of future recessions. Within a decade, more than $900 billion in interest payments will be due annually… Already the fastest-growing major government expense, the cost of interest is on track to hit $390 billion next year, nearly 50% more than in 2017, according to the Congressional Budget Office."

September 25 - Reuters (Lucia Mutikani): "U.S. consumer confidence surged to an 18-year high in September as households grew more upbeat about the labor market, pointing to sustained strength in the economy despite an increasingly bitter trade dispute between the United States and China… The Conference Board said its consumer confidence index increased to a reading of 138.4 this month from an upwardly revised 134.7 in August. That was the best reading since September 2000 and the index is not too far from an all-time high of 144.7 reached that year."

September 23 - Financial Times (John Authers and Brooke Fox): "Ten years on from the collapse of Lehman Brothers, are we any safer? The answer, at best, is only a qualified 'yes'. Excessive leverage in the banking systems of the US and the eurozone drove that crisis. Those risks have reduced, although Europe's banks, which entered the financial crisis in much worse shape, face serious problems and remain vulnerable to political shocks. But the risk did not go away. It moved. Pension funds have taken on many of the risks that were once held by banks. Low bond yields, which make it more expensive to guarantee an income, have forced them to take extra risks. They now hold assets, such as hedge fund and private equity investments, with much concealed leverage. And many companies have transferred the risk of bad investment performance from their shareholders to savers - and savers are not usually well-equipped to deal with them. The result: the risk of a sudden banking collapse, which almost happened 10 years ago, has reduced. But the risk of social crisis, as people enter retirement without enough money, is rising."

September 27 - Reuters (Lucia Mutikani): "New orders for key U.S.-made capital goods fell in August after four straight months of strong gains and the goods trade deficit widened sharply, prompting some economists to significantly lower their economic growth estimates for the third quarter… The goods trade deficit rose $3.8 billion to $75.8 billion in August. Exports of goods fell 1.6% to $137.9 billion, weighed down by a 9.5% plunge in shipments of food, feeds and beverages."

September 25 - CNBC (Olick): "Home prices are still rising, but the pace of the gains continues to slow, as potential homebuyers hit an affordability wall and sellers cave to the new reality. Home prices rose 6% annually in July, down from the 6.2% gain in June, according to the S&P Corelogic Case-Shiller national index. The 20-city index rose 5.9% annually, down from 6.4% in June. The 10-city index rose 5.5% annually, down from 6.0% the previous month. 'Rising homes prices are beginning to catch up with housing,' says David M. Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices."

September 26 - CNBC (Diana Olick): "Buying a home is getting more and more expensive, thanks to sharp increases in both prices and mortgage rates. That is juicing demand for apartment rentals and, in turn, pushing rents higher. Rents in the third quarter of this year were up 2.9% compared with a year ago, according to RealPage, a real estate analytics firm. That's up from 2.5% annual growth in the second quarter."

September 26 - Reuters (Lucia Mutikani): "Sales of new U.S. single-family homes rebounded in August after two straight monthly declines, but the underlying trend still pointed to a weakening housing market against the backdrop of rising mortgage rates and higher home prices. …New home sales rebounded 3.5% to a seasonally adjusted annual rate of 629,000 units last month. July's sales pace was revised down to 608,000 units from the previously reported 627,000 units."

September 27 - Reuters (Nick Carey): "U.S. auto sales in September likely fell 6% from the same month last year as dealerships felt the mixed impact of hurricanes both this year and in 2017, industry consultants J.D. Power and LMC Automotive said…"

September 23 - Wall Street Journal (Michael Rapoport and Theo Francis): "Last December's tax overhaul is boosting corporate profits in more ways than one. The legislation lowered companies' tax bills, improving their earnings. But the change has also helped them fund record stock buybacks-a move that makes their results appear even better, by boosting the per-share earnings they highlight for investors. S&P 500 companies bought back a record $189 billion of their own shares in the first quarter, and a similar number-if not more-is expected for the second quarter, according to S&P Dow Jones Indices. By contrast, S&P 500 buybacks totaled no more than $137 billion in any of the six quarters before the tax overhaul."

September 26 - CNBC (Jeff Cox): "After consecutive quarters of near-record profit growth, companies are starting to lower expectations. With third-quarter earnings right around the corner, S&P 500 companies are cutting their outlooks at levels not seen since the first quarter of 2016, when corporate America was in a profits recession. In all, 98 companies have offered guidance - 74 have provided a negative outlook, meaning they expect earnings to come in below Wall Street estimates, while just 24 have been positive, according to FactSet."

