Friday, May 26, 2023

Weekly Commentary: Melt-up Vs. Deleveraging

We have no reason to expect markets to function normally. So many facets of today’s environment are unique. For one, a once-in-a-century global pandemic fundamentally altered so many things – including central bank, commercial bank, and household balance sheets. Unprecedented monetary and fiscal stimulus disrupted price dynamics throughout economies and markets. What’s more, major shortages forced a rethink of supply chain management, including inventory and outsourcing strategies.

Importantly, the pandemic hit during the waning period of a multi-decade global Bubble – a historic period of central bank experimentation, financial innovation, technological development, economic structural transformation, and globalization.

Over-liquefied markets had turned highly speculative and levered. Market structure evolved to become dominated by trend-following behavior, with derivatives, algorithmic trading and hedging strategies creating latent fragility. Recurring bouts of monetary instability and progressively activist central bank market intervention crystalized the perception that central bankers were guarantors of liquidity, stability, and buoyant financial markets.

If pandemic-related dislocations weren’t enough, Russia ruthlessly attacks Ukraine. This threw energy, grain, and other resources procurement into chaos. Shortly before the invasion, Russia and China announced their “no limits” partnership. The rise of the all-powerful Xi Jinping autocracy, China’s unwavering support for Russia, and increasingly aggressive threats directed at Taiwan, forced the “free world” to take a hard look at the risks of outsourcing from China.

There’s no reason to expect inflation to behave as it has in the past. Aberrantly too much “money” chasing goods of vacillating supply. For households, businesses, and governments, it became prudent to build stockpiles – with ample financial resources available for the task. Climate change only adds to the uncertain and inflationary backdrop.

Job openings (“JOLTS” data) ended 2019 at a historically elevated 6.709 million. The interplay of massive fiscal and monetary stimulus with severe employment market dislocation saw a spike in openings to an unprecedented 12.027 million by March 2022. So many businesses – from small operations to major corporations – had to significantly ramp up compensation to secure the workforce necessary to operate. The acute labor shortage, coupled with multi-decade high consumer price inflation, induced a fundamental shift in compensation expectations – by employee and employer alike.

After ending Q2 2019 at $4.009 TN, the Fed’s balance sheet peaked in 2022 at almost $9.00 TN. Federal Reserve Total Assets ($8.43 TN) remain today more than double the pre-pandemic level. During this period, Total Bank Deposits inflated as much as $6.3 TN, or 42%. Bank Deposits ended 2022 at $20.698 TN, $5.7 TN, or 38%, higher than June 30, 2019.

Pandemic period stimulus measures fundamentally reshaped the U.S. Household balance sheet. The surge in liquid assets (“money”) was unprecedented. Total Household Deposits surged $4.75 TN, or 45%, over just the past 13 quarters (ended Q4 ’22). During this period, total Household Financial Assets inflated $19.46 TN, or 21.3%, to $110.71 TN.

But it wasn’t just inflating Financial Assets that ballooned perceived wealth. Household Real Estate holdings inflated $14.63 TN, or 44%, to $47.89 TN. In just 13 quarters, Household Net Worth surged $33.08 TN, or 28.9%, to $147.71 TN. As a percentage of GDP, Household Net Worth jumped from 537% (Q4 ’19) to end 2022 at 565% – this even after ‘22’s stock market swoon (down from Q4 ‘21’s record 624%). For perspective, Net Worth-to-GDP peaked at 491% during Q1 2007 and 445% at Q1 2000.

That inflation proved anything but transitory should not surprise. It was nothing short of an epic loosening of financial conditions – following years and decades of generally loose conditions. Clearly, the Fed – and global central bank community – waited too long to begin removing stimulus and raising rates. But with the mighty inflation genie sprung loose from the bottle and running roughshod, only a destabilizing tightening of liquidity and Credit would break newfound inflationary psychology. No one was willing to go down that path.

This is such a key Bubble Dynamic. Over time, Bubbles become increasingly vulnerable. Indeed, systemic fragilities stealthily grow exponentially over time – especially during culminating “Terminal Phase Excess”. And the bigger and increasingly vulnerable a Bubble becomes, the more cautious central bankers will be with tightening measures. Worse yet, acute fragility ensures policymakers will act quickly and forcefully to thwart Bubble deflation – ensuring a quick resurgence of speculative impulses.

The Bank of England restarted QE on September 28th to stem a crisis of confidence in the UK bond market – with 10-year yields at only 4.5% and weeks ahead of the scheduled start of quantitative tightening. This was soon followed by dovish comments from Fed officials, the ECB, Bank of Japan, and Bank of Canada. Speculative markets received the confirmation they demanded that central bank liquidity support was available as needed.

Federal Reserve assets surged $364 billion over three weeks during the March banking crisis. The FHLB provided several hundred billion of additional liquidity (Q1 asset growth $317bn). Indicative of the powerful boost to system liquidity, money market fund assets surged almost one-half Trillion over the past 11 weeks – a 48% annualized growth rate.

Market financial conditions loosened significantly, with the S&P500 jumping to a nine-month high. And in a key market dynamic dating back to the nineties, over-liquefied and speculative markets inherently fixate on the latest and greatest technological advancement. For the current mania, it’s all things A.I. (artificial intelligence).

May 25 – Bloomberg (David Marino): “Nvidia Corp.’s massive jump overnight flipped more than 500,000 bullish options from potentially worthless into winners, while turning one big trade from Wednesday into a loser. There were 549,483 outstanding contracts for call options allowing the owner to buy shares at levels ranging from $310 and $380, more than 150,000 of which — based on Wednesday’s $305.86 close — were set to expire worthless Friday. But the more than 25% surge has brought them ‘into the money’ in options parlance, meaning that near-term call owners are in line to own some 15 million shares below Thursday’s market value of about $388. On the other side, shareholders who sold calls as a way of collecting some extra premium would be forced to sell shares… And other traders short the options may have had to buy shares to cover their suddenly short positions.”

Don’t underestimate the liquidity impact of manic excess in big tech derivatives.

May 25 – Bloomberg (Lu Wang): “An end-of-week feeding frenzy in options of the world’s biggest companies has emerged as two of the hottest trends on Wall Street collide. Rampant demand for Big Tech exposure is combining with the boom in fast-expiring options to fuel an explosion in bullish bets in the first few minutes of Friday trading. That’s the day that weekly contracts on individual stocks like Apple Inc. and Microsoft Corp. expire, effectively turning them into the zero-day options that have become a trader obsession. Total call volume of the seven most-valuable tech firms — also including Alphabet Inc., Inc., Nvidia Corp., Meta Platforms Inc. and Tesla Inc. — last Friday spiked to 5 million contracts, doubling over the week… So frenzied is the late-week demand that some analysts see evidence it is moving the underlying stocks. ‘Friday should be known as megacap tech call option day,’ Brian Garrett, a managing director at Goldman Sachs…, wrote… ‘There have been days where hundreds of thousands of calls have traded in the first 10-15 minutes of the session.’”

When stocks and indexes with huge outstanding call options go into speculative melt-up mode, the sellers of those derivatives are forced to buy the underlying shares to mitigate/hedge losses. Many sell out-of-the-money call options – either to generate additional returns or to pay for put option protection. Large call option positions – especially out-of-the-money contracts – have the potential to create meaningful amounts of new liquidity when a big upward price move forces the purchase of the underlying stocks on margin.

The Nasdaq100 (NDX) is up almost 31% this year. The mania in A.I. and big tech has not only fueled huge gains in company market capitalization, but also powered significant moves in popular indexes including the NDX, SOX (semiconductors) and even the S&P500. This Bubble Dynamic is a powerful creator of marketplace liquidity. It also incites FOMO (fear of missing out). Between short covering and cajoling the under-invested, this speculation and derivatives-induced rally is pulling funds into the marketplace. The upshot is a further loosening of market financial conditions – irrespective of Fed tightening measures.

The bond market is turning nervous. Loose financial conditions have worked to bolster both the economy and pricing pressures. More data this week (PCE, GDP Price Index, Services PMI, Personal Income/Spending, Jobless Claims) point to resilient demand and inflation. And now market conditions are only loosening further.

