First vacation in a while, so coverage will be spotty for the next week or so. And I'll try to finish up this week's CBB news story extracts when I have a chance.
We certainly recognize these are trying times. Few of us have been spared from what has been an all-encompassing market decline. I hope today to focus on our overarching mission of informing and educating.
This is such an extraordinary and confounding environment. My objective is to further expound an analytical framework that hopefully sheds light on such a complex macro backdrop. It is not a positive message, and I apologize for that. I would prefer not to be the messenger in such circumstances. With Q2 validating my analytical framework and thesis, my commitment to analytical integrity compels today’s cautionary message.
With that said, let’s cut to the chase: “Nowhere to Hide.” Stocks were hammered. Fixed-income fared only somewhat better. Treasuries, the iShares Treasury Bond ETF (TLT), to be more exact, returned negative 12.6% - and is down about 20% y-t-d. The iShares investment-grade corporate bond ETF (LQD) returned negative 8.40% for the quarter, and the iShares high-yield bond EFT (HYG) returned negative 9.48%.
Through mid-June, commodities had offered refuge from the pounding taken by financial assets. At its June high, the Bloomberg Commodities Index was sporting a 15.3% q-t-d gain. Crude traded up to almost $124, while natural gas surged to a 44% q-t-d gain. But commodities reversed sharply lower during the final couple weeks of the quarter. The Bloomberg Commodities Index ended Q2 with a 5.9% decline, with most of crude’s advance gone, and natural gas actually ending the quarter lower. Even safe havens gold and silver reversed sharply lower and posted Q2 losses.
And with global yields surging along with the dollar, losses continued to mount in EM currencies, stocks and bonds. Meanwhile, one of history’s great manias collapsed in spectacular fashion. Cryptocurrencies suffered catastrophic losses, with withdrawal suspensions, insolvencies, panic runs and general chaos engulfing the sector. Bitcoin sank 59% during Q2 to $18,731, with prices down 73% from November 2021 highs. Most other cryptos were hit with even larger losses.
In short, the so-called “everything Bubble” transitioned to Bubbles bursting everywhere. The backdrop beckons, at least in my eyes, for some Credit and Bubble analysis. Bubbles are a monetary phenomenon. There is invariably an underlying source of Credit expansion driving a “self-reinforcing but inevitably unsustainable inflation” – my Bubble definition. As I am fond of explaining, a Bubble fueled by junk bonds might turn a little crazy, but it would not be expected to pose major systemic risk. Because of the elevated riskiness of the underlying Credit, a junk bond issuance boom will reach a point where apprehensive buyers say, “No more junk, I’ve got enough!” – and this point of risk aversion ensures the Bubble doesn’t inflate year upon year, thereby inflicting deep structural damage.
A Bubble fueled by “money” – Credit instruments perceived as safe liquid stores of value - is a completely different animal. Unlike junk bonds, “money” enjoys insatiable demand – we literally can never get enough of it. Bubbles fueled by money-like instruments can inflate for years, in the process imparting deep structural maladjustment to market, financial and economic structures.
For real life examples, think of the late-90’s “dot.com” Bubble, which was fueled by a boom in telecom and corporate debt, along with speculative leverage. It was certainly spectacular, but excess for the most part was contained within the technology arena. It’s bursting caused ample market pain and some economic hardship. But not being systemic, aggressive Federal Reserve stimulus rather quickly reflated the system – certainly boosted by the strong inflationary biases that had developed in housing.
The mortgage finance Bubble here in the U.S. was significantly more systemic. Fueled by “AAA” money-like mortgage securities, this more prolonged Bubble went to gross excess with associated major structural maladjustment. Accordingly, the bursting episode was much more destabilizing - for the markets, financial system and overall economy – the so-called “Great Financial Crisis” (GFC). And even with an unprecedented $1 TN of QE, it took years for even radical monetary inflation to generate system-wide reflation.
With that theoretical backdrop, let’s delve into the “everything Bubble”. Appraising the Fed’s post-bubble analytical and policy framework, I began warning of the potential for the “global government finance Bubble” – the “Granddaddy of All Bubbles” - back in 2009. With the introduction of QE in conjunction with massive fiscal deficits, the expansive Bubble had finally reached the foundation of finance – central bank Credit and government debt. From my analytical perspective, it was the worst-case scenario: The Bubble was being fueled by an egregious inflation of “money” - and it all was enveloping the world.
I also introduced the concept of “moneyness of risk assets” – an expansion of my “moneyness of Credit” tenet from the mortgage finance Bubble era. Basically, the Bernanke Fed used zero rates and inflated market prices to coerce savers into stocks and bonds. Then, aggressive monetary stimulus was employed to backstop the markets, promoting the perception of safety and liquidity. “Stocks always go up”. It was all reckless inflationism that was clearly fueling dangerous asset and speculative Bubbles.
There were some serious bouts of instability along the way – 2012, 2013, 2018, 2019 and March 2020. And, in each instance, the Fed and global central bank community adopted the ever increasing radical monetary inflation necessary to sustain Bubbles. It culminated during the pandemic, with $5 TN from the Fed and similar amounts from the ECB and BOJ. There were Trillions more from central banks everywhere.
It was monetary and fiscal stimulus – inflationism - on a global basis, the likes of which the world had never experienced. And, importantly, the Bubble inflated for an incredible 13 years. History teaches that things can get crazy at the end of cycles, and we witnessed some of the craziest things ever. Readers far into the future will ponder this era, as we do the tulip bulb mania and John Law’s Mississippi Bubble. And, most unfortunately, it’s all coming home to roost now.
Last quarter, I discussed the unfolding new cycle. We believe inflation dynamics have fundamentally changed. I doubt inflation will stay above 9% for long, but I do believe the Fed will be challenged to get – and keep - inflation under control. There were some anomalies that played major roles in keeping consumer price inflation relatively contained throughout the previous cycle – technological innovation, globalization, and the historic development in China and the emerging markets, to name the most obvious. I don’t see any of these factors playing the same role in the new cycle. Also, and this is a key point, financial assets have lost the huge advantage they enjoyed over real assets throughout the previous financial boom cycle.
Now, with consumer prices unleashed and inflation psychology altered, a chastened Fed and central bank community have begun to adjust their doctrines to stress resolve in containing inflation. This is a secular sea-change. During the previous cycle, relatively benign consumer inflation nurtured monetary policy drift to a securities market focus. This created a self-reinforcing dynamic, where liquidity injected during QE operations specifically gravitated to financial assets – stoking speculative Bubbles while having limited inflationary effect on general consumer prices.
Liquidity will inherently flow in the direction of the strongest inflationary biases. During the previous cycle that was financial assets. We don’t expect this dynamic to hold sway going forward.
We can’t overstate the significance of the so-called “Fed put” during the previous cycle. This liquidity backstop – that morphed over time into “whatever it takes” zero rates and Trillions of QE – created the perception of “moneyness” throughout the financial markets. Stocks became a can’t lose, corporate debt the same, and even the cryptocurrencies. The same can be said for derivatives and Wall Street structured finance. Private equity and venture capital were a can’t lose. And you couldn’t lose with hedge funds and leveraged speculation. This central bank-induced “moneyness of everything” stoked a historic period of myriad synchronized Bubbles across the globe. History offers nothing remotely comparable.
But the game has changed, and this lies at the heart of the unfolding new cycle. The central bank liquidity backstop has turned problematic and ambiguous. In the end, I believe central banks will have no alternative than to use QE to counter the forces of bursting asset and Credit Bubbles. But inflation’s resurgence suggests the halcyon “money” free-for-all days are behind us.
We’ll return to this new cycle theme, but let’s address a few of these bursting Bubbles. I find the “Periphery and Core” instability analytical framework particularly helpful in these kinds of environments. As a cycle begins to turn, risk aversion takes hold first out at the periphery – with the more fringe regions, countries, markets, sectors and companies. When finance is loose, it’s the fringe, offering enticing speculative opportunities, that sees the greatest impact from risk embracement and liquidity excess. But when the cycle inevitably turns, the maladjusted “Periphery” is vulnerable to even subtle shifts in risk tolerance and financial conditions. Losses, de-risking/deleveraging, and waning liquidity gain momentum, leading to contagion effects that over time gravitate from the “Periphery” to the “Core.”
This dynamic attained robust momentum during Q2. Powerful de-risking/deleveraging took hold throughout the emerging markets, with currencies and bond markets under heavy liquidation. The unwind of levered EM “carry trades” fueled a self-reinforcing dynamic of dollar strength, waning liquidity and intensifying de-risking/deleveraging. To support their faltering currencies, EM central banks resorted to aggressive rate hikes, along with sales of Treasuries and other international reserve holdings. It all fed a dramatic tightening of global financial conditions for a world that until recently had the semblance of endless liquidity abundance.
China’s international reserves dropped $116bn during Q2, suggesting significant capital flight. China’s currency lost 5.4% versus the dollar. China’s bubble collapse has recently taken a turn for the worse – perhaps a decisive turn. Recall that China faced heightened instability late in Q1. Its developer bond market crisis had jumped from the “Periphery” to the “Core”, with Country Garden, China’s largest developer, seeing bond yields spike from 6.5% to surpass 30%.
Predictably, Beijing moved forward with a series of aggressive stimulus measures that temporarily calmed the developer bond market while spurring a decent stock market rally. There were Covid outbreaks, including an extended crippling lockdown in Shanghai. Beijing announced more stimulus measures, including plans for massive infrastructure spending.
Then something very important transpired. Despite all of Beijing’s measures, developer bond yields began rising again. The crisis deepened. China’s apartment bubble is one of history’s greatest bubbles. Its collapse has significant ramifications – for China’s economy and financial system, along with the global economy and the global financial system. There are clear geopolitical repercussions. Crisis dynamics often move at a glacial pace – only to suddenly accelerate at seemingly lighting speed. And crisis dynamics can appear manageable for some time - only to reach a point where fear takes hold that they might be uncontainable. China’s crisis is on such a trajectory.
Last week, a movement caught fire, where owners of uncompleted apartment units decided to stop making mortgage payments. Within a few days, developments in 100 cities were impacted. We might look back at last week and see it as a critical juncture in the crisis – a point where crisis dynamics began to turn systemic.
Keep in mind this is new territory for China’s households, developers, banks, regulators and Beijing officials, all experiencing their first housing/mortgage finance bust. It’s worth noting that Consumer - chiefly mortgage - borrowings almost doubled over the past five years – and were up four-fold in 10 years - to almost $11 TN. Chinese Bank Assets – which, by the way, were up a record $1.95 TN just during Q1 - surged 50% over the past five years – and 200% in 10 years - to an astronomical $53 TN.
Country Garden saw its bond yields surge a full 11.5 percentage points last week to a record 41%. These bonds yielded 3.25% in September. Another top five developer, Lonfor bond yields have spiked 23 percentage points in eight sessions to 126%. Sunac yields jumped to 117% and Evergrande yields to 141%. Vanke, another top five developer, is worth special attention. It is considered the financially strongest of the major private sector developers. Its bonds yielded 3.0% in September, with its credit default swaps priced at 100 bps.
Vanke yields have surged to almost 10%, with its CDS surpassing 650 bps. The market is saying China’s apartment Bubble has made it to the strongest – to the “Core”. If Vanke is in trouble, I believe China’s Bubble collapse is quickly approaching the point of no return. And we’re talking about an industry with Trillions of liabilities.
Corroborating the thesis that China’s crisis has turned systemic, Chinese bank stocks sank almost 8% last week, as Chinese bank CDS spiked higher – blowing past highs from the March instability period. Notably, China Construction Bank CDS jumped 25 bps last week to 123 bps, surpassing the March 2020 pandemic crisis spike. With over $4 TN of assets, China Construction Bank is one of the largest banks in the world. Of China’s other “Big Four,” Bank of China CDS surged to the high back to 2014. China Development Bank and Industrial and Commercial Bank CDS rose to highs back to 2017.
We can call it the “Beijing put”. China’s historic Credit and apartment Bubbles are unmitigated disasters. Yet markets have been content to look the other way, while renewing their faith in the almighty Beijing meritocracy. No issue was too big to be resolved by Communist leadership. No amount of debt too excessive. No Bubble too big. No degree of structural maladjustment too deep for Beijing stimulus. And, apparently, there’s no economic downturn that won’t be countered by boundless Beijing-directed lending and spending.
I remember the mantra in mid-1998: “The West will never allow Russia to collapse.” And then in 2006/2007, “Washington will never allow a housing bust.” Today, it’s “Beijing won’t allow financial and economic crisis – it won’t tolerate fallout from bursting Bubbles – not with its global superpower status on the line.”
And this is precisely the mindset that sets the stage for destabilizing crisis. First, faith in government control underpins sustained Credit and speculative excess and associated maladjustment. Bouts of instability resolved by government actions over the course of a cycle only embolden risk-taking. With everyone well-conditioned, confidence is sustained for a while, even as Bubbles begin to deflate.
Importantly, however, there reaches a critical juncture where speculative de-risking/deleveraging attains certain momentum, where instability forces markets to begin questioning whether policymakers actually have things under control. I refer to a “holy crap moment” – in 1998, this dynamic revealed egregious leverage at Long-Term Capital Management and elsewhere. In 2008, it was with Lehman and Wall Street finance.
The unraveling process commenced last week in China. The movement to halt mortgage payments was on the heels of some protests by depositors of failed banks. I believe there’s growing recognition that the Chinese people are being pushed to their breaking point. A most protracted Bubble period inflated many things, including expectations. The Chinese have been willing to tolerate increasingly brazen government repression because of confidence that a highly effective Beijing would continue to improve standards of living. This trust is being shattered. There is heightened recognition that Beijing has seriously mismanaged economic development. Zero-Covid is seen by many as terribly misguided government overreach. And I would imagine there are many questioning China’s “partner without limits” alliance with Putin’s Russia.
