Friday, January 18, 2019

Weekly Commentary: Monetary Disorder 2019

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The S&P500 advanced 6.5% in 2019’s first 13 trading sessions. The DJ Transports are up 9.2% y-t-d. The broader market has outperformed. The small cap Russell 2000 sports a 9.9% gain after 13 sessions, with the S&P400 Midcap Index rising 9.3%. The Nasdaq Composite has gained 7.9% y-t-d (Nasdaq100 up 7.2%). The average stock (Value Line Arithmetic) has risen 9.7% to start the year. The Goldman Sachs Most Short index has jumped 13.6%.

Some of the sector gains have been nothing short of spectacular. This week’s 7.7% surge pushed y-t-d gains for the Bank (BKX) index to 13.7%. The Broker/Dealers (XBD) were up 5.3% this week – and 11.0% so far this year. The Nasdaq Bank index has a 2019 gain of 11.3% (up 4.9% this week). The Philadelphia Oil Services index surged 22.3% in 13 sessions. Biotechs (BTK) have jumped 16.1%.

Taking a deeper dive into y-t-d S&P500 sector performance, Energy leads the pack up 11.2%. Financials have gained 9.0%, Industrials 8.9%, Consumer Discretionary 8.4%, and Communications Services 7.9%. Last year’s leaders are badly lagging. The Utilities have gained only 0.4%, followed by Consumer Staples up 3.2% and Health Care gaining 4.2%.

Canadian stocks have gained 6.9% (“Best Start to Year Since 1980”). Mexico’s IPC Index has risen 6.3%. Major equities indices are up 6.1% in Germany, 7.6% in Italy, 6.2% in Spain, 3.6% in the UK and 3.1% in France. European Bank stocks have gained 5.3% (Italy’s banks up 5.1%). Brazil’s Ibovespa index has gained 9.3% and Argentina’s Merval 15.9%. Russian stocks are up 4.9%, lagging the 7.9% gain in Turkey. The Shanghai Composite has recovered 4.1%. Hong Kong’s Hang Seng index has rallied 4.8%, with the Hang Seng Financial Index up 5.1% to start the year. With WTI crude surging 19% y-t-d, the Goldman Sachs Commodities Index is up a quick 10.4% to begin 2019.

After trading as high as 3.25% on November 6th, 10-year Treasury yields ended 2018 at 2.69%. Yields quickly sank to as low of 2.54% on January 3rd and have since rallied to 2.79% - up 10 bps y-t-d. German bund yields traded to 0.57% in early-October before reversing course and ending the year at 0.24%. After trading as low as 15 bps on January 3rd, bund yields closed this week at 26 bps (up 2bps y-t-d). Japan’s JGB yields ended the week at about one basis point, up from the negative 5.4 bps on January 3rd. No “all clear” here.

I titled last year’s “Issues 2018” piece “Market Structure.” A decade of central bank policy-induced market Bubbles fostered momentous market distortions and structural maladjustment. At the top of the list is the historic shift into passive ETF “investing.” With the ETF complex approaching $5.0 Trillion – and another $3.0 TN plus in the hedge fund universe – financial history has never seen such a gargantuan pool of trend-following and performance-chasing finance. Add to this the global proliferation of listed and over-the-counter derivatives strategies (especially options) and trading, and we’re talking about a world of unprecedented financial speculation. It’s an aberrant Market Structure, and we’re witnessing repercussions.

After powerful speculative flows and early-2018 blow-off excess, we saw the emerging markets (EM) then succumb to abrupt market reversals, destabilizing outflows, illiquidity and Crisis Dynamics. We witnessed how fragility at the “Periphery” propelled inflows to the “Core,” pushing U.S. securities markets into a destabilizing speculative melt-up (in the face of a rapidly deteriorating fundamental backdrop). This speculative Bubble burst in Q4.

The Powell Fed chose not to come to the market’s defense at the December 19th FOMC meeting. I viewed this as confirmation that Chairman Powell appreciated how previous hurried Fed measures to backstop the markets had bolstered speculation, distorted market functioning and fueled Bubbles. By January 4th, however, the pressure of market illiquidity had become too much to bear.

The Fed, once again, intervened and reversed the markets. Those believing in the indomitable power of the “Fed put” were further emboldened. The resulting short squeeze and reversal of hedges surely played a commanding role in fueling the advance. And in a financial world dominated by trend-following and performance-chasing finance, market rallies can take on a wild life of their own. There is tremendous pressure on investment managers, the speculator community, advisors and investors not to miss out on rallies. All the makings for a wretchedly protracted bear market.

Serious illiquidity issues were unfolding a small number of trading sessions ago, as equities and fixed-income outflows – along with derivatives-related and speculative selling – began to overwhelm the marketplace. Fed assurances reversed trading dynamics. De-risking/deleveraging has, for now, given way to “risk on.” A powerful confluence of short covering and risk embracement (and leveraging) has acutely speculative markets once again perceiving liquidity abundance and unwavering central bank support. Dangerous.

At least at this point, I’m not anticipating a crisis of confidence in an individual institution (i.e. Lehman in October 2008) to dominate Crisis Dynamics. Rather, I see a more general unfolding crisis of confidence in market function and policymaking. A decade of reckless monetary expansion and near-zero rate policies unleashed Intractable Monetary Disorder. Among the myriad consequences are deep structural impairment to financial systems - certainly including global securities and derivatives markets. The world is in the midst of acute financial instability with little possibility of resolution (outside of crisis).

These policy-induced bouts of “risk on” bolster confidence in both the markets and real economies. Importantly, they also feed dysfunctional Market Dynamics. Upside market volatility exacerbates market instability, fueling pernicious speculation, manic-depressive flows, and destabilizing derivative-related trading dynamics. With fundamental deterioration accelerating both globally and domestically, I would argue a speculative run higher in securities prices exacerbates systemic risks – while ensuring a more problematic future dislocation.