Two-year Treasury yields surged 30 bps this week to 4.56% (high since March 10th). Benchmark MBS yields spiked 32 bps this week to a six-month high 5.79%. The rates market is now pricing a 69% probability of a 25 bps hike on June 14th – with peak Fed funds now at 5.33% for the July 26th meeting. The market expects a 5.00% policy rate at the December 13th meeting – up 36 bps this week and 70 bps in 11 sessions.

I certainly appreciate that when the stock market is luxuriating in a short squeeze/derivatives/FOMO “melt-up” dynamic, nothing else matters. But bond markets have their own dynamic percolating. UK 10-year yields surged 34 bps this week to 4.33%, trading this week to the highs since October. With world-beating UK inflation again surprising to the upside (8.7% y-o-y), two-year gilt yields spiked 54 bps this week to 4.48% - the high since the BOE was forced to intervene on September 28th. Trading action was certainly reminiscent of September’s deleveraging episode. I’ll assume the UK pension system remains highly levered and vulnerable.

It's worth noting that China’s renminbi declined 0.74% this week, trading to the low versus the dollar since December 1st. Chinese developer bonds were bludgeoned, with number one Country Garden yields jumping to 61% (began the month at 35%). A disorderly Chinese currency risks serious de-risking/deleveraging.

The yen traded to the low versus the dollar since November. Tokyo core CPI was reported up 3.9% y-o-y, the strongest inflation reading since 1981. With the Japanese economy gaining a head of steam, new BOJ governor Kazuo Ueda is running out of excuses to stand pat on Kuroda’s ultra-loose monetary policy. Any shift in BOJ policy would have immediate ramifications for global leveraged speculation and marketplace liquidity.

Here at home, the banking system remains highly levered and vulnerable. There are scores of big securities portfolios that become immediately problematic in the event of a yield spike. And it wouldn’t take much to restart the deposit exodus from vulnerable institutions. The mortgage marketplace is vulnerable to self-reinforcing deleveraging and interest-rate hedging-related selling. And, generally, leverage permeating the entire system creates vulnerability to a surge in market yields.

The Fed is in a bad place. The resurgent stock market speculative Bubble is a major force for loosening financial conditions and stoking inflationary pressures, while risking a melt-up and crash scenario. But additional Fed tightening measures are problematic for the bond market and banking system.

We’re back to the Fed hikes until something breaks. At this point, financial conditions must tighten significantly to keep inflation from becoming only more deeply ingrained. And especially after this speculative stock market run, tighter conditions pierce Bubbles. For now, such loose conditions set the stage for the nightmare scenario – a surprising jump in inflation, a spike in market yields, and a repricing for tens of Trillions of fixed-income securities. Stocks can relish the fun and games. But look over your shoulder, and you might see inklings of de-risking/deleveraging.

For the Week:

The S&P500 added 0.3% (up 9.5% y-t-d), while the Dow fell 1.0% (down 0.2%). The Utilities dropped 2.5% (down 9.9%). The Banks gained 1.3% (down 22.8%), and the Broker/Dealers rose 1.0% (down 0.4%). The Transports were little changed (up 3.8%). The S&P 400 Midcaps declined 0.5% (up 0.5%), while the small cap Russell 2000 was unchanged (up 0.7%). The Nasdaq100 jumped 3.6% (up 30.7%). The Semiconductors surged 10.7% (up 40.0%). The Biotechs dropped 2.3% (up 0.2%). With bullion down $31, the HUI gold equities index sank 5.0% (up 5.9%).

Three-month Treasury bill rates ended the week at 5.095%. Two-year government yields surged 30 bps this week to 4.56% (up 13bps y-t-d). Five-year T-note yields jumped 20 bps to 3.93% (down 8bps). Ten-year Treasury yields rose 13 bps to 3.80% (down 8bps). Long bond yields added three bps to 3.96% (unchanged). Benchmark Fannie Mae MBS yields surged 32 bps to a six-month high 5.79% (up 40bps).

Greek 10-year yields fell 10 bps to 3.89% (down 67bps y-t-d). Italian yields jumped 12 bps to 4.39% (down 31bps). Spain's 10-year yields rose 13 bps to 3.61% (up 9bps). German bund yields gained 11 bps to 2.54% (up 9bps). French yields rose 11 bps to 3.11% (up 13bps). The French to German 10-year bond spread was unchanged at 57 bps. U.K. 10-year gilt yields surged 34 bps to 4.33% (up 66bps). U.K.'s FTSE equities index fell 1.7% (up 2.4% y-t-d).

Japan's Nikkei Equities Index added 0.4% (up 18.5% y-t-d). Japanese 10-year "JGB" yields added two bps to 0.42% (unchanged y-t-d). France's CAC40 fell 2.3% (up 13.1%). The German DAX equities index slumped 1.8% (up 14.8%). Spain's IBEX 35 equities index declined 0.7% (up 11.7%). Italy's FTSE MIB index dropped 2.9% (up 12.7%). EM equities were mixed. Brazil's Bovespa index was little changed (up 1.1%), while Mexico's Bolsa index declined 0.5% (up 11.5%). South Korea's Kospi index increased 0.8% (up 14.4%). India's Sensex equities index rose 1.3% (up 2.7%). China's Shanghai Exchange Index dropped 2.2% (up 4.0%). Turkey's Borsa Istanbul National 100 index recovered 1.8% (down 16.9%). Russia's MICEX equities index gained 2.1% (up 24.5%).

Investment-grade bond funds posted inflows of $3.015 billion, while junk bond funds reported positive flows of $1.399 billion (from Lipper).

Federal Reserve Credit declined $42.3bn last week to $8.406 TN. Fed Credit was down $495bn from the June 22nd peak. Over the past 193 weeks, Fed Credit expanded $4.679 TN, or 126%. Fed Credit inflated $5.595 TN, or 199%, over the past 550 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $7.9bn last week to an 11-month high $3.398 TN. "Custody holdings" were down $27bn, or 0.8%, y-o-y.

Total money market fund assets surged $47bn to a record $5.388 TN, with a 11-week gain of $495bn. Total money funds were up $859bn, or 19.0%, y-o-y.

Total Commercial Paper fell $12.4bn to $1.127 TN. CP was down $5.0bn, or 0.4%, over the past year.

Freddie Mac 30-year fixed mortgage rates surged 25 bps to a six-month high 6.76% (up 166bps y-o-y). Fifteen-year rates jumped 29 bps to 6.09% (up 178bps). Five-year hybrid ARM rates spiked 29 bps to 6.28% (up 208bps) - the high since October 2008. Bankrate's survey of jumbo mortgage borrowing costs had 30-year fixed rates up 16 bps to 7.17% (up 193bps).

Currency Watch:

May 26 – Bloomberg: “China’s yuan gains for the first time this week after nearing the 7.1-per-dollar level earlier Friday. A few big Chinese state-owned banks actively sold large amounts of dollars in the onshore yuan spot market, according to several traders. At times when dollar-buying demand increased, the big banks met those bids and sold dollars, supporting the yuan, traders said; that in turn triggered selling from dollar bulls.”

May 21 – Bloomberg (Tania Chen): “Goldman Sachs… expects more gloom for the Chinese currency despite efforts from policymakers to shore up sentiment. The US bank has slashed its projection for the onshore yuan, targeting a move to 7.1 against the dollar in the next three months… ‘Significant weakness in China data and renewed dollar strengthening on the back of progress in US debt-ceiling negotiations’ have weighed on the currency, wrote China economist Hui Shan. The onshore yuan traded 0.1% weaker Monday at 7.0241. The Chinese currency fell past the key 7-per-dollar threshold last week, the first time since December.”

For the week, the U.S. Dollar Index gained 1.0% to 104.21 (down 0.7% y-t-d). For the week on the upside, the Mexican peso increased 0.9%, the South Korean won 0.2%, and the Brazilian real 0.1%. On the downside, the New Zealand dollar declined 3.7%, the Swedish krona 2.5%, the Australian dollar 2.0%, the Japanese yen 1.9%, the Norwegian krone 1.9%, the South African rand 1.0%, the British pound 0.8%, the Canadian dollar 0.8%, the euro 0.8%, the Swiss franc 0.7%, and the Singapore dollar 0.6%. The Chinese (onshore) renminbi declined 0.74% versus the dollar (down 2.34%).

