I have a rather simple Bubble definition: “A self-reinforcing but inevitably unsustainable inflation.” Most Bubble discussions center on the deflating rather than the inflating phase. A focus of my analysis is the progressively powerful dynamics that fuel Bubble excess, along with attendant distortions and maladjustment – and how they sow seeds of their own destruction.
The ongoing “global government finance Bubble” is unique in history. Rarely has market intervention and manipulation been so widely championed. Never have governments and central banks on a concerted basis inflated government debt and central bank Credit. And almost a full decade since the crisis, the massive inflation of “money”-like government obligations runs unabated – across the continents.
The IMF calculated first quarter real global GDP growth at 3.64%, near the strongest expansion since 2011. U.S. Q2 GDP of 4.1% was the strongest since Q3 2014. There have been only eight stronger quarters of U.S. growth over the past 18 years.
Extreme and protracted (fiscal and monetary) policy stimulus has indeed stimulated real economy expansion. Given sufficient scope and duration, stimulus will invariably fuel spending and investment. Unfortunately, the artificial boom is also not without myriad negative consequences. Is the boom sustainable? Have we today reached the point where economic growth is self-supporting? Or, instead, is the global boom vulnerable to the curtailment of aggressive stimulus measures? Has global government stimulus promoted a return to stability? Or has an almost decade of unprecedented measures only exacerbated Latent Fragilities?
It was yet another week that seemed to support the Acute Latent Fragility Thesis.
July 22 – Financial Times (Gabriel Wildau and James Kynge): “China’s central bank injected Rmb502bn ($74bn) into its banking system on Monday to help fortify a weakening domestic economy against the impact of an escalating trade war with the US and growing friction with Washington over its falling currency. The injection was the most emphatic move in a series of recent indications that Beijing is moving to ease monetary policy… Raising the risk that the US-China trade war could turn into a currency war, Mr Trump has accused Beijing of manipulating the renminbi, which last Friday reached its lowest point for a year against the US dollar. It has fallen 5% since the start of last month.”
Despite GDP growth in the neighborhood of 6.0%, booming household borrowings, an unrelenting apartment Bubble and an ongoing Credit boom, China has once again been compelled to resort to aggressive stimulus in an attempt to hold its tottering Bubble upright. The Chinese economy’s vulnerability to a U.S. trade war is generally offered as the impetus behind recently announced measures. Perhaps exposure to the faltering EM Bubble is also a pressing concern in Beijing.
July 22 – Wall Street Journal (Jeremy Page and Saeed Shah): “Pakistan’s first metro, the Orange Line, was meant to be an early triumph in China’s quest to supplant U.S. influence here and redraw the world’s geopolitical map. Financed and built by Chinese state-run companies, the soon-to-be-finished overhead railway through Lahore is among the first projects in China’s $62 billion plan for Pakistan. Beijing hoped the $2 billion air-conditioned metro, sweeping past crumbling relics of Mughal and British imperial rule, would help make Pakistan a showcase for its global infrastructure-building spree. Instead, it has become emblematic of the troubles that are throwing China’s modern-day Silk Road initiative off course. Three years into China’s program here, Pakistan is heading for a debt crisis, caused in part by a surge in Chinese loans and imports for projects like the Orange Line, which Pakistani officials say will require public subsidies to operate.”
A few decades back it was Japanese Bubble Finance spreading its tentacles across the world. This week saw Japanese 10-year yields almost reach 11 bps, near the high going back to January 2016. It took two Bank of Japan (BOJ) interventions – offers to buy unlimited JGBs – to push yields back below 10 bps by Friday. There is considerable market focus on next week’s BOJ policy meeting, along with heightened concerns in Japan for the sustainability of the BOJ’s policy course. Holding “market” yields indefinitely at zero promotes distortions and imbalances. Various reports have the BOJ contemplating adjusting this policy. The bank may also adjust an ETF purchase program viewed as distorting the Japanese equities market.
Sharing a similar experience to central bankers around the globe, the BOJ has seen the impact of its inflationary policies much more in booming securities markets rather than in (stagnant) aggregate price levels in the real economy. Despite a massive expansion of central bank Credit, Japanese core consumer price inflation is expected this year to be about half the bank’s 2.0% policy target. Increasingly, the 1% difference in CPI must seem secondary to risks mounting in the financial markets.