The global Bubble has begun to deflate. Chinese data continue to confirm a serious unfolding downturn. Not dissimilar to Washington policymakers, Beijing appears increasingly anxious. In theory, there would be advantages to letting air out of Bubbles gradually. But the bigger the Bubble – and the greater associated risks – the greater the impetus for policymakers to indefinitely postpone the day of reckoning. The upshot is only worsening Monetary Disorder. With still rising quantities of Credit of rapidly deteriorating quality, systemic risk continues to rise exponentially in China (and the world).

January 14 – Reuters (Kevin Yao): “China… signaled more stimulus measures in the near term as a tariff war with the United States took a heavy toll on its trade sector and raised the risk of a sharper economic slowdown. The world’s second-largest economy will aim to achieve ‘a good start’ in the first quarter, the National Development and Reform Commission (NDRC) said… Central bank and finance ministry officials gave similar assurances. Surprising contractions in China’s December trade and factory activity have stirred speculation over whether Beijing needs to switch to more forceful stimulus measures…”

January 15 – Reuters: “Chinese banks extended 1.08 trillion yuan ($159.95bn) in net new yuan loans in December, far more than analysts had expected but down from the previous month. Analysts polled by Reuters had predicted new yuan loans of 800 billion yuan last month, down from 1.25 trillion yuan in November…”

January 15 – Bloomberg: “China’s credit growth exceeded expectations in December, with the second acceleration in a row indicating the government and central bank’s efforts to spur lending are having an effect. Aggregate financing was 1.59 trillion ($235 billion) in December, the People’s Bank of China said on Tuesday. That compares with an estimated 1.3 trillion yuan in a Bloomberg survey.”

January 15 – South China Morning Post (Amanda Lee): “China’s banks extended a record 16.17 trillion yuan (US$2.4 trillion) in net new loans last year…, as policymakers pushed lenders to fund cash-strapped firms to prop up the slowing economy. The new figure, well above the previous record of 13.53 trillion yuan in 2017, is an indication that the bank has been moderately aggressive in using monetary policy to stimulate the economy, which slowed sharply as a result of the trade war with the US. Outstanding yuan loans were up 13.5% at the end of 2018 from a year earlier… In addition, debt issued by private enterprises increased by 70% year-on-year from November to December last year, indicating that the central bank’s efforts to support the private sector are working.”

There’s a strong consensus view that Beijing has things under control. Reality: China in 2019 faces a ticking Credit time bomb. Bank loans were up 13.5% over the past year and were 28% higher over two years, a precarious late-cycle inflation of Bank Credit. Ominously paralleling late-cycle U.S. mortgage finance Bubble excess, China’s Consumer Loans expanded 18.2% over the past year, 44% in two years, 77% in three years and 141% in five years. China’s industrial sector has slowed, while inflated consumer spending is indicating initial signs of an overdue pullback. Calamitous woes commence with the bursting of China’s historic housing/apartment Bubble.

Typically – and as experienced in the U.S. with problems erupting in subprime - nervous lenders and a tightening of mortgage Credit mark an inflection point followed by self-reinforcing downturns in housing prices, transactions and mortgage Credit. Yet there is nothing remotely typical when it comes to China’s Bubble. Instead of caution, lenders have looked to residential lending as a preferred (versus business) means of achieving government-dictated lending targets. Failing to learn from the dreadful U.S. experience, Beijing has used an inflating housing Bubble to compensate for structural economic shortcomings (i.e. manufacturing over-capacity). This is precariously prolonging “Terminal Phase” excess.

The Institute for International Finance is out with updated global debt data. In the public interest, they should make this data and their report available to the general public.

January 16 – Financial Times (Jonathan Wheatley): “Emerging-market companies have gorged on debt. Slower global growth and higher funding costs will make servicing that debt harder, just as the amount coming due this year reaches a record high. The result? Less investment for growth and yet more borrowing. These are some of the concerns raised by the Institute of International Finance… as it published its quarterly Global Debt Monitor… The world is ‘pushing at the boundaries of comfortably sustainable debt,’ says Sonja Gibbs, managing director at the IIF. ‘Higher debt levels [in emerging markets] really divert resources from more productive areas. This increasingly worries us.’ The IIF’s data show total global debt — owed by households, governments, non-financial corporates and the financial sector — at $244tn, or 318% of gross domestic product at the end of September, down from a peak of 320% two years earlier. In some areas, though, borrowing is rising. Of particular concern is the non-financial corporate sector in emerging markets (EMs), where debts are equal to 93.6% of GDP. That is more than among the same group in developed markets, at 91.1% of GDP.”

January 16 – Washington Post (Robert J. Samuelson): “Government debt has tripled from $20 trillion in 2000 to $65 trillion in 2018, rising as a share of GDP from 55% to 87%. Household debt has increased over the same years, from $17 trillion to $46 trillion (from 44% to 60% of GDP). Finally, nonfinancial corporate debt rose from $24 trillion to $73 trillion (71% of GDP to 92%)… According to the data from the IIF, emerging-market borrowers face $2 trillion of maturing debt in 2019, with about a quarter of those loans made in dollars (most of the rest are in local currency). To avoid default, borrowers must somehow raise those dollars, either from a new loan or from other sources.”

January 16 – Barron’s (Reshma Kapadia): “A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020. Most of the redemptions in 2019 will be outside of the financial sector, mainly from large corporate borrowers in China, Turkey, and South Africa. The question will be if they can refinance the debt…”

Considering the unprecedented global debt backdrop, it’s difficult for me to believe last year’s corrections went far in resolving deep structural issues throughout the emerging markets - and for the global economy more generally. “A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020…” “…Borrowers face $2 trillion of maturing debt in 2019, with about a quarter of those loans made in dollars.”

