Friday, October 1, 2021

Weekly Commentary: Inflation Watch

August Personal Consumption Expenditures (PCE) inflation rose to 4.3% y-o-y, the largest gain in 30 years. The S&P CoreLogic National Composite Home Price Index posted a 19.7% y-o-y gain in July – the strongest housing inflation in data back to 1987. Zumper data show national apartment (two-bedroom) rent inflated 13.1% y-o-y, with Zillow national rental prices rising 11.5%. The Bloomberg Commodities Index ended the week with a year-over-year rise of 44.6%. A benchmark United Nations food index inflated 33% over the past year. University of Michigan consumer one-year inflation expectations were down slightly from July’s high to 4.6%, near a 13-year high - and only 0.5% below 40-year highs. Forecasts have September y-o-y consumer price inflation (CPI) at 5.3%, near the high since 1990.

We’ll begin with a Chair Powell comment from his September 22nd press conference:

If you look at the last two or three years before the pandemic hit, you saw, after a lot of long progress, you saw a really strong labor market. And you saw wages at the low end moving up faster than everywhere else. Something that’s great to see. We also saw the lowest unemployment rates for minorities… We saw a really, really healthy set of dynamics. And, by the way, we also -- there was no reason why it couldn’t continue. There were no imbalances in the economy, and then along came the pandemic. We were not, there was nothing in the economy that looked like a buildup of imbalances that could cause a recession. So, I was very much thinking that the country would really benefit from a few more years of this. It would have been -- so we’re all quite eager to get back to that.

This is somewhat confounding. If there were “no imbalances in the economy,” why then did the Fed resume QE in September 2019 – months ahead of the pandemic (with markets near all-time highs and unemployment at 50-year lows)? Federal Reserve Assets have ballooned $4.678 TN over the past two years (107 weeks), of which about $200 billion occurred prior to the Fed’s March 2020 crisis ramp up.

There were clearly worsening fragilities in market structure. It’s a key analytical point that the return of QE was in response to market “imbalances” - most notably instability in the “repo” market, which had clear potential to erupt as a catalyst to prick U.S. and global Bubbles. Recall also that U.S. “repo” market disorder followed on the heels of Chinese money market instability. Reenergized U.S., Chinese and global Bubbles could not have been more vulnerable heading into the pandemic. Their near implosions unleashed global monetary stimulus without precedent.

September 28 – Bloomberg: “China’s central bank governor said quantitative easing implemented by global peers can be damaging over the long term and vowed to keep policy normal for as long as possible. Central banks should try their best to avoid asset purchases because in the long run they will ‘damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard,’ People’s Bank of China’s Governor Yi Gang said… When central banks have to purchase assets, the programs should be in proportion to the size of the market’s trouble, Yi said. The interest rate in some economies have approached or even dipped below zero, he said. ‘China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,’ the governor said.”

I agree with Governor Yi’s astute assessment that QE will “damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard.” As for “China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,” it has me pondering whether the PBOC fully comprehends the scope of the crisis they face.

September 28 – Bloomberg: “China’s central bank injected liquidity into the financial system for a ninth day in the longest run since December as it sought to meet a surge in seasonal demand for cash. The People’s Bank of China pumped in 100 billion yuan ($15.5bn) of cash with 14-day reverse repurchase agreements, resulting in a net injection of 40 billion yuan. The move may also have been aimed at calming jitters fueled by China Evergrande Group’s debt crisis… The central bank has added a total net 750 billion yuan via open market operations since Sept. 17.”

The PBOC injected over $100 billion into China’s financial system in nine days. This no doubt helped stabilize Chinese securities markets, including the increasingly unstable corporate debt market. It also hints at the scope of Chinese “QE” that will be forthcoming as de-risking/deleveraging gains momentum and China’s Bubble collapse accelerates.

Global bond markets have every reason to take notice. After all, the risk of a deflationary Chinese Bubble collapse has helped underpin bond prices in the face of unending massive supply and mounting inflationary pressures. But suddenly an even greater risk has begun to surface: An increasingly disorderly Bubble collapse could force Beijing into aggressive monetary inflation, even as China and the world are in the throes of an inflationary shock.

September 28 – Bloomberg: “The world’s second-biggest economy is caught in the grips of a widening power crisis that’s threatening to stymie growth and further tangle already snarled global supply chains. At least 20 Chinese provinces and regions making up more than 66% of the country’s gross domestic product have announced some form of power cuts, mostly targeted at heavy industrial users. The reasons are two-fold -- record high coal prices are causing power generators to trim output despite soaring demand, while some areas have pro-actively halted electricity flows to meet emissions and energy intensity goals.”

September 30 – Bloomberg (Alfred Cang): “China’s central government officials ordered the country’s top state-owned energy companies -- from coal to electricity and oil -- to secure supplies for this winter at all costs, according to people familiar… The order came directly from Vice Premier Han Zheng… and was delivered during an emergency meeting earlier this week with officials from Beijing’s state-owned assets regulator and economic planning agency, the people said… Blackouts won’t be tolerated, the people said.”

China’s Producer Price Index was up 9.5% y-o-y in August, the high all the way back to 1995 - when the Chinese economy and Credit system had minimal global impact. The nation’s energy crisis now has the potential to prolong what was expected to be a temporary inflationary spike. China will aggressively compete with Europe and others for stretched global energy supplies heading into the winter heating season. Already pressured by acute worldwide supply chain issues, global inflationary pressures will be bolstered by surging energy and related commodities prices, as well as from rising prices for Chinese goods.

September 24 – Associated Press (Christopher Rugaber): “Restaurant and hotel owners struggling to fill jobs. Supply-chain delays forcing up prices for small businesses. Unemployed Americans unable to find work even with job openings at a record high. Those and other disruptions to the U.S. economy… appear likely to endure, a group of business owners and nonprofit executives told Federal Reserve Chair Jerome Powell… The business challenges, described during a ‘Fed Listens’ virtual roundtable, underscore the ways that the COVID-19 outbreak and its delta variant are continuing to transform the U.S. economy… ‘We are really living in unique times,’ Powell said at the end of the discussion. ‘I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people. ... So, it’s a very fast changing economy. It’s going to be quite different from the one (before).’”

It's beginning to sink in that rising inflation is much more than a transitory phenomenon. Persistent supply shocks and inflationary pressures are altering perceptions, attitudes and behaviors. Would panicked drivers have drained UK gas stations dry before the pandemic? Will businesses large and small manage resources (i.e. materials, inventory and labor) differently after confronting prolonged supply-chain and labor shortage nightmares? Will spiking prices for so many things force governments, businesses and consumers to change purchasing habits? And in the latest indication of altered psychology, plastered across the news was the latest clue on hording behavior: “Costco brings back purchase limits on toilet paper, cleaning supplies and more.”

Powell: “I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people.

Well, never have we seen the Fed print $4.7 TN in two years. Never have we seen such concerted global monetary inflation – from the U.S., China, Europe and the “developing” economies.

From The Institute of International Finance’s Q2 Debt Monitor: “Global debt soared to a new record in Q2 2021. Following a slight decline in Q1 2021, the global debt pile increased by some $4.8 trillion in Q2 2021. At a fresh all-time high of $296 trillion, global debt is now more than $36 trillion above the pre-pandemic level… Mature market debt heading higher again – albeit more slowly… The debt buildup was most substantial in the Euro Area. Largely driven by Germany and France, the USD value of total debt in the Euro Area increased by $1.3 trillion to over $56 trillion in Q2… Total debt across emerging markets rose by some $3.5 trillion in Q2 2021, and now stands at nearly $92 trillion – over $15 trillion higher than pre-pandemic level.”

China’s debt levels rising rapidly: With total sectoral debt up by an estimated $2.3 trillion in Q2 to reach an all-time high of over $44 trillion, the pace of China’s debt buildup has been much steeper than in other countries.

Expanding at a blistering (“Terminal Phase of Bubble Excess”) 23% annualized rate, China ended Q2 with a debt-to-GDP ratio of 329% (led by the Non-Financial Corporate sector’s 158%). The U.S. ended Q2 with a debt-to-GDP ratio of 367%, with global debt at 353%. All-Embracing.

Rather than moderating back toward the Fed’s 2% target, inflationary pressures are broadening and accelerating – energy, commodities, housing and food, most conspicuously. Between last week’s press conference and this week’s congressional testimonies, Chair Powell has been peppered with inflation questions. It has become increasingly difficult to both dismiss inflation risk and assert the Fed has the situation under control. Below are a sampling of his responses:

The current inflation spike is really a consequence of supply constraints meeting very strong demand, and that is all associated with the reopening of the economy -- which is a process that will have a beginning, a middle and an end.”

