Friday, January 4, 2019

Weekly Commentary: Global Markets’ Plumbing Problem

“Goldilocks with a capital ‘J’,” exclaimed an enthusiastic Bloomberg Television analyst. The Dow was up 747 points in Friday trading (more than erasing Thursday’s 660-point drubbing) on the back of a stellar jobs report and market-soothing comments from Fed Chairman “Jay” Powell.

December non-farm payrolls surged 312,000. The strongest job gains since February blew away both estimates (184k) and November job creation (revised up 21k to 176k). Manufacturing jobs jumped 32,000 (3-month gain 88k), the biggest increase since December 2017’s 39,000. Average Hourly Earnings rose a stronger-than-expected 0.4% for the month (high since August), pushing y-o-y gains to 3.2%, near the high going back to April 2009.

Just 90 minutes following the jobs report, Chairman Powell joined Janet Yellen and Ben Bernanke for a panel discussion at an American Economic Association meeting in Atlanta. Powell’s comments were not expected to be policy focused (his post-FOMC press conference only two weeks ago). But the Fed Chairman immediately pulled out some prepared comments, perhaps crafted over the previous 24 hours (of rapidly deteriorating global market conditions).

Chairman Powell: “Financial markets have been sending different signals – signals of concern about downside risks, about slowing global growth particularly related to China, about ongoing trade negotiations, about – let’s call - general policy uncertainty coming out of Washington, among other factors. You do have this difference between, on the one hand, strong data, and some tension between financial markets that are signaling concern and downside risks. And the question is, within those contrasting set of factors, how should we think about the outlook and how should we think about monetary policy going forward. When we get conflicting signals, as is not infrequently the case, policy is very much about risk management. And I’ll offer a couple thoughts on that… First, as always, there is no preset path for policy. And particularly, with the muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves. But we’re always prepared to shift the stance of policy and to shift it significantly if necessary, in order to promote our statutory goals of maximum employment and stable prices. And I’d like to point to a recent example when the committee did just that in early 2016… As many of you will recall, in December 2015 when we lifted off from the zero bound, the median FOMC participant expected four rate increases for 2016. But very early in the year, in 2016, financial conditions tightened quite sharply and under Janet’s leadership, the committee nimbly – and I would say flexibly – adjusted our expected rate path. We did eventually raise rates a full year later in December 2016. Meanwhile, the economy weathered a soft patch in the first half of 2016 and then got back on track. And gradual policy normalization resumed. No one knows whether this year will be like 2016, but what I do know is that we will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy should that be appropriate to keep the expansion on track, to keep the labor market strong and to keep inflation near 2%.”

Powell heedfully hit key market hot buttons: “…Policy is very much about risk management.” “We will be patient as we watch to see how the economy evolves…” “…Always prepared to shift the stance of policy and to shift it significantly if necessary…” “We will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy…” A Bloomberg headline: “Powell Shows He Cares About Markets.” Markets heard assurances of an operative “Fed put” - with rate cuts and QE (“all of our tools”) available when demanded – and it was off to the races. The Nasdaq Composite surged 4.3%, the small cap Russell 2000 3.8% and the S&P500 3.4%. The Goldman Sachs Most Short index rose 3.8% in Friday trading.

Treasury investors, of late fixated on mounting global fragilities, saw the data, listened intently to Powell, glared at surging stock prices - and recoiled. Ten-year yields jumped 11 bps in Friday trading, with five-yields surging 14 bps. Friday’s equities buyers’ panic masked troubling market behavior over the previous week – important developments not to be swept under the rug.

January 4 – Financial Times (Robin Wigglesworth): “Housebuyers always carefully study the kitchen fittings and measure up the airy living room, but often neglect to check whether the pipes are up to scratch. Investors act similarly, often forgetting that dodgy market plumbing can lead to a smelly catastrophe. There has been no shortage of culprits offered up to explain the worst month for US markets since the financial crisis, with conveniently nebulous ‘algorithms’ emerging as a particularly popular bogeyman. But on New Year’s Eve a little-watched corner of the US money markets offered up clues as to another, arguably stronger candidate as a contributor to the recent volatility. On Dec 31, the rate on ‘general collateral’ overnight repurchase agreements suddenly rocketed from 2.56% to 6.125%, its highest level since 2001. This was a huge move, the single biggest outright percentage jump since at least 1998. The repo rate has since normalised, but the severity of the spike indicates that at least part of the market’s plumbing gummed up.”

The Global Markets’ Plumbing Problem didn’t unclog with the passing of year-end funding pressures.

January 3 – Bloomberg (Ruth Carson and Michael G Wilson): “It took seven minutes for the yen to surge through levels that have held through almost a decade. In those wild minutes from about 9:30 a.m. Sydney, the yen jumped almost 8% against the Australian dollar to its strongest since 2009, and surged 10% versus the Turkish lira. The Japanese currency rose at least 1% versus all its Group-of-10 peers, bursting through the 72 per Aussie level that has held through a trade war, a stock rout, Italy’s budget dispute and Federal Reserve rate hikes. Traders across Asia and Europe are still seeking to piece together what happened in those minutes when orders flooded in to sell Australia’s dollar and Turkey’s lira against the yen… Whatever the cause, the moves were exacerbated by algorithmic programs and thin liquidity with Japan on holiday.”