Positive headlines from Washington and Beijing engender optimism that a U.S./China trade deal is coming together. One can assume President Trump yearns for those morning Tweets lauding record stock prices. President Xi certainly has ample motivation for a deal to goose Chinese markets and the increasingly vulnerable Chinese economy.

A deal would be expected to boost U.S., Chinese and global equities. It will be curious to see how long Treasury bonds can observe rallying risk markets before turning nervous. So far, Treasuries, bunds and JGBs have been curiously tolerant. If the risk markets rally gains momentum, I would expect flows to be drawn out of the safe havens. A jump in global yields – perhaps accompanied by a resurgent dollar – could prove challenging for the fragile emerging markets.

Pondering the massive pool of unstable global speculative finance, I wonder how both EM and global corporate Credit will trade in the event of a more sustained recovery in global equities and sovereign yields. Bear market rallies feed optimism and perceptions of abundant liquidity. But I believe the global liquidity backdrop has fundamentally deteriorated. This predicament, however, is completely concealed during rallies – only to reemerge when the buyers’ panic runs its course and selling resumes. It would not be surprising to see liquidity issues resurface in EM currencies and debt markets. In general, the more intense the counter-trend rallies the greater the vulnerability to sharp market reversals and a return of illiquidity.

Fed officials have fallen in line with the Chairman’s cautious language. But I would not totally dismiss “data dependent.” With labor markets unusually tight, a scenario of a trade deal, speculative markets and economic resilience could possibly see the Fed contemplating a shift back to “normalization.” Market pundits were quick to highlight “hawkish” Kansas City Fed President Esther George’s newfound dovishness. Comments from “dovish” Chicago Fed President Charles Evans were as notable: “I wouldn’t be surprised if at the end of the year we have a funds rate that’s a little bit higher than where we are now. That would be associated with a better economy and inflation moving up.” It’s going to be a fascinating year.

For the Week:

The S&P500 jumped 2.9% (up 6.5% y-t-d), and the Dow rose 3.0% (up 5.9%). The Utilities slipped 0.4% (down 0.1%). The Banks surged 7.7% (up 13.7%), and the Broker/Dealers jumped 5.3% (up 11.0%). The Transports rose 4.0% (up 9.2%). The S&P 400 Midcaps gained 3.0% (up 9.3%), and the small cap Russell 2000 increased 2.4% (up 9.9%). The Nasdaq100 advanced 2.8% (up 7.2%). The Semiconductors increased 1.3% (up 6.3%). The Biotechs jumped 2.9% (up 16.1%). With bullion down $6, the HUI gold index sank 5.4% (down 6.1%).

Three-month Treasury bill rates ended the week at 2.35%. Two-year government yields jumped seven bps to 2.62% (up 13bps y-t-d). Five-year T-note yields rose nine bps to 2.62% (up 11bps). Ten-year Treasury yields gained eight bps to 2.79% (up 10bps). Long bond yields rose six bps to 3.10% (up 8bps). Benchmark Fannie Mae MBS yields jumped nine bps to 3.57% (up 7bps).

Greek 10-year yields fell 11 bps to 4.17% (down 18bps y-t-d). Ten-year Portuguese yields added two bps to 1.73% (up 1bp). Italian 10-year yields dropped 12 bps to 2.73% (down 1bp). Spain's 10-year yields fell 10 bps to 1.35% (down 7bps). German bund yields rose two bps to 0.26% (up 2bps). French yields were unchanged at 0.66% (down 8bps). The French to German 10-year bond spread narrowed two to 40 bps. U.K. 10-year gilt yields gained six bps to 1.35% (up 8bps). U.K.'s FTSE equities index increased 0.7% (up 3.6% y-t-d).

Japan's Nikkei 225 equities index gained 1.5% (up 3.3% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.02% (up 1bp y-t-d). France's CAC40 rose 2.0% (up 3.1% y-t-d). The German DAX equities index jumped 2.9% (up 6.1%). Spain's IBEX 35 equities index gained 2.2% (up 6.2%). Italy's FTSE MIB index rose 2.2% (up 7.6%). EM equities were higher. Brazil's Bovespa index jumped 2.6% (up 9.3%), and Mexico's Bolsa gained 1.6% (up 6.2%). South Korea's Kospi index advanced 2.3% (up 4.1%). India's Sensex equities index gained 1.0% (up 0.9%). China's Shanghai Exchange rose 1.7% (up 4.1%). Turkey's Borsa Istanbul National 100 index surged 7.4% (up 7.9%). Russia's MICEX equities index gained 1.2% (up 4.9%).

Investment-grade bond funds saw inflows of $913 million, and junk bond funds posted inflows of $3.284 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates were unchanged near a nine-month low 4.45% (up 41bps y-o-y). Fifteen-year rates slipped a basis point to 3.88% (up 39bps). Five-year hybrid ARM rates rose four bps to 3.87% (up 41bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 4.42% (up 14bps).

Federal Reserve Credit last week was little changed at $4.016 TN. Over the past year, Fed Credit contracted $388bn, or 8.8%. Fed Credit inflated $1.205 TN, or 43%, over the past 323 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $7.6bn last week to $3.403 TN. "Custody holdings" rose $48bn y-o-y, or 1.4%.

M2 (narrow) "money" supply declined $18.7bn last week to $14.505 TN. "Narrow money" gained $684bn, or 4.9%, over the past year. For the week, Currency increased $4.5bn. Total Checkable Deposits fell $14.3bn, and Savings Deposits dropped $20.8bn. Small Time Deposits gained $4.3bn. Retail Money Funds rose $9.0bn.