It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse. We see that continuing into next year probably and holding up inflation longer than we had thought.

We have an expectation that high inflation will abate, because we think the factors that are causing it are temporary and tied to the pandemic and the reopening of the economy. These aren’t things that we can control.

We expect that [prices being affected by supply side constrictions] will abate, that they’ll lessen and over time will come back down. Exactly when that will happen is not possible to say, but I would say we should be seeing some relief in coming months and over the course of the first half of next year.

And from the Associated Press (Christopher Rugaber): “Powell has also said that if there were indications that inflation could rise to unsustainable levels, the Fed would hike rates to bring it under control. ‘We just have to balance the two… But I would say our expectation is that inflation will come down and we won’t ultimately face that difficult trade-off of having the two goals in tension.’”

The “two goals in tension” would be stable prices and full employment. Despite an unprecedented 10 million job openings and a 5.2% unemployment rate, Fed officials still assert that the U.S. economy is “far away” from full employment.

September 27 – Reuters (Ann Saphir): “The Federal Reserve’s ‘highest priority’ is to make sure millions of Americans now out of a job can get back to work, Minneapolis Federal Reserve Bank President Neel Kashkari said… ‘Putting Americans back to work…to me that’s our highest priority,’ Kashkari said at the Community Foundations Leading Change Fall Forum, adding that ‘of course’ the Fed will pay close attention to inflation and keep that in check. Recent high readings of inflation do not signal permanently higher inflation, he said: ‘We don’t want to overreact to short-term price movements.’”

I sympathize with the unemployed and underemployed. But at this precarious phase of the cycle, monetary and price stability must be the Fed’s highest priority. Priority must be given to returning stability to a system responsible for the wellbeing of its 330 million citizens. “Money printing” is definitely not in our nation’s best interest, and this runaway experiment in monetary inflation needs to come to an end. Late in the “Terminal Phase” of Bubble wealth redistribution and destruction, our great nation faces greater peril by the day.

Powell: “Of course, if we were to see sustained higher inflation and that were to become a serious concern, I would tell you the FOMC would certainly respond and we would use our tools to ensure that inflation runs at levels that are consistent with our goal.

Higher inflation is in the process of being sustained – and it should today be a serious concern – yet few believe the Fed will actually use their “tools” to suppress it. To begin with, inflation dynamics are not under the Fed’s control. More today than ever before, inflation is a global phenomenon. What's more, a strong case can be made that China has supplanted the U.S.'s traditional commanding role in global inflationary dynamics.

The eminent market and economic analyst Mohammed El-Erian has been at the top of his game. His Friday Bloomberg piece is spot on: “Demand Is Not the Economy’s Problem. Supply Is - Policy Makers and Central Bankers are Stuck in a Mindset From the Last Crisis and Need to Alter Their Thinking.” And appearing Friday morning on Bloomberg TV, Mr. El-Erian made an astute observation: “When it comes to an orderly taper, the window is closing… We’re still buying $120 billion of assets every single month – what we have been buying since the worst of the Covid crisis. Does it make sense in this environment when demand isn’t a problem, when bond markets are wide open?”

It makes no sense. From my analytical perspective, the window has closed. Bubble fragilities preclude an orderly taper. What’s more, our focus on the Fed is too narrow. The window to a “tapering” of global monetary inflation is at this point likely shut as well. Whether they realize it yet or not, the PBOC has likely commenced what will prove to be massive ongoing liquidity injections. I’m also skeptical that the Fed, ECB, Bank of Japan and the Bank of England will have the gumption to wind down their QE programs.

China is providing an early glimpse of the serious predicament about to envelop the world: liquidity injections necessary to keep Bubbles from imploding will come concurrently with problematic supply shocks, acute economic imbalances, and destabilizing price pressures. At the end of the day, I don’t see the “two goals in tension” being price stability vs. full employment. The unfolding conflict is poised to match general price stability against market stability. If the Fed and others are, here in the ninth inning, determined to sustain securities and asset price Bubbles, the world faces the prospect of momentous Monetary Disorder and inflationary mayhem.

Key Issue: With inflation raging and the Republicans breathing down their necks, will the Fed flinch when faltering markets, in a raving tantrum, demand another quick Trillion or two? So many facets of the current environment point to monumental changes in policy, financial and market backdrops. The halcyon days, where the consequences of egregious monetary inflation primarily manifest in surging securities and asset prices, are drawing to a close.

Could the environment possibly encompass a greater litany of uncertainties? And I would expect markets to become only more volatile and unstable – equities, corporate Credit, commodities, currencies and derivatives more generally. Over the past two weeks, local currency bond yields have surged 121 bps in Turkey, 54 bps in Romania, 42 bps in Chile, 36 bps in Mexico, 27 bps in South Africa and 26 bps in Russia. In the currencies, the Chilean peso is down 2.5%, the Turkey lira 2.5%, the Hungarian forint 2.3%, and the Mexican peso 2.1%.

Pain in “carry trade” leveraged speculation is intensifying, with the U.S. dollar index jumping to one-year highs - likely signaling de-risking/deleveraging dynamics have gained important momentum. EM – including China – sovereign CDS have moved sharply higher. In short, “risk off” contagion has jumped from China’s “periphery” to the global “periphery,” with “core” Chinese and U.S. markets increasingly vulnerable.

Senator Pat Toomey: “We’re now seeing rates of inflation considerably higher than the Fed projected and it’s hurting businesses, consumers, and workers. And you don’t have to just take my word for it. Here’s what the CFO of one of the biggest retailers in America, Costco, said last week, and I quote, ‘Inflationary factors abound. High labor costs, higher freight costs, higher transportation demand, along with container shortages and port delays, increased demand in certain product categories, various shortages of everything from computer chips to oils and chemicals.’ To address this threat, I urge the Fed to accelerate the process of normalizing monetary policy so that it does not fall further behind the curve in responding to the inflation that is already with us."

For the Week:

The S&P500 dropped 2.2% (up 16.0% y-t-d), and the Dow fell 1.4% (up 12.2%). The Utilities lost 2.0% (up 1.7%). The Banks jumped 2.5% (up 36.2%), while the Broker/Dealers slipped 0.2% (up 25.8%). The Transports declined 0.6% (up 13.9%). The S&P 400 Midcaps dipped 0.6% (up 16.3%), and the small cap Russell 2000 slipped 0.3% (up 13.5%). The Nasdaq100 dropped 3.5% (up 14.8%). The Semiconductors sank 5.6% (up 16.7%). The Biotechs fell 4.0% (down 1.2%). While bullion recovered $11, the HUI gold index declined 0.9% (down 23.8%).

Three-month Treasury bill rates ended the week at 0.03%. Two-year government yields slipped a basis point to 0.27% (up 14bps y-t-d). Five-year T-note yields declined two bps to 0.93% (up 57bps). Ten-year Treasury yields added one basis point to 1.46% (up 55bps). Long bond yields rose four bps to 2.03% (up 38bps). Benchmark Fannie Mae MBS yields declined three bps to 1.91% (up 56bps).

Greek 10-year yields gained two bps to 0.83% (up 21bps y-t-d). Ten-year Portuguese yields were unchanged at 0.32% (up 29bps). Italian 10-year yields rose three bps to 0.81% (up 27bps). Spain's 10-year yield added a basis point to 0.42% (up 38bps). German bund yields were unchanged at negative 0.22% (up 35bps). French yields increased one basis point to 0.12% (up 46bps). The French to German 10-year bond spread widened about one to 34 bps. U.K. 10-year gilt yields jumped eight bps to 1.00% (up 81bps). U.K.'s FTSE equities index slipped 0.3% (up 8.8% y-t-d).

Japan's Nikkei Equities Index sank 4.9% (up 4.8% y-t-d). Japanese 10-year "JGB" yields were little changed at 0.06% (up 4bps y-t-d). France's CAC40 fell 1.8% (up 17.4%). The German DAX equities index dropped 2.4% (up 10.5%). Spain's IBEX 35 equities index declined 0.8% (up 9.0%). Italy's FTSE MIB index fell 1.4% (up 15.2%). EM equities were mostly lower. Brazil's Bovespa index slipped 0.3% (down 5.1%), while Mexico's Bolsa was little changed (up 15.9%). South Korea's Kospi index dropped 3.4% (up 5.1%). India's Sensex equities index lost 2.1% (up 23.1%). China's Shanghai Exchange fell 1.2% (up 2.7%). Turkey's Borsa Istanbul National 100 index rose 1.2% (down 5.1%). Russia's MICEX equities gained 1.0% (up 24%).