If not already, the bloom is at least coming off the rose for Beijing. Inflating Bubbles create genius, while Bubble deflation spawns blunders and incompetence. From my perspective, a crisis of confidence is unavoidable. The degree of mismanagement – especially in regard to Credit and speculative excess, its banking system – has been shocking. And with Beijing now forcing aggressive crisis lending – including to insolvent developers – how long can confidence be maintained in China’s bloated banking system?
But here’s what has me really worried. It’s not just Beijing that faces a crisis of confidence. Right now, emerging markets face sinking currencies, de-risking/deleveraging, “hot money” outflows, and a dramatic tightening of financial conditions. And it’s anything but clear what reverses these dynamics. I’ve witnessed a number of EM crises during my career, but never has there been a setup like today’s dominoes all lined up across the globe.
In Europe, the ECB raised rates 50 bps today for the first hike in 11 years. And even with its main policy rate not yet even positive, the troubled European periphery is already under acute stress. Highly indebted and dysfunctional Italy is in the crosshairs. Mario Draghi resigned earlier today, the Italian parliament was dissolved, and there will be at least two months of uncertainty, with elections now scheduled for September 25th. Crisis dynamics engulfed European periphery bonds last month, with destabilizing yield spikes in Italy and Greece.
The ECB responded with a pledge to create a so-called “anti-fragmentation” tool, which essentially means more QE directed at Italian and periphery bonds to thwart bond market collapse. A vague outline of this program was announced today. Not surprisingly, the Germans, Austrians and others are opposed to printing more money to support fiscally irresponsible governments. After all, the ECB’s balance sheet has inflated $5 TN over recent years, and now Europe faces a serious inflation problem, along with an energy crisis and economic stagnation.
It should be obvious by now that money printing will not resolve Europe’s issues. I’ve argued that, at the end of the day, I don't expect the Germans and Italians to share a common currency. And that’s why the ECB and global markets turn so anxious when European periphery yields spike. It poses nothing short of an existential threat to European monetary integration.
The ECB faces a crisis of confidence. They are concocting a liquidity backstop mechanism for the eurozone’s periphery that, truth be told, they really hope they won’t have to use. When they are forced to employ bond support operations and its efficacy is questioned, they will then face the real prospect of a serious run on periphery bond markets and even the euro currency.
And speaking of runs on bond markets, I fear the Bank of Japan is also facing a crisis of confidence. The Bank of Japan has been creating and spending hundreds of billions to maintain its 25 bps ceiling on Japanese 10-year yields. This was a crazy bad idea to begin with, and these days, with spiking global inflation and yields, it has become untenable. The yen has sunk to 20-year lows versus the dollar, and confidence in the yen and monetary management has taken a big hit. When their misguided yield peg breaks, there will be serious risk of a major bond market dislocation and currency turmoil.
Let’s now turn our focus homeward – away from the “Periphery” and more to the “Core”. Inflation surpassing 9%, bursting Bubbles, a sour public mood, economic fragility, and a central bank facing a serious crisis of confidence of its own.
Contemplating the extraordinary backdrop, it’s critical to think secular rather than cyclical. Unfolding financial and economic crises are decades in the making. JPMorgan’s Jamie Dimon has warned of a potential “hurricane.” A Pimco manager last week said he expects more of a “shower.” I am reminded of a passage from a book I read years ago analyzing the late-twenties: It said, “Everyone was prepared to hold their ground, but the ground gave way.”
There is incredible complacency these days, especially considering the environment. Ominous developments at the global “Periphery” are easily disregarded. This is typical. The dollar is exceptionally strong, commodities prices have reversed sharply lower, bond yields are lower, and some see the Fed winding down its tightening cycle in the not too distant future – and all this supports the narrative that peak inflation has passed, and market lows have been established.
Meanwhile, global de-risking/deleveraging, illiquidity and contagion are bearing down on the “Core”. And we’ve already witnessed serious stress unfold at our own “Periphery”. The crypto Bubble is collapsing, revealing a lot of leverage and shenanigans. The corporate debt market has also taken a hit. The junk bond market has been largely shut to new issuance for weeks, and even the investment-grade marketplace has experienced a dramatic change in the liquidity backdrop.
This equates to a destabilizing tightening of financial conditions at our “Periphery” after years of the loosest Credit conditions imaginable. And this is a major structural issue for an economy driven by a proliferation of negative cash-flow and uneconomic businesses. The shakeout has begun, with some of the clearest evidence of this dynamic unfolding in the technology arena. We’ve seen some layoffs, but we’re really early. Before this is over, I expect massive restructurings and bankruptcies. This will be a quite arduous adjustment to new market, policy, financial and economic realities.
Markets are extraordinarily vulnerable here – stocks, bonds, housing, private equity, commercial real estate, and so on. We’re so early in the adjustment process. There are two interrelated critical dynamics at play in the markets. Financial conditions have tightened meaningfully, which will imperil the solvency of many companies, while pressuring household and business spending.
Meanwhile, it’s a critical issue that the “Fed put” has turned ambiguous. Market faith in the Fed liquidity backstop has crystallized for over three decades, becoming deeply embedded in market perceptions, prices and speculative dynamics. In the eyes of the markets, it has been the most consequential facet of contemporary monetary policy doctrine. The Fed liquidity backstop has been integral to Trillions flowing into perceived safe and liquid ETF shares. It has been key to Trillions of hedge fund and speculator leverage. It has been crucial for risk-taking more generally. It has been absolutely fundamental to a multi-hundreds of trillions derivatives complex. And there is today uncertainty as to how the Federal Reserve will now respond to crisis dynamics.
I’m on record forecasting a much larger Fed balance sheet. There is no alternative to central bank liquidity in the event of serious de-risking/deleveraging. I also believe newfound inflation persistence will prevent the Fed from their singular focus on market stability. I expect another round of QE – but it seems likely that this liquidity comes later and in narrower scope than markets have grown accustomed to. And later and smaller will not suffice.
Recall the portentous dynamic from March 2020. The Fed hastily responded to de-risking/deleveraging and market dislocation by announcing a major QE program. Yet market dislocations only worsened. An increasingly desperate Fed repeatedly boosted its crisis policy response until the prospect of Trillions of QE finally reversed de-risking/deleveraging and halted the run on some ETFs.
The Fed’s most recent $5 TN QE onslaught pushed leverage and speculative excess to unprecedented extremes. When serious de-risking takes hold at the “Core”, it would take Trillions of additional liquidity to rejuvenate risk-taking and leveraged speculation. And, at this point, with inflation raging and bond markets fragile, such a massive QE program would pose great risk to inflation and bond market stability, not to mention Federal Reserve credibility.
Fundamentally altered inflation dynamics are a prominent aspect of the new cycle. The era of endless cheap imports from China and Asia has largely run their course. And Russia’s invasion of Ukraine and the new Iron Curtain solidified the end of a multi-decade period of integration and globalization. And while commodity prices have retreated over recent weeks, we believe the new cycle will be an era of hard asset outperformance versus financial assets. And this dynamic will change so many things, including raising the risk that QE injections feed directly into higher commodities prices and general inflation. The job of a central banker has become incredibly more challenging.
Markets can no longer take for granted that the Fed is willing and able to ensure the perpetual bull market. Late and limited QE will not thwart financial crisis, and this new dynamic implies significantly higher market and economic uncertainty. Markets are riskier. Speculation is riskier. Leverage is riskier. The cost of market protection is higher.
And let me summarize some key aspects of the new cycle that will profoundly impact the markets. Consumer prices will have a stronger and sustained inflationary bias. Central banks will be forced back to a traditional inflation focus, rather than the experimental market-centric approach of the past cycle. Policy rates will be higher, and QE will be relegated to a crisis-fighting tool. Financial conditions will be significantly tighter on a more sustained basis. The liquidity and policymaking backdrops will be much less conducive to leveraged speculation, and risk-taking more generally. The so-called “Fed put” will remain nebulous, with QE employed more unpredictably and sparingly.
I believe we’re early in the process of markets adjusting to new cycle realities. Markets are highly volatile at cycle inflection points, and we’ve been experiencing this phenomenon. I expect even more volatility. The fundamental tightening of financial conditions is currently having its greatest impact at the “Periphery”. And while our markets have retreated, the “Core” is currently benefiting from the strong dollar and generally low market yields. This creates a mirage of liquid and sound markets. There has been meaningful tightening at the “Core’s” periphery, with waning liquidity and market losses in U.S. corporate debt markets.
But a much more perilous storm is approaching, and we need to ponder the possibility that there will be nowhere to hide – that the unfolding crisis is global, deeply systemic and uncontrollable for the global central bank community. I worry about a crisis of confidence in policymaking, in the markets and finance more generally. As I’ve said many times, contemporary finance appears almost miraculous so long as it’s expanding – as it did in historic fashion over the previous cycle. It’s unclear to me how existing market and financial structures continue to operate effectively in the new cycle. How does contemporary finance expand with financial conditions much tighter, with the central bank community’s newfound stinginess with liquidity, with significantly reduced leveraged speculation and much less faith in forever rising securities prices?
And in closing, I fear there is nowhere to hide from escalating geopolitical risk. And I’ll again underscore a most pertinent cycle dynamic. During the up-cycle boom, the economic pie is perceived as robust and expansive. Cooperation, integration and strong alliances are viewed as beneficial - both individually and collectively. But as the cycle ages, strains mount, and insecurity increasingly takes hold. Eventually, the backdrop is viewed more in terms of a shrinking pie - with a newfound zero-sum game calculus. The downside of the cycle heralds a period of fragmentation, animus and conflict.
We’re now five months into the tragic war in Ukraine. The West is determined that Russia cannot be allowed to win. Putin seems as determined as ever to ensure Russia doesn’t lose. And the more munitions arriving from the West, the more it appears Putin is adopting a scorched earth strategy of destruction in the south and terrorizing missile strikes in population centers across Ukraine.
At this point, a return to the previous world order appears impossible. From this perspective, the world appears well into the transition to a perilous down cycle dynamic. Last week, Putin referred to the Ukraine conflict as “the beginning of a radical breakdown of the American world order… the beginning of the transition from liberal-globalist American egocentrism to a truly multipolar world.”
And there’s little doubt that China has aligned with Putin’s Russia to form an anti-U.S. alliance. An altered and much less hospitable world order is fundamental to the new cycle. I fear a scenario where the West has to significantly ramp up support to preserve Ukraine as an independent nation. I’ve worried for a while now that bursting Chinese Bubbles could spur a Beijing move on Taiwan. U.S./Chinese tensions are on a troubling trajectory. It’s difficult to imagine a backdrop with greater uncertainty and greater risk – market, policy, economic, political and geopolitical. I’m a broken record on this, but it’s time to hunker down and prepare for tumultuous times. I sincerely hope my analysis proves way too pessimistic.
This is such an extraordinary and confounding environment. My objective is to further expound an analytical framework that hopefully sheds light on such a complex macro backdrop. It is not a positive message, and I apologize for that. I would prefer not to be the messenger in such circumstances. With Q2 validating my analytical framework and thesis, my commitment to analytical integrity compels today’s cautionary message.
With that said, let’s cut to the chase: “Nowhere to Hide.” Stocks were hammered. Fixed-income fared only somewhat better. Treasuries, the iShares Treasury Bond ETF (TLT), to be more exact, returned negative 12.6% - and is down about 20% y-t-d. The iShares investment-grade corporate bond ETF (LQD) returned negative 8.40% for the quarter, and the iShares high-yield bond EFT (HYG) returned negative 9.48%.
Through mid-June, commodities had offered refuge from the pounding taken by financial assets. At its June high, the Bloomberg Commodities Index was sporting a 15.3% q-t-d gain. Crude traded up to almost $124, while natural gas surged to a 44% q-t-d gain. But commodities reversed sharply lower during the final couple weeks of the quarter. The Bloomberg Commodities Index ended Q2 with a 5.9% decline, with most of crude’s advance gone, and natural gas actually ending the quarter lower. Even safe havens gold and silver reversed sharply lower and posted Q2 losses.
And with global yields surging along with the dollar, losses continued to mount in EM currencies, stocks and bonds. Meanwhile, one of history’s great manias collapsed in spectacular fashion. Cryptocurrencies suffered catastrophic losses, with withdrawal suspensions, insolvencies, panic runs and general chaos engulfing the sector. Bitcoin sank 59% during Q2 to $18,731, with prices down 73% from November 2021 highs. Most other cryptos were hit with even larger losses.
In short, the so-called “everything Bubble” transitioned to Bubbles bursting everywhere. The backdrop beckons, at least in my eyes, for some Credit and Bubble analysis. Bubbles are a monetary phenomenon. There is invariably an underlying source of Credit expansion driving a “self-reinforcing but inevitably unsustainable inflation” – my Bubble definition. As I am fond of explaining, a Bubble fueled by junk bonds might turn a little crazy, but it would not be expected to pose major systemic risk. Because of the elevated riskiness of the underlying Credit, a junk bond issuance boom will reach a point where apprehensive buyers say, “No more junk, I’ve got enough!” – and this point of risk aversion ensures the Bubble doesn’t inflate year upon year, thereby inflicting deep structural damage.
A Bubble fueled by “money” – Credit instruments perceived as safe liquid stores of value - is a completely different animal. Unlike junk bonds, “money” enjoys insatiable demand – we literally can never get enough of it. Bubbles fueled by money-like instruments can inflate for years, in the process imparting deep structural maladjustment to market, financial and economic structures.
For real life examples, think of the late-90’s “dot.com” Bubble, which was fueled by a boom in telecom and corporate debt, along with speculative leverage. It was certainly spectacular, but excess for the most part was contained within the technology arena. It’s bursting caused ample market pain and some economic hardship. But not being systemic, aggressive Federal Reserve stimulus rather quickly reflated the system – certainly boosted by the strong inflationary biases that had developed in housing.
The mortgage finance Bubble here in the U.S. was significantly more systemic. Fueled by “AAA” money-like mortgage securities, this more prolonged Bubble went to gross excess with associated major structural maladjustment. Accordingly, the bursting episode was much more destabilizing - for the markets, financial system and overall economy – the so-called “Great Financial Crisis” (GFC). And even with an unprecedented $1 TN of QE, it took years for even radical monetary inflation to generate system-wide reflation.