September 21 - Wall Street Journal (Leslie Scism and Erin Ailworth): "After a week of heavy rains and record flooding, initial estimates for the damage that Florence wrought on the Carolinas rank the storm among history's top hurricanes… Moody's Analytics… estimated the economic cost of Florence to be between $38 billion and $50 billion including damage to property, vehicle losses, and lost output. At the upper end of that range, Florence would rank seventh among the biggest storms, just after Hurricane Andrew in 1992…"

China Watch:

September 24 - Reuters (Yawen Chen and Ben Blanchard): "A senior Chinese official said… it is difficult to proceed with trade talks with the United States while Washington is putting 'a knife to China's neck', a day after both sides heaped fresh tariffs on each other's goods. When the talks can restart would depend on the 'will' of the United States, Vice Commerce Minister Wang Shouwen said… 'Now that the United States has adopted such a huge trade restriction measure ... how can the negotiations proceed? It's not an equal negotiation,' Wang said, stressing the United States has abandoned its mutual understanding with China."

September 23 - Bloomberg: "Producers in China are already under stress even ahead of implementation of U.S. tariffs, as indicated by an explosion in corporate borrowing that isn't being captured by official government statistics, according to the China Beige Book. 'Manufacturing is under fire. The sector's multi-year rally has given way to declining revenue and sharply declining profit growth,' CBB International said in a report. 'Critically, manufacturing's plight is occurring before any meaningful American tariffs have been imposed. Absent a fall trade deal, this situation will likely deteriorate. The pace of borrowing -- at 41% of firms, the highest since 2012 -- sure smells a lot like panic."

September 24 - Bloomberg: "Surging interbank rates. A shock jump in the currency. Hong Kong's decade-long liquidity party suddenly appears to be ending, and that can only be bad news for its expensive property market. The one-month rate known as Hibor rose 28 bps on Monday, the most since December 2008. That followed the biggest jump in the Hong Kong dollar in 15 years at the end of last week. The chance of local banks raising the so-called prime rate, which caps the cost of some mortgages, is 'extremely high,' Financial Secretary Paul Chan said. That hasn't happened since 2006. A currency peg with the U.S., open financial borders and a booming economy meant Hong Kong property was one of the greatest beneficiaries of ultra-low lending costs in the wake of the global financial crisis. Home prices rose more than 170% in the past decade making the city the world's least affordable."

September 24 - Bloomberg: "China's debt-laden developers face a potentially devastating blow to their biggest source of financing, as authorities consider putting an end to the practice of selling apartments before they are finished. Guangdong's provincial housing authority is considering scrapping so-called pre-sales… The system allows developers to receive the entire sale proceeds upfront before construction has finished, which they then use to finance further land purchases and developments. The overhaul would threaten to remove the biggest funding channel for developers, after authorities tightened other financing options from bond sales to borrowing from shadow banks. Such a move would place further strain on the sector, which is facing a record $23 billion maturity wall in the first quarter of 2019."

September 26 - Financial Times (Gabriel Wildau and Edward White): "China's household debt reached a record high last year, adding to worries the burden of debt services could weigh on long-term consumer spending and drag on growth in the world's second-largest economy. The country's ratio of household debt to gross domestic product hit an all-time high of 49.1% in 2017, marking an increase of nearly 20 percentage points over the past five years, German insurer Allianz said in its latest global wealth report. 'This amounts to an increase of 30 percentage points in just 10 years - no other country saw its private debt burden rising so fast,' Allianz said, with the caveat that 'China needed to catch up to some extent, as Chinese private households only obtained access to bank loans in 2003'."

September 23 - Financial Times (Gabriel Wildau and Yizhen Jia): "Chinese local governments are flooding the debt market with a new type of bond, lining up $200bn in issuance designed to fund infrastructure investment as Beijing seeks to stimulate a slowing economy. China's parliament in March approved a quota of Rmb1.35tn ($197bn) for issuance of 'special-purpose' bonds for 2018, more than the combined quotas for the previous two years. But until recently, actual issuance was sluggish as local governments were under pressure to cut borrowing. As part of a slate of economic stimulus measures announced in late July, China's cabinet instructed local governments to accelerate issuance of such securities…"

September 26 - Wall Street Journal (Lingling Wei and Bob Davis): "DuPont Co. suspected its onetime partner in China was getting hold of its prized chemical technology, and spent more than a year fighting in arbitration trying to make it stop. Then, 20 investigators from China's antitrust authority showed up. For four days this past December, they fanned out through DuPont's Shanghai offices, demanding passwords to the company's world-wide research network… Investigators printed documents, seized computers and intimidated employees, accompanying some to the bathroom. Beijing leans on an array of levers to pry technology from American companies-sometimes coercively so, say businesses and the U.S. government. Interviews with dozens of corporate and government officials on both sides of the Pacific, and a review of regulatory and other documents, reveal how systemic and methodical Beijing's extraction of technology has become-and how unfair Chinese officials consider the complaints."