Thursday’s market gyrations hinted at a quite disconcerting scenario: illiquidity, dislocation and a “seizing up” of global markets. The day saw an 8% move in the yen vs. Australian dollar – two major – and supposedly highly liquid - global currencies. Trading in the yen dislocated across the currencies market, a so-called “flash crash.” We’ve seen the occasional “flash crash” in equities over the past decade. These abrupt bouts of selling and illiquidity reversed in relatively short order, with recovery only emboldening animal spirits. These recoveries, in contrast the current backdrop, were supported by expanding global central bank balance sheets (QE/liquidity).

I’m concerned that Thursday’s currency “flash crash” has potentially dire implications. Together with other key market indicators, evidence of systemic illiquidity risk is mounting. De-risking/deleveraging dynamics continue to gain momentum globally. Moreover, there are literally hundreds of Trillions of currency-related derivatives transactions – a byzantine edifice fabricated on a flimsy assumption of “liquid and continuous markets.”

I suspect the “global” derivatives marketplace is today much more global than the U.S.-dominated market heading into the 2008 crisis. This implies scores of new players, certainly including Chinese and Asian institutions. This suggests different types of strategies, complexities, counterparties and risks more generally. It certainly raises the issue of regulatory oversight along with potential policy challenges in the event of a globalized market dislocation. Interestingly, the AIG bailout was mentioned in Friday’s Fed head panel discussion. It’s been about a decade of derivative risk complacency.

When it comes to current global systemic liquidity risks, the Japanese yen may be the single-most critical global currency. Trillions have flowed out of Japan to play higher global yields. Zero Japanese rates and, importantly, negative market yields forced so-called “Mrs. Watanabe” to forage global securities markets in search of positive returns.

Years of radical monetary policies coerced enormous quantities of Japanese household savings into the realm of international securities and currency speculation. Likely an even greater source of global liquidity materialized from “carry trade” speculations – borrowing at zero (or negative yields) in Japan to finance levered holdings in higher-yielding instruments around the world – certainly including in Australia.

Keep in mind also that massive (reckless) BOJ balance sheet growth seemed to ensure a weak Japanese currency. Prospective yen devaluation has been integral to the yen becoming a prevailing “funding” currency for global speculation throughout this historic global government finance Bubble period (what’s better than borrowing for free in a currency you expect to be worth less in the future?). “King dollar,” with its positive rate differentials, shrinking Fed balance sheet and booming markets, bolstered the case for the yen as dominant global funding currency.

Thursday’s yen dislocation was quickly transmitted across global bond markets. After beginning the new year at an incredibly meager 0.005%, Japanese 10-year “JGB” yields in Friday trading dropped to a low of negative 0.054%, before closing at negative 0.045% - a 13-month low. Ten-year Treasury yields began Wednesday trading at 2.69%. Yields then sank to as low as 2.54% in late-Thursday trading, an almost one-year low. At that point, Treasury yields had collapsed 70 bps since the 3.24% closing yield on November 8th. And after beginning 2019 at 23 bps, German 10-year bund yields sank to as low as 15 bps in Thursday trading (down 30bps since Nov. 8th).

Italian yields, after trading Wednesday at a five-month low 2.66%, abruptly reversed course Thursday to close the session 20 bps higher at 2.86% (ending the week up 16bps to 2.90%). With their relatively high yields, Italian bonds have likely been a target of Japanese savers and yen “carry trade” speculators. Curiously, Portuguese 10-year yields, trading down to 1.69% Wednesday, reversed course and traded as high at 1.82% Friday before ending the week up nine bps to 1.81%. This week saw spreads to German bunds widen 19 bps in Italy, 12 bps in Portugal, nine bps in Spain and seven bps in Greece. European high-yield (iTraxx Crossover) CDS was up 12 bps for the week at Thursday’s close, the high going back to June 2016. European bank index CDS prices also rose to two-year highs in Thursday trading.

It’s worth noting that Goldman Sachs Credit default swap (5yr CDS) prices surged an eye-opening 19 bps in Thursday trading to 129 bps, the high going back to the early-2016 market tumult period. Goldman CDS traded below 60 in early-October, before ending October at 77 bps, November at 87 bps and closing out 2018 at 106 bps. Deutsche Bank CDS rose seven bps Thursday to 218 bps, near the highest level since 2016. Many large financial institutions saw CDS prices rise this week to highs going back to 2016 (Goldman up 17bps, Morgan Stanley 14 bps, Nomura 11 bps, Citigroup 9 bps and BofA 8 bps).

U.S. junk bonds were under significant pressure. U.S. high-yield corporate bond yields (Bloomberg Barclays average OAS index) jumped 10 bps Thursday to 5.37%, the high going back to July 2016. Energy-related debt was not helped by WTI crude trading as low as $44.35 in Wednesday trading, before reversing course and ending the week up almost 6% to $47.96. Investment-grade corporate spreads to Treasuries traded Thursday to new two-year highs (and narrowed little Friday).

Gold is worthy of a mention. Spot bullion traded to $1,299 Friday morning (pre-payrolls/Powell), the high since June. Bullion gained $10 in Thursday trading and was up $18 for the week at Friday highs (before closing the week up $4 to $1,285). As global systemic risk builds, Gold is demonstrating safe haven attributes.

And speaking of global systemic risk: China.

January 2 – Wall Street Journal (Nathaniel Taplin): “Champagne or no, New Year’s Eve must have been a somber affair for China’s top leadership, with word that manufacturing activity declined in December for the first time since 2016. The bad news from the official purchasing managers index was confirmed Wednesday by the privately compiled Caixin index, which further showed new orders in December down for the first time in 2½ years. It’s a sign that nine months of monetary easing by the central bank has failed to boost lending to the real economy, though it has succeeded in pushing housing and government-bond prices into bubbly territory. This kink in China’s monetary-policy machinery bodes ill for 2019, and makes predictions that growth could bottom out in the first quarter look optimistic. Where banks are lending again, it’s mostly to other financial institutions and the government, not the cash-starved private companies that really drive growth.”