Total money market fund assets fell $17.4bn to $3.049 TN. Money Funds gained $233bn y-o-y, or 8.3%.

Total Commercial Paper dropped $7.5bn to $1.066 TN. CP declined $53bn y-o-y, or 4.7%.

Currency Watch:

The U.S. dollar index recovered 0.7% to 96.364 (up 0.2% y-t-d). For the week on the upside, the Mexican peso increased 0.2%, the British pound 0.2% and the Canadian dollar 0.1%. For the week on the downside, the New Zealand dollar declined 1.3%, the Swiss franc 1.2%, the Japanese yen 1.2%, the Brazilian real 1.1%, the Swedish krona 1.1%, the euro 0.9%, the Australian dollar 0.7%, the South Korean won 0.5%, the Singapore dollar 0.4%, the Norwegian krone 0.3% and the South African rand 0.1%. The Chinese renminbi declined 0.22% versus the dollar this week (up 1.49% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index gained 2.6% (up 10.4% y-t-d). Spot Gold slipped $5 to $1,282 (down 0.1%). Silver fell 1.6% to $15.399 (down 0.9%). Crude jumped $2.21 to $53.80 (up 19%). Gasoline rose 3.7% (up 12%), and Natural Gas surged 12.4% (up 18%). Copper gained 2.1% (up 3%). Wheat slipped 0.3% (up 3%). Corn increased 0.9% (up 2%).

Market Dislocation Watch:

January 18 – Bloomberg (James Crombie and Gowri Gurumurthy): “HCA Healthcare Inc. swooped into the red-hot U.S. junk bond market Thursday to find booming demand for its debt, allowing it to increase the offering by 50% and lower its yield. Yet the hospital chain is finding little company. Through Thursday, total speculative-grade U.S. bond issuance was just shy of $4 billion. That’s less than half of the $11.2 billion that had been sold by this time last year and the $8.4 billion during the same period in 2017. January is typically a good time for junk-rated companies to tap the bond market.”

January 15 – Reuters (Elizabeth Dilts and Siddharth Cavale): “JPMorgan… missed profit estimates for the fourth quarter as a slump in bond trading revenue overpowered strong consumer loan growth and record revenues. It was the first time JPMorgan Chase, the largest U.S. bank by assets, has underperformed earnings-per-share expectations in 16 quarters, according to Barclays equity analyst Jason Goldberg.”

January 14 – Reuters (Saqib Iqbal Ahmed): “An anonymous trader caused a stir in the U.S. equity options market on Monday with a massive bet that recalled Warren Buffett’s famous wager on global stocks more than a decade ago. The trader sold 19,000 put options on the S&P 500 Index obligating him or her to buy the market benchmark at 2,100 on Dec. 18, 2020, data from… options analytics firm Trade alert showed. As long as the index doesn’t drop more than 22% from its current level of 2,582 by that date, the bet will earn the trader roughly $175 million in premiums.”

January 16 – Bloomberg (Lu Wang and Melissa Karsh): “If December was a crisis of confidence rivaling 2008 for professionals in the stock market, January has been a season of faith restored. Hedge funds, initially leery of the equity bounce that has lifted the S&P 500 by 11%, are showing signs of buying in as the rally endures. Their gross leverage, a measure of industry risk appetite, last week jumped the most since May 2017, client data compiled by Goldman Sachs… showed. The spike in demand for borrowed money is the latest indication of improving sentiment after stocks suffered the worst December since the Great Depression.”

Trump Administration Watch:

January 17 – Wall Street Journal (Ruth Simon): “The longest government shutdown in modern U.S. history is choking the economic lifeblood of many entrepreneurs. The Small Business Administration has stopped approving routine small-business loans that the agency backs to ensure entrepreneurs have access to funds, halting their plans for expansion and repairs and forcing some owners to consider costlier sources of cash.”

January 17 – Reuters (Makini Brice and Jeff Mason): “U.S. Treasury Secretary Steven Mnuchin discussed lifting some or all tariffs imposed on Chinese imports and suggested offering a tariff rollback during trade discussions scheduled for Jan. 30, the Wall Street Journal reported on Thursday, citing people familiar with the internal deliberations.”

January 17 – Reuters (David Shepardson): “U.S. President Donald Trump is likely to move ahead with tariffs on imported vehicles, a move that could prompt the European Union to agree a new trade deal, said Senate Finance Committee Chairman Charles Grassley…”

January 18 – Reuters (David Shepardson and Alexandra Alper): “U.S. President Donald Trump is reviving efforts to win approval for a significant infrastructure plan lasting up to 13 years, two people briefed on the matter said, as the administration seeks to bring a long-stalled campaign promise back to life.”

January 16 – CNBC (Kate Fazzini): “The U.S. Justice Department will pursue a criminal case against Chinese tech giant Huawei for alleged trade secrets theft, according to The Wall Street Journal. The charges revolve around theft of trade secrets related to a robotic device called ‘Tappy’ made by T-Mobile, which was used in testing smartphones, according to the report.”

January 13 – Reuters (Daren Butler and Lesley Wroughton): “The United States and Turkey sparred… over the fate of U.S.-allied Kurdish fighters in Syria, with Washington insisting they not be harmed and Ankara rejecting a perceived U.S. threat to punish Turkey economically if it attacked them. The disagreement, played out in rival tweets, is the latest consequence of U.S. President Donald Trump’s Dec. 19 decision to withdraw U.S. troops from Syria, potentially leaving the Kurdish militia under threat as Turkey weighs a new offensive there… On Sunday, Trump said the United States was starting the pull-out of U.S. forces that were deployed to Syria to help drive Islamic State fighters out of the country… ‘Will attack again from existing nearby base if it reforms. Will devastate Turkey economically if they hit Kurds. Create 20 mile safe zone ... Likewise, do not want the Kurds to provoke Turkey,’ Trump tweeted.”