Investment-grade bond funds saw inflows of $3.064 billion, and junk bond funds posted positive flows of $196 million (from Lipper).

Federal Reserve Credit last week declined $13.1bn to $8.425 TN. Over the past 107 weeks, Fed Credit expanded $4.699 TN, or 126%. Fed Credit inflated $5.614 Trillion, or 200%, over the past 464 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week increased $0.7bn to $3.485 TN. "Custody holdings" were up $72.5bn, or 2.1%, y-o-y.

Total money market fund assets jumped $29bn to $4.544 TN. Total money funds increased $140bn y-o-y, or 3.2%.

Total Commercial Paper slipped $3.1bn to $1.185 TN. CP was up $240bn, or 25.3%, year-over-year.

Freddie Mac 30-year fixed mortgage rates surged 13 bps to a 14-week high 3.01% (up 13bps y-o-y). Fifteen-year rates rose 13 bps to 2.28% (down 8bps). Five-year hybrid ARM rates gained five bps to 2.48% (down 42bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates up 15 bps to an almost six-month high 3.20% (up 9 bps).

Currency Watch:

September 28 – Reuters: “China's regulators are tightening control over the inner workings of its currency market, pressuring banks to trade less and in smaller ranges, two banking sources told Reuters, as part of a sweeping push to curb speculation. The moves follow recent efforts at curtailing financial risks that include dampening commodity price rises, banning cryptocurrency transactions and restricting property speculation. And they bring the campaign deeper into day-to-day operations on the dealing desks of a $30 trillion market. It is also the latest example of scrutiny focused on foreign exchange, which analysts said might be aimed at tightening the leash on the yuan at a sensitive time when U.S. policymakers prepare to withdraw monetary stimulus and China seems poised to add more.”

For the week, the U.S. Dollar Index gained 0.8% to a one-year high 94.04 (up 4.6% y-t-d). For the week on the upside, the South African rand increased 0.5%. For the week on the downside, the Mexican peso declined 1.9%, the Swedish krona 1.1%, the euro 1.1%, the British pound 1.0%, the South Korean won 1.0%, the New Zealand dollar 1.0%, the Swiss franc 0.7%, the Brazilian real 0.6%, the Norwegian krone 0.5%, the Japanese yen 0.3%, the Singapore dollar 0.3% and the Australian dollar 0.1%. The Chinese renminbi gained 0.33% versus the dollar (up 1.28% y-t-d).

Commodities Watch:

The Bloomberg Commodities Index jumped 2.0% (up 29.3% y-t-d). Spot Gold recovered $11 to $1,761 (down 7.3%). Silver rallied 0.5% to $22.54 (down 14.6%). WTI crude surged $1.90 to $75.88 (up 56%). Gasoline rose 2.9% (up 60%), and Natural Gas surged 9.3% (up 121%). Copper dropped 2.3% (up 19%). Wheat jumped 4.4% (up 18%). Corn gained 2.8% (up 12%). Bitcoin rallied $5,483, or 12.8%, this week to $48,402 (up 67%).

Coronavirus Watch:

September 26 – Reuters (Victor Jack): “The COVID-19 pandemic reduced life expectancy in 2020 by the largest amount since World War Two, according to a study… by Oxford University, with the life expectancy of American men dropping by more than two years. Life expectancy fell by more than six months compared with 2019 in 22 of the 29 countries analysed in the study, which spanned Europe, the United States and Chile. There were reductions in life expectancy in 27 of the 29 countries overall.”

Market Mania Watch:

September 30 – Financial Times (Eric Platt, Joe Rennison, Nicholas Megaw and Siddharth Venkataramakrishnan): “Capital markets have never been so hot. Companies across the globe have tapped investors for trillions of dollars in debt and equity this year, taking advantage of rallying stock markets and rushing to exploit the easiest borrowing conditions in decades before the Federal Reserve and other major central banks start to withdraw their support. The feeding frenzy, including more than $1tn worth of share sales and nearly $4tn of bond issuance, involves the biggest names in the corporate world… And even though bankers are racing to ink loans and finalise initial public offerings, the backlog of deals still to be done remains daunting… Some $8.7tn has been raised across equity sales, bond offerings and loan deals — including loans syndicated and held by banks — at a record pace, according to… Refinitiv.”

September 25 – New York Times (Ron Lieber): “Robinhood, the free stock-trading app with 21 million active users and counting, is about to hit the road for a college coffeehouse tour to drum up new customers. Now where have we heard this one before? Ah, yes, the credit card industry. The campus antics that the card companies got up to two decades ago were so egregious that they helped lead to a 2009 federal law that made it harder for anyone under 21 to get their products in the first place. There are some important differences… But here’s what they have in common: Both products are habit-forming, and if you get in over your head, the ramifications can be costly.”

September 28 – Bloomberg (Elaine Chen): “One of Vanguard’s exchange-traded funds has just taken the crown for the biggest annual inflow, giving the issuer an edge over competitors within the $6.8 trillion U.S. industry. Investors have poured $41.1 billion into the Vanguard S&P 500 ETF (ticker VOO) so far this year, surpassing the 2008 record of $39.5 billion held by State Street’s SPDR S&P 500 ETF Trust…”

September 28 – Bloomberg (Lu Wang): “The S&P 500 Index has managed to stay above its recent bottom amid a renewed selloff, but Bank of America Corp. is urging investors to keep their guard up. The plunge in the benchmark on Sept. 20 and the subsequent swift rebound at the end of last week reinforced the idea that 2021 is a perfect year to buy the dip. On average, the S&P has taken 4.6 days to fully recover from a significant drawdown, which BofA defines as a two-sigma event. That’s the fastest since the firm’s data began in 1928. A sign of market resilience? Maybe. But to BofA strategists including Gonzalo Asis and Benjamin Bowler, it’s really evidence of market fragility. The dip-buying mentality prevailing among investors sets the stage for bigger trouble, they warn…”

September 29 – Reuters (Krystal Hu and Manya Saini): “A new trading cards business launched by sports retailer Fanatics has raised $350 million in fresh capital from new and existing investors at a valuation of $10.4 billion, according to… documents reviewed by Reuters. The latest financing round was led by existing investors Silver Lake and Insight Partners, the source said.”

Market Instability Watch:

September 26 – Financial Times (Steve Johnson): “The trillions of dollars that have flooded into passive funds in recent years have inflated valuations, radically reshaping the US stock market and insulating it from the threat of a sustained bear market, research has claimed. Vincent Deluard, global macro strategist at brokerage StoneX, argued that the unprecedented flows have led to structurally higher stock valuations disconnected from company fundamentals, benefited large and growth stocks at the expense of value and small-cap shares and resulted in fewer, and shorter lived, market corrections. ‘A preponderance of evidence suggests that the rise of passive has played a major role in the stock market bubble of the past decade,’ Deluard said. ‘If the rise of passive is the main cause for this bull market, a sustained bear market can only occur if the passive sector shrinks.’”

September 27 – Bloomberg (Edward Bolingbroke): “The latest burst higher in Treasury yields could get an extra push from hedging flows linked to mortgage-backed securities and a cold shoulder from Japanese investors, often known to buy the dip in the U.S. government bond market. The climb in yields since last week’s Federal Reserve meeting ‘has brought the mortgage universe closer to the point of peak negative convexity,’ Morgan Stanley agency MBS strategists wrote... Negative-convexity hedging involves selling Treasuries to compensate for a scenario where rising yields lengthen the duration of mortgage debt as refinancings slow.”

September 28 – Bloomberg (Laura Benitez and Tasos Vossos): “When investors wanted to flee the fallout from China Evergrande Group, those in Europe’s 500-billion euro ($584bn) high-yield bond market found some of the normal escape routes blocked. As trading stagnated in the market for the region’s riskiest bonds, investors were reminded of the problem of buying illiquid securities from an array of sometimes small unlisted companies. When it came to the crunch, credit derivatives indexes offering insurance on junk bonds proved the best avenues to unload positions, according to Jochen Felsenheimer, managing director at XAIA Investment in Munich who trades CDS and bonds. ‘The CDS market looks much more like a market should look like,’ Felsenheimer said… ‘Bond markets rather look like a supermarket after Brexit.’”