With that theoretical backdrop, let’s delve into the “everything Bubble”. Appraising the Fed’s post-bubble analytical and policy framework, I began warning of the potential for the “global government finance Bubble” – the “Granddaddy of All Bubbles” - back in 2009. With the introduction of QE in conjunction with massive fiscal deficits, the expansive Bubble had finally reached the foundation of finance – central bank Credit and government debt. From my analytical perspective, it was the worst-case scenario: The Bubble was being fueled by an egregious inflation of “money” - and it all was enveloping the world.
I also introduced the concept of “moneyness of risk assets” – an expansion of my “moneyness of Credit” tenet from the mortgage finance Bubble era. Basically, the Bernanke Fed used zero rates and inflated market prices to coerce savers into stocks and bonds. Then, aggressive monetary stimulus was employed to backstop the markets, promoting the perception of safety and liquidity. “Stocks always go up”. It was all reckless inflationism that was clearly fueling dangerous asset and speculative Bubbles.
There were some serious bouts of instability along the way – 2012, 2013, 2018, 2019 and March 2020. And, in each instance, the Fed and global central bank community adopted the ever increasing radical monetary inflation necessary to sustain Bubbles. It culminated during the pandemic, with $5 TN from the Fed and similar amounts from the ECB and BOJ. There were Trillions more from central banks everywhere.
It was monetary and fiscal stimulus – inflationism - on a global basis, the likes of which the world had never experienced. And, importantly, the Bubble inflated for an incredible 13 years. History teaches that things can get crazy at the end of cycles, and we witnessed some of the craziest things ever. Readers far into the future will ponder this era, as we do the tulip bulb mania and John Law’s Mississippi Bubble. And, most unfortunately, it’s all coming home to roost now.
Last quarter, I discussed the unfolding new cycle. We believe inflation dynamics have fundamentally changed. I doubt inflation will stay above 9% for long, but I do believe the Fed will be challenged to get – and keep - inflation under control. There were some anomalies that played major roles in keeping consumer price inflation relatively contained throughout the previous cycle – technological innovation, globalization, and the historic development in China and the emerging markets, to name the most obvious. I don’t see any of these factors playing the same role in the new cycle. Also, and this is a key point, financial assets have lost the huge advantage they enjoyed over real assets throughout the previous financial boom cycle.
Now, with consumer prices unleashed and inflation psychology altered, a chastened Fed and central bank community have begun to adjust their doctrines to stress resolve in containing inflation. This is a secular sea-change. During the previous cycle, relatively benign consumer inflation nurtured monetary policy drift to a securities market focus. This created a self-reinforcing dynamic, where liquidity injected during QE operations specifically gravitated to financial assets – stoking speculative Bubbles while having limited inflationary effect on general consumer prices.
Liquidity will inherently flow in the direction of the strongest inflationary biases. During the previous cycle that was financial assets. We don’t expect this dynamic to hold sway going forward.
We can’t overstate the significance of the so-called “Fed put” during the previous cycle. This liquidity backstop – that morphed over time into “whatever it takes” zero rates and Trillions of QE – created the perception of “moneyness” throughout the financial markets. Stocks became a can’t lose, corporate debt the same, and even the cryptocurrencies. The same can be said for derivatives and Wall Street structured finance. Private equity and venture capital were a can’t lose. And you couldn’t lose with hedge funds and leveraged speculation. This central bank-induced “moneyness of everything” stoked a historic period of myriad synchronized Bubbles across the globe. History offers nothing remotely comparable.
But the game has changed, and this lies at the heart of the unfolding new cycle. The central bank liquidity backstop has turned problematic and ambiguous. In the end, I believe central banks will have no alternative than to use QE to counter the forces of bursting asset and Credit Bubbles. But inflation’s resurgence suggests the halcyon “money” free-for-all days are behind us.
We’ll return to this new cycle theme, but let’s address a few of these bursting Bubbles. I find the “Periphery and Core” instability analytical framework particularly helpful in these kinds of environments. As a cycle begins to turn, risk aversion takes hold first out at the periphery – with the more fringe regions, countries, markets, sectors and companies. When finance is loose, it’s the fringe, offering enticing speculative opportunities, that sees the greatest impact from risk embracement and liquidity excess. But when the cycle inevitably turns, the maladjusted “Periphery” is vulnerable to even subtle shifts in risk tolerance and financial conditions. Losses, de-risking/deleveraging, and waning liquidity gain momentum, leading to contagion effects that over time gravitate from the “Periphery” to the “Core.”
This dynamic attained robust momentum during Q2. Powerful de-risking/deleveraging took hold throughout the emerging markets, with currencies and bond markets under heavy liquidation. The unwind of levered EM “carry trades” fueled a self-reinforcing dynamic of dollar strength, waning liquidity and intensifying de-risking/deleveraging. To support their faltering currencies, EM central banks resorted to aggressive rate hikes, along with sales of Treasuries and other international reserve holdings. It all fed a dramatic tightening of global financial conditions for a world that until recently had the semblance of endless liquidity abundance.
China’s international reserves dropped $116bn during Q2, suggesting significant capital flight. China’s currency lost 5.4% versus the dollar. China’s bubble collapse has recently taken a turn for the worse – perhaps a decisive turn. Recall that China faced heightened instability late in Q1. Its developer bond market crisis had jumped from the “Periphery” to the “Core”, with Country Garden, China’s largest developer, seeing bond yields spike from 6.5% to surpass 30%.
Predictably, Beijing moved forward with a series of aggressive stimulus measures that temporarily calmed the developer bond market while spurring a decent stock market rally. There were Covid outbreaks, including an extended crippling lockdown in Shanghai. Beijing announced more stimulus measures, including plans for massive infrastructure spending.
Then something very important transpired. Despite all of Beijing’s measures, developer bond yields began rising again. The crisis deepened. China’s apartment bubble is one of history’s greatest bubbles. Its collapse has significant ramifications – for China’s economy and financial system, along with the global economy and the global financial system. There are clear geopolitical repercussions. Crisis dynamics often move at a glacial pace – only to suddenly accelerate at seemingly lighting speed. And crisis dynamics can appear manageable for some time - only to reach a point where fear takes hold that they might be uncontainable. China’s crisis is on such a trajectory.
Last week, a movement caught fire, where owners of uncompleted apartment units decided to stop making mortgage payments. Within a few days, developments in 100 cities were impacted. We might look back at last week and see it as a critical juncture in the crisis – a point where crisis dynamics began to turn systemic.
Keep in mind this is new territory for China’s households, developers, banks, regulators and Beijing officials, all experiencing their first housing/mortgage finance bust. It’s worth noting that Consumer - chiefly mortgage - borrowings almost doubled over the past five years – and were up four-fold in 10 years - to almost $11 TN. Chinese Bank Assets – which, by the way, were up a record $1.95 TN just during Q1 - surged 50% over the past five years – and 200% in 10 years - to an astronomical $53 TN.
Country Garden saw its bond yields surge a full 11.5 percentage points last week to a record 41%. These bonds yielded 3.25% in September. Another top five developer, Lonfor bond yields have spiked 23 percentage points in eight sessions to 126%. Sunac yields jumped to 117% and Evergrande yields to 141%. Vanke, another top five developer, is worth special attention. It is considered the financially strongest of the major private sector developers. Its bonds yielded 3.0% in September, with its credit default swaps priced at 100 bps.
Vanke yields have surged to almost 10%, with its CDS surpassing 650 bps. The market is saying China’s apartment Bubble has made it to the strongest – to the “Core”. If Vanke is in trouble, I believe China’s Bubble collapse is quickly approaching the point of no return. And we’re talking about an industry with Trillions of liabilities.
Corroborating the thesis that China’s crisis has turned systemic, Chinese bank stocks sank almost 8% last week, as Chinese bank CDS spiked higher – blowing past highs from the March instability period. Notably, China Construction Bank CDS jumped 25 bps last week to 123 bps, surpassing the March 2020 pandemic crisis spike. With over $4 TN of assets, China Construction Bank is one of the largest banks in the world. Of China’s other “Big Four,” Bank of China CDS surged to the high back to 2014. China Development Bank and Industrial and Commercial Bank CDS rose to highs back to 2017.
We can call it the “Beijing put”. China’s historic Credit and apartment Bubbles are unmitigated disasters. Yet markets have been content to look the other way, while renewing their faith in the almighty Beijing meritocracy. No issue was too big to be resolved by Communist leadership. No amount of debt too excessive. No Bubble too big. No degree of structural maladjustment too deep for Beijing stimulus. And, apparently, there’s no economic downturn that won’t be countered by boundless Beijing-directed lending and spending.
I remember the mantra in mid-1998: “The West will never allow Russia to collapse.” And then in 2006/2007, “Washington will never allow a housing bust.” Today, it’s “Beijing won’t allow financial and economic crisis – it won’t tolerate fallout from bursting Bubbles – not with its global superpower status on the line.”
And this is precisely the mindset that sets the stage for destabilizing crisis. First, faith in government control underpins sustained Credit and speculative excess and associated maladjustment. Bouts of instability resolved by government actions over the course of a cycle only embolden risk-taking. With everyone well-conditioned, confidence is sustained for a while, even as Bubbles begin to deflate.
Importantly, however, there reaches a critical juncture where speculative de-risking/deleveraging attains certain momentum, where instability forces markets to begin questioning whether policymakers actually have things under control. I refer to a “holy crap moment” – in 1998, this dynamic revealed egregious leverage at Long-Term Capital Management and elsewhere. In 2008, it was with Lehman and Wall Street finance.
The unraveling process commenced last week in China. The movement to halt mortgage payments was on the heels of some protests by depositors of failed banks. I believe there’s growing recognition that the Chinese people are being pushed to their breaking point. A most protracted Bubble period inflated many things, including expectations. The Chinese have been willing to tolerate increasingly brazen government repression because of confidence that a highly effective Beijing would continue to improve standards of living. This trust is being shattered. There is heightened recognition that Beijing has seriously mismanaged economic development. Zero-Covid is seen by many as terribly misguided government overreach. And I would imagine there are many questioning China’s “partner without limits” alliance with Putin’s Russia.
If not already, the bloom is at least coming off the rose for Beijing. Inflating Bubbles create genius, while Bubble deflation spawns blunders and incompetence. From my perspective, a crisis of confidence is unavoidable. The degree of mismanagement – especially in regard to Credit and speculative excess, its banking system – has been shocking. And with Beijing now forcing aggressive crisis lending – including to insolvent developers – how long can confidence be maintained in China’s bloated banking system?
But here’s what has me really worried. It’s not just Beijing that faces a crisis of confidence. Right now, emerging markets face sinking currencies, de-risking/deleveraging, “hot money” outflows, and a dramatic tightening of financial conditions. And it’s anything but clear what reverses these dynamics. I’ve witnessed a number of EM crises during my career, but never has there been a setup like today’s dominoes all lined up across the globe.
In Europe, the ECB raised rates 50 bps today for the first hike in 11 years. And even with its main policy rate not yet even positive, the troubled European periphery is already under acute stress. Highly indebted and dysfunctional Italy is in the crosshairs. Mario Draghi resigned earlier today, the Italian parliament was dissolved, and there will be at least two months of uncertainty, with elections now scheduled for September 25th. Crisis dynamics engulfed European periphery bonds last month, with destabilizing yield spikes in Italy and Greece.
The ECB responded with a pledge to create a so-called “anti-fragmentation” tool, which essentially means more QE directed at Italian and periphery bonds to thwart bond market collapse. A vague outline of this program was announced today. Not surprisingly, the Germans, Austrians and others are opposed to printing more money to support fiscally irresponsible governments. After all, the ECB’s balance sheet has inflated $5 TN over recent years, and now Europe faces a serious inflation problem, along with an energy crisis and economic stagnation.
It should be obvious by now that money printing will not resolve Europe’s issues. I’ve argued that, at the end of the day, I don't expect the Germans and Italians to share a common currency. And that’s why the ECB and global markets turn so anxious when European periphery yields spike. It poses nothing short of an existential threat to European monetary integration.
The ECB faces a crisis of confidence. They are concocting a liquidity backstop mechanism for the eurozone’s periphery that, truth be told, they really hope they won’t have to use. When they are forced to employ bond support operations and its efficacy is questioned, they will then face the real prospect of a serious run on periphery bond markets and even the euro currency.
And speaking of runs on bond markets, I fear the Bank of Japan is also facing a crisis of confidence. The Bank of Japan has been creating and spending hundreds of billions to maintain its 25 bps ceiling on Japanese 10-year yields. This was a crazy bad idea to begin with, and these days, with spiking global inflation and yields, it has become untenable. The yen has sunk to 20-year lows versus the dollar, and confidence in the yen and monetary management has taken a big hit. When their misguided yield peg breaks, there will be serious risk of a major bond market dislocation and currency turmoil.
Let’s now turn our focus homeward – away from the “Periphery” and more to the “Core”. Inflation surpassing 9%, bursting Bubbles, a sour public mood, economic fragility, and a central bank facing a serious crisis of confidence of its own.
Contemplating the extraordinary backdrop, it’s critical to think secular rather than cyclical. Unfolding financial and economic crises are decades in the making. JPMorgan’s Jamie Dimon has warned of a potential “hurricane.” A Pimco manager last week said he expects more of a “shower.” I am reminded of a passage from a book I read years ago analyzing the late-twenties: It said, “Everyone was prepared to hold their ground, but the ground gave way.”
There is incredible complacency these days, especially considering the environment. Ominous developments at the global “Periphery” are easily disregarded. This is typical. The dollar is exceptionally strong, commodities prices have reversed sharply lower, bond yields are lower, and some see the Fed winding down its tightening cycle in the not too distant future – and all this supports the narrative that peak inflation has passed, and market lows have been established.