Commodities Watch:

The Bloomberg Commodities Index fell 1.0% (down 11.3% y-t-d). Spot Gold declined 1.6% to $1,946 (up 6.7%). Silver fell 2.3% to $23.30 (down 2.7%). WTI crude rallied $1.12, or 1.6%, to $72.67 (down 10%). Gasoline jumped 4.9% (up 10%), while Natural Gas dropped 6.5% to $2.42 (down 46%). Copper declined 1.3% (down 3%). Wheat recovered 1.8% (down 22%), and Corn surged 8.9% (down 11%). Bitcoin dipped $150, or 0.5%, this week to $26,750 (up 61%).

Global Bank Crisis Watch:

May 25 – Wall Street Journal (Richard Vanderford): “Large U.S. banks found to have consistently poor risk management and other failings will face more heavy-handed government intervention, including demands to shore up capital or exit lines of business. ‘A policy unveiled Thursday creates a new set of guardrails targeting complex banks that fail to fix ‘persistent weaknesses,’ said Michael Hsu, head of one of the nation’s top banking regulators, the Office of the Comptroller of the Currency… ‘A bank’s inability to correct persistent weaknesses will result in proportionate, fair and appropriate consequences,’ Hsu said.”

May 25 – Bloomberg (Hannah Levitt): “First Republic Bank made its name catering to wealthy clients across California and New York, reeling in many with unusually sweet mortgages that eventually doomed the firm. The system made its employees rich, too. The… bank… was paying dozens of employees more than $10 million apiece annually in the heyday before its collapse, according to people with knowledge... Some racked up incentives for arranging home loans, amassing deposits and growing wealth-management portfolios. For at least one unnamed banker who wasn’t a top executive, the tally exceeded $35 million last year…”

May 24 – Bloomberg (Tom Schoenberg and Lydia Beyoud): “US prosecutors are reviewing stock trading by some of First Republic Bank’s employees during the lender’s recent collapse, according to people familiar with the matter. The Justice Department is looking at whether anyone working at the firm used inside information in transactions as it was crumbling in the second-biggest bank failure in American history, said the people… The probe, which is in an early stage, is also scrutinizing the company’s financial disclosures.”

May 22 – Wall Street Journal (Jonathan Weil and Peter Rudegeair): “The recent spate of bank failures is upending a long-held theory among banking executives and regulators—that the value of a lender’s deposit business goes up when interest rates move higher. The theory rests on an assumption: That banks don’t have to pay depositors much to keep their money around, even as rates rise. The deposits would be a stable source of low-cost funding while the bank earned more money lending at higher rates. The more rates rose, the bigger the franchise value of those deposits would become… But if rising rates or plunging asset values cause a bank’s depositors to flee en masse, the franchise value is zero—and, worse, it could beget other bank runs.”

May 23 – Financial Times (Stephen Gandel): “US regional banks are rushing to exploit rules that allow depositors to hold tens of millions of dollars in insured accounts, offering security far exceeding government-backed insurance to soothe clients unnerved by the recent banking turmoil. The move entails the use of reciprocal deposits, which funnel a portion of customer cash to other lenders, keeping the total amount in each account less than the Federal Deposit Insurance Corporation’s $250,000 cap on insurance coverage. Deposits in so-called reciprocal accounts soared to a new record high of $221bn at the end of the first quarter, up from $158bn at the end of 2022…”

May 24 – Reuters (Chris Prentice): “Short-selling, the practice of seeking to profit off bets that a stock will fall, is a key focus for U.S. prosecutors, and there will be more activity by the Justice Department in coming months… The recent rout in shares of U.S. regional banks brought fresh scrutiny by criminal prosecutors and regulators of short sellers, who had previously come under review in the wake of the ‘meme stock’ craze of 2021… Short selling, including via options, is a priority for prosecutors, Avi Perry, the chief of the market integrity team, said… ‘You’ll see some more activity from us involving short sellers sometime in the next few months,’ he said.”

May 25 – Reuters (Jaiveer Shekhawat and Manya Saini): “JPMorgan… has told clients with personal credit lines at First Republic Bank that it will no longer offer them when they come up for renewal, a person familiar… told Reuters… The bank does not offer personal lines of credit and therefore has no plans to offer them to former First Republic clients when they come up for renewal, the source said.

Debt Ceiling Watch:

May 24 – Reuters (Akriti Sharma): “Fitch put the United States' credit on watch for a possible downgrade…, raising the stakes as talks over the country's debt ceiling go down to the wire, and adding to the jitters in global markets. Fitch put the country's ‘AAA’ rating, its highest rank, on a negative watch in a precursor to a possible downgrade should lawmakers fail to raise the amount that the Treasury can borrow before it runs out of money… Fitch now predicts that the U.S. government will spend more than it earns, creating a deficit of 6.5% of the country's total economy in 2023 and 6.9% in 2024.”

May 25 – Bloomberg (Laura Litvan): “On Friday, June 2, millions of Americans are due a total of $25 billion worth of Social Security payments. And more than anything else, that may prove a decisive element in forcing an end to the partisan standoff over raising the federal debt limit. That obligation is ‘an enforcement mechanism we can’t ignore,’ Democratic Senator Chris Coons of Delaware, one of President Joe Biden’s top allies in Congress, said… ‘When they find out that they’re not getting that check, our phones will light up like a Christmas tree.’”

May 24 – Bloomberg (Christopher Anstey): “Federal Reserve policymakers suggested that they viewed with concern the partisan standoff over the debt limit, with ‘a number’ of them saying earlier this month the central bank should be ready to act to preserve financial stability if needed… ‘A number of participants emphasized that the Federal Reserve should maintain readiness to use its liquidity tools, as well as its microprudential and macroprudential regulatory and supervisory tools, to mitigate future financial-stability risks,’ the minutes showed.”

May 23 – Bloomberg (Anna Edgerton and Billy House): “House Republicans aren’t buying Treasury Secretary Janet Yellen’s warning that the US government will run out of money as soon as June 1, or her dire predictions of default, undercutting the urgency to raise the debt limit. ‘We’d like to see more transparency on how they came to that date,’ House Majority Leader Steve Scalise told reporters... ‘It looks like they’re hedging now and opening the door to move that date back.’”

May 21 – Bloomberg (Carol Ryan): “Goldman Sachs… economists estimated that the Treasury Department will by June 8 or 9 see its cash levels drop below the $30 billion it’s signaled as a bare minimum for meeting federal obligations falling due… As of Thursday, the Treasury’s cash balance stood at just over $57 billion. As of the day before, it also had about $92 billion of special measures available.”

May 23 – Politico (Olivia Beavers): “Speaker Kevin McCarthy’s negotiations with President Joe Biden are serving another purpose besides reaching a debt deal — as his second job interview with conservatives. As the talks lurch closer to the Treasury Department’s default deadline, it should not be forgotten that McCarthy’s speakership is still on the line, with any single disgruntled member empowered to force a vote on ousting him. So the California Republican must ensure his right flank can swallow any deal he strikes with the White House, or at least hold its nose while voting no. For the moment, multiple members of the conservative House Freedom Caucus are pleased with McCarthy’s outreach. They say they’re confident he won’t let them down in the debt fight.”

Market Instability Watch:

May 23 – Bloomberg (Ksenia Galouchko and Jan-Patrick Barnert): “Investors are boosting their bullish bets on US equities, making positioning increasingly ‘one-sided,’ according to Citigroup Inc. strategists. Market participants have added $21 billion in new long positions on S&P 500 futures, Citi’s data showed, even as talks in Washington to resolve the debt-ceiling impasse drag on. The weekly flow of new longs was one of the largest seen in recent years, it added. ‘The momentum is clear, and positioning is increasingly one-sided. Longs outnumber shorts by more than 9 to 1,’ said Citi strategists... ‘The few remaining shorts are all in loss, but a short squeeze is not likely to significantly impact markets.’”