Hong Kong’s Hang Seng index dropped 2.8% during the first trading session of 2019 (down 3.6% y-t-d at Thursday’s lows). The Shanghai Composite was down more than 2% y-t-d as of early Friday, trading at the lowest level since November 2014. An abrupt 3% rally pushed the index positive (up 0.8%) for the first few sessions 2019. The People’s Bank of China Friday announced another reduction in reserve requirements (0.5%).

From Reuters (Kevin Yao and Lusha Zhang): “The announcement came just hours after Premier Li Keqiang said China would take further action to bolster the economy, including reserve requirement ratio (RRR) cuts and more cuts in taxes and fees, highlighting the urgency to cope with increasing headwinds. ‘This speedy RRR cut with great intensity fully demonstrates the determination of policymakers to stabilize growth,’ said Yang Hao, an analyst at Nanjing Securities.”

It's hardly coincidence that Powell’s market-pleasing comments followed by only a few hours the PBOC’s policy move. The situation has turned more serious – in China, in global finance and in U.S. markets. Apple’s Thursday cut in earnings guidance was one more important indication of rapidly slowing Chinese demand. That China’s economic slowdown is occurring in the facing of a historic apartment Bubble significantly complicates policymaking. Beijing would surely prefer to cautiously deflate this colossal Bubble. But, at this point, aggressive measures to stimulate China’s economy would further extend the precarious “Terminal Phase” of mortgage and housing excess.

December 31 – New York Times (Alexandra Stevenson and Cao Li): “Unwanted apartments are weighing on China’s economy — and, by extension, dragging down growth around the world. Property sales are dropping. Apartments are going unsold. Developers who bet big on continued good times are now staggering under billions of dollars of debt. ‘The prospects of the property market are grim,’ said Xiang Songzuo, a senior economist at Renmin University, said… ‘The property market is the biggest gray rhino,’ he said, referring to a term the government has used to describe visibly big problems in the Chinese economy that are disregarded until they start gaining momentum… More than one in five apartments in Chinese cities — roughly 65 million — sit unoccupied, estimates Gan Li, a professor at Southwestern University of Finance and Economics in Chengdu.”

It's difficult to fathom 65 million vacant apartment units – more than 20% of China’s housing stock. What is the scope of future bad debts and bank impairment associated with such a fiasco? Economic impact – China and globally? Financial ramifications? With a bear market in Chinese equities, China’s vulnerable Bubble Economy and waning global growth, it’s perfectly reasonable for the world to start really worrying about China’s vulnerable apartment Bubble. With all the Friday excitement surrounding Powell and rallying U.S. equities, it’s worth noting that Asian shares underperformed this week. Copper declined another 1.3%.

Along with sinking Treasury and bund yields, there’s ample evidence that something lurking out there is stirring up a palpable degree of angst. And I would like to be more sanguine about U.S. economic prospects, especially considering strong December payroll data. I’m actually not expecting the economy to just fall off a cliff. Tightened financial conditions are a relatively recent development. Barring an accident, it might take some time for faltering markets to feed into the real economy. Yet the U.S. has a Bubble Economy structure unusually vulnerable to deflating securities and asset markets. It also faces perilous structural issues throughout its securities markets and financial system more generally. I certainly believe the U.S. is highly exposed to the unfolding issue of illiquidity afflicting global financial markets.

January 4 – Bloomberg (Rizal Tupaz): “Investors pulled the most money out of investment-grade bond funds in three years last week amid the ongoing turmoil in credit markets. The funds lost $4.5 billion for the weekly reporting period ending Jan. 2, the biggest outflow since December 2015, according to Lipper. That marks the sixth straight retreat by investors. High-yield funds saw a seventh week in a row of outflows as investors yanked $628 million versus the previous period’s $3.9 billion.”

For the Week:

The S&P500 gained 1.9% (up 1.0% y-t-d), and the Dow rose 1.6% (up 0.5%). The Utilities slipped 0.2% (down 0.3%). The Banks surged 4.7% (up 4.0%), and the Broker/Dealers jumped 4.0% (up 3.2%). The Transports increased 1.3% (up 0.6%). The S&P 400 Midcaps gained 2.3% (up 1.3%), and the small cap Russell 2000 jumped 3.2% (up 2.4%). The Nasdaq100 rose 2.2% (up 1.5%). The Semiconductors slipped 0.3% (down 1.0%). The Biotechs surged 6.8% (up 4.4%). With bullion up $4, the HUI gold index rose 2.6% (up 1.1%).

Three-month Treasury bill rates ended the week at 2.36%. Two-year government yields declined two bps to 2.49% (up 53bps y-o-y). Five-year T-note yields fell five bps to 2.50% (up 21bps). Ten-year Treasury yields declined five bps to 2.67% (up 19bps). Long bond yields fell four bps to 2.98% (up 17bps). Benchmark Fannie Mae MBS yields dropped seven bps to 3.46% (up 42bps).

Greek 10-year yields gained four bps to 4.39% (up 66bps y-o-y). Ten-year Portuguese yields jumped nine bps to 1.81% (down 13bps). Italian 10-year yields surged 16 bps to 2.90% (up 89bps). Spain's 10-year yields rose six bps to 1.47% (down 5bps). German bund yields declined three bps to 0.21% (down 23bps). French yields slipped a basis point to 0.70% (down 10bps). The French to German 10-year bond spread widened two to 49 bps. U.K. 10-year gilt yields added one basis point to 1.28% (up 3bps). U.K.'s FTSE equities index rallied 1.5% (up 1.6% y-t-d).