Meanwhile, global de-risking/deleveraging, illiquidity and contagion are bearing down on the “Core”. And we’ve already witnessed serious stress unfold at our own “Periphery”. The crypto Bubble is collapsing, revealing a lot of leverage and shenanigans. The corporate debt market has also taken a hit. The junk bond market has been largely shut to new issuance for weeks, and even the investment-grade marketplace has experienced a dramatic change in the liquidity backdrop.
This equates to a destabilizing tightening of financial conditions at our “Periphery” after years of the loosest Credit conditions imaginable. And this is a major structural issue for an economy driven by a proliferation of negative cash-flow and uneconomic businesses. The shakeout has begun, with some of the clearest evidence of this dynamic unfolding in the technology arena. We’ve seen some layoffs, but we’re really early. Before this is over, I expect massive restructurings and bankruptcies. This will be a quite arduous adjustment to new market, policy, financial and economic realities.
Markets are extraordinarily vulnerable here – stocks, bonds, housing, private equity, commercial real estate, and so on. We’re so early in the adjustment process. There are two interrelated critical dynamics at play in the markets. Financial conditions have tightened meaningfully, which will imperil the solvency of many companies, while pressuring household and business spending.
Meanwhile, it’s a critical issue that the “Fed put” has turned ambiguous. Market faith in the Fed liquidity backstop has crystallized for over three decades, becoming deeply embedded in market perceptions, prices and speculative dynamics. In the eyes of the markets, it has been the most consequential facet of contemporary monetary policy doctrine. The Fed liquidity backstop has been integral to Trillions flowing into perceived safe and liquid ETF shares. It has been key to Trillions of hedge fund and speculator leverage. It has been crucial for risk-taking more generally. It has been absolutely fundamental to a multi-hundreds of trillions derivatives complex. And there is today uncertainty as to how the Federal Reserve will now respond to crisis dynamics.
I’m on record forecasting a much larger Fed balance sheet. There is no alternative to central bank liquidity in the event of serious de-risking/deleveraging. I also believe newfound inflation persistence will prevent the Fed from their singular focus on market stability. I expect another round of QE – but it seems likely that this liquidity comes later and in narrower scope than markets have grown accustomed to. And later and smaller will not suffice.
Recall the portentous dynamic from March 2020. The Fed hastily responded to de-risking/deleveraging and market dislocation by announcing a major QE program. Yet market dislocations only worsened. An increasingly desperate Fed repeatedly boosted its crisis policy response until the prospect of Trillions of QE finally reversed de-risking/deleveraging and halted the run on some ETFs.
The Fed’s most recent $5 TN QE onslaught pushed leverage and speculative excess to unprecedented extremes. When serious de-risking takes hold at the “Core”, it would take Trillions of additional liquidity to rejuvenate risk-taking and leveraged speculation. And, at this point, with inflation raging and bond markets fragile, such a massive QE program would pose great risk to inflation and bond market stability, not to mention Federal Reserve credibility.
Fundamentally altered inflation dynamics are a prominent aspect of the new cycle. The era of endless cheap imports from China and Asia has largely run their course. And Russia’s invasion of Ukraine and the new Iron Curtain solidified the end of a multi-decade period of integration and globalization. And while commodity prices have retreated over recent weeks, we believe the new cycle will be an era of hard asset outperformance versus financial assets. And this dynamic will change so many things, including raising the risk that QE injections feed directly into higher commodities prices and general inflation. The job of a central banker has become incredibly more challenging.
Markets can no longer take for granted that the Fed is willing and able to ensure the perpetual bull market. Late and limited QE will not thwart financial crisis, and this new dynamic implies significantly higher market and economic uncertainty. Markets are riskier. Speculation is riskier. Leverage is riskier. The cost of market protection is higher.
And let me summarize some key aspects of the new cycle that will profoundly impact the markets. Consumer prices will have a stronger and sustained inflationary bias. Central banks will be forced back to a traditional inflation focus, rather than the experimental market-centric approach of the past cycle. Policy rates will be higher, and QE will be relegated to a crisis-fighting tool. Financial conditions will be significantly tighter on a more sustained basis. The liquidity and policymaking backdrops will be much less conducive to leveraged speculation, and risk-taking more generally. The so-called “Fed put” will remain nebulous, with QE employed more unpredictably and sparingly.
I believe we’re early in the process of markets adjusting to new cycle realities. Markets are highly volatile at cycle inflection points, and we’ve been experiencing this phenomenon. I expect even more volatility. The fundamental tightening of financial conditions is currently having its greatest impact at the “Periphery”. And while our markets have retreated, the “Core” is currently benefiting from the strong dollar and generally low market yields. This creates a mirage of liquid and sound markets. There has been meaningful tightening at the “Core’s” periphery, with waning liquidity and market losses in U.S. corporate debt markets.
But a much more perilous storm is approaching, and we need to ponder the possibility that there will be nowhere to hide – that the unfolding crisis is global, deeply systemic and uncontrollable for the global central bank community. I worry about a crisis of confidence in policymaking, in the markets and finance more generally. As I’ve said many times, contemporary finance appears almost miraculous so long as it’s expanding – as it did in historic fashion over the previous cycle. It’s unclear to me how existing market and financial structures continue to operate effectively in the new cycle. How does contemporary finance expand with financial conditions much tighter, with the central bank community’s newfound stinginess with liquidity, with significantly reduced leveraged speculation and much less faith in forever rising securities prices?
And in closing, I fear there is nowhere to hide from escalating geopolitical risk. And I’ll again underscore a most pertinent cycle dynamic. During the up-cycle boom, the economic pie is perceived as robust and expansive. Cooperation, integration and strong alliances are viewed as beneficial - both individually and collectively. But as the cycle ages, strains mount, and insecurity increasingly takes hold. Eventually, the backdrop is viewed more in terms of a shrinking pie - with a newfound zero-sum game calculus. The downside of the cycle heralds a period of fragmentation, animus and conflict.
We’re now five months into the tragic war in Ukraine. The West is determined that Russia cannot be allowed to win. Putin seems as determined as ever to ensure Russia doesn’t lose. And the more munitions arriving from the West, the more it appears Putin is adopting a scorched earth strategy of destruction in the south and terrorizing missile strikes in population centers across Ukraine.
At this point, a return to the previous world order appears impossible. From this perspective, the world appears well into the transition to a perilous down cycle dynamic. Last week, Putin referred to the Ukraine conflict as “the beginning of a radical breakdown of the American world order… the beginning of the transition from liberal-globalist American egocentrism to a truly multipolar world.”
And there’s little doubt that China has aligned with Putin’s Russia to form an anti-U.S. alliance. An altered and much less hospitable world order is fundamental to the new cycle. I fear a scenario where the West has to significantly ramp up support to preserve Ukraine as an independent nation. I’ve worried for a while now that bursting Chinese Bubbles could spur a Beijing move on Taiwan. U.S./Chinese tensions are on a troubling trajectory. It’s difficult to imagine a backdrop with greater uncertainty and greater risk – market, policy, economic, political and geopolitical. I’m a broken record on this, but it’s time to hunker down and prepare for tumultuous times. I sincerely hope my analysis proves way too pessimistic.
For the Week:
The S&P500 rallied 2.5% (down 16.9% y-t-d), and the Dow rose 2.0% (down 12.2%). The Utilities slipped 0.6% (down 3.8%). The Banks gained 2.1% (down 19.7%), and the Broker/Dealers surged 4.1% (down 15.1%). The Transports advanced 4.5% (down 16.2%). The S&P 400 Midcaps recovered 4.0% (down 15.7%), and the small cap Russell 2000 rallied 3.6% (down 19.5%). The Nasdaq100 rallied 3.4% (down 24.0%). The Semiconductors jumped 5.5% (down 28.0%). The Biotechs declined 1.3% (down 14.6%). While bullion rallied $19, the HUI gold index fell 1.1% (down 22.3%).
Three-month Treasury bill rates ended the week at 2.3325%. Two-year government yields fell 15 bps to 2.97% (up 224bps y-t-d). Five-year T-note yields sank 17 bps to 2.84% (up 158bps). Ten-year Treasury yields dropped 17 bps to 2.75% (up 124bps). Long bond yields declined 11 bps to 2.975% (up 107bps). Benchmark Fannie Mae MBS yields sank 23 bps to 4.165% (up 210bps).
Greek 10-year yields sank 27 bps to 3.23% (up 192bps y-t-d). Ten-year Portuguese yields fell 12 bps to 2.19% (up 173bps). Italian 10-year yields rose four bps to 3.32% (up 215bps). Spain's 10-year yields declined four bps to 2.26% (up 169bps). German bund yields dropped 10 bps to 1.03% (up 121bps). French yields fell 13 bps to 1.62% (up 142bps). The French to German 10-year bond spread narrowed three to 59 bps. U.K. 10-year gilt yields dropped 15 bps to 1.94% (up 97bps). U.K.'s FTSE equities index rallied 1.6% (down 1.5% y-t-d).
Japan's Nikkei Equities Index surged 4.2% (down 3.0% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.215% (up 14bps y-t-d). France's CAC40 rose 3.0% (down 13.1%). The German DAX equities index recovered 3.0% (down 16.6%). Spain's IBEX 35 equities index gained 1.3% (down 7.6%). Italy's FTSE MIB index rose 1.3% (down 22.4%). EM equities were mostly higher. Brazil's Bovespa index rallied 2.5% (down 5.6%), and Mexico's Bolsa index increased 0.4% (down 11.3%). South Korea's Kospi index jumped 2.7% (down 19.6%). India's Sensex equities index rallied 4.3% (down 3.7%). China's Shanghai Exchange Index increased 1.3% (down 10.2%). Turkey's Borsa Istanbul National 100 index recovered 5.6% (up 35.5%). Russia's MICEX equities index dipped 0.6% (down 44.6%).
Investment-grade bond funds posted outflows of $3.309 billion, and junk bond funds reported negative flows of $885 million (from Lipper).
Federal Reserve Credit last week expanded $11.2bn to $8.870 TN. Fed Credit is down $30.7bn from the June 22nd peak. Over the past 149 weeks, Fed Credit expanded $5.143 TN, or 138%. Fed Credit inflated $6.059 Trillion, or 216%, over the past 506 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week dropped another $13.4bn to a 26-month low $3.352 TN. "Custody holdings" were down $174bn, or 4.9%, y-o-y.
Total money market fund assets rose $9.0bn to $4.583 TN. Total money funds were up $96bn, or 2.1%, y-o-y.
Total Commercial Paper was little changed at $1.170 TN. CP was up $38bn, or 3.3%, over the past year.
Freddie Mac 30-year fixed mortgage rates added three bps to 5.54% (up 243bps y-o-y). Fifteen-year rates rose eight bps to 4.75% (up 242bps). Five-year hybrid ARM rates declined four bps to 4.31% (up 190bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates down 17 bps to 5.60% (up 237bps).
Currency Watch:
For the week, the U.S. Dollar Index declined 1.2% to 106.73 (up 11.6% y-t-d). For the week on the upside, the Swedish krona increased 2.6%, the Norwegian krone 2.4%, the Australian dollar 2.0%, the Japanese yen 1.8%, the New Zealand dollar 1.6%, the Swiss franc 1.5%, the South African rand 1.5%, the euro 1.3%, the British pound 1.2%, the South Korean won 1.0%, the Canadian dollar 0.9%, and the Singapore dollar 0.9%. On the downside, the Brazilian real declined 1.7%. The Chinese (onshore) renminbi increased 0.08% versus the dollar (down 5.86% y-t-d).
Commodities Watch:
The Bloomberg Commodities Index rallied 2.7% (up 17.5% y-t-d). Spot Gold recovered 1.1% to $1,728 (down 5.6%). Silver slipped 0.6% to $18.60 (down 20.2%). WTI crude dropped $2.89 to $94.70 (up 25.9%). Gasoline increased 0.3% (up 45%), and Natural Gas surged 18.3% to $8.30 (up 123%). Copper rallied 3.6% (down 25%). Wheat fell 2.3% (down 2%), and Corn sank 6.5% (down 5%). Bitcoin surged $1,872, or 9.0%, this week to $22,732 (down 51%).
Market Instability Watch:
July 21 – Bloomberg (Wei Zhou and Dorothy Ma): “China’s credit market is now showing stress on an almost daily basis, as a worsening property crisis shatters assumptions about safe borrowers and even Chinese investors turn against troubled debtors. The country’s junk dollar bonds were on the brink of record lows Thursday, as a state-backed developer sought payment delays on $1.6 billion of dollar notes. In other signs of stress, the debt of a private builder deemed healthy just months ago sank, while creditors spurned a restructuring plan by the parent of BMW AG’s China partner. Taken together, the incidents point to a credit market in a new phase of turmoil as stress spreads from cash-starved private developers to those with government backing and companies outside the housing sector. Chinese investors pushing back on debt reprieves or unfavorable restructuring plans also suggest dwindling confidence in Beijing’s ability to pull off a fast economic turnaround.”
July 21 – Financial Times (Amy Kazmin and Silvia Sciorilli Borrelli): “Mario Draghi has resigned as Italy’s prime minister, triggering the dissolution of parliament and pushing the country into snap elections in September. Draghi quit as prime minister… a day after the three large parties in parliament boycotted a confidence vote in his leadership following a rancorous parliamentary debate. President Sergio Mattarella… noted that the early dissolution of parliament — whose term was due to expire next year — was supposed to be a ‘last resort’ but that the political situation left him with no alternative. He also expressed concern about Italy’s ability to meet ‘pivotal deadlines’ for access to its next instalments of the €200bn in EU coronavirus recovery funds. The election will take place on September 25.”
July 21 – Reuters (Dhara Ranasinghe and Yoruk Bahceli): “Debt-laden Italy finds itself in markets' crosshairs again, as a collapse in its national unity government coincides with the European Central Bank preparing to deliver its first interest rate rise in 11 years. Like other indebted euro zone countries, Italy has spent the past few years when cash was cheap and plentiful trying to reduce its vulnerability to rising rates and market panic. But it is more exposed to increasing borrowing costs than it might appear, according to a Reuters review of its debt profile. For sure, Italy has extended its debt maturities, but by less than Southern European peers and outright debt is higher than it was during the euro zone debt crisis.”