May 22 – Bloomberg (Andrew Atkinson and Philip Aldrick): “The UK government borrowed more than forecast in the first month of the fiscal year as debt interest payments and cost-of-living support measures for consumers drove spending higher. Spending exceeded revenue by £25.6 billion ($31.8bn) in April, almost double the deficit a year earlier… That was more than the £19.1 billion economists had expected and the £22.4 billion forecast by the Office for Budget Responsibility. The deficit, the second-highest for the month of April since 1993, highlights the challenge for Prime Minister Rishi Sunak to bring the public finances under control…”

May 26 – Bloomberg (Sonali Basak, Liz Capo McCormick, Lydia Beyoud and Hema Parmar): “A highly leveraged bond trade that’s become popular with hedge funds is drawing fresh scrutiny three years after it blew up spectacularly. Officials at the Securities and Exchange Commission and the Federal Reserve have questioned prime brokers about leveraged trading in government bonds by their fast-money clients, according to people familiar… Several of the hedge funds that have recently pursued the so-called basis trade were also active in 2020, when the outbreak of the pandemic upended the Treasury market and caught them wrong-footed until Fed officials intervened to restore normalcy.”

May 24 – Bloomberg (Masaki Kondo and Masahiro Hidaka): “Demand for inflation protection hit fresh highs for the year in Japan as traders bet easy monetary policy will remain in place despite the relentless rise in consumer prices. The 10-year break-even rate, a gauge of price expectations derived from inflation-linked government notes, climbed to 0.94% this week, the highest since late December.”

Bubble and Mania Watch:

May 22 – Wall Street Journal (Carol Ryan): “Even if the property world gets a lot rockier, landlords with the deepest pockets should be able to service their debts. That doesn’t mean they will. Optimists point out that today’s real estate troubles aren’t as serious as the 2008 crash. For one, property investors are more creditworthy than the overly indebted and flighty homeowners who got banks into hot water during the global financial crisis. Of all the loans that Fannie Mae issued on single-family homes in 2007, around 16% wound up in default. Delinquency rates for commercial property are close to record lows today, although they are rising. And loan-to-value ratios are lower than they were 15 years ago, so owners with more equity in their properties will find it painful to walk away. But recent high-profile defaults show that creditors still face risks even from star borrowers.”

May 24 – Bloomberg: “America’s second-largest city is at the forefront of mounting property distress that threatens to bring widespread defaults and deeper pain for landlords. With downtown LA’s office vacancy rate at a record 30%, buildings have plunged in value as workers stay away from the urban core of a sprawling, car-centric region. It’s a scenario unfolding in downtowns across the US…, afflicting cities with vacant storefronts, crime concerns and fiscally strained transit systems. Now, rising interest rates are colliding with falling real estate prices, pressuring building owners whose debt burdens are higher than the market value of their properties. That’s in turn spurred warnings of financial instability from bankers, private equity executives and the Federal Reserve… More than $900 billion of debt on US commercial real estate is set to mature through 2024, and much of it will need refinancing at interest rates that have more than doubled since early last year.”

May 25 – Bloomberg (Patrick Clark and Prashant Gopal): “US apartment landlords who benefited from rapid rent growth during the pandemic are suddenly in the red. Higher interest rates and surging expenses are erasing their profits, even as rents are still climbing in many places. Debt payments already exceed income from multifamily buildings financed with more than $47 billion of securitized loans, according to… Trepp. Making matters worse, property taxes are escalating swiftly and the destructive path of climate change is sending insurance costs skyward. And building values are falling, complicating owners’ efforts to sell or refinance their way out of trouble. ‘The problem is, nobody expected expenses to rise as much as they did,’ said Jay Parsons, chief economist for RealPage… ‘In particular, investors with floating-rate loans resetting at significantly higher rates could be challenged to cover debt payments.’”

May 24 – Financial Times (Anna Nicolaou and Sujeet Indap): “When private equity investors put nearly half a billion dollars into Vice Media in 2017, co-founder Shane Smith hinted that the cash would help his digital media company achieve a public listing that ‘would look very sexy’. Speaking at an advertising festival in Cannes… the blustering media executive joked with reporters that he ‘rounds up’ Vice’s $5.7bn valuation to $6bn ‘because it’s easier to say’. For years, Vice had been widely regarded as the future of media. The injection of cash led by private equity group TPG and its then-partner Sixth Street was meant to propel the company towards either a splashy initial public offering or a multibillion-dollar sale. Instead, the opposite happened. After a series of disappointing results, years of chaotic management, risky endeavours and a liquidity crisis, Vice has filed for bankruptcy. TPG’s $450mn bet has been wiped to zero. Vice’s overall valuation rests below $300mn.”

May 20 – Bloomberg (Nina Trentmann and Davide Scigliuzzo): “Corporate America is waking up to what higher interest rates really mean. Companies across the credit spectrum are facing sharply higher financing costs after the Federal Reserve raised its benchmark rate for ten consecutive meetings… Interest costs at US companies rose by nearly 20% on average in the first quarter compared to a year earlier, according to a sample of about 1,700 businesses from data provider Calcbench Inc.”

May 23 – Reuters (Angus Berwick and Tom Wilson): “The world’s largest cryptocurrency exchange, Binance, commingled customer funds with company revenue in 2020 and 2021, in breach of U.S. financial rules that require customer money to be kept separate, three sources familiar… told Reuters. One of the sources… said the sums ran into billions of dollars and commingling happened almost daily in accounts the exchange held at U.S. lender Silvergate Bank. Reuters couldn’t independently verify the figures or the frequency. But the news agency reviewed a bank record showing that on Feb. 10, 2021, Binance mixed $20 million from a corporate account with $15 million from an account that received customer money.”

May 22 – Reuters (Tatiana Bautzer and Saeed Azhar): “The turmoil facing U.S. regional banks has prompted some lenders to step back, leaving space for investors such as asset managers, private equity (PE) funds and insurers to lend more. Non-bank lenders with deep pockets have invested in credit assets for years, but the regional banking crisis could supercharge their expansion into areas such as providing consumer car loans and mortgages, or financing the construction of buildings, according to industry executives… ‘With loan terms tougher and tighter, the option for private credit providers is on steroids,’ said Drew Schardt, head of investment strategy at Hamilton Lane, one of the largest investment firms in private markets.”

May 23 – Reuters (Samuel Shen, Li Gu and Tom Westbrook): “Chinese money is pouring into Japan-focused stock funds as the Nikkei hits 33-year highs, triggering repeated warnings from fund managers about market risks. Two Shanghai-listed exchange-traded funds (ETFs) that track the Nikkei 225 Index have drawn such feverish interest, that their prices far exceed their net asset value.”

U.S./Russia/China/Europe Watch:

May 21 – Associated Press (Elaine Kurtenbach): “The Group of Seven wealthy democracies united in urging China to pressure its strategic partner Russia to end its war on Ukraine and resolve territorial disputes peacefully, and China lashed back. In a joint statement, the G7 leaders emphasized they did not want to harm China and were seeking ‘constructive and stable relations’ with Beijing, ‘recognizing the importance of engaging candidly with and expressing our concerns directly to China.’ ‘We call on China to press Russia to stop its military aggression, and immediately, completely and unconditionally withdraw its troops from Ukraine… We encourage China to support a comprehensive, just and lasting peace based on territorial integrity and the principles and purposes of the U.N. Charter,’ including in direct talks with Ukraine.”

May 21 – Associated Press (Joe McDonald): “Stepping up a feud with Washington over technology and security, China’s government… told users of computer equipment deemed sensitive to stop buying products from the biggest U.S. memory chipmaker, Micron Technology Inc. Micron products have unspecified ‘serious network security risks’ that pose hazards to China’s information infrastructure and affect national security, the Cyberspace Administration of China said on its website. Its six-sentence statement gave no details. ‘Operators of critical information infrastructure in China should stop purchasing products from Micron Co.,’ the agency said.”

May 25 – Financial Times (Kana Inagaki): “Microsoft has warned that a state-sponsored Chinese hacking group has compromised ‘critical’ infrastructure in the US in order to disrupt communications between the country and Asia in the event of a crisis. In a rare announcement about a systems breach, the US technology group said the hackers, codenamed ‘Volt Typhoon’, have operated since mid-2021. They have been able to infiltrate organisations across industries by exploiting vulnerabilities in a popular cyber security platform called FortiGuard... ‘In this campaign, the affected organisations span the communications, manufacturing, utility, transportation, construction, maritime, government, information technology, and education sectors,’ Microsoft said. It added that the hacking group’s actions had focused on gathering intelligence and espionage, rather than causing immediate disruption. It added: ‘Microsoft assesses with moderate confidence that this Volt Typhoon campaign is pursuing development of capabilities that could disrupt critical communications infrastructure between the United States and Asia region during future crises.’”