EM Watch:

September 24 - Bloomberg (Klaus Wille): "Asian family offices' love of emerging markets may prove painful in 2018. Family offices in the region have the highest allocation globally to equities in developing markets, according to the 2018 Global Family Office Report published… by UBS Group AG and Campden Wealth… 'Family offices are favoring higher risk, more illiquid investments in the pursuit of alpha,' the report said. 'And with developing-market equities grabbing an average return of 38% and developed-market equities 23%, this asset class deserves the spotlight.'"

Central Bank Watch:

September 26 - Reuters (Swati Pandey and Vatsal Srivastava): "China, Taiwan and New Zealand sat tight after the Federal Reserve's latest rate hike, but Indonesia and the Philippines pulled the trigger on Thursday to prop up their battered currencies and temper risks to inflation and financial stability."

September 24 - Wall Street Journal (Tom Fairless): "European Central Bank President Mario Draghi said the bank would push ahead with plans to phase out easy money as wages and inflation pick up across the Eurozone… Speaking at the European Parliament…, Mr. Draghi delivered an upbeat assessment of the region's economy and confirmed a plan, announced in June, to end the ECB's €2.5 trillion ($2.94 trillion) bond-buying program in December. 'Households' disposable income in the euro area is currently growing at the highest rates observed in the last 10 years,' Mr. Draghi said."

September 23 - Reuters (Michael Shields): "The European Central Bank should speed up its exit from 'crisis-mode' monetary policy, ECB policymaker Ewald Nowotny said…, reiterating his hawkish line about the timing of potential rate hikes. The ECB is due to end its money-printing program at the end of this year after pumping 2.6 trillion euros ($3.05 trillion) into the bond market and has hinted at a rate hike late next year if euro zone inflation accelerates gently. Nowotny, governor of Austria's central bank, questioned the wisdom of waiting nearly a year before adjusting borrowing costs. 'We are in a really very good economic situation ...I think the normalization should perhaps take place somewhat more quickly,' he told Austrian broadcaster ORF…"

September 24 - Reuters (Leika Kihara): "A few Bank of Japan board members said the central bank must consider more seriously the potential dangers of ultra-easy policy, such as the negative impact on the country's banking system, minutes of their policy meeting in July showed… Some in the nine-member board also worried whether the BOJ could trigger a spike in long-term interest rates by allowing bond yields to move more flexibly around its zero percent target."

Europe Watch:

September 27 - Financial Times (Miles Johnson and Kate Allen): "Italy's coalition government is making a last-minute push to ensure its expensive election promises are included in new spending targets that risk increasing the country's budget deficit beyond the comfort level of Brussels and financial markets. Luigi Di Maio, deputy prime minister and leader of the country's anti-establishment Five Star party, said… that the budget framework would be a 'courageous measure for the people', and suggested that he had not yet agreed on a fixed number for Italy's budget deficit as a percentage of its economic output ahead of an important cabinet meeting."

September 27 - Bloomberg: "German inflation unexpectedly accelerated to a four-month high, suggesting the rate in the euro area will rise further above the European Central Bank's goal. Consumer prices rose an annual 2.2% in September, exceeding the median estimate in a Bloomberg survey and the 1.9% reached in August."

Global Bubble Watch:

September 25 - Financial Times (Colby Smith): "A few things actually have changed since the financial crisis. Banks, for example, are no longer the primary suppliers of international credit. A new report by the Bank of International Settlements (BIS) shows that after the crisis, borrowers began to fund themselves through debt issuance instead. But because most of this debt is dollar-denominated, much of what's new has ended up affirming something very old: the world wants US dollars…The BIS - the bank for central banks - finds that debt securities, not bank loans, have driven the surge in global liquidity since 2010. Between the turn of the century and 2008, bank loans' share of global GDP doubled to 20%. But after a sharp contraction following the crash, bank loans have flatlined. One debt replaced another, and since then, international debt securities have grown. As of the first quarter of 2018, debt securities make up roughly 57% of total international credit, up from 48% in the first quarter of 2008."

September 23 - Reuters (Saikat Chatterjee): "International debt issuance has soared in recent years as financing conditions improve, with dollar-denominated bonds beating bank debt as the most popular funding tool a decade after the global financial crisis… International credit, defined as bank loans and debt securities like bonds, has soared to 38% of the global economy in the first quarter of 2018, compared with 33% three years ago, according to a quarterly report by the Bank of International Settlements… Dollar lending to non-bank emerging markets have more than doubled to around $3.7 trillion since the 2008 crisis. A similar amount has been borrowed through currency swaps, according to the BIS."

September 25 - Reuters (Karen Lema and Enrico Dela Cruz): "Developing Asia could grow more slowly than previously thought next year as the U.S.-China trade war inflicts damage on the region's export-reliant economies, the Asian Development Bank (ADB) said… Tightening global liquidity could also weigh on business activity by pushing up borrowing costs, while capital outflows are also a risk. The Manila-based institution kept its 2018 economic growth estimate for the region at 6.0% in an update of its Asian Development Outlook. But it trimmed next year's forecast to 5.8% from 5.9%..."