July 21 – Financial Times (Ian Johnston and Kate Duguid): “Italy’s debt sold off on Thursday after prime minister Mario Draghi resigned and the European Central Bank sharply raised interest rates in its effort to tame blistering inflation. The yield on Italy’s 10-year government bond rose as much as 0.27 percentage points to almost 3.7% as Draghi’s national unity coalition unravelled and the ECB lifted its deposit rate… The decline in Italian bond prices took the gap between Italian and German benchmark 10-year yields… to 2.38 percentage points, reflecting a widening of more than 0.3 percentage points in just two days. The pressure on Italian debt eased slightly later in the session…”
July 21 – Bloomberg (Greg Ritchie): “The collapse of Italy’s government is awakening a dormant threat in European bond markets. Credit-default swaps suggest investors are starting to worry about a future administration pulling or crashing the nation out of the euro. They are buying newer swaps, which offer more protection against such an event, driving up their premium to older swaps to the highest since 2018 on Thursday. That came after Italian bonds slid in the wake of Prime Minister Mario Draghi resigning, which opens the door to snap elections that could bring in a more euroskeptic or less fiscally responsible government. The debt sold off further after the European Central Bank hiked borrowing costs more than expected, with a new tool to stop unwarranted yield spikes failing to stop the rout.”
July 22 – Bloomberg: “China’s bond market is becoming the locus for global capital outflows and there are signs the government is growing concerned about the $30 billion exodus as it delays data and seeks to manage investor expectations. Foreign funds offloaded 55.9 billion yuan ($8.3bn) of the nation’s debt in June, a fifth month of net sales that swelled the total outflows this year to 200 billion yuan. That’s an abrupt reversal for a market that had seen global participation grow every year since 2014…”
July 19 – South China Morning Post (Frank Tang): “China's holdings of US Treasuries fell from US$1.003 trillion in April to US$980.8 billion in May, the lowest since 2010… A desire by Beijing to avoid ‘the risk of possible conflict’ with Washington could have contributed to China cutting its holding of US government debt to below US$1 trillion for the first time in over 12 years, analysts said. China's holdings of US Treasuries fell from US$1.003 trillion in April to US$980.8 billion in May…, representing the lowest point since May 2010 when its holdings stood at US$843.7 billion.”
Bursting Bubble/Mania Watch:
July 20 – Financial Times (Chris Flood): “New business for exchange traded fund providers dropped by almost 30% in the first six months of the year as equity and bond markets both fell sharply in response to soaring inflation and rising interest rates. Global net inflows into ETFs reached $463.8bn in the first half of 2022, down 29.6% from the same period last year, according to ETFGI… Declines in stocks and bonds this year overshadowed inflows, pushing global ETF assets to $8.6tn, down from $10.3tn at the end of December.”
July 19 – Bloomberg (Jill R. Shah and Davide Scigliuzzo): “Chasing leveraged buyout financing business cost the biggest US banks at least $1.3 billion in the second quarter, and more such losses are likely on the way from their European counterparts. Six banks including JPMorgan…, Goldman Sachs... and Citigroup Inc. recorded the paper losses on loans, mostly made to fund leveraged buyouts. Bank of America Corp. led the pack with a $320 million writedown, while Morgan Stanley reported $282 million in losses… The pain stems from loans that banks agreed to make months ago to fund LBOs, before credit markets were hit by fears of a recession. Lenders have about $38.1 billion of committed loan financing left to sell to investors, plus around $31.3 billion of junk bond funding, according to a Deutsche Bank…”
July 21 – Bloomberg (Lisa Lee and Kiel Porter): “The giants of private credit -- the only game in town lately for big-ticket leveraged buyouts -- are dialing back on risk, in a turning point that threatens to reduce crucial financing for mega deals. Blackstone Inc., Apollo Global Management Inc., Ares Management Corp., KKR & Co., Antares Capital LP and the asset management arm of Goldman Sachs… are cutting the amount of debt they’re providing per deal as recession risk rises, according to people with knowledge of the matter who aren’t authorized to speak publicly. They’re also asking for, and getting, higher yields on financing packages with less leverage, while commanding stronger investor protections in case corporate borrowers go under, the people said.”
July 20 – Bloomberg (Janet Lorin, Hema Parmar and Dawn Lim): “Princeton, Harvard and Yale generated robust returns for their endowments in recent years, fueled in part by billions of dollars of investments in private equity and venture capital. That golden era appears to be over, at least for now. College endowments across the US are likely to report losses for the fiscal year ended June 30 as valuations for startups and other closely held companies deflate, following a sharp decline in public markets and the end of cheap leverage. ‘The magnitude of the drawdown in venture companies and public markets is so much greater than it has been going back to the financial crisis,’ said Jay Ripley, co-head of investments at Global Endowment Management…”
July 20 – Wall Street Journal (Miriam Gottfried): “Blackstone Inc. posted a loss in the second quarter as the broader market tumbled and the value of its private-equity portfolio fell. The… firm reported a net loss of $29.4 million, or 4 cents a share, compared with a profit of $1.31 billion, or $1.82, during the same period last year. Blackstone said the value of its corporate private-equity portfolio fell by 6.7% in the quarter. The decline was smaller than that of the S&P 500, which slumped by 16.5%. Still, it was a far cry from a 13.8% increase a year earlier.”
July 22 – Reuters (Gaurav Dogra and Patturaja Murugaboopathy): “Global equity funds recorded their biggest weekly outflow in five weeks in the week to July 20… According to Refinitiv Lipper, investors offloaded a net $13.79 billion worth of global equity funds, marking the biggest weekly outflow since June 15.”
July 22 – Reuters (Gaurav Dogra and Patturaja Murugaboopathy): “U.S. equity funds witnessed their biggest weekly outflow in five weeks in the week to July 20… According to Refinitiv Lipper data, U.S. equity funds recorded $8.45 billion worth of net selling, which was the biggest weekly outflow since June 15… U.S. growth funds booked outflows of $3.46 billion after small purchases in the week before, while investors exited value funds worth $1.62 billion in a fourth subsequent week of net selling.”
Economic War/Iron Curtain Watch:
July 21 – Reuters (Vitalii Hnidyi and Jonathan Spicer): “Russia and Ukraine will sign a deal on Friday to reopen Ukraine's Black Sea ports, Turkey said, a potential breakthrough that could ease the threat of hunger facing millions around the world as a consequence of Russia's invasion… Although Russia's ports have not been shut, Moscow had complained that its shipments were hurt by Western sanctions. The United States and the European Union have both adjusted their sanctions recently to spell out more clearly exceptions for Russian food and fertiliser exports.”
Inflation Watch:
July 20 – Associated Press (Cathy Bussewitz): “When long-haul trucker Deb LaBree sets out on the road to deliver pharmaceuticals, she has strategies to hold down costs. She avoids the West Coast and the Northeast, where diesel prices are highest. She organizes her delivery route to minimize ‘deadheading’ — driving an empty truck in between deliveries. And if a customer’s load is too far away or they can’t pay more for fuel? She turns the job down… The price of diesel fuel has skyrocketed in recent months — much more even than regular gasoline — especially after Russia invaded Ukraine in February.”
July 21 – Wall Street Journal (Leslie Scism): “Big car, home and business insurer Travelers Cos. posted a 41% decline in second-quarter net income, as inflation has continued to drive up costs, including to repair and replace automobiles and pay for medical care of injured people. Allstate Corp., meanwhile, said inflation would worsen its coming second-quarter quarter results… Both insurers said more premium-rate increases lie ahead in an effort to improve their bottom lines.”
July 22 – CNBC (Jeff Cox): “Goldman Sachs CEO David Solomon set the tone early this earnings season when he said inflation is ‘deeply entrenched’ in the U.S. economy and impacting conditions on a multitude of fronts. Since then, company leader after company leader has expressed similar sentiments. Most say they’ve managed to navigate difficult times spurred by inflationary pressures at their highest level in more than 40 years. They report cutting costs, raising prices and generally trying to adapt models to the uncertainty of what’s ahead.”
U.S. Bubble Watch:
July 21 – CNBC (Jeff Cox): “Initial jobless claims hit their highest level since mid-November last week, the latest sign that a historically tight labor market is beginning to slow… Claims totaled 251,000 for the week ended July 16, up 7,000 from the week before and above the 240,000 Dow Jones estimate.”
July 20 – CNBC (Diana Olick): “Sales of previously owned homes in June fell 5.4% from May…, as prices set records and rates surged. The sales count declined to a seasonally adjusted annualized rate of 5.12 million units last month, the group said. Sales were 14.2% lower compared with June 2021 This is the slowest sales pace since the same month in 2020… These numbers are based on home closings, so the contracts were likely signed in April and May, before the average rate on the 30-year fixed mortgage shot above 6%... There were 1.26 million homes for sales at the end of June. That is an increase of 2.4% from the previous June, and the first year-over-year gain in three years. At the current sales pace, inventory now stands at a three-month supply… The still-tight supply, however, is keeping the heat under home prices. The median price of an existing home sold in June set yet another record at $416,000, an increase of 13.4% year over year.”
July 19 – CNBC (Diana Olick): “The pain in the mortgage market is only getting worse as higher interest rates and inflation hammer American consumers. Mortgage demand fell more than 6% last week compared with the previous week, hitting the lowest level since 2000, according to the Mortgage Bankers Association’s seasonally adjusted index. Applications for a mortgage to purchase a home dropped 7% for the week and were 19% lower than the same week in 2021. Buyers have been contending with high prices all year, but with rates almost double what they were in January, they’ve lost considerable purchasing power.”
July 21 – Financial Times (Richard Waters): “After a period of breakneck expansion, Big Tech is hitting the pause button. A round of internal announcements in recent days has revealed the sudden wave of caution sweeping through the tech companies’ top ranks. Last year, as Big Tech accelerated out of the pandemic, the brakes came off on hiring. Now, facing more difficult year-over-year comparisons and an uncertain economy, the mood has turned quickly. Google, after warning last week that it would target its hiring more carefully in the coming months, followed up this week with a two-week pause on all new job offers… Microsoft also confirmed it was working through a business-by-business review to decide how to focus investments more narrowly.”
Fixed-Income Bubble Watch:
July 20 – Bloomberg (Caleb Mutua): “Wall Street banks were supposed to be done with much of their borrowing in bond markets for the year. Then this week, they sold another $27.5 billion of notes. About $10 billion came from Bank of America Corp. on Tuesday. JPMorgan…, Wells Fargo & Co. and Morgan Stanley sold a combined $17.5 billion on Monday. And Goldman Sachs… may bring the total still higher. The sales are far more than many had expected: JPMorgan strategists had forecast somewhere between $14 billion and $16 billion from the big banks.”
July 20 – Wall Street Journal (Matt Wirz and Heather Gillers): “Paradise, Calif., the town destroyed by the 2018 Camp Fire, says it is close to a debt default, heightening municipal bond investors’ concerns over how a warming planet is adding risk to their $4 trillion market… S&P Global Ratings slashed the bonds’ rating by six notches to triple-C in June, pushing it deeper into junk territory. Municipalities have long suffered from weather-related destruction. Many investors are growing more concerned that climate change is intensifying wildfires, even while critical infrastructure is unprepared and underfunded.”
China Watch:
July 20 – Bloomberg: “Chinese Premier Li Keqiang signaled flexibility on the growth target and reiterated caution on excessive stimulus, as the economy shows initial signs of recovery from Covid outbreaks. The most important thing is to keep employment and prices stable, and slightly higher or lower growth rates were acceptable as long as employment is relatively sufficient, household income grows and prices are stable, Li told global business leaders hosted by the World Economic Forum... ‘China won’t roll out massive stimulus, issue an excessive amount of money or overdraw the future for an overly high growth target,’ Li was quoted as saying…”
July 19 – Bloomberg (Rebecca Choong Wilkins): “Over the past few years, President Xi Jinping has reined in China’s biggest tech companies, stamped out democracy in Hong Kong and locked down 26 million people in Shanghai to eliminate Covid cases. Yet he now faces a surprise challenge from middle-class homeowners who are watching their family wealth slip away with a sustained slide in the property market, which makes up a fifth of China’s economic activity. Some 70% of household wealth in China is tied up in property, far more than in the US, making it one of the most sensitive political issues for the Communist Party. For months Xi has stood firm in reining in over-leveraged Chinese developers, spurring a record wave of defaults that spooked global investors and brought at least 24 leading property companies to the brink of collapse. In the process, more than $80 billion has been wiped from its offshore bond market.”
July 19 – Guardian (Martin Farrer): “Chinese banks have been told to bail out struggling property developers to help them complete unfinished housing projects and head off the growing mortgage strike that threatens to seriously damage the economy. With thousands of homebuyers banding together to refuse to keep up with mortgage instalments on unfinished apartments bought off the plan, regulators have stepped up efforts to encourage lenders to extend loans… The China Banking and Insurance Regulatory Commission (CBIRC) told the official industry newspaper… that banks should meet developers’ financing needs where reasonable. The CBIRC expressed confidence that with concerted efforts, ‘all the difficulties and problems will be properly solved’, the China Banking and Insurance News reported.”
July 21 – Bloomberg: “China’s banking regulator vowed to ensure developers complete construction for pre-sold homes, an attempt to alleviate homebuyer concern as more people threaten to boycott mortgage payments. The China Banking and Insurance Regulatory Commission will work with the central bank, the housing ministry and local governments to ensure home delivery and social stability, Liu Zhongrui, an official with the regulator’s statistics department, said… The authorities will also keep property financing ‘stable and orderly’ while supporting the industry, Liu said. Regulators are seeking to defuse a growing consumer boycott of mortgage payments that risks spreading the real estate crisis to the banking system. The CBIRC earlier urged banks to increase lending to developers so they can complete unfinished housing projects…”
July 18 – Bloomberg (Wei Zhou and Tim Smith): “Chinese developers’ liquidity stress will evolve into insolvency risk if a property-sales recovery stalls, with at least one-fifth of rated builders facing such prospects, according to S&P Global Ratings. Developers can’t exchange and extend their defaulted bonds forever, as investors will lose patience if home sales do not soon improve, said a report from analysts including Chang Li. ‘We assume debt extensions only serve to buy time, and do not fundamentally resolve developers’ excess leverage.’ Amid a record wave of offshore delinquencies, distressed Chinese builders also have been forcing a growing number of debt extensions on investors in a bid to buy time… The stress is now starting to move from developers to banks, as some homebuyers in China refuse to pay mortgages on stalled projects.”