October 1 – Bloomberg (Lilian Karunungan): “A strengthening dollar is reducing the appeal of emerging-market carry trades, which handed investors their biggest monthly loss in 18 months. An index that measures returns from borrowing in dollars and investing the funds in eight high-yielding currencies, such as the Turkish lira, Brazilian real and Indonesian rupiah, lost 3.3% in September, the most since March 2020. The Bloomberg Cumulative FX Carry Trade Index is now down 1.2% this year.”

September 27 – Bloomberg (Justina Lee): “The quant revolution in fixed income is here at long last, if the latest Invesco Ltd. poll is anything to go by. With the work-from-home era fueling a boom in electronic trading, the majority of investors in a $31 trillion community say they now deploy factor strategies in bond portfolios. It’s the latest evidence the systematic crowd are running wild in a market long seen as hostile to their allocation methods. The strategies have been put into practice by 55% of respondents compared with 40% last year.”

October 1 – Bloomberg (Finbarr Flynn): “Global bond investors are facing their worst year at this point in more than two decades after a selloff in September triggered by hawkish statements from central bankers including Federal Reserve Chair Jerome Powell. The Bloomberg Global Aggregate Index, a benchmark for government and corporate debt, has lost 4.1% so far this year, the biggest slump for any such period since at least 1999.”

September 29 – Reuters (Pete Schroeder and Michelle Price): “Wall Street firms are sounding alarm bells and dusting off contingency plans as fears grow that Congress may fail to reach a deal to raise the country's debt limit in time, executives said… ‘If there were to be some kind of failure to pay Treasury securities, we honestly don't know what would happen,’ said Rob Toomey, managing director and associate general counsel for capital markets at the Securities Industry and Financial Markets Association (SIFMA).”

Inflation Watch:

October 1 – Associated Press (Christopher Rugaber and David McHugh): “Inflation has reached new highs in the United States and Europe as rising energy prices and supply bottlenecks restrain an economic recovery from the pandemic in both economies. The U.S. Commerce Department reported Friday that prices rose 4.3% in August from a year earlier. While only lightly higher than the previous month, it was still the largest annual increase since 1990. Energy costs have jumped nearly 25% in the past year, while supply backlogs have pushed up prices for cars, furniture, and appliances.”

September 28 – Yahoo Finance (Amanda Fung): “Home price growth in the U.S. soared to new highs in July. Standard & Poor’s said… its S&P CoreLogic Case-Shiller national home price index posted a 19.7% annual gain in July, up from 18.7% in June — the fourth straight month in which the growth rate set a record. The 20-City Composite posted a 19.9% annual gain, up from 19.1% a month earlier… ‘The National Composite Index marked its fourteenth consecutive month of accelerating prices with a 19.7% gain from year-ago levels, up from 18.7% in June and 16.9% in May,’ said Craig J. Lazzara, managing director and global head of index investment strategy at S&P Dow Jones... ‘The last several months have been extraordinary not only in the level of price gains, but in the consistency of gains across the country.’”

September 29 – Bloomberg (Alex Tanzi): “The pace of rent increases is heating up in the U.S. Rent data for the past two months show no sign yet of the usual seasonal dip at this time of year, following peaks early in the summer… A Zillow… index based on the mean of listed rents rose 11.5% in August from a year earlier, with some cities in Florida, Georgia and Washington state seeing increases of more than 25%. ‘To have double digit rent growth over the course of a year and a half is a shocking level of growth, especially considering the vast majority of it has come in the last 9 months,’ according to the Zumper National Rent report. Since the start of the pandemic, the median rent for a two-bedroom apartment has soared 13.1% to $1,663, Zumper data show.”

September 28 – Bloomberg: “China’s power-hungry commodities producers are in Beijing’s firing line, but the government’s efforts to stave off a full-blown energy crisis are also fueling rallies in everything from fertilizer to silicon. Production of metals from aluminum to steel has been spluttering for months as power curbs have intensified across key industrial provinces. Now factories producing high-end goods are starting to feel the pinch too, creating burgeoning risks to the nation’s economic growth. What’s worse, the energy crunch is spreading to a sector that alarms Beijing the most: food.”

October 1 – Bloomberg (Elena Mazneva and Anna Shiryaevskaya): “The deepening global energy crunch has pushed natural gas in Europe and Asia to the equivalent of about $190 a barrel, something the oil market has never seen. Both regions saw fresh records in the heating and power-generation fuel this week as utilities rush to restock lower-than-average inventories ahead of winter in the northern hemisphere, while alternatives -- like coal -- are also in short supply.”

September 27 – Bloomberg: “China’s power crisis looks set to spur it to import more coal from a wider range of producers, putting it into competition with European and Indian buyers that are also snapping up more of the dirtiest fossil fuel. More than two-thirds of China’s electricity comes from coal-fired plants and, while more than 90% of the fuel it uses is mined locally, it’s difficult to raise local output at short notice. Looking offshore is the easier option, but that’s been complicated somewhat by Beijing’s decision to ban imports from Australia -- the world’s second-biggest exporter -- late last year. It isn’t easy to ramp up local coal supply, given the low investment in new mines in recent years, Bloomberg Intelligence analyst Michelle Leung said…”

September 28 – Bloomberg (Peter Millard, Fabiana Batista and Leslie Patton): “No country on Earth puts more breakfasts on kitchen tables than Brazil. The farms that dot the vast plains and highlands that rise above the Atlantic coast produce four-fifths of the world’s orange juice exports, half of its sugar exports, a third of coffee exports and a third of the soy and corn used to feed egg-laying hens and other livestock. So when the region’s crops were scorched and then frozen this year by a devastating one-two punch fueled by climate change — the worst drought in a century followed by an unprecedented Antarctic front that repeatedly coated the land in thick frost — global commodity markets shook. The cost of Arabica beans soared 30% over a six-day stretch in late July; orange juice jumped 20% in three weeks; and sugar hit a four-year high in August.”

September 28 – Bloomberg (Marvin G. Perez): “Cotton futures raced past $1 a pound for the first time in nearly a decade as adverse weather and shipping snags threaten supplies, driving up costs for clothing around the world. In New York, the contract for December delivery climbed to $1.005 a pound, the highest since November 2011. The price has surged 28% this year as torrid demand, especially from China, combines with disruptions to supplies from the pandemic and logistics chaos spurred by rising freight costs.”

Biden Administration Watch:

October 1 – Associated Press (Lisa Mascaro): “Despite a long night of frantic negotiations, Democrats were unable to reach an immediate deal to salvage President Joe Biden’s $3.5 trillion government overhaul, forcing leaders to call off promised votes on a related public works bill. Action is to resume Friday. Speaker Nancy Pelosi had pushed the House into an evening session and top White House advisers huddled for talks at the Capitol as the Democratic leaders worked late Thursday to negotiate a scaled-back plan that centrist holdouts would accept. Biden had cleared his schedule for calls with lawmakers, but it appeared no deal was within reach, particularly with Democratic Sen. Joe Manchin. Manchin refused to budge, the West Virginia centrist holding fast to his earlier declaration that he was willing to meet the president less than halfway — $1.5 trillion.”

September 28 – Financial Times (Colby Smith): “Treasury secretary Janet Yellen has warned that the US risks running out of money by October 18 as Senate Republicans blocked attempts to increase the borrowing limit and stave off a government shutdown. ‘At that point, we expect Treasury would be left with very limited resources that would be depleted quickly,’ she said in a letter to congressional leaders. ‘It is uncertain whether we could continue to meet all the nation’s commitments after that date. We know from previous debt limit impasses that waiting until the last minute can cause serious harm to business and consumer confidence, raise borrowing costs for taxpayers, and negatively impact the credit rating of the United States for years to come,’ she wrote.”

Federal Reserve Watch:

October 1 – Bloomberg (Craig Torres): “Federal Reserve Vice Chair Richard Clarida traded between $1 million and $5 million out of a bond fund into stock funds one day before Chair Jerome Powell issued a statement flagging possible policy action as the pandemic worsened, his 2020 financial disclosures show.”