Japan's Nikkei 225 equities index dropped 2.3% (down 2.3% y-t-d). Japanese 10-year "JGB" yields fell four bps to negative 0.04% (down 10bps y-o-y). France's CAC40 gained 1.2% (up 0.1% y-t-d). The German DAX equities index recovered 2.0% (up 2.0%). Spain's IBEX 35 equities index jumped 2.9% (up 2.3%). Italy's FTSE MIB index rose 2.8% (up 2.8%). EM equities were mixed. Brazil's Bovespa index surged 4.5% to all-time highs (up 4.5%), and Mexico's Bolsa gained 2.4% (up 2.0%). South Korea's Kospi index fell 1.5% (down 1.5%). India's Sensex equities index declined 1.1% (down 1.1%). China's Shanghai Exchange increased 0.8% (up 0.8%). Turkey's Borsa Istanbul National 100 index dropped 1.8% (down 2.7%). Russia's MICEX equities index rose 2.0% (up 2.0%).

Investment-grade bond funds saw outflows of $4.517 billion, and junk bond funds posted outflows of $628 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell four bps to an eight-month low 4.51% (up 56bps y-o-y). Fifteen-year rates declined two bps to 3.99% (up 61bps). Five-year hybrid ARM rates dipped two bps to 3.98% (up 53bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down four bps to a ten-month low 4.38% (up 25bps).

Federal Reserve Credit last week declined $15.0bn to $4.029 TN. Over the past year, Fed Credit contracted $379bn, or 8.6%. Fed Credit inflated $1.218 TN, or 43%, over the past 321 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt fell $7.9bn last week to $3.389 TN. "Custody holdings" rose $33bn y-o-y, or 1.0%.

M2 (narrow) "money" supply surged $84.5bn last week to a record $14.498 TN. "Narrow money" gained $663bn, or 4.8%, over the past year. For the week, Currency declined $1.4bn. Total Checkable Deposits jumped $64.8bn, and Savings Deposits added $8.9bn. Small Time Deposits rose $5.4bn. Retail Money Funds gained $6.9bn.

Total money market fund assets gained $8.5bn to a near nine-year high $3.047 TN. Money Funds gained $209bn y-o-y, or 7.4%.

Total Commercial Paper dropped $10.6bn to near an 13-month low $1.045 TN. CP declined $41.2bn y-o-y, or 3.8%.

Currency Watch:

The U.S. dollar index slipped 0.2% to 96.179 (unchanged y-t-d). For the week on the upside, the Brazilian real increased 4.3%, the South African rand 3.4%, the Canadian dollar 2.0%, the Japanese yen 1.6%, the Mexican peso 1.2%, the Norwegian krone 1.1%, the Australian dollar 0.9%, the Singapore dollar 0.5%, the Swedish krona 0.3%, the New Zealand dollar 0.2% and the British pound 0.2%. For the week on the downside, the South Korean won declined 0.8%, the euro 0.4% and the Swiss franc 0.3%. The Chinese renminbi increased 0.14% versus the dollar this week (up 0.14% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index rallied 3.2% (up 3.3% y-t-d). Spot Gold added $4 to $1,285 (up 0.2%). Silver jumped 2.3% to $15.786 (up 1.6%). Crude recovered $2.63 to $47.96 (up 5.6%). Gasoline gained 1.6% (up 3.5%), while Natural Gas sank 7.8% (up 3.5%). Copper declined 1.3% (up 1%). Wheat gained 1.1% (up 3%). Corn fell 1.5% (up 2%).

2018 in Review:

December 30 – Financial Times (Don Weinland): “A trade dispute with the US and a crackdown on shadow banking made China the world’s worst-performing major stock market in 2018, shedding some $2.3tn in value. Investors say that while China’s intensifying trade war with the US grabbed much of the attention, a government campaign against leverage in the financial system played a big role in slowing market demand and forcing some funds into liquidation. China’s benchmark CSI 300 index will finish the year close to 3,000, down more than 25% from where it started 2018…”

December 31 – Bloomberg (Christopher DeReza): “U.S. investment-grade credit spreads are at the highest level in more than two years as the market nears the end of 2018 with the worst returns in a decade. High-grade bonds are returning -2.75% this year as of the start of the final trading day of 2018, which is the biggest loss since the asset class lost 4.94% in 2008, according to the Bloomberg Barclays U.S. corporate index… Investment-grade bond spreads held at 152 bps Friday.”

January 2 – Bloomberg (Natalya Doris): “It may be the end of an era. If all the pieces that suppressed U.S. investment-grade corporate bond issuance in 2018 remain in place, what has been a decade of heavy bond sales could come to an end in 2019. Borrowers sold nearly $1.1 trillion of bonds in 2018, just short of 2017’s record $1.2 trillion. Analysts expect some of the main drivers of the decline -- corporate repatriation of cash, borrowing costs rising off of record lows, and broader uncertainty, somewhat offset by strong M&A-related supply – to persist in the new year, affecting some sectors more than others.”