May 25 – Wall Street Journal (Mike Cherney and Austin Ramzy): “The U.S. and its closest allies said Chinese hackers are targeting critical infrastructure using a novel method that is difficult to detect, sounding an alarm that could be a hurdle to recent efforts to improve ties between Beijing and the West. Cybersecurity agencies in the U.S., the U.K., Canada, Australia and New Zealand—an intelligence-sharing group of countries known as the Five Eyes—said a Chinese state-sponsored actor is employing a tactic known as ‘living off the land,’ which involves using built-in network administration tools to gain access to systems… The campaign is impacting communications, manufacturing, transportation, maritime and other sectors in parts of the U.S. and Guam, the American territory that hosts major military installations in the Pacific, according to a blog post from Microsoft…”

May 24 – Bloomberg: “President Xi Jinping called on Russia to help bolster their countries’ ties at multilateral groups, as both nations seek to counter a US-led world order they’ve become increasingly isolated within. ‘China is willing to work with Russia to continue to firmly support each other on issues of core interests, and strengthen cooperation in multilateral arenas,’ Xi told Prime Minister Mikhail Mishustin… The Russian leader echoed Xi’s sentiments, saying: ‘Russia is willing to work with China to promote the process of multi-polarization and consolidate the international law-based global order.’”

De-globalization and Iron Curtain Watch:

May 22 – Reuters (Joyce Lee): “China's ban on the use of… Micron Technology's chips in certain sectors… is a stark reminder of risks facing the global chip industry as it braces for escalating Sino-U.S. trade tensions. China's move against Micron, the biggest U.S. memory chipmaker, was widely seen as retaliation for Washington's efforts to restrict Beijing's access to key technology. It came just a day after the Group of Seven (G7) rich nations agreed they would look to ‘de-risk, not decouple’ from China, and as Washington pressures its allies to join it in restricting chip equipment exports to China.”

May 23 – Bloomberg: “China lashed out at Japan over Tokyo’s new export restrictions on some chipmaking technology and said it would take action to defend its interests, just days after it banned some domestic firms from using semiconductors from Micron Technology Inc. China ‘firmly opposes’ Japan’s decision to impose curbs on the shipment of 23 types of chipmaking technology… The action is an ‘abuse’ of export control measures and goes against free trade and international trade regulations, the statement said.”

Inflation Watch:

May 26 – CNBC (Jeff Cox): “Inflation stayed stubbornly high in April, potentially reinforcing the chances that interest rates could stay higher for longer… The personal consumption expenditures price index, which measures a variety of goods and services and adjusts for changes in consumer behavior, rose 0.4% for the month excluding food and energy costs, higher than the 0.3%... estimate. On an annual basis, the gauge increased 4.7%, 0.1 percentage point higher than expected… Including food and energy, headline PCE also rose 0.4% and was up 4.4% from a year ago, higher than the 4.2% rate in March.”

May 24 – Wall Street Journal (Paul Hannon): “Fresh out of an energy crisis, Europeans are facing a food-price explosion that is changing diets and forcing consumers across the region to tighten their belts... This is happening even though inflation as a whole is falling thanks to lower energy prices, presenting a new policy challenge for governments that deployed billions in aid last year to keep businesses and households afloat through the worst energy crisis in decades. New data… showed inflation in the U.K. fell sharply in April as energy prices cooled, following a similar pattern around Europe and in the U.S. But food prices were 19.3% higher than a year earlier.”

May 20 – Financial Times (Ian Johnston and Marton Dunai): “Europe’s retailers and governments are locked in their fiercest tussle over food costs for 50 years, with policymakers resorting to price controls to tackle the worst cost of living crisis for a generation. Despite lower energy prices easing overall price pressures, growth in the cost of food has continued to soar, prompting increasingly unconventional market interventions from politicians trying to assuage public anger. Food prices in the EU rose 16.6% in the year to April…, far in excess of a headline inflation rate of 8.1%. Some of the biggest surges have been in the cost of staples, with the cost of eggs rising 22.7% over the period, whole milk up 25%, and sugar by 54.9%.”

May 24 – Reuters (William Schomberg and Andy Bruce): “British inflation fell in April but by less than expected and it remains above the rate of price growth in the United States and most of Europe, putting pressure on the Bank of England to keep raising interest rates… Britain's consumer price index rose by 8.7% in annual terms in April, down from 10.1% in March and 11.1% last October. But it still left the country with the joint highest inflation rate among Group of Seven advanced economies alongside Italy.”

Biden Administration Watch:

May 22 – Reuters (Andrea Shalal and David Lawder): “The U.S. Treasury Department reiterated Monday it expects to be able to pay the U.S. government's bills only through June 1 without a debt limit increase, leaving just 10 days for White House negotiators and congressional Republicans to reach a deal. In her third letter to Congress in three weeks, Treasury Secretary Janet Yellen said it was ‘highly likely’ that the agency will be unlikely to meet all U.S. government payment obligations by early June, and as early as June 1, without congressional action to raise the $31.4 trillion debt ceiling, which would trigger the first-ever U.S. default.”

May 22 – Financial Times (Demetri Sevastopulo, Eleanor Olcott and Joe Leahy): Joe Biden’s prediction of an imminent ‘thaw’ in US-China relations was quickly followed by a reminder of how much tension still exists between Washington and Beijing. Within hours of the US president’s words at the end of a G7 summit in Japan…, China ordered a swath of its infrastructure companies to stop buying from US chipmaker Micron. It underscored the big challenges to stabilising US-China relations at the end of a summit in Hiroshima where Biden and other leaders of the advanced economies issued their harshest criticism of Beijing… The summit communique sparked an angry response from Beijing, which summoned Japan’s ambassador to China to protest… ‘The G7 communique points the finger at China in every dimension,’ said Wu Xinbo, dean of the Institute of International Studies at Fudan University... It would ‘make China even less willing to co-operate with the G7 to address issues of their concern’, Wu added.”

May 22 – Bloomberg: “China has questioned the ‘sincerity’ of the Biden administration, as it pushes to resume high-level diplomatic talks with Beijing while also heaping tech sanctions on its main economic rival. ‘It imposes sanctions on Chinese officials, entities and companies — what is the sincerity and meaning of such communication?’ she added. ‘The US should roll back sanctions immediately, clear the hurdles and create favorable conditions for dialog.’”

Federal Reserve Watch:

May 24 – Financial Times (Colby Smith): “Federal Reserve officials concluded the need to further lift interest rates had become ‘less certain’ as economic risks had increased, although the US central bank remained open to additional rate rises if warranted by the data… Minutes from the May meeting, when the Federal Open Market Committee delivered its 10th consecutive rate rise in just over a year, confirmed that the US central bank is considering whether to pause to its aggressive monetary tightening campaign as it assesses how much more it needs to squeeze the economy to control inflation. Citing both the ‘lagged effects’ of the Fed’s previous rate rises, as well as the spectre of tighter credit conditions stemming from the recent bank failures, participants ‘generally agreed’ that ‘the extent to which additional increases in the target range may be appropriate after this meeting had become less certain’.”

May 22 – Bloomberg (Steve Matthews, Catarina Saraiva and Craig Torres): “Two Federal Reserve hawks saw the need to raise interest rates further this year, days after Chair Jerome Powell signaled a pause in June… Federal Reserve Bank of St. Louis President James Bullard said… he backed two more increases and his Minneapolis colleague Neel Kashkari said if the central bank does pause, it should signal tightening isn’t over… Kashkari… said he’s not seen evidence yet that banking-sector strains are helping to cool prices. But they might, which is why he’d be comfortable with not lifting rates in June, provided officials leave the door open to going higher if price pressures fail to ease as expected. ‘I think right now it’s a close call, either way, versus raising another time in June or skipping. What’s important to me is not signaling that we’re done,’ Kashkari said… ‘If we were to skip in June that does not mean we’re done with our tightening cycle, it means to me we’re getting more information. Do we then start raising again in July, potentially?’ he said.”

May 22 – Bloomberg (Steve Matthews): “Federal Reserve Bank of St. Louis President James Bullard said he expects the central bank will need to raise interest rates twice more this year to quell inflation. ‘I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner… I’m thinking two more moves this year – exactly where those would be this year I don’t know – but I’ve often advocated sooner rather than later,’ he told an American Gas Association financial forum.”