September 29 – Reuters (Howard Schneider): “Resolving ‘tension’ between high inflation and still-elevated unemployment is the most urgent issue facing the Federal Reserve right now, Fed Chair Jerome Powell said…, acknowledging the central bank’s two goals are in potential conflict. ‘This is not the situation that we have faced for a very long time and it is one in which there is a tension between our two objectives... Inflation is high and well above target and yet there appears to be slack in the labor market,’ Powell said…, an apparent reference to the 1970s bout of U.S. ‘stagflation’ that combined high unemployment and fast-rising prices… ‘Managing through that over the next couple of years is the highest and most important priority and it is going to be very challenging,’ Powell said…”

September 29 – Bloomberg (Matthew Boesler): “Federal Reserve Chair Jerome Powell and his counterparts at the European Central Bank, Bank of Japan and Bank of England voiced cautious optimism… that supply-chain disruptions lifting inflation rates around the world would ultimately prove temporary. ‘The current inflation spike is really a consequence of supply constraints meeting very strong demand, and that is all associated with the reopening of the economy -- which is a process that will have a beginning, a middle and an end,’ Powell said…”

September 27 – Reuters (Howard Schneider and Ann Saphir): “U.S. Federal Reserve officials including one influential board member on Monday tied reduction in the Fed's monthly bond purchases to continued job growth, with a September employment report now a potential trigger for the central bank’s bond ‘taper.’ The Fed last week said a reduction in its $120 billion in monthly bond purchases could be warranted ‘soon,’ and Fed Chair Jerome Powell… said it would take one more ‘decent’ jobs report to set the process in motion. But while some policymakers have said they already feel bond purchases should be cut, those speaking Monday stopped short of saying the economy had fully cleared the Fed's benchmark for a bond taper.”

September 27 – Reuters (Jonnelle Marte, Ann Saphir and Howard Schneider): “Two Federal Reserve officials who came under scrutiny for investment trades they made last year announced their retirements…, in a controversy that has already sparked a planned review of the Fed's ethics rules. Dallas Fed President Robert Kaplan said he will retire on Oct. 8, citing the ‘distraction’ of the controversy over his investments, while Boston Fed President Eric Rosengren said he will retire on Sept. 30, pointing to a long-term health condition… Kaplan and Rosengren had faced calls to step down for investment trades made in 2020, a year in which the Fed took unprecedented action to steady the economy, while news of the transactions, revealed in recent financial disclosures, raised questions about the effectiveness of Fed trading guidelines for policymakers.”

September 28 – Reuters (Howard Schneider): “The Federal Reserve should let its roughly $8 trillion balance sheet shrink next year as soon as it winds down a bond purchase program, St. Louis Federal Reserve president James Bullard said, cautioning high inflation may require more aggressive steps by the central bank including two interest rate hikes in 2022… Bullard said he now expects inflation to remain at 2.8% through next year, well above the central bank's 2% target… While Bullard said he agrees inflation will ease somewhat on its own, he said it will take more central bank effort to ensure that happens smoothly over time, and never requires the sort of restrictive policies that could imperil the current expansion. Inflation ‘is going to stay above target over the forecast horizon. That is a good thing. We are delivering on our...framework,’ Bullard said…”

September 27 – Bloomberg (Matthew Boesler): “The U.S. central bank needs to keep monetary policy easy to raise the public’s inflation expectations even after the current bout of inflationary pressures from supply-chain disruptions fades, Federal Reserve Bank of Chicago President Charles Evans said. ‘I do not think the supply-side-induced transitory surge in inflation we are seeing today will be enough to do the trick,’ Evans said… ‘I expect that we will need a period of sustained, monetary-policy-induced overshooting of 2% inflation to boost long-run inflation expectations enough to deliver on our mandated goals.’”

September 28 – CNBC (Jeff Cox): “Sen. Elizabeth Warren charged… that Federal Reserve Chairman Jerome Powell has led an effort to weaken the nation’s banking system, and she vowed to oppose his renomination. In remarks made during a hearing before the Senate Banking Committee, the Massachusetts Democrat cited several instances where she said the Powell Fed has watered down post-financial crisis bank regulations. ‘Your record gives me grave concerns. Over and over, you have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed, and it’s why I will oppose your renomination,’ Warren said.”

U.S. Bubble Watch:

September 28 – Bloomberg (Lucia Mutikani): “Expectations for slower GDP growth were reinforced by a separate report from the Commerce Department… showing the goods trade deficit rose 0.9% to $87.6 billion in August as businesses imported more products to replenish inventories. Trade has subtracted from GDP growth for four straight quarters. Imports of goods climbed 0.8% to $236.6 billion, lifted by consumer goods and industrial supplies. But imports of food, capital goods and motor vehicles fell.”

September 28 – Reuters (Lucia Mutikani): “U.S. consumer confidence unexpectedly weakened in September as soaring COVID-19 infections deepened concerns about the economy's near-term prospects. The Conference Board said… its consumer confidence index dropped to a reading of 109.3 this month from 115.2 in August. That was the third straight decline and the lowest level since February.”

September 30 – Reuters (Lucia Mutikani): “The number of Americans filing new claims for jobless benefits rose further last week amid another increase in California, but the labor market recovery remains intact, with unemployment rolls steadily shrinking in mid-September. Still, the third straight weekly increase in jobless claims… could raise concerns that slowing economic growth could persist beyond the third quarter… Initial claims for state unemployment benefits rose 11,000 to a seasonally adjusted 362,000 for the week ended Sept. 25… Unadjusted claims, which economists say offer a better read of the labor market, fell 8,326 to 298,255 last week. Claims in California increased 17,978 last week, adding to the 17,218 rise in the prior week.”

September 27 – Reuters (Lucia Mutikani): “New orders and shipments of key U.S.-made capital goods increased solidly in August amid strong demand for computers and electronic products, keeping business spending on equipment on track for another quarter of robust growth. The sustained strength in business investment is expected to limit the hit on economic growth from an anticipated slowdown in consumer spending in the third quarter as the boost from fiscal stimulus fades and COVID-19 infections flare up. Demand for goods is being driven by businesses desperate to replenish inventories, but strained supply chains remain a challenge.”

September 25 – Financial Times (Obey Manayiti): “In more than 30 years in the retail business, said Ken Giddon, ‘I have never seen anything like this before.’ Rothmans, the men’s clothing business he runs with his brother, not only survived the pandemic but is expanding from three New York outlets to four. Having found a competitive deal on a new location, everything is set for the opening, except that Giddon cannot find the 10 people he needs to staff the new shop. Two prospective employees promised to join, only to drop out. Giddon’s challenge is one being felt by employers in industries from nursing homes to trucking companies, after 18 months in which health fears, childcare shortages and enhanced unemployment benefits kept millions of Americans out of the workforce. But the shortage of people willing to work in stores and warehouses is particularly acute.”

September 29 – Bloomberg (David Wethe): “America’s oil producers are boosting output at a slower place as record costs hammer the shale patch, according to a survey of industry executives. Out of 47 responding companies that supply producers with everything from software to workers, just one reported lower input costs in the third quarter, according to… the Federal Reserve Bank of Dallas. Hiring has become a big headache for oilfield service companies trying to meet increased demand from explorers. Of those reporting difficulties in attracting workers, 70% blamed it on a lack of qualified applicants. Wages are up 20%, and companies are poaching employees from competitors…”

Fixed-Income Bubble Watch:

September 28 – Bloomberg (Lisa Lee and Davide Scigliuzzo): “Ultra low interest rates globally have sparked a new credit cycle for the leveraged loan market with little expected to bog it down any time soon. That’s the sentiment of some of the biggest names in the $1.2 trillion market who spoke at a Bloomberg News leveraged loan conference... While risk-off sentiment could create some volatility in the short-term and default rates will eventually rise, fundamentals are expected to be strong for the foreseeable future with significant distress a long way off, they said. ‘This is as robust a market as we’ve seen,’ said Mark Attanasio, co-founder of Crescent Capital Group. ‘And we actually think that all makes sense given where yields are right now.’”

September 26 – Wall Street Journal (Matt Wirz): “A buyout boom fueled by easy money and a looming hike in the capital-gains tax is sweeping Wall Street deal making to highs not seen since before the 2008 financial crisis. Companies have issued $120 billion of ‘leveraged loans’ this year through Sept. 23 to finance corporate buyouts by private-equity firms—just shy of the $124 billion record for the first nine months of the year set in 2007… Most deals have also gotten bigger. The average leveraged buyout cost about $2.5 billion in debt and equity this year, eclipsing the mean of roughly $2 billion in 2007, according to S&P.”