July 26 – Bloomberg (Masaki Kondo and Chikafumi Hodo): “For all the speculation over possible Bank of Japan policy tweaks next week, the most important change for global bond markets may already be underway. While market watchers disagree about whether the BOJ will adjust its target of keeping 10-year yields around zero percent, its steady reduction in purchases of longer-maturity debt and more expensive overseas hedging costs mean Japanese funds are already contemplating bringing more money back home. The BOJ’s steps to buy fewer bonds has seen the annual increase in its debt holdings slow to 44.1 trillion yen ($398bn) versus its guidance of 80 trillion yen. Last quarter the reductions were entirely focused on so-called super-long bonds, which are the most attractive to insurers. What happens next in the world’s second-largest bond market has the potential to cascade globally given Japanese investors hold $2.4 trillion of overseas debt.”
It’s a big number: $2.4 TN. BOJ policy has nurtured great Latent Fragilities. For one, policy measures have incentivized Japanese institutions and investors to comb the world for positive yields (Bubble fuel). Moreover, there is surely a large yen “carry trade” component, as financial speculators essentially borrow free in yen to leverage in higher-yield global instruments. The dollar/yen bottomed in late March, not coincidently about the same time U.S. and global (developed) equities put in trading bottoms. After trading as low as 104.74, a weaker yen saw the dollar/yen rally to trade last week at 112.88. Having reversed course, the dollar/yen closed Friday at 111.05.
I would argue that the ECB has also nurtured great Latent Fragilities. The ECB Thursday confirmed that policy rates would remain near zero at least through the summer of 2019. “What are they afraid of?” German two-year yields ended the week at negative 0.61%, the French two-year at negative 0.44%, and Spanish yields at negative 0.33%. Even Portugal enjoys negative borrowing costs out to two-year maturities (-0.23%). The German government is paid to borrow out to five years (-0.17%). To be sure, European debt instruments have inflated into one of history’s most distorted Bubble markets. I’ll assume Mario Draghi is not oblivious.
Italian 10-year yields jumped 15 bps this week to a four-week high 2.74%. Draghi was again questioned about Target2 balances during the ECB’s post-meeting press conference. It’s a critical issue that garners surprisingly little attention, perhaps because it is deftly deflected by the head of the ECB. Besides, it was a 2012 worry that proved short-lived.
Journalist: “How do you rate the risk in this [Target2] system, especially for the Bundesbank and compared to the Italy National Bank, for example?”
ECB President Mario Draghi: “First of all, let me make a general point. Target2 is a payment system, as such it doesn’t generate instability. It’s the way a monetary union settles its payments, and it’s devised to make sure the money flows unencumbered across countries, individual sectors, companies – all economic agents. So that’s the first thing we should always keep in mind.
The second thing is how to interpret recent numbers which show an increased number of Target liabilities in certain countries. Well, this is again a question that was asked several times in the past. Most of the movement in Target2 liabilities depends on our own asset purchase program – and depends on how and where – especially where – the balances of the purchases of bonds are settled. About 50% of the institutions… that sell bonds to the national central banks are not in the euro area and settle their account with one or two core countries where the financial centers reside. So, in this sense, you see that the accounting settlement of the balances do depend on where the settlement is made. It has nothing to do with capital flows from one country or another. Keep in mind that 80% of the institutions – banks namely – that sell bonds to the national central banks do not reside in the country where the purchaser’s national central bank resides. A lot of inter-country payments and flows do not say anything very specific about the overall situation.
But going back to the recent movements in the liabilities in certain countries, you see that first of all they are not unprecedented – this is not the first time. We’ve seen movements as large and even larger in the past. Second…, they are of second order with respect to the massive movements produced by our own purchase program. So, the bottom line is the system works very well. The people who want to cap it, collateralize, limit – I mean, the truth is that they don’t like the euro. They don’t like the monetary union. Because the only way a monetary union can work is if they have an efficient payment system – which is what Target2 is. And I think it is just too early to understand exactly what part of the liabilities do reflect political uncertainty.”
Italy’s Target2 liabilities rose $16.3 billion during June to a record $481 billion, with a two-month gain of almost $55 billion. It’s worth noting that Italy’s liabilities surged from about zero in mid-2011 to $289 billion at the height of the European crisis back in August 2012. The ECB’s “whatever it takes” stabilization program saw these liabilities shrink to $130 billion by July 2014. They’ve been basically heading south ever since.