Fixed Income Bubble Watch:

September 24 - Reuters (Kate Duguid): "The $37 billion in new supply of 2-year Treasury notes on Monday were sold at the highest yield at auction since June 2008 to the weakest demand since December 2008. Demand was lackluster despite low prices, notching the yield on the 2-year note up to 2.817% on Monday after the Treasury Department sale. The high yield at auction was 2.829%, the highest since June 2008 at 2.922%..."

September 25 - Bloomberg (Adam Tempkin): "One of the most popular mortgage-bond trades since the financial crisis is going out of fashion as rising rates punish down-on-their-luck borrowers. So-called 'scratch and dent' mortgages -- which are tied to borrowers that fell behind or began repaying their debts after a default -- accounted for the largest piece of the U.S. residential mortgage-backed securities market without government backing over the last decade. But rising rates make it harder for homeowners to refinance their mortgages, potentially lengthening how long it will take them to pay off that loan. This means bond buyers could get stuck with these non-performing loan and re-performing loan mortgage securities for more time than they anticipated. And investors are taking a step back, pushing yields higher. 'There are higher rates across the board, which has a fairly negative impact because it impedes the ability of the borrower to refinance out of their properties, and is also deadly for bond duration,' said Neil Aggarwal, senior portfolio manager and head of trading at Semper Capital."

Geopolitics Watch:

September 26 - Reuters (Idrees Ali): "The U.S. military flew B-52 bombers in the vicinity of the South China Sea this week, U.S. officials told Reuters, a move that is likely to cause anger in Beijing amid heightened tensions between the two countries."

September 25 - Wall Street Journal (Nancy A. Youssef and Gordon Lubold): "The Chinese government denied a U.S. Navy ship permission for a port visit to Hong Kong in October, U.S. military officials said, a decision issued as Beijing also canceled a high-level naval meeting in the U.S. The rebuffs come as tensions build between the two countries over a range of military and economic differences. Last week, the State Department imposed sanctions on a Chinese military agency for buying Russia's SU-35 combat aircraft and S-400 surface-to-air missile system, leading China to formally complain to the U.S. ambassador and acting defense attaché."

September 22 - Reuters (David Stanway and Lesley Wroughton): "China summoned the U.S. ambassador in Beijing and postponed joint military talks in protest against a U.S. decision to sanction a Chinese military agency and its director for buying Russian fighter jets and a surface-to-air missile system… China's Defence Ministry said… it would recall navy chief Shen Jinlong from a visit to the United States and postpone planned talks in Beijing between Chinese and U.S. military officials that had been set for next week."

September 24 - Reuters (Mohammad Zargham): "The U.S. State Department has approved the sale to Taiwan of spare parts for F-16 fighter planes and other military aircraft worth up to $330 million, prompting China to warn… that the move jeopardized Sino-U.S. cooperation. U.S. military sales to self-ruled Taiwan, which China claims as its territory, is an irritant in the relations between the world's two largest economies."

September 23 - Associated Press: "Iran's President Hassan Rouhani said… that an unnamed U.S.-allied country in the Persian Gulf was behind an attack on a military parade that killed 25 people and wounded around 70. Rouhani did not identify those behind Saturday's attack, which was claimed by an Arab separatist group… 'All of those small mercenary countries that we see in this region are backed by America. It is Americans who instigate them and provide them with necessary means to commit these crimes,' Rouhani said."

September 25 - Reuters (Steve Holland and Parisa Hafezi): "U.S. President Donald Trump and Iranian President Hassan Rouhani exchanged taunts at the United Nations General Assembly… with Trump vowing more sanctions against Tehran and Rouhani suggesting his American counterpart suffers from a 'weakness of intellect.' Trump used his annual address to the United Nations to attack Iran's 'corrupt dictatorship,' praise last year's bogeyman North Korea and lay down a defiant message that he will reject globalism and protect American interests. But much of his 35-minute address was aimed squarely at Iran, which the United States accuses of harboring nuclear ambitions and fomenting instability in the Middle East through its support for militant groups in Syria, Lebanon and Yemen. 'Iran's leaders sow chaos, death and destruction,' Trump told the gathering... 'They do not respect their neighbors or borders or the sovereign rights of nations.'"

September 25 - Reuters (Parisa Hafezi): "Turkish President Tayyip Erdogan said… that his country could not remain silent over the use of sanctions as weapons while it is in a bitter standoff with the United States over the fate of an American evangelical Christian pastor detained by Ankara… 'None of us can remain silent to the arbitrary cancellation of commercial agreements and the use of economic sanctions as weapons,' Erdogan said in a speech to the United Nations General Assembly."