July 19 – Bloomberg: “Some suppliers to Chinese real estate developers are refusing to repay bank loans because of unpaid bills owed to them, a sign that the loan boycott that started with homebuyers is starting to spread. Hundreds of contractors to the property industry complained that they can no longer afford to pay their own bills because developers including China Evergrande Group still owe them money, Caixin reported… One group of small businesses and suppliers circulated a letter online saying they will stop repaying debts after Evergrande’s cash crisis left them out of pocket. ‘We decided to stop paying all loans and arrears, and advise our peers to decline any requests to be paid on credit or commercial bill,’ the group said… ‘Evergrande should be held responsible for any consequence that follows because of the chain reaction of the supply-chain crisis.’”
July 19 – CNBC (Evelyn Cheng): “China’s real estate market desperately needs a boost in confidence, analysts said, after reports of homebuyers halting mortgage payments rocked bank stocks and raised worries of a systemic crisis. The size of the mortgages isn’t as worrisome as the impact of the latest events on demand and prices for one of the biggest financial assets in China: residential housing. ‘It is critical for policymakers to restore confidence in the market quickly and to circuit-break a potential negative feedback loop,’ Goldman Sachs chief China economist Hui Shan and a team said…”
July 21 – Reuters (Liangping Gao and Ryan Woo): “China's largest policy bank said on Friday that it had disbursed 181.5 billion yuan ($27bn) in loans for urban development projects in the first half of the year, and pledged to maintain an accelerated pace of lending to fund infrastructure. The China Development Bank (CDB) has supplied 650 million yuan in loans to fund the renewal of an economic zone in the eastern city of Yantai, including the renovation of industrial facilities, it said.”
July 21 – Reuters: “China reported 1,011 new coronavirus cases for July 21, of which 175 were symptomatic and 836 were asymptomatic, the National Health Commission said on Friday. That compared with 943 new cases a day earlier - 200 symptomatic and 743 asymptomatic infections, which China counts separately.”
July 20 – Financial Times (James Kynge, Kathrin Hille, Ben Parkin and Jonathan Wheatley): “The 350m Lotus Tower that looms over the skyline in Sri Lanka’s capital Colombo is one of the tallest buildings in South Asia. Funded by a Chinese state bank and designed to look like a giant lotus bud about to burst into flower, it was intended to be a metaphor for the flourishing of Sri Lanka’s economy and the ‘brilliant future’ of the bilateral co-operation between Beijing and Colombo. Instead, the tower has become a symbol of the mounting problems facing China’s overseas lending scheme, the ‘Belt and Road Initiative’. The construction suffered from lengthy delays and an allegation of corruption levelled by Sri Lanka’s then-president Maithripala Sirisena against one of the Chinese contractors. Now, three years after its official launch, the tower’s amenities including a shopping mall, a conference centre and several restaurants stand either unfinished or largely unused while outside on the streets outrage over Sri Lanka’s financial mismanagement has boiled over into popular protests.”
July 21 – Economic Times: “In a grim reminder of the 1989 Tiananmen Square Massacre, armoured tanks were seen deployed on the streets of China amidst large-scale protests by people demanding the release of their savings frozen by banks. The country's Henan province has been for the past several weeks witnessing clashes between police and depositors with the latter saying they have been prevented from withdrawing their savings from banks since April this year. Fresh videos have surfaced online in which Chinese Peoples Liberation Army (PLA's) tanks can be seen deployed on the streets to scare protestors. Large-scale protests are being held in the province by bank depositors over the release of their frozen funds.”
Central Banker Watch:
July 21 – Financial Times (Martin Arnold and Ian Johnston): “The European Central Bank has raised interest rates by half a percentage point, pledging to prevent surging borrowing costs from sparking a eurozone debt crisis amid political turmoil in Italy and the resignation of prime minister Mario Draghi. It was the first ECB rate rise for more than a decade and twice the size of the increase mooted by the bank only last month. The move ends eight years of negative rates and raises the ECB’s deposit rate to zero. ECB president Christine Lagarde said it was ‘time to deliver’ after eurozone inflation hit a record high of 8.6% in the year to June, more than four times the central bank’s target of 2%.”
July 21 – Bloomberg (Alice Gledhill): “When a central bank sets a red line, the market will start looking for ways to test it. And now that the European Central Bank has unveiled the initial details of its anti-fragmentation tool, traders say the next step is to figure out what it takes to set it in motion. They’re asking: How wide do European spreads need to be? What are the conditions for policymakers to start supporting bond markets, and to what extent does Italy’s own political chaos prevent the ECB from taking action? ‘We would anticipate the market will test the ECB’s resolve,’ said David Zahn, the head of European fixed income at Franklin Templeton. ‘The market is interested in when or at what level the ECB would step in to help restrict government spreads widening.’”
Global Bubble and Instability Watch:
July 22 – Bloomberg (Chikako Mogi): “Japanese investors cut holdings of overseas bonds for a record eighth week as Federal Reserve interest-rate hikes and accelerating global inflation sap their demand for foreign debt. Funds in the Asian nation offloaded a net 919.6 billion yen ($6.7bn) of overseas fixed-income securities in the week through July 15… The latest figures extend weekly sales to the longest since Bloomberg started collecting the data in 2005. ‘Wariness over a further drop in Treasury prices remains deep-rooted amid concern over US inflation, and that is deterring appetite to buy overseas bonds,’ said Tsuyoshi Ueno, a senior economist at NLI Research Institute... ‘There may also be a move to cut losses.’”
Europe Watch:
July 21 – Financial Times (Amy Kazmin): “After Italian prime minister Mario Draghi’s second and conclusive resignation this week, the conservative Il Tempo newspaper’s front page carried the headline: ‘Draghi’s suicide’. But rival title La Stampa depicted him as the victim of political murder, declaring his government had been ‘drowned’. Just who is responsible for the fall of the highly respected former European Central Bank chief, feted for his role in saving the single currency in the eurozone crisis of 2012, is the subject of bitter debate among Italy’s politicians as they seek to deflect a wave of public anger over the collapse of the ruling coalition. Opinion polls last week showed Italians overwhelmingly wanted Draghi to stay in office to steer Italy through its economic and geopolitical challenges rather than going to the polls early.”
July 21 – Financial Times (Tony Barber): “In ancient times the senators of Rome begged Cincinnatus to come out of retirement and save the republic. His mission accomplished, he returned to his farm, becoming a revered symbol of selfless virtue for centuries to come. Like Cincinnatus, Mario Draghi was called upon to be the saviour of Italy at a moment of national peril during the pandemic almost 18 months ago. As prime minister he, too, rose to the occasion. But his reward is to lose the reins of power just when new, even graver emergencies are unfolding in Italy and around Europe. Many Italians can barely contain their despair at the machinations of the professional politicians that have contributed to their hero’s exit. ‘And now there is nothing left to us but to cry: poor Italy, poor us,’ tweeted one admirer of Draghi.”
July 22 – Bloomberg (Carolynn Look): “Private-sector activity in the euro area unexpectedly shrank for the first time since the pandemic lockdowns of early 2021, adding to signs that a recession might be on the horizon. A survey of purchasing managers by S&P Global dropped to a 17-month low in July, dipping beneath the level that signals contraction… ‘A steep loss of new orders, falling backlogs of work and gloomier business expectations all point to the rate of decline gathering further momentum,’ said Chris Williamson, an economist at S&P Global. ‘Of greatest concern is the plight of manufacturing, where producers are reporting that weaker-than-expected sales have led to an unprecedented rise in unsold stock.’”
July 20 – Reuters (Elizabeth Piper and Andrew Macaskill): “Former finance minister Rishi Sunak and foreign secretary Liz Truss will battle it out to become Britain's next prime minister after they won the final lawmaker vote, setting up the last stage of the contest to replace Boris Johnson. Sunak has led in all rounds of the voting among Conservative lawmakers, but it is Truss who seems to have gained the advantage so far among the 200,000 members of the governing party who will ultimately choose the winner. The final stretch of a weeks-long contest will pit Sunak, a former Goldman Sachs banker who has raised the tax burden towards the highest level since the 1950s, against Truss, a convert to Brexit who has pledged to cut taxes and regulation.”
EM Crisis Watch:
July 22 – Bloomberg: “Russia’s central bank brought interest rates below their level before the invasion of Ukraine, seizing on steep slowdown in inflation to ease monetary policy more than forecast. Policy makers lowered their benchmark to 8% from 9.5% on Friday and signaled they will consider further reductions in the second half of the year. The fifth straight cut was bigger than predicted…”
Japan Watch:
July 21 – Reuters (Leika Kihara): “The Bank of Japan projected inflation would exceed its target this year in fresh forecasts issued on Thursday, but maintained ultra-low interest rates and signalled its resolve to remain an outlier in a wave of global central banks'policy tightening. BOJ Governor Haruhiko Kuroda brushed aside the chance of near-term policy tightening, saying he had ‘absolutely no plan’ to raise interest rates or hike an implicit 0.25% cap set for the bank's 10-year bond yield target.”
July 21 – Bloomberg (Yuko Takeo and Yoshiaki Nohara): “Japan’s key inflation gauge rose further above the Bank of Japan’s target level of 2%, a result that will likely keep speculation smoldering over possible policy adjustments at the central bank despite Governor Haruhiko Kuroda’s continued commitment to ultra-low rates. Consumer prices excluding fresh food climbed at a faster pace of 2.2% in June from a year earlier, with energy costs amplified by a weaker yen and higher processed food prices the main contributors…”
Social, Political, Environmental, Cybersecurity Instability Watch:
July 21 – Wall Street Journal (Talal Ansari and Alyssa Lukpat): “More than 100 million Americans were in the path of a dangerous heat wave Wednesday, from the West to the Northeast, officials said. Temperatures in the triple digits were recorded from Arizona to Louisiana, according to the National Weather Service. Forecasters warned the roughly one-third of Americans that were under heat alerts to drink fluids and stay out of the sun…”
The S&P500 rallied 2.5% (down 16.9% y-t-d), and the Dow rose 2.0% (down 12.2%). The Utilities slipped 0.6% (down 3.8%). The Banks gained 2.1% (down 19.7%), and the Broker/Dealers surged 4.1% (down 15.1%). The Transports advanced 4.5% (down 16.2%). The S&P 400 Midcaps recovered 4.0% (down 15.7%), and the small cap Russell 2000 rallied 3.6% (down 19.5%). The Nasdaq100 rallied 3.4% (down 24.0%). The Semiconductors jumped 5.5% (down 28.0%). The Biotechs declined 1.3% (down 14.6%). While bullion rallied $19, the HUI gold index fell 1.1% (down 22.3%).
Three-month Treasury bill rates ended the week at 2.3325%. Two-year government yields fell 15 bps to 2.97% (up 224bps y-t-d). Five-year T-note yields sank 17 bps to 2.84% (up 158bps). Ten-year Treasury yields dropped 17 bps to 2.75% (up 124bps). Long bond yields declined 11 bps to 2.975% (up 107bps). Benchmark Fannie Mae MBS yields sank 23 bps to 4.165% (up 210bps).
Greek 10-year yields sank 27 bps to 3.23% (up 192bps y-t-d). Ten-year Portuguese yields fell 12 bps to 2.19% (up 173bps). Italian 10-year yields rose four bps to 3.32% (up 215bps). Spain's 10-year yields declined four bps to 2.26% (up 169bps). German bund yields dropped 10 bps to 1.03% (up 121bps). French yields fell 13 bps to 1.62% (up 142bps). The French to German 10-year bond spread narrowed three to 59 bps. U.K. 10-year gilt yields dropped 15 bps to 1.94% (up 97bps). U.K.'s FTSE equities index rallied 1.6% (down 1.5% y-t-d).
Japan's Nikkei Equities Index surged 4.2% (down 3.0% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.215% (up 14bps y-t-d). France's CAC40 rose 3.0% (down 13.1%). The German DAX equities index recovered 3.0% (down 16.6%). Spain's IBEX 35 equities index gained 1.3% (down 7.6%). Italy's FTSE MIB index rose 1.3% (down 22.4%). EM equities were mostly higher. Brazil's Bovespa index rallied 2.5% (down 5.6%), and Mexico's Bolsa index increased 0.4% (down 11.3%). South Korea's Kospi index jumped 2.7% (down 19.6%). India's Sensex equities index rallied 4.3% (down 3.7%). China's Shanghai Exchange Index increased 1.3% (down 10.2%). Turkey's Borsa Istanbul National 100 index recovered 5.6% (up 35.5%). Russia's MICEX equities index dipped 0.6% (down 44.6%).
Investment-grade bond funds posted outflows of $3.309 billion, and junk bond funds reported negative flows of $885 million (from Lipper).
Federal Reserve Credit last week expanded $11.2bn to $8.870 TN. Fed Credit is down $30.7bn from the June 22nd peak. Over the past 149 weeks, Fed Credit expanded $5.143 TN, or 138%. Fed Credit inflated $6.059 Trillion, or 216%, over the past 506 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week dropped another $13.4bn to a 26-month low $3.352 TN. "Custody holdings" were down $174bn, or 4.9%, y-o-y.
Total money market fund assets rose $9.0bn to $4.583 TN. Total money funds were up $96bn, or 2.1%, y-o-y.
Total Commercial Paper was little changed at $1.170 TN. CP was up $38bn, or 3.3%, over the past year.