Clearly, there is a lack of confidence in Italy’s future status in the monetary union. And, at this point, it is not clear what might reverse the steady outflows from Italian financial institutions and assets. I don’t completely disagree with Mr. Draghi’s assertion that ECB policy is having a significant influence on Target2 balances. When Eurozone central banks buy Italian debt securities in the marketplace, the sellers are choosing to hold (or dispose of) these balances in other countries – thus creating a Bank of Italy liability to eurozone central banks (largely the Bundesbank). Why is this not a major festering problem? Germany’s Target2 assets rose $20 billion in June to a record $976 billion – having now more than doubled since December 2014.
That Germany will soon have accumulated an astounding $1.0 TN of Target2 assets implies acute Latent Fragility in the euro region. This was never supposed to happen. These balances reflect mounting imbalances plugged by free-flowing central bank “money.” ECB sovereign debt purchases have so compressed interest-rate differentials that there is today insufficient incentive to hold Italian and other “periphery” debt. But a market adjustment toward more realistic Credit spreads risks bursting Bubbles and blowing up debt markets. The entire European monetary integration experiment hangs in the balance.
So, the ECB is forced to stick with negative interest rates and “money” printing operations, as countries such as Italy accumulate liabilities that they will never service – leaving the German people to fret receivables that will never settle. Draghi’s assertion that the payment system “works very well” is at best misleading. With imbalances growing bigger by the month, the semblance of a well-functioning payment system depends on monetary policy remaining extraordinarily loose. Stated differently, Acute Financial Fragilities are held at bay only so long as “money” remains free and created in abundance.
I believe we’ve reached the stage where a meaningful tightening of finance in Europe risks both acute bond market instability and even the entire euro experiment. For those believing this is hyperbole, allow me to phrase this differently: Italy and other “periphery” nations are one financial crisis away from demanding an alternative monetary regime.
A reasonable question: Why then is the euro not under more pressure? Well, Japan is only a meaningful tightening of financial conditions away from major bond market and financial system issues. The yen is a big wildcard. China is only a meaningful tightening away from major financial and economic issues. The renminbi is a big wildcard. The emerging markets are already suffering the effects of a tightening of financial conditions. Many EM currencies are in trouble.
Why is the euro not weaker against king dollar? Because the dollar is fundamentally an unsound currency – in a world of competing unsound currencies.
July 24 – Wall Street Journal (Josh Zumbrun): “The U.S. remained by far the largest driver of global current-account imbalances in 2017, running the world’s largest deficit and adopting policies-mainly a shift toward much larger fiscal deficits-that are likely to increase its imbalances in coming years. The U.S. ran a $466 billion current-account deficit, meaning the nation imported far more than it exported. The U.S. has become an increasingly large driver of global deficits, accounting for 43% of all global deficits last year, up from 39% in 2016, according to the International Monetary Fund’s annual assessment of the state of global imbalances. Washington’s shift toward major deficit spending will move the U.S. trade deficit ‘further from the level justified by medium term fundamentals and desirable policies,’ the IMF said.”
I would argue that the U.S., as well, is only a meaningful tightening of financial conditions away from serious issues. Inflated U.S. securities markets have been on the receiving end of huge international flows, much a direct consequence of QE (i.e. ECB and BOJ) and rampant Credit growth (China and EM). It would appear that U.S. residential and commercial real estate markets are already feeling the effects of waning international flows.
In the eyes of complacent markets, vulnerabilities – China, Japan, EM, Eurozone, UK, etc. – ensure the coterie of global central bankers remain trapped in aggressive stimulus. Yet there appears increasing recognition within the central bank community that further delays in the start of “normalization” come with mounting risks. That they have all in concert for far too long delayed getting the process started ensures great Latent Fragilities.
The Dow jumped 1.6% this week, the Banks 2.4% and the Transports 2.0%. The S&P500 added 0.6%, its fourth straight weekly gain. But the week saw (Crowded Long) declines of 16.7% in Facebook, 21.4% in Twitter, 9.5% in Electronic Arts and 8.2% for Intel. The broader market underperformed. Interestingly, the Goldman Sachs Most Short index dropped 3.1%. Rather abruptly, there are indications of nervousness and vulnerability below the market’s surface.
The historic mistake was to believe that aggressive monetary policy would reduce systemic Fragilities. Stimulation of economies and animal spirits, no doubt, but at the cost of mounting latent instability. It’s the six-year anniversary of “whatever it takes;” approaching the 10-year anniversary of the financial crisis; and going on ten years since China’s massive stimulus. This week provided further evidence of trapped central banks.