May 24 – Yahoo Finance (Jennifer Schonberger): “Federal Reserve Governor Christopher Waller said… he doesn’t think the Fed should stop raising interest rates until there is clear evidence inflation is cooling. ‘I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2% objective,’ Waller said… ‘Whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks.’”

May 23 – Reuters (Howard Schneider): “U.S. banks should be prepared to borrow regularly from the Federal Reserve's discount window, while the Fed should make sure loans can be accessed at any time given changes in the speed of banking and transactions, Dallas Fed President Lorie Logan said… The rapid run on and sudden failure of Silicon Valley Bank showed ‘how the combination of the rapid spread of information and the speed of financial transactions...put a premium on banks’ effective management of liquidity risks,’ Logan said… ‘Every bank should be fully prepared,’ to borrow from the Fed, Logan said, adding ‘our liquidity backstop should be available whenever’ banks need it.”

May 22 – Bloomberg (Craig Torres): “Federal Reserve policymakers are increasingly grappling with a critical question: How much should they weigh the adverse impact of their interest-rate hikes on banks against the goal of containing the fastest price increases in decades? The answer will play a major role in determining whether the Fed is steadfast in keeping rates elevated through year-end as officials expect, or cuts them as traders are betting. Since US banking turmoil flared in March, the Fed has raised interest rates twice to combat inflation while pumping emergency liquidity into the banking system — discrete actions that underscore officials’ long-standing habit of keeping financial-stability actions apart from monetary policy.”

May 23 – Bloomberg (Rich Miller): “The Federal Reserve needs to cool off the overheated labor market to tame inflation, though it’s not clear how far unemployment must rise to achieve that, according to… Ben Bernanke and ex-International Monetary Fund Chief economist Olivier Blanchard. While a steep run-up in goods prices was the main impetus to the surge in inflation over the last 2 1/2 years, the impact of a ‘very tight’ job market is growing and is likely to prove more persistent, they wrote in a paper… ‘Controlling inflation will thus ultimately require achieving a better balance between labor demand and labor supply,’ the two economists said.”

U.S. Bubble Watch:

May 22 – Wall Street Journal (Gwynn Guilford): “Americans reported a sharp decline in their financial well-being last fall as high inflation eroded earnings and savings, according to a Federal Reserve survey… The survey, conducted in October 2022, found that rising prices left more families in an economically precarious place, though households continued to benefit from a strong labor market. The share of adults who reported being worse off financially in 2022 than a year earlier climbed to 35%, the highest on record going back to 2014, when the question was first asked. Overall, 73% of adults said they were either doing OK or living comfortably, down from 78% in 2021 and 75% in 2020.”

May 25 – Reuters (Lucia Mutikani): “The number of Americans filing new claims for unemployment benefits increased moderately last week and data for the prior two weeks was revised sharply lower likely as fraudulent applications from Massachusetts were stripped out, indicating persistent labor market strength… Initial claims for state unemployment benefits increased 4,000 to a seasonally adjusted 229,000 for the week ended May 20. Data for the prior week was revised to show 17,000 fewer applications received than previously reported. Claims for the week ending May 6 were revised down by 33,000.”

May 26 – Reuters (Lucia Mutikani): “U.S. consumer spending increased more than expected in April, boosting the economy's growth prospects for the second quarter, and inflation picked up, which could prompt the Federal Reserve to raise interest rates again next month… Consumer spending jumped 0.8% last month… Spending on goods rebounded 1.1% after two straight monthly declines. Services outlays increased 0.7%, lifted by gains in financial services and insurance as well as healthcare, recreation and housing and utilities… Consumer spending is being supported by strong wage gains in a tight labor market. Wages increased 0.5% after rising 0.3% in March.”

May 23 – Reuters (Lucia Mutikani): “U.S. business activity increased to a 13-month high in May, lifted by strong growth in the services sector, the latest indication that the economy regained momentum early in the second quarter despite rising risks of a recession. S&P Global said… its flash U.S. Composite PMI Output Index, which tracks the manufacturing and services sectors, rose to a reading of 54.5 this month. That was the highest level since April 2022 and followed a final reading of 53.4 in April.”

May 23 – Bloomberg (Augusta Saraiva): “US new-home sales unexpectedly rose last month to the highest level since March 2022 and prices declined, indicating builders continue to benefit from limited inventory in the resale market. Purchases of new single-family homes increased 4.1% to an annualized 683,000 pace last month from a downwardly revised 656,000 rate in March…”

May 24 – CNBC (Diana Olick): “The average rate on the popular 30-year fixed mortgage crossed over 7%... That is the highest level since early March… Mortgage applications to purchase a home dropped 4% for the week and were 30% lower than the same week a year ago.”

May 26 – Dow Jones (Jeffry Bartash): “Business investment rises sharply in good sign. The numbers: Orders for U.S. manufactured goods jumped 1.1% in April largely because of the military, but business investment also rose sharply in a positive sign for the economy. Economists… had forecast a 0.8% decline. Durable goods are items meant to last a long time. Yet orders fell 0.2% if transportation is excluded…”

May 26 – Dow Jones (Jeffry Bartash): “Rebound in imports from recent low points to steady consumer spending. The numbers: The trade deficit in goods shot up 17% in April to a six-month high of $96.8 billion, reflecting a rebound in imports and a broad decline in American exports. The trade gap in goods rose from $82.7 billion in March…”

May 23 – Washington Post (Jeanne Whalen): “Corporate bankruptcies are edging back up after a two-year lull as pressures in the economy grow, a situation sure to worsen if the nation's political leaders fail to reach a deal to prevent the government from defaulting on its debt. The increase is most visible among large companies, where there were 236 bankruptcy filings in the first four months of this year, more than double 2022 levels, according to S&P Global Market Intelligence.”

May 22 – Reuters (Isabel Woodford): “JPMorgan increased its corporate default rate forecast for all emerging markets to 6% from 5.5% on Monday, citing in particular growing risk among Latin American companies as access to credit markets gets tougher. The bank's forecasted default rate for Latin American corporates, meanwhile, came in even higher at 6.6%, up from 5%, which if realized will be the highest default rate for the region since 2016… ‘While we have already seen four defaults and distressed exchanges in Brazil, more are expected this year,’ JPMorgan analysts wrote…”

Fixed Income Watch:

May 25 – Bloomberg (Lisa Lee): “The leveraged loan market is on track to hand investors the biggest losses on record for defaulted loans. Loans have been trading for around 22 cents on the dollar after default this year, implying that investors will ultimately recover somewhere around that range, according to Bank of America... That’s far below the average of about 70 cents that leveraged loan investors have historically recovered from busted companies. What’s different in this cycle is, the legal documents for loans offer fewer protections than they have historically, after money managers gave up safeguards during a decade of easy money. It’s harder for investors to put companies that are starting to struggle into bankruptcy, for example. And companies often have the right to pledge key assets against new debt, stripping them away from existing lenders and reducing recoveries when the borrower actually fails.”

China Watch:

May 25 – Bloomberg (Bruce Grant): “China’s central government borrowed at the fastest pace on record last quarter and weak credit creation will only strengthen its role as borrower of last resort. With non-government sectors burdened by a debt load heavier than Japan’s in the 1990s, policy makers have no choice but to ramp up bond issuance at a time of feeble growth and low rates. Total credit to Japan’s non-financial, non-government sectors, namely households and corporations, reached an all-time high of 214% of GDP in 1994 before gradually easing toward 150% in 2016… The same measure for China topped at around 225% two years ago and has fluctuated within 210%-220% ever since.”

May 21 – Financial Times (Ruchir Sharma): “Something is rotten in the Chinese economy, but don’t expect Wall Street analysts to tell you about it. There has never been a bigger disconnect, in my experience, between some of the rosier investment bank views on China and the dim reality on the ground. Perhaps reluctant to back off their calls for a reopening boom this year, sellside economists keep sticking to their forecasts for growth in gross domestic product in 2023, and now expect it to come in well above 5%. That’s even more optimistic than the official target, and wildly out of line with dismal news from Chinese companies. Hopes for a reopening boom were based on the premise that, once released from lockdown, Chinese consumers would go on a spending spree, but company reports show no sign of one. If China’s economy were growing at 5%, then based on historical trends corporate revenues should be growing faster than 8%. Instead, revenues grew at 1.5% in the first quarter.”