December 30 – Financial Times (Joe Rennison): “Investors have withdrawn a record amount of cash from funds invested in junk-rated debt in 2018 as sentiment over the outlook for the economy has soured and oil prices plummeted. The total outflow from US high-yield bond funds is on track to exceed $60bn, according to… EPFR Global, double the amount withdrawn last year… It is also double the amount withdrawn in 2014, another period when oil prices fell sharply. Energy companies account for about 15% of the junk bonds outstanding, so the 20% fall in the oil price this year has damped investor appetite for the companies’ debt.”

January 2 – Bloomberg (Kelsey Butler): “There was no U.S. high-yield bond issuance last month for the first time in at least 10 years… There hasn’t been a December with no openly syndicated high-yield bond issuance in at least 12 years… December 2017 saw $19.9b in sales, up from $18.6b in the last month of 2016. There was $5.2b in volume during November 2018. High-yield issuance dropped 42.3% last year as rising rates and volatility made bond markets less attractive to issuers…”

January 2 – Bloomberg (Lisa Lee and Lara Wieczezynski): “December brought to a dismal end the second-biggest year on record for U.S. leveraged loan issuance. The outlook is rocky as volatility sets in. U.S. leveraged loan sales fell to $814b in 2018, down 25% from the record $1.1t sold in 2017…”

January 32 – Bloomberg: “Bank of China was the top underwriter of emerging market bonds in 2018 as the value of deals fell 1%. Issuers sold $1.97 trillion of bonds vs. $1.99 trillion in 2017, according to… Bloomberg League Tables. Bank of China ranked No. 1 capturing 4.23%...”

January 32 – Bloomberg: “Bank of China was the top underwriter of Offshore China bonds in 2018 as the value of deals fell 23%. Issuers sold $166.2 billion of bonds vs. $215.8 billion in 2017, according to… Bloomberg League Tables…”

December 29 – Reuters (Douglas Busvine): “Deutsche Bank is strong and its turnaround strategy is bearing fruit, Chairman Paul Achleitner said, ruling out the need for state aid and playing down speculation that the lossmaking German bank should merge.”

Market Dislocation Watch:

January 2 – Reuters (Abhinav Ramnarayan): “Benchmark German government bond yields were set for their biggest one-day fall since September 2016 after business surveys in China and the euro zone underlined worries about the global growth outlook and hit stock markets.”

January 2 – Reuters (Trevor Hunnicutt): “U.S. fund investors anguished over economic growth and policies pulled the most cash from stocks in any weekly period since last February, Investment Company Institute data showed… Mutual funds and exchange-traded funds (ETFs) tracked by the trade group reported $37.8 billion in withdrawals overall, a 12th week of declines and the most cash pulled since a Chinese growth scare in August 2015. More than $21 billion tumbled out of stock funds during the week ended Dec. 26, the most since February 2018.”

December 29 – Reuters (Rich Barbieri and David Goldman): “The past two weeks on Wall Street have been epic. In the last 10 trading days, the Dow fell more than 350 points six times. There was also one day when the Dow rose by 1,000 points — the biggest point gain ever. The market is in an historic period of volatility. The S&P 500 was up or down more than 1% nine times in December and 64 times this year. In all of 2017, that happened only eight times.”

January 3 – Bloomberg (Edward Bolingbroke and Emily Barrett): “Bond traders are showing little sign of stepping back from their fight with the Federal Reserve over the path of interest rates and the market is now positioned for cuts on the horizon. Just over a month ago the market was pointing to a quarter-point hike in 2019, but it’s now factoring in a more than 50% chance of a reduction this year. That’s in stark contrast to the median projection of two increases projected by Fed officials last month. On top of that, traders are now fully pricing in a cut by April 2020. The rate on the June 2020 U.S. dollar overnight index swap, which was close to 3% less than two months ago, dropped as low as 2.04% on Thursday -- suggesting a benchmark rate more than 30 bps below the current effective fed funds rate by the middle of 2020.”

January 2 – Bloomberg (Lisa Lee): “U.S. leveraged loans suffered their biggest loss in December since mid-2011, following record-breaking fund outflows. Despite this, the floating-rate asset class eked out a slim gain for 2018. Loans posted a 2.5% loss in December, the worst since August 2011… This followed a 0.9% drop in November and compared to a 2.1% loss for U.S. junk bonds last month… Still, loans held onto a rare gain in U.S. credit markets, rising 0.44% as high-yield bonds lost 2.1% and investment-grade bonds fell 2.5% for the year.”

Trump Administration Watch:

December 29 – Reuters (Yeganeh Torbati and Ryan Woo): “U.S. President Donald Trump said on Twitter that he had a ‘long and very good call’ with Chinese President Xi Jinping and that a possible trade deal between the United States and China was progressing well. As a partial shutdown of the U.S. government entered its eighth day, with no quick end in sight, the Republican president was in Washington, sending out tweets attacking Democrats and talking up possibly improved relations with China.”

January 2 – CNBC (Fred Imbert): “U.S. Trade Representative Robert Lighthizer has warned President Donald Trump that additional tariffs on Chinese imports may be needed to get meaningful concessions in trade negotiations… Lighthizer, who is taking the lead in trade negotiations with China, has told friends and associates he is intent on preventing Trump from accepting ‘empty promises’ like temporary increases in soybean purchases, the newspaper said. In order to avoid this, the U.S. may have to slap tariffs on more Chinese goods, Lighthizer reportedly said.”

December 31 – Wall Street Journal (Bob Davis): “The U.S. is urging Beijing to fill in the details of a slew of trade and investment proposals Chinese officials have made recently, as the two sides try to resolve a trade battle that has rocked global markets. Since President Trump and Chinese President Xi Jinping met in Buenos Aires on Dec. 1, Beijing has pledged to cut tariffs, buy more U.S. goods and services, ease restrictions on foreign companies operating in China and further open sectors for foreign investment. But details have been scant. That has led to skepticism in the administration that the initiatives will lead to meaningful progress unless Beijing specifies the types of changes it will adopt, the schedule for implementing them and ways to enforce the pledges, said people tracking the talks.”