October 1 – Bloomberg (Adam Tempkin and Charles Williams): “Sales of U.S. collateralized loan obligations reached a fresh annual record on Friday, topping $131 billion, as investors clamor to buy securities that offer high ratings and protection against inflation. New issuance surpassed 2018’s record of $130.4 billion, and may not slow down in the coming months. Some banks are projecting that CLO sales can go as high as $160 billion, and there are some 200 short-term credit lines funding upcoming transactions.”

September 28 – Wall Street Journal (Peter Grant): “When the pandemic hit the commercial mortgage finance industry in the spring last year, Ladder Capital Corp.’s chief executive spent so much time glued to his desk at his home office he developed a rash on the back of his legs. ‘I didn’t move from the chair in three days,’ recalls the CEO, Brian Harris. His… real estate investment trust looked vulnerable to Wall Street because of the large size of its real-estate securities portfolio, Mr. Harris said. Concerns about Ladder’s liquidity persisted even after the firm paid $100 million in margin calls to its funders, he added. Today, Ladder and other so-called nonbank lenders are on track to have one of their biggest years for loan volume… Ladder in the second quarter made $803 million in loans, mostly to developers needing so-called bridge capital to finance new developments or renovations, compared with $260 million in the second quarter of 2019… ‘The amount of lending going on outside the banking system is unbelievable,’ Mr. Harris said.”

September 27 – Bloomberg (Patrick Clark and Noah Buhayar): “Zillow… is best known for the addictive real estate listings that keep people browsing the internet all night, checking out interior shots of homes for sale or the estimated prices of their own houses or the ones down the street. But Chief Executive Officer Rich Barton has staked his company’s future on a bet that its software can also ease a critical pain point for U.S. homeowners: the time it takes to sell. In recent years, Zillow has essentially dived into the house-flipping business, offering to quickly take properties off sellers’ hands. And in the process it’s helping pull Wall Street even deeper into the $2 trillion U.S. housing market. In August, Zillow raised $450 million from a bond backed by homes it’s bought but not yet sold.”

September 30 – Bloomberg (Sam Potter and Katie Greifeld): “When the first ETFs tracking collateralized loan obligations arrived, worries about easing access to these complex securities were assuaged by the fact the funds targeted only the highest-rated debt. Just over a year later the market is taking the next inevitable step: A fund loaded with loans rated BBB or lower is on the way. Janus Henderson… filed for the Janus Henderson B-BBB CLO exchange-traded fund (ticker JBBB). If approved, it’ll invest at least 80% of assets in securities rated from BBB+ to B-, according to the application.”

China Watch:

September 29 – Bloomberg: “China has urged financial institutions to help local governments stabilize the rapidly cooling housing market and ease mortgages for some homebuyers, another signal that authorities are worried about fallout from the debt crisis at China Evergrande Group. At a meeting chaired by central bank Governor Yi Gang, authorities told financial institutions to cooperate with governments ‘to jointly maintain the steady and healthy development of the real estate market and safeguard the legitimate rights and interests of housing consumers…’ The meeting, attended by officials from the country’s banking and securities regulators, the housing ministry and executives from 24 banks, also called for ‘accurately grasping and enforcing the prudential management system of real estate finance around the goal of ‘stabilizing land prices, house prices and expectations,’ the PBOC said.”

September 30 – Bloomberg: “China stepped in to buy a stake in a struggling regional bank from China Evergrande Group as it seeks to limit contagion in the financial sector from the embattled property developer. Evergrande agreed to sell a 20% stake in Shengjing Bank Co. to the local Shenyang government for 10 billion yuan ($1.55bn), with the bank demanding that all proceeds go to settle debts with the lender…”

September 30 – Reuters (Gabriel Crossley and Shivani Singh): “Small firms caught in China's prolonged energy crunch are turning to diesel generators, or simply shutting shop, as coal industry officials voiced fears about stockpiles ahead of winter and manufacturing shrank in the world's no. 2 economy. Beijing is scrambling to deliver more coal to utilities to restore supply as the northeast grapples with its worst power outages in years, particularly the three provinces of Liaoning, Heilongjiang and Jilin, home to nearly 100 million people.”

September 30 – Reuters (Gabriel Crossley and Shivani Singh): “China… demanded railway companies and local authorities raise their game in shipping vital coal supplies to utilities, as regions key to the world's no. 2 economy grapple with power cuts that have crippled industrial output. The order, handed down from China's powerful state planner, comes after a collision of tight coal supplies, tougher emissions standards and strong manufacturing demand has pushed the price of coal, the biggest source of China's electricity, to eye-watering records - just as winter approaches.”

September 29 – Bloomberg: “Activity in China’s vast factory sector contracted in September for the first time since the pandemic began, the latest sign of deceleration in the world’s second-largest economy. The drop in the official manufacturing purchasing managers’ index below the 50-mark, which signals a decline in output, shows the damage a widespread electricity crunch is having on growth… The problem for the economy is that manufacturing and property investment have been the main drivers of growth since the pandemic hit, while consumption growth remains relatively weak with households still cautious about travel and eating out. Electricity shortages, which have caused power cuts across China this week, combined with property curbs are ‘a double whammy on the key drivers of growth this year,’ said Bo Zhuang, China economist at Loomis Sayles Investments Asia. ‘A further growth slowdown is inevitable.’”

September 28 – Reuters (Clare Jim and Jing Xu): “Beijing is prodding government-owned firms and state-backed property developers such as China Vanke Co Ltd to purchase some of embattled China Evergrande Group’s assets, people with knowledge of the matter said. Evergrande, saddled with $305 billion in liabilities, is teetering on the brink of collapse. But the central government is unlikely to intervene directly to resolve Evergrande's crisis in the form of a bailout, according to six people, including four in government and regulatory bodies. Authorities are hoping, however, that asset purchases will ward off or at least mitigate any social unrest that could occur if Evergrande were to suffer a messy collapse, they said, declining to be identified due to the sensitivity of the matter.”

September 27 – Bloomberg (Mark Gongloff): “When playing word association with China’s economy right now, some phrases spring to mind that may seem unfair: pyramid scheme, house of cards, Jenga tower with half the pieces missing, intoxicated teenager on stilts. But two terms that do not come to mind, and absolutely should not, are ‘stable’ and ‘sustainable.’ If you’re a New Zealander or Canadian or American, you might think your housing market is wild. And it is. But for sheer deadly froth, nothing matches China. Not only have prices been soaring, but real estate makes up nearly 30% of GDP, compared with 19% for the U.S. in its housing bubble, writes Noah Smith. Worse, housing makes up 78% of Chinese assets, compared with 35% for the U.S., writes Niall Ferguson. Popping this bubble would hammer China’s economy in a way that could make the Great Recession look like a spoiled gender-reveal party.”

September 28 – Bloomberg: “China Evergrande Group’s liquidity crisis is putting the spotlight on the health of the nation’s property sector, particularly junk-rated firms. Such companies are facing increasingly tough conditions. Borrowing costs have surged amid fears of an Evergrande failure, with the yield on an index of dollar-denominated junk bonds climbing to about 15%, the highest in about a decade. Strict rules on leverage mean companies need to reduce debt, while measures to cool the housing market are damping sales.”

September 28 – New York Times (Alexandra Stevenson, Michael Forsythe and Cao Li): “Xu Jiayin was China’s richest man, a symbol of the country’s economic rise who helped transform poverty-stricken villages into urbanized metropolises for the fledgling middle class. As his company, China Evergrande Group, became one of the country’s largest property developers, he amassed the trappings of the elite, with trips to Paris to taste rare French wines, a million-dollar yacht, private jets and access to some of the most powerful people in Beijing. ‘All I have and all that Evergrande Group has achieved were endowed by the party, the state and the whole society,’ Mr. Xu said in a 2018 speech thanking the Chinese Communist Party… China is threatening to take it all away. The debt that powered the country’s breakneck growth for decades is now jeopardizing the economy — and the government is changing the rules. Beijing has signaled that it will no longer tolerate the strategy of borrowing to fuel business expansion that turned Mr. Xu and his company into a real estate powerhouse, pushing Evergrande to the precipice.”

September 27 – Reuters (Ryan Woo, Anne Marie Roantree and Tom Westbrook): “China’s central bank vowed to protect consumers exposed to the housing market on Monday and injected more cash into the banking system as the Shenzhen government began investigating the wealth management unit of ailing developer Evergrande, the clearest sign yet the authorities could move to contain contagion risks.”