May 21 – Wall Street Journal (Rebecca Feng and Cao Li): “One of China’s poorest provinces is testing Beijing’s mettle with a mountain of debt that local borrowers are struggling to repay. Investors worry it is a harbinger of another major debt crisis in the country, and believe the central government will have no choice but to defuse it. Cracks have been showing in the finances of Guizhou… It was one of China’s fastest-growing local economies over the past decade—thanks in large part to its heavy spending on infrastructure development. More than 110 state-backed entities known as local government financing vehicles in Guizhou have outstanding bonds, which in many cases were issued to help pay for the construction of bridges, highways and tunnels. Including these entities, the provincial government had the equivalent of $388 billion in outstanding debt by the end of 2022, about 1.3 times its gross domestic product…”

May 21 – Bloomberg: “In 2021, a remote coal town in northeastern China was forced to undergo an unprecedented financial restructuring. Its struggles since are an ominous sign for President Xi Jinping as other heavily indebted municipalities look set to follow suit… Hegang represents just the tip of the iceberg of a local government debt problem that’s making investors increasingly nervous and that threatens to be a drag on the world’s second-largest economy for years to come. Goldman Sachs… estimates China’s total government debt is about $23 trillion, a figure that includes the hidden borrowing of thousands of financing companies set up by provinces and cities. While the chance of a municipal default in China is relatively low given Beijing’s implicit guarantee on the debt, the bigger worry is that local governments will have to make painful spending cuts or divert money away from growth-boosting projects to continue repaying their debt.”

May 22 – Financial Times (Hudson Lockett, Cheng Leng and Thomas Hale): “China has opened the door for more overseas investors to access its prized $5tn interest rate swaps market, a move Beijing hopes can help stem a protracted sell-off of local debt as US rates rise. The market link-up, known as Swap Connect, launched on May 15 and is similar to existing programmes in Hong Kong that allow offshore investors to trade bonds and stocks in Shanghai and Shenzhen. Eddie Yue, chief executive of the Hong Kong Monetary Authority, said… allowing foreign investors to hedge the interest rate risk on their renminbi bonds ‘can prevent heavy sell-offs for bonds, decrease market volatility and improve financial stability’.”

May 22 – Bloomberg: “China is likely to see its Covid-19 wave peaking at about 65 million infections a week toward the end of June, according to a senior health adviser, while authorities rush to bolster their vaccine arsenal to target the latest omicron variants. XBB has been fueling a resurgence in cases across China since late April and is expected to result in 40 million infections a week by the end of May, before peaking at 65 million a month later, local media outlet the Paper reported…”

May 24 – Wall Street Journal (Sha Hua and Alexandra Wexler): “Chinese companies have long dominated lithium refining, but their hunt to secure a greater share of the world’s supplies of the metal is leading them to buy up stakes in mines throughout the developing world as they face increasing resistance in Western countries. It is a risky strategy. China is spending billions on stakes in nations that have histories of political instability, local resistance and resource nationalism. Projects often face protests, regulatory delays and even cancellations.”

May 25 – Bloomberg: “Hunan Yongxiong Asset Management, one of China’s biggest personal debt collectors, said it will suspend operations amid a police investigation… Police have imposed ‘compulsory measures’ such as home surveillance and detention on 179 employees, the company says.”

May 21 – Wall Street Journal (Chun Han Wong): “Chinese leader Xi Jinping is taking a page out of Mao Zedong’s crisis playbook to contain the damage caused by the tumultuous final months of his zero-tolerance Covid controls. In recent months, Xi has launched indoctrination drives, including a mass-study campaign to propagate his political doctrine. The campaign has swept through schools, hospitals, banks, courts, police stations, military bases and places of worship in what he describes as a ‘spiritual baptism’ for all members of the Communist Party. To deliver on its mission of rejuvenating the Chinese nation, ‘the entire party must unify its thinking, unify its will and unify its actions,’ Xi told officials at an April meeting. In parallel, Xi has commanded officials at every level to conduct on-the-ground ‘investigation and research,’ echoing a program that Mao directed in the early 1960s in what historians say was an attempt to shift blame for the disastrous consequences of the Great Leap Forward.”

May 21 – Reuters (Yew Lun Tian and Casey Hall): “One joke by a Chinese comedian about the nation's military has spurred online uproar, a $2 million fine, a police probe, a sweep of cancelled shows and fears for the survival of Chinese stand-up comedy, a rare refuge for somewhat free speech. The furore over Li Haoshi's wisecrack in Beijing last weekend marks the biggest scandal yet for a form of entertainment that, despite China's tightening censorship regime, had managed to gain popularity with performances in small groups and material that managed to just toe the line. ‘Stand-up comedy has been the last bastion in which people ... can still enjoy entertaining commentary about public life,’ said… independent political analyst Wu Qiang. ‘After this, the space for stand-up comedy and public expression in general will inevitably keep shrinking.’”

May 20 – Bloomberg: “Saturday’s ‘What the Folkstival’ outdoor concert was meant to kick off in the early afternoon in a Beijing suburb near the airport, with 10 live acts, including foreign performers, playing ‘acoustic music to soothe your soul.’ It never began. Near booths selling barbecue skewers and craft beer, festival-goers had begun to gather on blankets or folding chairs, enjoying the breeze and freedom from Covid-era restrictions, when police officers appeared, lights flashing, to speak with the organizers. Minutes later, a volunteer took to the stage and said the event was being postponed because of unforeseen reasons. Organizers said the police had ordered them to vacate the premises. The incident is one of an unusual spate of sudden cancellations or shutdowns in the past week across the country that seem unrelated, spanning arts, business and equality.”

Central Banker Watch:

May 23 – Reuters (William Schomberg and Andy Bruce): “Bank of England Governor Andrew Bailey said… the British central bank had ‘very big lessons to learn’, with inflation still in double digits and food prices rising at the fastest rate since the 1970s. Bailey and other top BoE officials faced two hours of often harsh criticism from lawmakers during a question-and-answer session in parliament about the central bank's failure to forecast the scale of inflation's jump. ‘I think there are very big lessons about how we operate monetary policy in the face of very big shocks,’ Bailey said. Britain's inflation rate in March was the highest in Western Europe at 10.1%, putting the BoE under intense political scrutiny.”

May 24 – Bloomberg (Tracy Withers): “New Zealand’s central bank raised interest rates by a quarter-percentage point and unexpectedly signaled that no further policy tightening will be needed to tame inflation, sending the nation’s currency tumbling… The Reserve Bank’s Monetary Policy Committee lifted the Official Cash Rate to 5.5% from 5.25%...”

Europe Watch:

May 23 – Bloomberg (Craig Stirling): “Euro-zone manufacturing activity shrank this month at the fastest pace since the pandemic shuttered factories three years ago… An index based on surveys of purchasing managers across the region unexpectedly dropped to 44.6 in May, further below the 50 level that indicates contraction, according to the report from S&P Global. A similar gauge of services also fell, though its reading of 55.9 still signals robust expansion.”

May 25 – Reuters (Maria Martinez and Christian Kraemer): “The German economy was in recession in early 2023 after household spending in Europe's economic engine finally succumbed to the pressure of high inflation. Gross domestic product fell by 0.3% in the first quarter of the year when adjusted for price and calendar effects… This follows a decline of 0.5% in the fourth quarter of 2022. German GDP data showed ‘surprisingly negative signals,’ Finance Minister Christian Lindner said…”

Japan Watch:

May 25 – Financial Times (Kana Inagaki): “Japan’s companies are changing their behaviour on wages and prices and raising the risks of a monetary policy error, the country’s new central bank governor has warned. Kazuo Ueda vowed that the Bank of Japan would ‘respond quickly’ if there were any signs of a structural change in price pressures across the economy, but admitted there was a chance that the bank would be mistaken in its forecasts as the country’s inflation hits levels not seen in decades. ‘The risk of getting [our inflation forecast] wrong is not zero,’ Ueda said… ‘There is a risk that we will be late in raising interest rates if we get our future outlook wrong, and there is also the risk of prematurely doing a rate hike.’”