Federal Reserve Watch:

January 17 – Reuters (Jonathan Spicer and Suzanne Barlyn): “The U.S. economy and labor market are strong with inflation contained, even while financial markets have recently been focused on the risk that global economic growth will slow further, a Federal Reserve governor said… ‘Clearly markets are more attuned currently to downside risks but the core, base case remains very strong’ for the U.S. economy, Randal Quarles, the central bank’s vice chair for supervision, said…”

January 13 – Reuters (Jonathan Spicer): “The Federal Reserve is set to take a ‘patient’ approach to policy decisions this year given there is good U.S. economic momentum but also a slowdown overseas, Fed Vice Chairman Richard Clarida said… ‘We can afford to be patient in 2019, there is good momentum,’ he said on Fox Business Network, adding U.S. central bankers will decide interest rates on a ‘meeting by meeting’ basis in the months ahead.”

U.S. Bubble Watch:

January 14 – CNBC (Jeff Cox): “After years of U.S. companies taking advantage of low interest rates to pile up cheap debt, Wall Street is beginning to take notice of a problem forming. Corporate debt outstanding ended 2018 at just over $9 trillion, a 64% increase over a decade’s time… However, credit quality is showing signs of weakening, with heavily indebted companies already feeling the pinch as the Fed raises rates gradually and global economic conditions start to weaken. The result has been a trickle of warnings from financial experts that the price tag for all that debt is coming due. The latest admonition comes from Jeffrey Gundlach, founder of DoubleLine Capital, who said in a warning… that the debt load is about to become a bigger problem. ‘We are talking about the creation of an ocean of debt,’ Gundlach told Barron’s…, during which he noted that the Fed is engaging in ‘quantitative tightening’ that will create ‘a problem for the stock market.’”

January 16 – Reuters (Pete Schroeder): “Labor markets tightened across the United States as businesses struggled to find workers at any skill level and wages generally grew moderately, the Federal Reserve said… The U.S. central bank’s ‘Beige Book’ report, a snapshot of the economy gleaned from discussions with business contacts, found tight labor markets across all 12 Fed districts, with a majority reporting moderate wage gains. A majority of districts also reported modest-to-moderate price increases, with a number saying higher tariffs had driven up costs.”

January 15 – Reuters (Lucia Mutikani): “U.S. producer prices dropped by the most in more than two years in December as the cost of energy products and trade services fell, adding to signs of tame inflation that may allow the Federal Reserve to be patient about raising interest rates this year… The Labor Department said its producer price index for final demand dropped 0.2% last month after edging up 0.1% in November. That was the first decline since February 2017 and largest decrease since August 2016. In the 12 months through December, the PPI increased 2.5%...”

January 13 – Wall Street Journal (Akane Otani): “The U.S.’s biggest public companies are warning that their earnings may not be as strong as they hoped this year, intensifying pressure on a bull market that has struggled to regain its footing. Firms in the S&P 500 were projected back in September to report fourth-quarter earnings growth of 17% from the year earlier. But dimmer expectations for global growth and disappointing holiday sales have forced many companies to slash their forecasts, pushing the estimated earnings-growth rate for the quarter closer to 11%, according to FactSet. The drop-off in estimates—the steepest since 2017—is the latest sign that U.S. corporations, from retailers and airlines to phone makers, are losing momentum after several quarters of standout growth.”

January 18 – Wall Street Journal (Peter Loftus): “Drugmakers have sharply boosted prices of some older, low-cost prescription medicines amid supply shortages and recalls—in some cases, by threefold and more. At least three sellers of a widely used blood-pressure medication, valsartan, have raised prices since a series of safety-related recalls of the drug by other manufacturers began in the summer of 2018.”

January 17 – Reuters (Richard Leong): “The Philadelphia Federal Reserve said… its barometer on U.S. Mid-Atlantic business activity increased more than forecast in January, suggesting resilience in the region’s manufacturing sector amid trade tensions between China and the United States.”

January 11 – CNBC (Diana Olick): “The government shutdown hasn't completely stopped the flow of stunningly bad housing data. Sales of newly built homes fell 18% in December compared with December of 2017, according to… John Burns Real Estate Consulting… Sales were also down a steep 19% annually in November, according to JBRC's analysts. The firm counts 373 market ratings by local builders overseeing more than 3,500 new home communities, estimated to be 16% of U.S. new home sales. JBRC's figures correlate closely with government readings.”

January 16 – CNBC (Jeff Cox): “Student loan debt is putting a dent in young people’s pockets that is contributing to a much lower level of home ownership over the past decade. Federal Reserve economists studied the impact that the $1.5 trillion in educated-related loans is having on those aged 24 to 32. They found that while it is not the principal contributor to the decline in housing purchases, it is playing a significant role. ‘In surveys, young adults commonly report that their student loan debts are preventing them from buying a home,’ Fed researchers Alvaro Mezza, Daniel Ringo, and Kamila Sommer said in a paper…”

January 17 – CNBC (Jeff Daniels): “California’s housing affordability crisis has made it more difficult for school districts to attract and retain teachers, a large reflection of a problem affecting education systems across the country. The challenge of luring and keeping teachers is notoriously a problem for the San Francisco Bay Area, where housing prices are among the highest in the nation. But it’s become a difficult issue in other areas of the state, as well… ‘The main impacts have been in the Bay Area first and now we’re seeing it more and more in Los Angeles with rising rents,’ said Eric Heins, president of the California Teachers Association… ‘If you think that a one-bedroom apartment is $2,000 to $3,000, that’s pretty much a teachers’ take-home pay for the month…”

January 13 – Reuters (Douglas Busvine): “Chinese foreign direct investment into North America and Europe fell by 73% to a six-year low last year as the United States tightened scrutiny of deals and Chinese restrictions on outbound investment bit, law firm Baker & McKenzie said. The figures reflected the impact of escalating trade and political friction between Washington and Beijing. After taking divestitures into account, net Chinese FDI flows into the United States actually turned negative. Investment into the United States fell by 83% but, by contrast, grew by 80% into Canada.”