September 29 – Bloomberg: “China’s hidden local government debt has swelled to more than half the size of the economy, according to economists at Goldman Sachs…, who said the government will need to be flexible in dealing with this as revenue is already under pressure due to a slowdown in land sales. The total debt of local government financing vehicles rose to about 53 trillion yuan ($8.2 trillion) at the end of last year from 16 trillion yuan in 2013, the economists wrote... That’s equal to about 52% of gross domestic product and is larger than amount of official outstanding government debt. The LGFVs are a tool for governments to borrow money without it appearing on their balance sheets, but it is seen as the same as a government liability by financial markets.”

September 26 – Bloomberg (Anjani Trivedi): “Even the savviest of investors were caught off-guard by the speed of China Evergrande Group’s unraveling. They shouldn’t have been: Trouble has long been brewing at China Inc., where balance sheets are weakening in the face of a rocky economic recovery. This could be Beijing’s worst blind spot yet. At over 1,100 listed companies in China’s industrial and manufacturing sectors, receivables are piling up; cash conversion cycles are getting longer (that is, the time it takes to turn inventory investments into cash); and net short-term debt levels are becoming increasingly volatile, a Bloomberg Opinion analysis shows.”

September 29 – Bloomberg: “Chinese developer Fantasia Holdings Group Co. is struggling to avoid falling deeper into distress, just as the crisis at China Evergrande Group flags broader risks to other heavily indebted developers. The… firm has had a dramatic few days. Just this week, it’s suffered credit rating downgrades further into junk territory, refuted a report that money for a privately placed bond hadn’t been transferred and seen market indications for some of its bonds maturing in several years drop to deeply distressed levels.”

September 29 – Bloomberg: “Sunac China Holdings Ltd. is under heightened market scrutiny amid questions over its financial health, at a time when concerns about the nation’s developers are being amplified by China Evergrande Group’s cash crunch. Some of Sunac’s dollar bonds have posted negative returns approaching 20% in September, among the worst performers in an index of such high-yield notes in China… Shares this week reached their lowest level since 2017 and have lost nearly half their value this year…”

September 29 – Bloomberg (Jasmine Ng and Alfred Cang): “China is set for a difficult harvest season as a severe energy crunch hurts the outlook for booming production, a development that risks triggering a renewed surge in world agriculture and food prices. Autumn harvest in the top agricultural producer is underway just as the world’s No. 2 economy faces power shortages in industrial hubs that threaten to slow growth. Among the worst hit are northeastern provinces such as Jilin, Liaoning and Heilongjiang -- where about half of China’s corn and soybeans are grown.”

September 28 – Bloomberg: “The electricity crisis that’s wreaking havoc on the Chinese economy is at risk of worsening this winter if freezing weather exacerbates surging power demand and soaring fuel prices. The chance of a La Nina -- a weather pattern that usually brings colder-than-normal temperatures to the Northern Hemisphere -- is looking more likely, which would further stretch already tight energy supplies. There’s a 70% to 80% chance of a La Nina over the winter of 2021/22, the U.S. National Weather Service said earlier this month.”

Central Banker Watch:

September 29 – Reuters (Balazs Koranyi and Francesco Canepa): “Supply constraints thwarting global economic growth could still get worse, keeping inflation elevated longer, even if the current spike in prices is still likely to remain temporary, the world’s top central bankers warned… The disruptions to the global economy during the pandemic have upset supply chains across continents, leaving the world short of a plethora of goods and services from car parts and microchips to container vessels that transport goods across the seas. ‘It’s ... frustrating to see the bottlenecks and supply chain problems not getting better, in fact at the margin apparently getting a little bit worse,’ …Jerome Powell told a conference. ‘We see that continuing into next year probably and holding inflation up longer than we had thought,’ Powell told the European Central Bank’s Forum on Central Banking. Speaking alongside Powell, ECB chief Christine Lagarde voiced similar concerns, arguing that the end of these bottlenecks, once thought by economists to be just weeks away, is uncertain. ‘The supply bottlenecks and the disruption of supply chains, which we have been experiencing for a few months ... seem to be continuing and in some sectors accelerating,’ Lagarde said. ‘I’m thinking here about shipping, cargo handling and things like that.’”

September 29 – Financial Times (Martin Arnold and Colby Smith): “Four of the world’s leading central bankers have warned supply bottlenecks are likely to last longer than expected and said they are watching for as-yet unrealised signs of them spawning a self-fulfilling cycle of higher expected inflation and wage increases. Jay Powell, chair of the US Federal Reserve, said it was ‘frustrating’ that supply-chain bottlenecks were holding back the recovery of the world’s largest economy and have helped to fuel more elevated price pressures as they have intensified. ‘The combination of strong demand for goods and the bottlenecks has meant that inflation is running well above target,’ Powell… ‘We expect that it will continue to do so in the coming months before moderating as bottlenecks ease.’”

September 28 – Bloomberg (Jana Randow and Alexander Weber): “President Christine Lagarde said the European Central Bank should be wary of withdrawing stimulus too quickly, reasserting her view that inflation isn’t getting out of control in the euro area. There are ‘no signs that this increase in inflation is becoming broad-based across the economy,’ Lagarde said... ‘The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term.’”

September 30 – Reuters (Anthony Esposito and Dave Graham): “The Bank of Mexico raised its benchmark interest rate by 25 bps to 4.75% on Thursday, as expected, in a four-to-one vote by its governing board, as the central bank expressed concern about above-target inflation.”

Global Bubble Watch:

September 29 – Bloomberg (Catherine Bosley): “The world economy is facing a buildup in stagflationary forces as surging energy prices boost inflation and slow the recovery from the pandemic recession. Oil’s climbed to more than $80 a barrel for the first time in three years, natural gas for October delivery traded at the costliest in seven years and the Bloomberg Commodity Spot Index rose to the highest level in a decade. Food prices are also advancing, driven in part by crop failures in Brazil, with a benchmark UN index up 33% over the past 12 months. Rising costs for households and companies are hitting confidence while pushing inflation faster than economists had expected only a few months ago.”

September 27 – Bloomberg: “China’s energy crisis is shaping up as the latest shock to global supply chains as factories in the world’s biggest exporter are forced to conserve energy by curbing production. The disruption comes as producers and shippers race to meet demand for everything from clothing to toys for the year-end holiday shopping season, grappling with supply lines that have been upended by soaring raw material costs, long delays at ports and shortages of shipping containers.”

September 30 – Associated Press (Elaine Kurtenbach): “Shortages of power, computer chips and other parts, soaring shipping costs and shutdowns of factories to battle the pandemic are taking a toll on Asian economies. Data… showed Japan’s factory output slowed while China’s manufacturing outlook weakened. Japan’s Suzuki Motor Corp. became the latest automaker to idle production lines for a few extra days due to shortfalls in components. While Japan and some other countries are beginning to ease out of emergency measures to curb the spread of the coronavirus, others are having to reimpose such precautions, adding to uncertainty over the outlook for regional and global growth. Factory output in Japan fell in August by 3.2% from the month before, as pandemic-related shutdowns hit manufacturers across Asia. That followed a 1.5% decline in July.”

September 29 – Financial Times (Gill Plimmer): “Global supply chains are at risk of collapse unless governments worldwide restore freedom of movement to transport workers and give them priority over vaccines, a coalition of international business leaders has warned. In an open letter to heads of state and government attending the United Nations General Assembly, the International Chamber of Shipping and other transport groups warned that almost two years of travel bans and other restrictions had had an ‘enormously detrimental impact on [transport workers’] wellbeing and safety’. The ‘mistreatment’ of workers was piling pressure on the already ‘crumbling’ global supply chain, they said, adding that any failure to act was likely to exacerbate shortages of essential goods including electronics, food, fuel and medical supplies ahead of Christmas.”

September 27 – Reuters (Guy Faulconbridge and Alistair Smout): “Gas station pumps ran dry in British cities on Monday and vendors rationed sales as a shortage of truckers strained supply chains to breaking point. A post-Brexit shortage of lorry drivers as the COVID-19 pandemic eases has sown chaos through British supply chains in everything from food to fuel, raising the spectre of disruptions and price rises in the run-up to Christmas. Drivers queued for hours to fill their cars at petrol stations that were still selling fuel, albeit often rationed. There were also calls for National Health Service (NHS) staff and other emergency workers to be given priority.”

September 29 – Reuters (Guy Faulconbridge and Michael Holden): “Britain ordered soldiers… to start driving fuel tankers to replenish empty pumps, as motorists remained mired in queues after nearly a week of shortages, despite Prime Minister Boris Johnson saying the situation was improving. Britain has been gripped by a rush of panic buying that has left pumps dry across major cities, after oil companies warned they did not have enough tanker drivers to move petrol and diesel from refineries to filling stations.”