May 25 – Bloomberg (Toru Fujioka and Sumio Ito): “Bank of Japan Governor Kazuo Ueda indicated his desire to hold on to policy flexibility by playing down the importance of wages or any single economic dataset as a trigger for change. ‘We aren’t targeting wage growth itself,’ Ueda said… ‘The key point for our policy decisions is whether inflation will rise in a stable and sustainable manner at 2%... It is more important to judge whether the inflation rate is sustainable and stable, rather than extremely small differences of decimal points around the 2% target,’ he said.”

May 25 – Bloomberg (Yoshiaki Nohara): “Japan’s government raised its monthly economic assessment in May for the first time in 10 months as consumption, production and exports improved. The Cabinet Office said… the economy is recovering at a moderate pace, saying the trend is expected to continue with the jobs and income situation improving. It also upgraded its assessment of consumer spending, production and exports.”

May 25 – Wall Street Journal (Megumi Fujikawa): “Rising prices of hotel rooms are an indication that Japan might be decisively pulling free of deflation, the country’s central bank chief said. Bank of Japan Gov. Kazuo Ueda said he saw the trend of higher lodging costs when he used to make his own hotel bookings for business trips before he took up the governor’s post in April. ‘There appear to be moves leading towards sustainable inflation,’ Ueda said… ‘Whether price increases in the service sector become widespread and continue is one of the points’ to monitor to see if inflation above 2% can be sustained, Ueda said.”

May 22 – Reuters (Kaori Kaneko): “Japan's manufacturing activity expanded for the first time in seven months in May, while the service-sector hit record growth…, as the post-COVID recovery shored up business conditions. The au Jibun Bank flash Japan manufacturing purchasing managers' index (PMI) rose to a seasonally adjusted 50.8 in May, from a final 49.5 in April. It's the PMI's first reading above 50, which separates contraction from expansion, since October.”

EM Watch:

May 25 – Bloomberg (Kerim Karakaya): “Turkey’s central bank asked some local lenders this week to step in and buy the country’s dollar bonds, the latest effort to provide a backstop to private markets as pressure builds before a presidential runoff election on Sunday. Officials called some of the country’s banks… and asked them to buy dollar bonds across multiple maturities in secondary markets, according to people familiar…”

May 25 – Reuters (Can Sezer): “The Turkish central bank's net forex reserves dropped into negative territory for the first time since 2002, standing at $-151.3 million on May 19…, as it sought to counter forex demand ahead of Sunday's runoff vote.”
May 24 – Bloomberg (Martha Viotti Beck, Felipe Saturnino and Maria Eloisa Capurr): “There are few, if any, leaders in the world who are publicly lashing out at central bankers more than Brazil’s Luiz Inacio Lula da Silva. The reasons are increasingly evident as Brazilians feel the pinch of a weakening economy. Nine months after policymakers pinned benchmark interest rates at 13.75%, capping off a dozen rapid-fire hikes, household debt is lingering at a record, banks are gutting lending and corporate bankruptcies are rising.”

May 20 – Reuters (Ira Dugal and Aftab Ahmed): “India will start withdrawing its highest value currency notes from circulation, the central bank said…, in a move that economists said could boost bank deposits at a time of high credit growth. The withdrawal of 2,000-rupee ($24.5) notes - which the finance ministry's top official, T.V Somanathan, said would not cause disruption ‘either in normal life or in the economy’ - also comes ahead of elections in four large states at the end of the year and a national ballot in spring 2024. Most of India's political parties are believed to hoard cash in high denomination bills to fund election campaign expenses to get around tough spending limits imposed by the Election Commission.”

May 23 – Financial Times (Michael Stott): “Ecuador’s president Guillermo Lasso is a US-educated, pro-business conservative. But his government has just signed a trade deal with China, and when he secured $1.4bn of debt relief last year, it was from Xi Jinping. ‘Xi was very understanding,’ said Lasso of the Chinese president. Experts say Ecuador’s experience with China shows how the US and other western countries risk losing further ground in Latin America to Beijing unless they can offer better trade and investment opportunities.”

Leveraged Speculation Watch:

May 25 – Bloomberg (Brian Chappatta): “Bill Ackman said Hindenburg Research has ‘outed’ the way billionaire Carl Icahn runs his publicly traded company and suggested shares have room to fall after tumbling to the lowest levels since 2009. In a lengthy Twitter post, Ackman, 57, also called out 87-year-old Icahn’s use of margin loans against his shares in Icahn Enterprises LP. The stock plunged more than 13% on Wednesday, with the price reaching the lowest level in more than 14 years. ‘$IEP reminds me somewhat of Archegos where the swap counterparties were comforted by each having relatively smaller exposures to the situation,’ Ackman said…”

Social, Political, Environmental, Cybersecurity Instability Watch:

May 22 – Reuters (Tom Polansek): “Farmers in Kansas, the biggest U.S. producer of wheat used to make bread, are abandoning their crops after a severe drought and damaging cold ravaged farms. They are intentionally spraying wheat fields with crop-killing chemicals and claiming insurance payouts more than normal… Other growers are turning over dismal-looking fields to cattle for grazing… Nationally, winter-wheat farmers plan to abandon 33% of the acres they planted, the highest percentage since World War I, the U.S. Department of Agriculture said…”

Geopolitical Watch:

May 25 – Reuters (Elwely Elwelly): “Iran successfully test-launched a ballistic missile with a potential 2,000-km range…, two days after the chief of Israel's armed forces raised the prospect of ‘action’ against Tehran over its nuclear programme. Iran, which has one of the biggest missile programmes in the Middle East, says its weapons are capable of reaching the bases of arch-foes Israel and the United States in the region.”

May 25 – Reuters (Soo-Hyang Choi and Daewoung Kim): “South Korean and U.S. forces began live-fire exercises simulating a ‘full-scale attack’ from North Korea… in what they said were the biggest such drills to demonstrate their ‘overwhelming’ military capability against the North's threats. Howitzers pounded into a mountainside in Pocheon near the fortified border with North Korea, while battle tanks manoeuvred and fired their guns at targets, sending smoke, dust and shockwaves across the valley.”

May 24 – Reuters: “The Asia-Pacific region does not welcome NATO's plan to open a liaison office in Japan, Chinese foreign ministry spokesperson Mao Ning said…, after Japan acknowledged NATO's plan. ‘We want to say that the Asia-Pacific does not welcome group confrontation, does not welcome military confrontation,’ Mao said. She also said Japan should be ‘extra cautious on the issue of military security’ given its ‘history of aggression’.”

May 22 – Financial Times (Edward White): “From the waters of the Pacific Ocean to the coasts of Antarctica and Africa, China’s fishing fleet is emerging as a new geopolitical flashpoint between Washington and Beijing. The Chinese distant water industry is by far the world’s biggest in terms of catch volume and fleet size, and is estimated to have about 10,000 vessels worldwide. It has long drawn criticism from conservationists for its pillage of endangered species… Over the past year, however, a crackdown on the industry has become a pillar of Joe Biden’s broader Indo-Pacific policy designed to push back against China. With US-China relations at their lowest point in decades, fishing has become an increasingly acute point of tension… Elizabeth Freund Larus, a China expert at the Pacific Forum…, said Washington had determined that illegal, unreported and unregulated (IUU) fishing by Chinese boats was a ‘national security concern’. The fleet was depleting fish stocks worldwide and depriving coastal communities of critical food sources, she said. But even more troubling to Washington, Larus added, was the dual use of China’s fishing vessels for both commercial operations and as a maritime militia that allegedly supports China’s navy, coastguard and maritime police.”

Friday Evening Links

[Yahoo/Bloomberg] Tech Extends Rally as Traders Await Debt Deal: Markets Wrap

[Yahoo/Bloomberg] Oil Posts Second Weekly Gain as Debt-Limit Deal Inches Closer 

[Reuters] US debt ceiling talks struggle before deadline as 'major issues' remain

[Politico] Where the debt talks stand six days before default deadline

[Reuters] Fed 'pause' on rate hikes in doubt after strong US data

[Yahoo/Bloomberg] Hot Inflation Puts Another Fed Hike In Play for June or July

[Yahoo/Bloomberg] Bond Traders Are Starting to Eye Potential Risks Beyond the Debt Ceiling

[Reuters] US rebukes Kosovo for escalating tensions, Serbia puts army on alert

[WSJ] Debt-Ceiling Negotiators Clash Over Work Requirements as Deal Takes Shape