January 17 – Reuters (Aishwarya Venugopal): “Sears Holdings Corp Chairman Eddie Lampert won a bankruptcy auction to buy the once iconic U.S. retailer after presenting an improved offer of $5.2 billion, Sears said on Thursday, allowing it to keep its more than 400 stores running.”

China Watch:

January 13 – Reuters (Yawen Chen and Martin Quin Pollard): “China’s exports unexpectedly fell the most in two years in December, while imports also contracted, pointing to further weakness in the world’s second-largest economy in 2019 and deteriorating global demand. Adding to policymakers’ worries, data on Monday also showed China posted its biggest trade surplus with the United States on record in 2018… China’s December exports unexpectedly fell 4.4% from a year earlier, with demand in most of its major markets weakening. Imports also saw a shock drop, falling 7.6% in their biggest decline since July 2016… China’s politically-sensitive surplus with the U.S. widened by 17.2% to $323.32 billion last year, the highest on record going back to 2006…”

January 14 – Bloomberg: “China’s government is turning increasingly to tax cuts as the first line of defense against a slowing economy, as credit data… showed some vindication of its gradual stimulus strategy. Further evidence of the dominance of fiscal measures emerged, as senior policy officials pledged that tax reductions on a ‘larger scale’ are in the pipeline, amid worsening… data. JPMorgan… economists estimate the total impact will be around 2 trillion yuan ($300bn), or 1.2% of gross domestic product. That’s a departure from the infrastructure binges coupled with massive monetary stimulus that were deployed in the aftermath of global financial crisis. Beijing is trying to put a floor under the economic slowdown without another debt blowout…”

January 13 – Reuters (Yilei Sun and Brenda Goh): “Car makers in China will face more fierce competition this year, after a tough 2018 when the world’s biggest auto market contracted for the first time in more than two decades, the country’s top auto industry association said… China car sales fell 13% in December, the sixth straight month of declines, bringing annual sales to 28.1 million, down 2.8% from a year earlier… This was against a 3% annual growth forecast set at the start of 2018…”

January 17 – Financial Times (He Wei): “Chinese private companies may face an even more difficult ride in the domestic bond market in 2019 as billions of renminbi in maturing issuance conspire with reduced risk appetite, threatening an even bigger wave of defaults. Last year’s Rmb151bn ($22.3bn) in defaults made it a banner year for credit events in the domestic corporate bond market. Ordinarily, this would be welcomed: the first renminbi corporate bond default was as recent as 2014 and was a watershed moment for regulators… However, nearly 90% of the defaulted paper in 2018 was issued by private sector companies… The difference in the yields between bonds rated AA+ and the highest triple A rating has narrowed since the beginning of 2018, while the spread of bonds rated AA and below over AA+ bonds has more than doubled… Bond ratings issued by Chinese credit rating agencies are not comparable to those of international peers; nearly 60% of corporate issuers in China have a triple A rating, compared with just two in the US.”

January 14 – Bloomberg: “China asked some state-run enterprises to avoid business trips to the U.S. and its allies and to take extra precautions to protect their devices if they need to travel, according to people familiar… In recent weeks, the State-Owned Assets Supervision and Administration Commission -- a regulatory body that oversees about 100 government-run companies -- has told some firms to only take secure, company-issued laptops meant for overseas use if traveling is necessary, the people said. They said the warning extended to the other countries in the Five Eyes intelligence-sharing pact: the U.K., Canada, Australia and New Zealand.”

January 15 – Bloomberg (Venus Feng and Blake Schmidt): “Four Chinese tycoons transferred more than $17 billion of their wealth into family trusts late last year, underscoring how the rich are scrambling to protect their fortunes from the nation’s newly toughened tax regime… All of the four Hong Kong-listed companies but Sunac cited succession planning as the purpose of the transfers. The ownership structures of all four tycoons involve entities in the British Virgin Islands.

Central Bank Watch:

January 16 – Reuters (Leika Kihara): “Bank of Japan Governor Haruhiko Kuroda said… central banks must carefully evaluate the effects of unconventional monetary policy steps, as their benefits and side-effects could differ from those brought about by conventional policy. Kuroda also said demographic changes in major economies could affect how financial institutions behave, thereby affecting central banks’ policy decisions. ‘As a low interest rate environment persists and credit demands become stagnant amid a declining population, banks might accelerate their search-for-yield activities such as expanding their exposure to overseas assets and increasing loans and investments to firms with higher credit risks,’ he said.”

EM Watch:

January 16 – Financial Times (Jonathan Wheatley): “Emerging-market companies have gorged on debt. Slower global growth and higher funding costs will make servicing that debt harder, just as the amount coming due this year reaches a record high. The result? Less investment for growth and yet more borrowing. These are some of the concerns raised by the Institute of International Finance… as it published its quarterly Global Debt Monitor… The world is ‘pushing at the boundaries of comfortably sustainable debt,’ says Sonja Gibbs, managing director at the IIF. ‘Higher debt levels [in emerging markets] really divert resources from more productive areas. This increasingly worries us.’ The IIF’s data show total global debt — owed by households, governments, non-financial corporates and the financial sector — at $244tn, or 318% of gross domestic product at the end of September, down from a peak of 320% two years earlier. In some areas, though, borrowing is rising. Of particular concern is the non-financial corporate sector in emerging markets (EMs), where debts are equal to 93.6% of GDP. That is more than among the same group in developed markets, at 91.1% of GDP.”