Federal Reserve Watch:

January 3 – Bloomberg (Jeanna Smialek): “Federal Reserve Bank of Dallas President Robert Kaplan said the U.S. central bank should put interest rates on hold as it waits to see how uncertainties about global growth, weakness in interest-sensitive industries and tighter financial conditions play out. ‘We should not take any further action on interest rates until these issues are resolved, for better, for worse,’ Kaplan told Bloomberg’s Michael McKee… ‘So I would be an advocate of taking no action and -- for example -- in the first couple of quarters this year, if you asked me my base case, my base case would be take no action at all.’ Kaplan, who next votes on policy in 2020, also indicated a willingness to be open-minded about adjusting the Fed’s balance-sheet runoff if needed -- something some market commentators have been calling for but the central bank has resisted to date.”

U.S. Bubble Watch:

January 3 – Bloomberg (Jeff Kearns): “A gauge of U.S. manufacturing plunged last month by the most since October 2008, a fresh sign of deceleration in the economy amid global strains across the sector. U.S. stocks extended declines and Treasury yields fell after the report. The Institute for Supply Management index dropped to a two-year low of 54.1, missing all estimates in Bloomberg’s survey… All five main components declined, led by new orders slumping the most in almost five years and the steepest slide for production since early 2012. Employment, delivery and inventory gauges fell, and ISM said just 11 of 18 industries reported growth in December, the fewest in two years. The index compiled from a survey of manufacturers has tumbled sharply from a 14-year high in August..."

January 3 – CNBC (Jeff Cox): “Contrary to growing concerns about a potentially slowing U.S. economy, job creation surged in December as measured by the latest ADP/Moody’s Analytics survey… Companies added 271,000 new positions as 2018 came to a close, smashing estimates of 178,000… It was the survey’s best month since February 2017, which saw a gain of 280,000, and brought the average monthly gain for last year to 206,000.”

December 29 – Wall Street Journal (Sam Goldfarb and Rachel Louise Ensign): “In the aftermath of the financial crisis, a swath of individuals and families began a long and painful deleveraging process. Businesses, meanwhile, quickly moved in the opposite direction—loading up on cheap debt to the point where many observers now worry that highly leveraged companies pose a threat to the global economy. U.S. corporate debt has climbed to roughly 46% of gross domestic product, the highest on record… Businesses in emerging markets, such as China, have gone on an even bigger borrowing binge, taking advantage of ultralow interest rates and, in some cases, state-driven policies designed to propel economies forward.”

December 30 – Wall Street Journal (Dana Mattioli, Dana Cimilluca and Ben Dummett): “The year got off to a fast start for deal making as companies struck mergers including Takeda Pharmaceutical Co.’s $63 billion acquisition of Shire PLC. The pace was so torrid, some thought 2018 would be the biggest year ever for M&A. But choppy financial markets, trade tensions and fears of an economic slowdown hampered deal makers when they returned from summer vacation. It was still a good year and is set to go down as the third-busiest ever for M&A, trailing only 2007 and 2015, with more than $3.8 trillion in announced deals. It was also a good year for the bankers and lawyers who helped arrange all those corporate marriages, for which they reap fees that can run into the tens of millions of dollars.”

December 29 – Wall Street Journal (Jared S. Hopkins): “Pharmaceutical companies are ringing in the new year by raising the price of hundreds of drugs, with Allergan PLC setting the pace with increases of nearly 10% on more than two dozen products… Many companies’ increases are relatively modest this year, amid growing public and political pressure on the industry over prices. Yet a few are particularly high, including on some generics, the cheaper alternative to branded accounting for nine out of 10 prescriptions filled in the U.S. Overall, price increases, including recently restored price increases from Pfizer Inc. continue to exceed inflation.”

January 4 – Bloomberg (Mark Chediak and Margot Habiby): “PG&E Corp. is considering filing for bankruptcy protection within weeks as a way of organizing billions of dollars in potential liabilities tied to deadly wildfires that ravaged parts of California in 2017 and 2018, according to people familiar with the situation. The California utility giant may decide to file by February, said the people… A bankruptcy filing isn’t certain and is one of a number of steps being considered… PG&E said in a statement that it’s ‘working diligently to assess the company’s potential liabilities as a result of the wildfires and the options for addressing those liabilities.’ …The stock slid as much as 32% in after-hours trading.”

January 2 – Wall Street Journal (Bradley Olson, Rebecca Elliott and Christopher M. Matthews): “Thousands of shale wells drilled in the last five years are pumping less oil and gas than their owners forecast to investors, raising questions about the strength and profitability of the fracking boom that turned the U.S. into an oil superpower. The Wall Street Journal compared the well-productivity estimates that top shale-oil companies gave investors to projections from third parties about how much oil and gas the wells are now on track to pump over their lives, based on public data of how they have performed to date. Two-thirds of projections made by the fracking companies between 2014 and 2017 in America’s four hottest drilling regions appear to have been overly optimistic, according to the analysis of some 16,000 wells operated by 29 of the biggest producers in oil basins in Texas and North Dakota.”