September 28 – Bloomberg (Stephen Stapczynski, Ann Koh and Isis Almeida): “China, the world’s top coal consumer, is in dire need of more supply and is willing to pay any price -- a move that threatens to leave less fuel for energy-starved rivals. With winter on the way for much of the world and natural gas prices at record levels, economies across the globe are competing for a finite supply of coal. At the center of the scramble is China, where stockpiles are low and demand is at an all-time high. The dirtiest fossil fuel, which was struggling against cleaner energy sources, is now seeing its biggest comeback ever, complicating international climate talks set to begin in just a few weeks.”

September 30 – Wall Street Journal (Mike Colias): “The global chip shortage has slammed the auto sector this year, cutting factory output by several million vehicles and erasing billions in revenue for car companies. Next year is expected to be nearly as challenging, industry analysts say. Auto executives for months have expressed optimism that the problem would begin to ease by year’s end. Now, there is an emerging view that the chip shortage has morphed from a short-term crisis into a structural upheaval for the automotive supply chain that could take years to fully overcome.”

September 28 – Financial Times (Edward White): “China’s Belt and Road Initiative has left scores of lower- and middle-income countries saddled with ‘hidden debts’ totalling $385bn. New research suggests that many countries’ financial liabilities linked to President Xi Jinping’s hallmark foreign policy initiative have been systematically under-reported for years. This has resulted in mounting ‘hidden debts’, or undisclosed liabilities that governments might be obliged to pay. The findings are part of a new report published by AidData, an international development research lab based at the College of William & Mary in Virginia, which has analysed more than 13,000 aid- and debt-financed projects worth more than $843bn across 165 countries…”

EM Watch:

September 27 – Financial Times (Bryan Harris and Michael Pooler): “A sea of yellow and green stretched in front of Jair Bolsonaro as the far-right populist president clambered on to the stage in São Paulo. Clad in the vivid colours of the Brazilian flag, more than 100,000 of his most ardent supporters had converged on Latin America’s largest city for a raucous show of support for the man they call mito — the myth — and Bolsonaro was not about to disappoint them. ‘There are those who think they can take me from the presidency with the mark of a pen. Well, I say to everyone I have only three possible fates: arrest, death or victory. And tell the bastards I’ll never be arrested,’ the former army captain told the roaring crowd… ‘Only God can take me from the presidency.’ It was music to the ears of Bolsonaro’s hardcore supporters…”

September 27 – Bloomberg (Maria Eloisa Capurro): “Brazil’s overall consumer debt reached an all-time high, just as loans become more expensive amid an aggressive central bank campaign to raise interest rates. Outstanding household debt reached 59.9% of total wages in June, the highest level since data started being published… in 2005. The total debt, ranging from short-term credit card loans to mortgages, increased by 10.6% from a year ago…”

Europe Watch:

September 30 – Bloomberg (Jana Randow): “German consumer prices are rising at the fastest pace in nearly three decades, fueled by supply bottlenecks and a series of temporary pressures accompanying the economy’s pandemic recovery. Inflation jumped to 4.1% in September, exceeding economists’ median estimate… Energy alone was 14% more expensive than last year... Europe’s largest economies -- all experiencing strong growth following the end of lockdowns at the start of summer -- are reporting a similar trend. France, Italy and Spain were among those with inflation rates far above 2%...”

September 27 – Reuters (Emma Thomasson and Paul Carrel): “German Social Democrat Olaf Scholz vowed… to strengthen the European Union and keep up the transatlantic partnership in a three-way coalition government he hopes to form by Christmas to take over from Angela Merkel's conservatives. Scholz's Social Democrats (SPD) came first in Sunday's national election, just ahead of the conservatives, and aim to lead a government for the first time since 2005 in a coalition with the Greens and the liberal Free Democrats (FDP). Scholz, 63, projected a sense of calm assurance when asked whether the close election result and the prospect of prolonged coalition negotiations sent a message of instability in Germany to its European partners.”

October 1 – Bloomberg (Alexander Weber): “Inflation in the euro area accelerated more than expected to the highest level in 13 years, adding fuel to a debate over how long the post-crisis spike will last. Consumer prices rose 3.4% in September, compared with an estimate for a 3.3% gain… Energy prices rose 1.3% in September and were up more than 17% on the previous year. Non-energy industrial goods were 2.3% more expensive than in August.”

Japan Watch:

September 29 – Reuters (Leika Kihara): “Japan's struggle to emerge from the pandemic-induced doldrums will leave next prime minister Fumio Kishida with little choice but to maintain massive fiscal and monetary support for a fragile economy. But Kishida may gradually shake off the legacies of former premier Shinzo Abe's ‘Abenomics’ stimulus policies if he strengthens his grip on power by winning a general election expected in November, some analysts say. Having won a ruling Liberal Democratic Party (LDP) leadership race on Wednesday with support from various factions, Kishida is unlikely to rock the boat by overhauling the current pro-business, reflationary policies undertaken by Abe and his successor Yoshihide Suga any time soon.”

Social, Political, Environmental, Cybersecurity Instability Watch:

September 25 – Reuters (Kate Abnett): “Young people around the world took to the streets… to demand urgent action to avert disastrous climate change, in their largest protest since the start of the COVID-19 pandemic. The strike takes place five weeks before the U.N. COP26 summit, which aims to secure more ambitious climate action from world leaders to drastically cut the greenhouse gas emissions heating the planet. ‘The concentration of CO2 in the sky hasn't been this high for at least 3 million years,’ Swedish activist Greta Thunberg told a crowd of thousands of protesters in the German capital.”

September 27 – Bloomberg (Jonathan Levin): “Miami Mayor Francis Suarez has been approaching cryptocurrency miners about the prospects of setting up operations near South Florida’s Turkey Point nuclear-power plant. The pitch is part of Suarez’s broader effort to lure crypto entrepreneurs to South Florida, and it comes as miners face mounting criticism over their extraordinarily high use of often dirty energy.”

Levered Speculation Watch:

September 24 – Financial Times (Laurence Fletcher): “So far 2021 has not quite gone to plan for macro hedge funds. They will be hoping that a prospective rise in inflation will soon start providing some more attractive trades… Macro funds on average are up 2.8% in the first eight months of the year, according… eVestment, some way behind the hedge fund industry’s average 9.5% return.”

Geopolitical Watch:

September 25 – Reuters (Steve Holland, David Brunnstrom, Nandita Bose and Michael Martina): “Leaders of the United States, Japan, India and Australia vowed… to pursue a free and open Indo-Pacific region ‘undaunted by coercion’ at their first in-person summit, which presented a united front amid shared concerns about China. The… meeting at the White House of the Quad, as the grouping of four major democracies is called, will be watched closely in Beijing, which criticized the group as ‘doomed to fail.’ ‘We stand for the rule of law, freedom of navigation and overflight, peaceful resolution of disputes, democratic values, and territorial integrity of states," U.S. President Joe Biden, Australian Prime Minister Scott Morrison, Japanese Prime Minister Yoshihide Suga and Indian Prime Minister Narendra Modi said in a joint statement…”

September 30 – Bloomberg: “The U.S. has serious problems in how it sees itself, China and today’s world, Chinese Defense Ministry spokesperson Wu Qian said… The militaries of the two nations have been in contact, Wu said, and China welcomes such communication and cooperation. House bill hyping U.S. military ties with Taiwan is ‘playing with fire,’ Wu said…”

September 29 – Associated Press: “Beijing said… it will block Taiwan’s application to join a Pacific Rim trade initiative, citing as its reason the island’s refusal to concede that it is a part of China. The Cabinet’s Taiwan Affairs Office… said Taiwan’s participation in regional trade cooperation is based on the ‘one China principle.’ ‘We oppose the Taiwan region participating in any trade arrangements of an official nature or signing any trade agreements of an official nature,’ spokesperson Zhu Fenglian told reporters…”

September 25 – Associated Press: “An executive of Chinese global communications giant Huawei Technologies returned from Canada Saturday night following a legal settlement that also saw the release of two Canadians held by China, potentially bringing closure to a nearly 3-year-long feud embroiling Ottawa, Beijing and Washington. Meng Wanzhou, Huawei’s chief financial officer and the daughter of the company’s founder, arrived Saturday evening aboard a chartered jet…”