Freddie Mac 30-year fixed mortgage rates added three bps to 5.54% (up 243bps y-o-y). Fifteen-year rates rose eight bps to 4.75% (up 242bps). Five-year hybrid ARM rates declined four bps to 4.31% (up 190bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates down 17 bps to 5.60% (up 237bps).
Currency Watch:
For the week, the U.S. Dollar Index declined 1.2% to 106.73 (up 11.6% y-t-d). For the week on the upside, the Swedish krona increased 2.6%, the Norwegian krone 2.4%, the Australian dollar 2.0%, the Japanese yen 1.8%, the New Zealand dollar 1.6%, the Swiss franc 1.5%, the South African rand 1.5%, the euro 1.3%, the British pound 1.2%, the South Korean won 1.0%, the Canadian dollar 0.9%, and the Singapore dollar 0.9%. On the downside, the Brazilian real declined 1.7%. The Chinese (onshore) renminbi increased 0.08% versus the dollar (down 5.86% y-t-d).
Commodities Watch:
The Bloomberg Commodities Index rallied 2.7% (up 17.5% y-t-d). Spot Gold recovered 1.1% to $1,728 (down 5.6%). Silver slipped 0.6% to $18.60 (down 20.2%). WTI crude dropped $2.89 to $94.70 (up 25.9%). Gasoline increased 0.3% (up 45%), and Natural Gas surged 18.3% to $8.30 (up 123%). Copper rallied 3.6% (down 25%). Wheat fell 2.3% (down 2%), and Corn sank 6.5% (down 5%). Bitcoin surged $1,872, or 9.0%, this week to $22,732 (down 51%).
Market Instability Watch:
July 21 – Bloomberg (Wei Zhou and Dorothy Ma): “China’s credit market is now showing stress on an almost daily basis, as a worsening property crisis shatters assumptions about safe borrowers and even Chinese investors turn against troubled debtors. The country’s junk dollar bonds were on the brink of record lows Thursday, as a state-backed developer sought payment delays on $1.6 billion of dollar notes. In other signs of stress, the debt of a private builder deemed healthy just months ago sank, while creditors spurned a restructuring plan by the parent of BMW AG’s China partner. Taken together, the incidents point to a credit market in a new phase of turmoil as stress spreads from cash-starved private developers to those with government backing and companies outside the housing sector. Chinese investors pushing back on debt reprieves or unfavorable restructuring plans also suggest dwindling confidence in Beijing’s ability to pull off a fast economic turnaround.”
July 21 – Financial Times (Amy Kazmin and Silvia Sciorilli Borrelli): “Mario Draghi has resigned as Italy’s prime minister, triggering the dissolution of parliament and pushing the country into snap elections in September. Draghi quit as prime minister… a day after the three large parties in parliament boycotted a confidence vote in his leadership following a rancorous parliamentary debate. President Sergio Mattarella… noted that the early dissolution of parliament — whose term was due to expire next year — was supposed to be a ‘last resort’ but that the political situation left him with no alternative. He also expressed concern about Italy’s ability to meet ‘pivotal deadlines’ for access to its next instalments of the €200bn in EU coronavirus recovery funds. The election will take place on September 25.”
July 21 – Reuters (Dhara Ranasinghe and Yoruk Bahceli): “Debt-laden Italy finds itself in markets' crosshairs again, as a collapse in its national unity government coincides with the European Central Bank preparing to deliver its first interest rate rise in 11 years. Like other indebted euro zone countries, Italy has spent the past few years when cash was cheap and plentiful trying to reduce its vulnerability to rising rates and market panic. But it is more exposed to increasing borrowing costs than it might appear, according to a Reuters review of its debt profile. For sure, Italy has extended its debt maturities, but by less than Southern European peers and outright debt is higher than it was during the euro zone debt crisis.”
July 21 – Financial Times (Ian Johnston and Kate Duguid): “Italy’s debt sold off on Thursday after prime minister Mario Draghi resigned and the European Central Bank sharply raised interest rates in its effort to tame blistering inflation. The yield on Italy’s 10-year government bond rose as much as 0.27 percentage points to almost 3.7% as Draghi’s national unity coalition unravelled and the ECB lifted its deposit rate… The decline in Italian bond prices took the gap between Italian and German benchmark 10-year yields… to 2.38 percentage points, reflecting a widening of more than 0.3 percentage points in just two days. The pressure on Italian debt eased slightly later in the session…”
July 21 – Bloomberg (Greg Ritchie): “The collapse of Italy’s government is awakening a dormant threat in European bond markets. Credit-default swaps suggest investors are starting to worry about a future administration pulling or crashing the nation out of the euro. They are buying newer swaps, which offer more protection against such an event, driving up their premium to older swaps to the highest since 2018 on Thursday. That came after Italian bonds slid in the wake of Prime Minister Mario Draghi resigning, which opens the door to snap elections that could bring in a more euroskeptic or less fiscally responsible government. The debt sold off further after the European Central Bank hiked borrowing costs more than expected, with a new tool to stop unwarranted yield spikes failing to stop the rout.”
July 22 – Bloomberg: “China’s bond market is becoming the locus for global capital outflows and there are signs the government is growing concerned about the $30 billion exodus as it delays data and seeks to manage investor expectations. Foreign funds offloaded 55.9 billion yuan ($8.3bn) of the nation’s debt in June, a fifth month of net sales that swelled the total outflows this year to 200 billion yuan. That’s an abrupt reversal for a market that had seen global participation grow every year since 2014…”
July 19 – South China Morning Post (Frank Tang): “China's holdings of US Treasuries fell from US$1.003 trillion in April to US$980.8 billion in May, the lowest since 2010… A desire by Beijing to avoid ‘the risk of possible conflict’ with Washington could have contributed to China cutting its holding of US government debt to below US$1 trillion for the first time in over 12 years, analysts said. China's holdings of US Treasuries fell from US$1.003 trillion in April to US$980.8 billion in May…, representing the lowest point since May 2010 when its holdings stood at US$843.7 billion.”
Bursting Bubble/Mania Watch:
July 20 – Financial Times (Chris Flood): “New business for exchange traded fund providers dropped by almost 30% in the first six months of the year as equity and bond markets both fell sharply in response to soaring inflation and rising interest rates. Global net inflows into ETFs reached $463.8bn in the first half of 2022, down 29.6% from the same period last year, according to ETFGI… Declines in stocks and bonds this year overshadowed inflows, pushing global ETF assets to $8.6tn, down from $10.3tn at the end of December.”
July 19 – Bloomberg (Jill R. Shah and Davide Scigliuzzo): “Chasing leveraged buyout financing business cost the biggest US banks at least $1.3 billion in the second quarter, and more such losses are likely on the way from their European counterparts. Six banks including JPMorgan…, Goldman Sachs... and Citigroup Inc. recorded the paper losses on loans, mostly made to fund leveraged buyouts. Bank of America Corp. led the pack with a $320 million writedown, while Morgan Stanley reported $282 million in losses… The pain stems from loans that banks agreed to make months ago to fund LBOs, before credit markets were hit by fears of a recession. Lenders have about $38.1 billion of committed loan financing left to sell to investors, plus around $31.3 billion of junk bond funding, according to a Deutsche Bank…”
July 21 – Bloomberg (Lisa Lee and Kiel Porter): “The giants of private credit -- the only game in town lately for big-ticket leveraged buyouts -- are dialing back on risk, in a turning point that threatens to reduce crucial financing for mega deals. Blackstone Inc., Apollo Global Management Inc., Ares Management Corp., KKR & Co., Antares Capital LP and the asset management arm of Goldman Sachs… are cutting the amount of debt they’re providing per deal as recession risk rises, according to people with knowledge of the matter who aren’t authorized to speak publicly. They’re also asking for, and getting, higher yields on financing packages with less leverage, while commanding stronger investor protections in case corporate borrowers go under, the people said.”
July 20 – Bloomberg (Janet Lorin, Hema Parmar and Dawn Lim): “Princeton, Harvard and Yale generated robust returns for their endowments in recent years, fueled in part by billions of dollars of investments in private equity and venture capital. That golden era appears to be over, at least for now. College endowments across the US are likely to report losses for the fiscal year ended June 30 as valuations for startups and other closely held companies deflate, following a sharp decline in public markets and the end of cheap leverage. ‘The magnitude of the drawdown in venture companies and public markets is so much greater than it has been going back to the financial crisis,’ said Jay Ripley, co-head of investments at Global Endowment Management…”
July 20 – Wall Street Journal (Miriam Gottfried): “Blackstone Inc. posted a loss in the second quarter as the broader market tumbled and the value of its private-equity portfolio fell. The… firm reported a net loss of $29.4 million, or 4 cents a share, compared with a profit of $1.31 billion, or $1.82, during the same period last year. Blackstone said the value of its corporate private-equity portfolio fell by 6.7% in the quarter. The decline was smaller than that of the S&P 500, which slumped by 16.5%. Still, it was a far cry from a 13.8% increase a year earlier.”
July 22 – Reuters (Gaurav Dogra and Patturaja Murugaboopathy): “Global equity funds recorded their biggest weekly outflow in five weeks in the week to July 20… According to Refinitiv Lipper, investors offloaded a net $13.79 billion worth of global equity funds, marking the biggest weekly outflow since June 15.”
July 22 – Reuters (Gaurav Dogra and Patturaja Murugaboopathy): “U.S. equity funds witnessed their biggest weekly outflow in five weeks in the week to July 20… According to Refinitiv Lipper data, U.S. equity funds recorded $8.45 billion worth of net selling, which was the biggest weekly outflow since June 15… U.S. growth funds booked outflows of $3.46 billion after small purchases in the week before, while investors exited value funds worth $1.62 billion in a fourth subsequent week of net selling.”
Economic War/Iron Curtain Watch:
July 21 – Reuters (Vitalii Hnidyi and Jonathan Spicer): “Russia and Ukraine will sign a deal on Friday to reopen Ukraine's Black Sea ports, Turkey said, a potential breakthrough that could ease the threat of hunger facing millions around the world as a consequence of Russia's invasion… Although Russia's ports have not been shut, Moscow had complained that its shipments were hurt by Western sanctions. The United States and the European Union have both adjusted their sanctions recently to spell out more clearly exceptions for Russian food and fertiliser exports.”
Inflation Watch:
July 20 – Associated Press (Cathy Bussewitz): “When long-haul trucker Deb LaBree sets out on the road to deliver pharmaceuticals, she has strategies to hold down costs. She avoids the West Coast and the Northeast, where diesel prices are highest. She organizes her delivery route to minimize ‘deadheading’ — driving an empty truck in between deliveries. And if a customer’s load is too far away or they can’t pay more for fuel? She turns the job down… The price of diesel fuel has skyrocketed in recent months — much more even than regular gasoline — especially after Russia invaded Ukraine in February.”
July 21 – Wall Street Journal (Leslie Scism): “Big car, home and business insurer Travelers Cos. posted a 41% decline in second-quarter net income, as inflation has continued to drive up costs, including to repair and replace automobiles and pay for medical care of injured people. Allstate Corp., meanwhile, said inflation would worsen its coming second-quarter quarter results… Both insurers said more premium-rate increases lie ahead in an effort to improve their bottom lines.”
July 22 – CNBC (Jeff Cox): “Goldman Sachs CEO David Solomon set the tone early this earnings season when he said inflation is ‘deeply entrenched’ in the U.S. economy and impacting conditions on a multitude of fronts. Since then, company leader after company leader has expressed similar sentiments. Most say they’ve managed to navigate difficult times spurred by inflationary pressures at their highest level in more than 40 years. They report cutting costs, raising prices and generally trying to adapt models to the uncertainty of what’s ahead.”
U.S. Bubble Watch:
July 21 – CNBC (Jeff Cox): “Initial jobless claims hit their highest level since mid-November last week, the latest sign that a historically tight labor market is beginning to slow… Claims totaled 251,000 for the week ended July 16, up 7,000 from the week before and above the 240,000 Dow Jones estimate.”
July 20 – CNBC (Diana Olick): “Sales of previously owned homes in June fell 5.4% from May…, as prices set records and rates surged. The sales count declined to a seasonally adjusted annualized rate of 5.12 million units last month, the group said. Sales were 14.2% lower compared with June 2021 This is the slowest sales pace since the same month in 2020… These numbers are based on home closings, so the contracts were likely signed in April and May, before the average rate on the 30-year fixed mortgage shot above 6%... There were 1.26 million homes for sales at the end of June. That is an increase of 2.4% from the previous June, and the first year-over-year gain in three years. At the current sales pace, inventory now stands at a three-month supply… The still-tight supply, however, is keeping the heat under home prices. The median price of an existing home sold in June set yet another record at $416,000, an increase of 13.4% year over year.”
July 19 – CNBC (Diana Olick): “The pain in the mortgage market is only getting worse as higher interest rates and inflation hammer American consumers. Mortgage demand fell more than 6% last week compared with the previous week, hitting the lowest level since 2000, according to the Mortgage Bankers Association’s seasonally adjusted index. Applications for a mortgage to purchase a home dropped 7% for the week and were 19% lower than the same week in 2021. Buyers have been contending with high prices all year, but with rates almost double what they were in January, they’ve lost considerable purchasing power.”
July 21 – Financial Times (Richard Waters): “After a period of breakneck expansion, Big Tech is hitting the pause button. A round of internal announcements in recent days has revealed the sudden wave of caution sweeping through the tech companies’ top ranks. Last year, as Big Tech accelerated out of the pandemic, the brakes came off on hiring. Now, facing more difficult year-over-year comparisons and an uncertain economy, the mood has turned quickly. Google, after warning last week that it would target its hiring more carefully in the coming months, followed up this week with a two-week pause on all new job offers… Microsoft also confirmed it was working through a business-by-business review to decide how to focus investments more narrowly.”