Global Bubble Watch:

January 14 – Bloomberg (William Horobin): “Momentum is easing across the world’s major economies, according to a gauge that the Organization for Economic Co-Operation and Development uses to predict turning points. The Composite Leading Indicator is the latest sign of a synchronized slowdown in global growth, adding to recession warnings sparked by industrial figures in Germany last week and slumping trade figures for China… The indicator, which is designed to anticipate turning points six-to-nine months ahead, has been ticking down since the start of 2018 and fell again in November. The OECD singled out the U.S. and Germany, where it said ‘tentative signs’ of easing momentum are now confirmed.”

January 14 – Financial Times (Kate Beioley): “Last year was a rocky one for stock markets and new investment trusts but a record year for passive funds, with more exchange traded funds (ETFs) listed on the London Stock Exchange in 2018 than in any previous year… Globally, the volume of money held in ETFs in particular has soared. Some $4.6tn was held in ETF assets globally at the end of 2018, according to… consultancy ETFGI, up from less than $100bn at the turn of the century. In the US, that has resulted in passive fund groups such as Vanguard owning a significant volume of the country’s stock markets. Vanguard alone owns at least 5% of 491 stocks out of 500 in the S&P 500… — a fourfold increase since 2010.”

January 16 – Bloomberg (Carrie Hong): “China will likely end Japan’s reign as the world’s second-largest bond market this year, according to Standard Chartered Plc. The mainland’s debt pile will grow 15% to 98 trillion yuan ($14.5 trillion) in 2019… As of the second quarter, the size stood at $12.3 trillion versus Japan’s $13 trillion and only 31% of the U.S. market, it said… The central bank on Wednesday pumped in a net 560 billion yuan into the financial system via open-market operations, the biggest one-day addition on record, to meet seasonal demand… ‘Bond demand is supported by flush interbank liquidity and expectations of more easing,’ Standard Chartered said. ‘The size of China’s bond market may overtake that of Japan by year-end.’ Gross issuance of Chinese onshore bonds is forecast to rise 13% to 49.4 trillion yuan this year.”

January 15 – Financial Times (Mamta Badkar): “A gauge of global policy uncertainty is ‘flashing red’ amid anxiety on Brexit, the US government shutdown and the Sino-American trade war, according to Deutsche Bank. The global economic policy uncertainty index is at record high levels at a time of deepening unrest in British politics ahead of the country’s scheduled exit from the EU on March 29, the trade war between the US and China and a government shutdown in the US that has entered its fourth week.”

January 13 – Financial Times (Lucy Hornby and Chris Giles): “Emma Liu has a good job in Beijing, but she has decided to forgo her normal Giorgio Armani face cream and started buying cheaper sweaters online. Her choices are reverberating in boardrooms around the world. A slowdown in the Chinese economy — and flagging consumer expectations — are clouding the outlook for foreign brands. From VW to Apple, the Chinese economy is now the world’s business. No international brand can safely ignore China’s economic prospects. On a market exchange-rate basis, China accounted for 16% of the global economy in 2018.”

January 17 – Bloomberg (Alexandra Harris): “The benchmark being eyed as a potential replacement for dollar Libor is facing renewed scrutiny after a year-end surge in the market underpinning the new rate. With more volatility possible, Wall Street is increasingly wondering if the nascent Secured Overnight Financing Rate will be up to the task. Last month’s jump in rates on overnight Treasury repurchase agreements -- the market that supports SOFR -- pushed the benchmark higher by almost 70 bps over a two-day span. It has since retreated and was set at 2.43% for Wednesday. But given that both repo and SOFR are also susceptible to swings in Treasury-bill supply, which itself could become more erratic as the U.S. grapples with the reintroduction of the debt ceiling, some market veterans are forecasting further fluctuations ahead. Concerns about SOFR range from a lack of term structure to tepid volumes in derivatives that are tied to it.”

Europe Watch:

January 18 – Financial Times (Valentina Romei): “Growth in eurozone house prices slowed in the third quarter as Italy’s property market worsened while others, such as Portugal, cooled from a double-digit pace at the beginning of the year. Eurozone house prices rose at an annual rate of 4.3% in the three months to September, slower than the 4.5% recorded from the start of the year. The slowdown reflected a deterioration in Italy’s house prices that contracted at an annual rate of 0.8%...”

Brexit Watch:

January 14 – Financial Times (Philip Stafford): “As investors wait for the UK’s vote on the Brexit withdrawal agreement, banks and brokers have already accepted that, from March 29, Europe will be split into two distinct capital markets. For most of them, the priority has been to ensure that EU-based clients have access to crucial market plumbing in London. One example: JPMorgan’s German subsidiary last week became a member of ICE Futures Europe’s clearing house in London, so it can clear credit derivatives for EU customers. EU institutions have been anxious to preserve access to the UK’s clearing houses, which act as go-betweens for buyers and sellers in financial markets. Brussels has said it will issue temporary licences, recognising UK laws as ‘equivalent’ to EU standards, to ensure that Europe’s €660tn derivatives market will function with minimal disruption.”

Fixed-Income Bubble Watch:

January 14 – Wall Street Journal (Juliet Chung and Nicole Friedman): “Utilities have long been considered ultrasafe bets. But PG&E Corp.’s announcement Monday that it will file for bankruptcy is teaching investors that isn’t always true. The Baupost Group LLC, Viking Global Investors LP and BlueMountain Capital Management LLC were among the hedge funds that snapped up shares of PG&E… during the third quarter of 2018, just before the deadliest wildfire in California history triggered an existential crisis for the state’s largest utility. That crisis entered a new phase Monday when PG&E said that it intends to seek chapter 11 bankruptcy protection by the end of the month due to more than $30 billion it faces related to its role in sparking deadly California wildfires in 2017 and 2018.”