January 2 – Reuters (Sanjana Shivdas): “U.S. office vacancy rate rose to 16.7% in the fourth quarter from 16.4% a year earlier, according to real estate research firm Reis Inc. Net absorption, measured in terms of available office space sold in the market during a certain time period, dropped to 7.4 million sq ft of office space in the quarter, compared with 7.6 million sq ft a year earlier.”

January 3 – Bloomberg (Justina Vasquez): “Manhattan home prices fell in the fourth quarter, with the median slipping to less than $1 million for the first time in three years, as ample inventory continued to allow buyers to demand sweeter deals. Condo and co-op prices declined to $999,000 in the three months through December, a drop of 5.8% from a year earlier, appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate said... Many apartments were sold for less than sellers originally sought, with an average discount of 6.2% from the last list price. That’s up from price cuts of 5.4% a year earlier.”

China Watch:

December 28 – Bloomberg: “A rough year for China’s markets draws to a close, with tired stocks near multiyear lows. The yuan, despite a bump higher this month, is still one of the weakest Asian currencies in 2018. At least bonds have done OK. Equities have demanded plenty of attention due to the eye-watering size of the slump -- $3 trillion wiped off China’s stock market since a January… The yuan’s near 8% slide from June to mid-August also weighed on sentiment over a bruising summer.”

January 2 – Reuters (Stella Qiu and Ryan Woo): “China’s factory activity contracted for the first time in 19 months in December as domestic and export orders continued to weaken, a private survey showed, pointing to a rocky start for the world’s second-largest economy in 2019… The Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI) for December… fell to 49.7 from 50.2 in November, marking the first contraction since May 2017.”

December 31 – Bloomberg: “Chinese President Xi Jinping stressed self- reliance amid ‘changes unseen in 100 years,’ as the country faced an economic slowdown and a more confrontational U.S. under President Donald Trump. In his annual New Year’s Eve address, Xi stressed China’s capacity to weather the storm, citing a series of industrial and technological achievements in 2018. He said the government would keep growth from slowing too quickly and follow through on a tax cut as part of an effort ‘to ease the burden on enterprises.’ ‘Despite all sorts of risks and challenges, we pushed our economy towards high-quality development, sped up the replacement of the old drivers of growth, and kept the major economic indicators within a reasonable range,’ Xi said.”

January 2 – Reuters (Andrew Galbraith): “China will not yield on issues it deems to be its core national interests, a commentary in the ruling Communist Party’s official newspaper said…, a day after China’s president called for cooperation with the United States. ‘In matters related to core national interests, China has not given in, is not giving in, and will never give in,’ the People’s Daily commentary said.”

January 2 – Reuters (Kevin Yao): “China’s economic growth could fall below 6.5% in the fourth quarter as companies face increased difficulties, a central bank magazine said… ‘The trend of economic slowdown still continues, and the slowing momentum is increasing. The fourth quarter GDP growth is very possible to be lower than 6.5%,’ said China Finance magazine, which is published by the People’s Bank of China.”

January 2 – Bloomberg: “China will cut the reserve requirement ratio and improve funding conditions this month, as liquidity tightens toward the Spring Festival holidays, the country’s largest securities firm says. Fresh demand for funds will amount to nearly 4.3 trillion yuan ($625 billion) in January, according to Citic Securities… Mainland residents will withdraw 1 trillion yuan of cash in preparation for the holiday, when money is gifted in red envelopes. Corporate tax payments and maturities of lenders’ interbank debt will also mop up liquidity, prompting authorities to step up cash injections.”

December 30 – Bloomberg: “China announced plans to rein in the expansion of lending by the nation’s regional banks to areas beyond their home bases, the latest step policy makers have taken to defend against financial risk in the world’s second-biggest economy. Those lenders, which include rural cooperatives, must have the proper licenses to provide financing beyond the region where they’re based, or else must wind down those businesses, the China Banking and Insurance Regulatory Commission said…”

EM Watch:

December 31 – Reuters (Anthony Boadle): “Brazil’s newly inaugurated President Jair Bolsonaro said… his election had freed the country from ‘socialism and political correctness,’ and he vowed to tackle corruption, crime and economic mismanagement in Latin America’s largest nation. Bolsonaro, a former army captain turned lawmaker who openly admires Brazil’s 1964-1985 military dictatorship, promised in his first remarks as president to adhere to democratic norms, after his tirades against the media and political opponents had stirred unease.”

January 2 – Bloomberg (Subhadip Sircar): “Fiscal worries are back to haunt India’s sovereign bonds just after they posted the best quarter in four years. Prime Minister Narendra Modi’s party, which recently met with electoral losses in key states, is said to be preparing to unveil a farm-relief package ahead of general elections due by May. The prospect of substantial aid for farmers at a time when the nation’s tax and asset sales collections are lagging estimates is stoking fears that India may miss its fiscal deficit target. ‘Fiscal concerns are again taking center-stage,’ said Badrish Kulhalli, head of fixed income at HDFC Standard Life Insurance Co. ‘Any extra spending on a large farm relief package when the government is falling short on indirect tax and divestment revenue may lead to a high fiscal slippage.’”

Global Bubble Watch:

January 1 – Reuters (Jonathan Cable and Marius Zaharia): “Factory activity weakened across much of Europe and Asia in December as the U.S.-China trade war and a slowdown in demand hit production in many economies, offering little reason for optimism as the new year begins. A series of purchasing managers’ indexes for December… mostly showed declines or slowdowns in manufacturing activity across the globe.”