EM rallied again this week, reducing the safe haven Treasury bid. Two-year Treasury yields jumped eight bps this week to 2.67%. The ten-year is again knocking on the door of 3.0% yields. I have little doubt that a surprising spike in Treasury yields would expose Latent Fragilities. The same question applies to Treasuries as it does to fixed-income markets around the globe: How much speculative leverage has accumulated over the past decade? Keep in mind it’s the speculation and leverage that typically dooms a Bubble. Indeed, the interaction of leverage and depreciating asset values becomes a critical factor in why Bubbles are unsustainable.
First it was the February blow-up of the “short vol” trade. Then instability engulfed the emerging currencies, debt and equities markets, followed by a destabilizing spike in Italian yields. The Chinese renminbi sinks a quick 5%. This week saw further weakness in the Chinese currency, along with hints of instability in Japanese and Italian bonds. Importantly, Beijing stimulus measures come with atypical currency vulnerability.
All in all, the Latent Fragility case is coming together. Financial conditions are tightening, and myriad Bubbles are showing the strain. And while the VIX traded below 12 this week (closing Friday at 13.03), my hunch would be that liquidity in the volatility markets has quietly receded. The next VIX spike could get interesting.
For the Week:
The S&P500 added 0.6% (up 5.4% y-t-d), and the Dow rose 1.6% (up 3.0%). The Utilities increased 0.6% (down 0.3%). The Banks jumped 2.4% (up 2.6%), while the Broker/Dealers slipped 0.5% (up 4.9%). The Transports rose 2.0% (up 3.2%). The S&P 400 Midcaps fell 1.2% (up 3.9%), and the small cap Russell 2000 dropped 2.0% (up 8.3%). The Nasdaq100 declined 0.7% (up 14.1%). The Semiconductors gained 1.0% (up 9.5%). The Biotechs lost 1.5% (up 19.3%). With bullion down $9, the HUI gold index sank 3.7% (down 13.9%).
Three-month Treasury bill rates ended the week at 1.94%. Two-year government yields jumped eight bps to 2.67% (up 79bps y-t-d). Five-year T-note yields rose eight bps to 2.84% (up 63bps). Ten-year Treasury yields gained six bps to 2.96% (up 55bps). Long bond yields rose six bps to 3.08% (up 34bps). Benchmark Fannie Mae MBS yields gained seven bps to 3.68% (up 68bps).
Greek 10-year yields slipped four bps to 3.81% (down 26bps y-t-d). Ten-year Portuguese yields fell six bps to 1.73% (down 22bps). Italian 10-year yields jumped 15 bps to 2.74% (up 73bps). Spain’s 10-year yields rose six bps to 1.38% (down 19bps). German bund yields added three bps to 0.40% (down 2bps). French yields increased two bps to 0.70% (down 8bps). The French to German 10-year bond spread narrowed one to 30 bps. U.K. 10-year gilt yields rose five bps to 1.28% (up 9bps). U.K.’s FTSE equities index added 0.3% (up 0.3%).
Japan’s Nikkei 225 equities index was little changed (down 0.2% y-t-d). Japanese 10-year “JGB” yields jumped seven bps to 0.10% (up 6bps). France’s CAC40 rallied 2.1% (up 3.7%). The German DAX equities index jumped 2.4% (down 0.4%). Spain’s IBEX 35 equities index rose 1.5% (down 1.8%). Italy’s FTSE MIB index increased 0.7% (up 0.5%). EM equities were mixed. Brazil’s Bovespa index gained 1.6% (up 4.5%), and Mexico’s Bolsa advanced 1.5% (up 0.6%). South Korea’s Kospi index added 0.3% (down 7.0%). India’s Sensex equities index rose 2.3% (up 9.3%). China’s Shanghai Exchange rallied 1.6% (down 13.1%). Turkey’s Borsa Istanbul National 100 index gained 1.6% (down 17.1%). Russia’s MICEX equities index rose 2.0% (up 8.7%).
Investment-grade bond funds saw inflows of $1.986 billion, while junk bond funds had outflows of $548 million (from Lipper).
Freddie Mac 30-year fixed mortgage rates gained two bps to 4.54% (up 62bps y-o-y). Fifteen-year rates added two bps to 4.02% (up 82bps). Five-year hybrid ARM rates were unchanged at 3.87% (up 69bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 4.58% (up 47bps).
Federal Reserve Credit last week declined $7.0bn to $4.249 TN. Over the past year, Fed Credit contracted $186bn, or 4.2%. Fed Credit inflated $1.438 TN, or 51%, over the past 299 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $4.1bn last week to $3.412 TN. “Custody holdings” were up $86.5bn y-o-y, or 2.6%.