Fixed-Income Bubble Watch:
July 20 – Bloomberg (Caleb Mutua): “Wall Street banks were supposed to be done with much of their borrowing in bond markets for the year. Then this week, they sold another $27.5 billion of notes. About $10 billion came from Bank of America Corp. on Tuesday. JPMorgan…, Wells Fargo & Co. and Morgan Stanley sold a combined $17.5 billion on Monday. And Goldman Sachs… may bring the total still higher. The sales are far more than many had expected: JPMorgan strategists had forecast somewhere between $14 billion and $16 billion from the big banks.”
July 20 – Wall Street Journal (Matt Wirz and Heather Gillers): “Paradise, Calif., the town destroyed by the 2018 Camp Fire, says it is close to a debt default, heightening municipal bond investors’ concerns over how a warming planet is adding risk to their $4 trillion market… S&P Global Ratings slashed the bonds’ rating by six notches to triple-C in June, pushing it deeper into junk territory. Municipalities have long suffered from weather-related destruction. Many investors are growing more concerned that climate change is intensifying wildfires, even while critical infrastructure is unprepared and underfunded.”
China Watch:
July 20 – Bloomberg: “Chinese Premier Li Keqiang signaled flexibility on the growth target and reiterated caution on excessive stimulus, as the economy shows initial signs of recovery from Covid outbreaks. The most important thing is to keep employment and prices stable, and slightly higher or lower growth rates were acceptable as long as employment is relatively sufficient, household income grows and prices are stable, Li told global business leaders hosted by the World Economic Forum... ‘China won’t roll out massive stimulus, issue an excessive amount of money or overdraw the future for an overly high growth target,’ Li was quoted as saying…”
July 19 – Bloomberg (Rebecca Choong Wilkins): “Over the past few years, President Xi Jinping has reined in China’s biggest tech companies, stamped out democracy in Hong Kong and locked down 26 million people in Shanghai to eliminate Covid cases. Yet he now faces a surprise challenge from middle-class homeowners who are watching their family wealth slip away with a sustained slide in the property market, which makes up a fifth of China’s economic activity. Some 70% of household wealth in China is tied up in property, far more than in the US, making it one of the most sensitive political issues for the Communist Party. For months Xi has stood firm in reining in over-leveraged Chinese developers, spurring a record wave of defaults that spooked global investors and brought at least 24 leading property companies to the brink of collapse. In the process, more than $80 billion has been wiped from its offshore bond market.”
July 19 – Guardian (Martin Farrer): “Chinese banks have been told to bail out struggling property developers to help them complete unfinished housing projects and head off the growing mortgage strike that threatens to seriously damage the economy. With thousands of homebuyers banding together to refuse to keep up with mortgage instalments on unfinished apartments bought off the plan, regulators have stepped up efforts to encourage lenders to extend loans… The China Banking and Insurance Regulatory Commission (CBIRC) told the official industry newspaper… that banks should meet developers’ financing needs where reasonable. The CBIRC expressed confidence that with concerted efforts, ‘all the difficulties and problems will be properly solved’, the China Banking and Insurance News reported.”
July 21 – Bloomberg: “China’s banking regulator vowed to ensure developers complete construction for pre-sold homes, an attempt to alleviate homebuyer concern as more people threaten to boycott mortgage payments. The China Banking and Insurance Regulatory Commission will work with the central bank, the housing ministry and local governments to ensure home delivery and social stability, Liu Zhongrui, an official with the regulator’s statistics department, said… The authorities will also keep property financing ‘stable and orderly’ while supporting the industry, Liu said. Regulators are seeking to defuse a growing consumer boycott of mortgage payments that risks spreading the real estate crisis to the banking system. The CBIRC earlier urged banks to increase lending to developers so they can complete unfinished housing projects…”
July 18 – Bloomberg (Wei Zhou and Tim Smith): “Chinese developers’ liquidity stress will evolve into insolvency risk if a property-sales recovery stalls, with at least one-fifth of rated builders facing such prospects, according to S&P Global Ratings. Developers can’t exchange and extend their defaulted bonds forever, as investors will lose patience if home sales do not soon improve, said a report from analysts including Chang Li. ‘We assume debt extensions only serve to buy time, and do not fundamentally resolve developers’ excess leverage.’ Amid a record wave of offshore delinquencies, distressed Chinese builders also have been forcing a growing number of debt extensions on investors in a bid to buy time… The stress is now starting to move from developers to banks, as some homebuyers in China refuse to pay mortgages on stalled projects.”
July 19 – Bloomberg: “Some suppliers to Chinese real estate developers are refusing to repay bank loans because of unpaid bills owed to them, a sign that the loan boycott that started with homebuyers is starting to spread. Hundreds of contractors to the property industry complained that they can no longer afford to pay their own bills because developers including China Evergrande Group still owe them money, Caixin reported… One group of small businesses and suppliers circulated a letter online saying they will stop repaying debts after Evergrande’s cash crisis left them out of pocket. ‘We decided to stop paying all loans and arrears, and advise our peers to decline any requests to be paid on credit or commercial bill,’ the group said… ‘Evergrande should be held responsible for any consequence that follows because of the chain reaction of the supply-chain crisis.’”
July 19 – CNBC (Evelyn Cheng): “China’s real estate market desperately needs a boost in confidence, analysts said, after reports of homebuyers halting mortgage payments rocked bank stocks and raised worries of a systemic crisis. The size of the mortgages isn’t as worrisome as the impact of the latest events on demand and prices for one of the biggest financial assets in China: residential housing. ‘It is critical for policymakers to restore confidence in the market quickly and to circuit-break a potential negative feedback loop,’ Goldman Sachs chief China economist Hui Shan and a team said…”
July 21 – Reuters (Liangping Gao and Ryan Woo): “China's largest policy bank said on Friday that it had disbursed 181.5 billion yuan ($27bn) in loans for urban development projects in the first half of the year, and pledged to maintain an accelerated pace of lending to fund infrastructure. The China Development Bank (CDB) has supplied 650 million yuan in loans to fund the renewal of an economic zone in the eastern city of Yantai, including the renovation of industrial facilities, it said.”
July 21 – Reuters: “China reported 1,011 new coronavirus cases for July 21, of which 175 were symptomatic and 836 were asymptomatic, the National Health Commission said on Friday. That compared with 943 new cases a day earlier - 200 symptomatic and 743 asymptomatic infections, which China counts separately.”
July 20 – Financial Times (James Kynge, Kathrin Hille, Ben Parkin and Jonathan Wheatley): “The 350m Lotus Tower that looms over the skyline in Sri Lanka’s capital Colombo is one of the tallest buildings in South Asia. Funded by a Chinese state bank and designed to look like a giant lotus bud about to burst into flower, it was intended to be a metaphor for the flourishing of Sri Lanka’s economy and the ‘brilliant future’ of the bilateral co-operation between Beijing and Colombo. Instead, the tower has become a symbol of the mounting problems facing China’s overseas lending scheme, the ‘Belt and Road Initiative’. The construction suffered from lengthy delays and an allegation of corruption levelled by Sri Lanka’s then-president Maithripala Sirisena against one of the Chinese contractors. Now, three years after its official launch, the tower’s amenities including a shopping mall, a conference centre and several restaurants stand either unfinished or largely unused while outside on the streets outrage over Sri Lanka’s financial mismanagement has boiled over into popular protests.”
July 21 – Economic Times: “In a grim reminder of the 1989 Tiananmen Square Massacre, armoured tanks were seen deployed on the streets of China amidst large-scale protests by people demanding the release of their savings frozen by banks. The country's Henan province has been for the past several weeks witnessing clashes between police and depositors with the latter saying they have been prevented from withdrawing their savings from banks since April this year. Fresh videos have surfaced online in which Chinese Peoples Liberation Army (PLA's) tanks can be seen deployed on the streets to scare protestors. Large-scale protests are being held in the province by bank depositors over the release of their frozen funds.”
Central Banker Watch:
July 21 – Financial Times (Martin Arnold and Ian Johnston): “The European Central Bank has raised interest rates by half a percentage point, pledging to prevent surging borrowing costs from sparking a eurozone debt crisis amid political turmoil in Italy and the resignation of prime minister Mario Draghi. It was the first ECB rate rise for more than a decade and twice the size of the increase mooted by the bank only last month. The move ends eight years of negative rates and raises the ECB’s deposit rate to zero. ECB president Christine Lagarde said it was ‘time to deliver’ after eurozone inflation hit a record high of 8.6% in the year to June, more than four times the central bank’s target of 2%.”
July 21 – Bloomberg (Alice Gledhill): “When a central bank sets a red line, the market will start looking for ways to test it. And now that the European Central Bank has unveiled the initial details of its anti-fragmentation tool, traders say the next step is to figure out what it takes to set it in motion. They’re asking: How wide do European spreads need to be? What are the conditions for policymakers to start supporting bond markets, and to what extent does Italy’s own political chaos prevent the ECB from taking action? ‘We would anticipate the market will test the ECB’s resolve,’ said David Zahn, the head of European fixed income at Franklin Templeton. ‘The market is interested in when or at what level the ECB would step in to help restrict government spreads widening.’”
Global Bubble and Instability Watch:
July 22 – Bloomberg (Chikako Mogi): “Japanese investors cut holdings of overseas bonds for a record eighth week as Federal Reserve interest-rate hikes and accelerating global inflation sap their demand for foreign debt. Funds in the Asian nation offloaded a net 919.6 billion yen ($6.7bn) of overseas fixed-income securities in the week through July 15… The latest figures extend weekly sales to the longest since Bloomberg started collecting the data in 2005. ‘Wariness over a further drop in Treasury prices remains deep-rooted amid concern over US inflation, and that is deterring appetite to buy overseas bonds,’ said Tsuyoshi Ueno, a senior economist at NLI Research Institute... ‘There may also be a move to cut losses.’”
Europe Watch:
July 21 – Financial Times (Amy Kazmin): “After Italian prime minister Mario Draghi’s second and conclusive resignation this week, the conservative Il Tempo newspaper’s front page carried the headline: ‘Draghi’s suicide’. But rival title La Stampa depicted him as the victim of political murder, declaring his government had been ‘drowned’. Just who is responsible for the fall of the highly respected former European Central Bank chief, feted for his role in saving the single currency in the eurozone crisis of 2012, is the subject of bitter debate among Italy’s politicians as they seek to deflect a wave of public anger over the collapse of the ruling coalition. Opinion polls last week showed Italians overwhelmingly wanted Draghi to stay in office to steer Italy through its economic and geopolitical challenges rather than going to the polls early.”
July 21 – Financial Times (Tony Barber): “In ancient times the senators of Rome begged Cincinnatus to come out of retirement and save the republic. His mission accomplished, he returned to his farm, becoming a revered symbol of selfless virtue for centuries to come. Like Cincinnatus, Mario Draghi was called upon to be the saviour of Italy at a moment of national peril during the pandemic almost 18 months ago. As prime minister he, too, rose to the occasion. But his reward is to lose the reins of power just when new, even graver emergencies are unfolding in Italy and around Europe. Many Italians can barely contain their despair at the machinations of the professional politicians that have contributed to their hero’s exit. ‘And now there is nothing left to us but to cry: poor Italy, poor us,’ tweeted one admirer of Draghi.”
July 22 – Bloomberg (Carolynn Look): “Private-sector activity in the euro area unexpectedly shrank for the first time since the pandemic lockdowns of early 2021, adding to signs that a recession might be on the horizon. A survey of purchasing managers by S&P Global dropped to a 17-month low in July, dipping beneath the level that signals contraction… ‘A steep loss of new orders, falling backlogs of work and gloomier business expectations all point to the rate of decline gathering further momentum,’ said Chris Williamson, an economist at S&P Global. ‘Of greatest concern is the plight of manufacturing, where producers are reporting that weaker-than-expected sales have led to an unprecedented rise in unsold stock.’”
July 20 – Reuters (Elizabeth Piper and Andrew Macaskill): “Former finance minister Rishi Sunak and foreign secretary Liz Truss will battle it out to become Britain's next prime minister after they won the final lawmaker vote, setting up the last stage of the contest to replace Boris Johnson. Sunak has led in all rounds of the voting among Conservative lawmakers, but it is Truss who seems to have gained the advantage so far among the 200,000 members of the governing party who will ultimately choose the winner. The final stretch of a weeks-long contest will pit Sunak, a former Goldman Sachs banker who has raised the tax burden towards the highest level since the 1950s, against Truss, a convert to Brexit who has pledged to cut taxes and regulation.”
EM Crisis Watch:
July 22 – Bloomberg: “Russia’s central bank brought interest rates below their level before the invasion of Ukraine, seizing on steep slowdown in inflation to ease monetary policy more than forecast. Policy makers lowered their benchmark to 8% from 9.5% on Friday and signaled they will consider further reductions in the second half of the year. The fifth straight cut was bigger than predicted…”
Japan Watch:
July 21 – Reuters (Leika Kihara): “The Bank of Japan projected inflation would exceed its target this year in fresh forecasts issued on Thursday, but maintained ultra-low interest rates and signalled its resolve to remain an outlier in a wave of global central banks'policy tightening. BOJ Governor Haruhiko Kuroda brushed aside the chance of near-term policy tightening, saying he had ‘absolutely no plan’ to raise interest rates or hike an implicit 0.25% cap set for the bank's 10-year bond yield target.”
July 21 – Bloomberg (Yuko Takeo and Yoshiaki Nohara): “Japan’s key inflation gauge rose further above the Bank of Japan’s target level of 2%, a result that will likely keep speculation smoldering over possible policy adjustments at the central bank despite Governor Haruhiko Kuroda’s continued commitment to ultra-low rates. Consumer prices excluding fresh food climbed at a faster pace of 2.2% in June from a year earlier, with energy costs amplified by a weaker yen and higher processed food prices the main contributors…”
Social, Political, Environmental, Cybersecurity Instability Watch:
July 21 – Wall Street Journal (Talal Ansari and Alyssa Lukpat): “More than 100 million Americans were in the path of a dangerous heat wave Wednesday, from the West to the Northeast, officials said. Temperatures in the triple digits were recorded from Arizona to Louisiana, according to the National Weather Service. Forecasters warned the roughly one-third of Americans that were under heat alerts to drink fluids and stay out of the sun…”