December 31 – Reuters (Sujata Rao, Ritvik Carvalho): “U.S. companies have sent home over half a trillion dollars of cash they held overseas in 2018 to take advantage of tax changes, but data suggest the pace is slowing, potentially removing a key source of support for Wall Street. Dollar repatriation in the July-September period fell to $93 billion, around half of second-quarter volumes and less than a third of the $300 billion or so sent home from January to March, U.S. current account data shows. The repatriation bonanza followed new regulations that allowed the U.S. government to tax profits accumulated overseas, regardless of where the money was held… The current account data shows repatriation in all sectors. Looking at just non-financial companies, JPMorgan calculates $60 billion was repatriated in the third quarter, versus $225 billion in the first quarter and $115 billion in the second quarter.”

December 31 – Wall Street Journal (Mike Bird): “The banks hit hardest by the financial crisis have retreated from overseas lending in the decade since the 2008 collapse of Lehman Brothers, marking a rare example of a sector in which leverage has been curtailed even as global debt has boomed. The total amount of cross-border bank debt has dropped from a peak of $35.453 trillion in the first quarter of 2008 to $29.456 trillion in the second quarter of this year, a fall of nearly 17%. The decline in interbank lending—the credit banks extend to other banks—has been particularly steep. The 10-year period of decline and stagnation is unprecedented in the records of the Bank for International Settlements, which monitors global financial trends.”

Europe Watch:

January 2 – Bloomberg (Sotiris Nikas): “After emerging from its steepest economic crisis in living memory, Greece still has a mountain to climb in 2019 if it’s to consummate its comeback with a sustained return to bond markets. The government plans to issue as much as 7 billion euros ($8 billion) of new debt this year, using part of its cash buffer to repay some International Monetary Fund loans early. The finance ministry could test markets with a short or medium-term note as soon as this month if market conditions allow it…”

Japan Watch:

January 3 – Bloomberg (Cecile Vannucci): “For Japanese investors, skepticism remains high after a year that has seen $938 billion of stock values vanish. The cost of hedging against declines in the Nikkei 225 Stock Average is near its highest level since February 2016… The gauge’s 10% slide in December worsened its first annual slump since 2011.”

Fixed-Income Bubble Watch:

January 1 – Financial Times (Mark Vandevelde): “A $2bn loan fund that was once managed by Blackstone has seen its market value plunge by more than a quarter since private equity rival KKR took over management of the vehicle in April. The stark reversal at Franklin Square Investment Corp highlights the uncertainties facing credit funds that have displaced banks as major lenders to the midsized companies that are the economic engine of middle America. It also shows how two of the most powerful investment firms in the US are taking sharply different views of investments forged in the heat of a credit boom, at a time when investors and central bankers are warning of dangerously loose lending standards.”

Leveraged Speculation Watch:

January 2 – Bloomberg (Katherine Burton, Katia Porzecanski and Nishant Kumar): “Hedge fund managers set on starting their own firms in 2019 face the worst money-raising environment in years. Only one is slated to begin with more than $1 billion: San Francisco-based Woodline Partners… ‘You have to be borderline crazy to be starting a hedge fund in this environment and the only way you should do it is if you feel you have something differentiated to offer,’ said Ilana Weinstein, founder and chief executive officer of IDW Group, a hedge fund recruiter.”

Geopolitical Watch:

January 2 – Bloomberg: “Chinese President Xi Jinping said Taiwan must be unified with the mainland to achieve his goal of completing the country’s rejuvenation. ‘China must and will be united, which is an inevitable requirement for the historical rejuvenation of the Chinese nation in the new era,” Xi told a gathering in Beijing to mark the 40th anniversary of a landmark Beijing overture to Taipei... Xi also sent a warning to advocates of Taiwan’s independence, who include supporters of Taiwanese President Tsai Ing-wen. ‘It’s a legal fact that both sides of the straits belong to one China, and cannot be changed by anyone or any force,’ Xi said. Tsai warned against continued threats from China in her New Year’s Day address Tuesday, signaling a hard line despite her recent election losses to Taiwan’s more Beijing-friendly Kuomintang opposition.”

December 31 – Reuters (Hyonhee Shin and Soyoung Kim): “North Korean leader Kim Jong Un said… he is ready to meet U.S. President Donald Trump again anytime to achieve their common goal of denuclearizing the Korean Peninsula, but warned he may have to take an alternative path if U.S. sanctions and pressure against the country continued. In a nationally televised New Year address, Kim said denuclearization was his ‘firm will’ and North Korea had ‘declared at home and abroad that we would neither make and test nuclear weapons any longer nor use and proliferate them.’”

January 2 – Reuters (Mary Milliken and Gabrielle T├ętrault-Farber): “The United States wants an explanation for why Russia detained a former U.S. Marine on spying charges in Moscow and will demand his immediate return if it determines his detention is inappropriate, Secretary of State Mike Pompeo said…”

January 1 – Reuters (Jessie Pang and James Pomfret): “Thousands of demonstrators marched in Hong Kong on Tuesday to demand full democracy, fundamental rights, and even independence from China in the face of what many see as a marked clampdown by the Communist Party on local freedoms.”

Friday Evening Links

[AP] Stocks swing to huge gains after jobs report, trade talks

[Reuters] U.S. shutdown talks falter, Trump threatens emergency powers

[AP] Trump says shutdown could last ‘months or even years’

[Reuters] China's economic woes put U.S. in strong position in trade talks: Trump

[MarketWatch] PG&E stock plummets after report it's eyeing bankruptcy filing

[Reuters] Fed's Mester: Rates near neutral mean Fed can 'take our time' on next moves

[CNBC] Rent, mortgage payments hard to meet for workers entangled in the government shutdown