January 13 – Wall Street Journal (Russell Gold, Katherine Blunt and Rebecca Smith): “PG&E Corp. equipment started more than one fire a day in California on average in recent years as a historic drought turned the region into a tinderbox. The utility’s unsuccessful efforts to prevent such blazes have put it in a state of crisis. The fires included one on Oct. 8, 2017, when nearly 50-mile-an-hour winds snapped an alder tree in California’s Sonoma County wine country. The tree’s top hit a half-century-old PG&E power line and knocked it into a dry grass field… The line set the grass ablaze, sparking what became known as the Nuns Fire. It was among at least 17 major wildfires that year that California investigators have tied to PG&E. Data from the state firefighting agency, Cal Fire, show the fires together scorched 193,743 acres in eight counties, destroyed 3,256 structures and killed 22 people.”

January 12 – Bloomberg (Hailey Waller and James Ludden): “Jeffrey Gundlach said yet again that the U.S. economy is gorging on debt. …Gundlach took part in a round-table of 10 of Wall Street’s smartest investors for Barron’s. He highlighted the dangers especially posed by the U.S. corporate bond market. Prolific sales of junk bonds and significant growth in investment grade corporate debt, coupled with the Federal Reserve weaning the market off quantitative easing, have resulted in what the DoubleLine Capital LP boss called ‘an ocean of debt.’ The investment manager countered President Donald Trump’s claim that he’s presiding over the strongest economy ever. The growth is debt-based, he said… ‘I’m not looking for a terrible economy, but an artificially strong one, due to stimulus spending,’ Gundlach told the panel. ‘We have floated incremental debt when we should be doing the opposite if the economy is so strong.’”

Leveraged Speculation Watch:

January 18 – Bloomberg (Vincent Bielski): “Investors fled hedge funds as markets plunged in the fourth quarter, pulling $22.5 billion, the most in more than two years. The exodus added to the total withdrawals of $34 billion in 2018, or about 1% of industry assets, according to… Hedge Fund Research.”

January 12 – Financial Times (Chris Flood): “Hedge funds run by GAM, Schroders and BlackRock delivered significant losses in 2018 as declines for stock markets globally and rising US interest rates led to widespread difficulties for alternative managers. Many large hedge funds failed to protect their clients from substantial losses, raising more questions about the performance claims made by some of the investment industry’s best-paid managers. Only 16 hedge funds had reported positive full-year 2018 returns after fees in the latest update from HSBC's alternative investment group for the week to January 4. The HSBC research, which monitors around 450 hedge funds, found a further 169 funds were in positive territory in 2018 but they were yet to report numbers for the full year.”

January 16 – Bloomberg (Yakob Peterseil): “Some of the nimblest hedge-funds that trade volatility are hoping history doesn’t repeat after suffering their worst year in over a decade. Managers famed for posting steady profits from relative-value strategies, which shuffle between long- and short-volatility bets, lost a record 2.5% in 2018… You’d think funds that profit from swings would thrive from crazed markets. But these rarefied players were sunk instead by erratic moves in implied volatility and an outsized spike in U.S. equity angst versus the rest of the world. The question now is whether these obstacles will continue to confound market-neutral trades. ‘Higher volatility is positive, but erratic spikes can prove difficult to navigate for volatility-sensitive strategies,’ strategists Karim Cherif and Georg Weidlich at UBS Global Wealth Management wrote…”

Geopolitical Watch:

January 17 – Reuters (Tim Kelly): “The U.S. Navy has not ruled out sending an aircraft carrier through the Taiwan Strait, despite military technology advances by China that pose a greater threat to U.S. warships than ever before, the chief of U.S. naval operations said…”

January 13 – Reuters (Phil Stewart, Sarah N. Lynch and Doina Chiacu): “The White House’s national security team last fall asked the Pentagon to provide it with options for striking Iran after a group of militants aligned with Tehran fired mortars into an area in Baghdad that is home to the U.S. Embassy, a source familiar with the matter said… The source said that the Pentagon drew up options in response to the request, which was first reported by the Wall Street Journal and which originated from the White House National Security Council led by John Bolton.”

January 17 – Wall Street Journal (Benoit Faucon): “China’s state-run energy giant is making a new approach to strike a $3 billion Iranian oil field, seeking to take advantage of waivers allowed under U.S. sanctions even as two European nations have ended crude purchases... The moves highlight the divergent ways nations are reacting to temporary exemptions from U.S. sanctions on Iran. China’s decision to pursue lucrative deals with Tehran and deepen its presence there contrasts with a retreat by Italy and Greece stemming from fear that financial transactions and physical trade with Iran have become too difficult.”

January 16 – CNBC (Kate Fazzini): “Iranian hackers have congregated since at least 2002 in online forums to share tips on the best ways to create successful cyberattacks. Those conversations have given birth to some of the most significant global cybersecurity incidents, including devastating attacks on Saudi Aramco, attacks against the public-facing websites of large banks and espionage campaigns on a wide range of Western targets, according to new research by cybersecurity intelligence firm Recorded Future.”

Friday Evening Links

[Reuters] Wall Street extends rally on U.S.-China trade optimism

[Reuters] Exclusive: U.S. demands regular review of China trade reform

[Reuters] White House adviser Kudlow says making good progress on China trade talks

[Reuters] Testing times from Beijing to Wall Street

[Bloomberg] Hedge Funds Had Year to Forget in 2018