M2 (narrow) “money” supply jumped $20.0bn last week to a record $14.148 TN. “Narrow money” gained $521bn, or 3.8%, over the past year. For the week, Currency increased $3.7bn. Total Checkable Deposits slipped $1.5bn, while Savings Deposits rose $10.7bn. Small Time Deposits increased $2.3bn. Retail Money Funds gained $4.9bn.
Total money market fund assets slipped $3.0bn to $2.843 TN. Money Funds gained $203bn y-o-y, or 7.7%.
Total Commercial Paper rose $5.9bn to $1.068 TN. CP gained $91bn y-o-y, or 9.3%.
The U.S. dollar index added 0.2% to 94.669 (up 2.8% y-t-d). For the week on the upside, the Mexican peso increased 2.1%, the South African rand 1.8%, the Brazilian real 1.5%, the South Korean won 1.4%, the Canadian dollar 0.7%, the Japanese yen 0.3%, the Swedish krona 0.1% and the Singapore dollar 0.1%. For the week on the downside, the euro declined 0.6%, the New Zealand dollar 0.3%, the British pound 0.2%, the Swiss franc 0.2%, the Australian dollar 0.2% and the Norwegian krone 0.1%. The Chinese renminbi declined 0.64% versus the dollar this week (down 4.5% y-t-d).
The Goldman Sachs Commodities Index rallied 1.5% (up 5.0% y-t-d). Spot Gold declined 0.7% to $1,223 (down 6.1%). Silver slipped 0.4% to $15.493 (down 9.6%). Crude recovered 43 cents to $68.69 (up 14%). Gasoline rallied 4.5% (up 20%), and Natural Gas gained 0.9% (down 5.8%). Copper jumped 1.7% (down 15%). Wheat rose 2.8% (up 24%). Corn gained 2.0% (up 7%).
Trump Administration Watch:
July 25 – Wall Street Journal (Valentina Pop, Vivian Salama and Bob Davis): “President Donald Trump and European Commission President Jean-Claude Juncker turned down the heat on a trade dispute between two of the world’s largest economic powers, suggesting… they would hold off on further tariffs while they talk through their differences. Speaking in a joint news conference…, the two leaders agreed to begin discussions on eliminating the tariffs and subsidies that hamper trade across the Atlantic, and to resolve the steel and aluminum tariffs the Trump administration had imposed this year as well as the retaliatory tariffs the European Union imposed in response.”
July 26 – Financial Times (Edward Luce): “It was Wednesday so Europe went from being a ‘foe’ of America to a ‘great friend’. Next Monday might be different. Perhaps Europe will still be in Donald Trump’s good books. The only person who can say for sure is Mr Trump. Even he probably has little idea. But my hunch is that the ceasefire he struck with Jean-Claude Juncker, president of the European Commission, will hold… Europe has won a reprieve. The portents for China have commensurately darkened. They were already dimming before Mr Trump’s latest rabbit trick. His squeeze on China is now likely to be backed by the Europeans and the US business community. Both have long advocated combined western pressure on China to put foreign investors on a level playing field. Both share deep concern about China’s systemic technology transfer.”
July 24 – CNBC (Jeff Cox): “President Donald Trump cranked up the rhetoric on tariffs on Tuesday, saying they are a good bargaining tool in his quest to get better trade agreements. In a morning tweet, the president dug in on his position in the global trade war, declaring ‘Tariffs are the greatest!’ ‘Tariffs are the greatest! Either a country which has treated the United States unfairly on Trade negotiates a fair deal, or it gets hit with Tariffs. It’s as simple as that – and everybody’s talking! Remember, we are the ‘piggy bank’ that’s being robbed. All will be Great!'”
July 25 – Reuters: “U.S. President Donald Trump accused China… of targeting American farmers in a vicious way and using them as leverage to get concessions from him on trade. ‘China is targeting our farmers, who they know I love & respect, as a way of getting me to continue allowing them to take advantage of the U.S. They are being vicious in what will be their failed attempt. We were being nice – until now!’ Trump wrote…”
July 26 – CNBC (Berkeley Lovelace Jr.): “Treasury Secretary Steven Mnuchin told CNBC… he’s ‘closely monitoring’ the weakening in the Chinese currency. ‘What I’ve said over the last week [is] we are obviously closely monitoring the Chinese rmb and the weakening in that market,” Mnuchin said… He said the administration is looking at other currencies as well. ‘The long-term strength of the dollar is important. It’s the result of a very strong U.S. economy,’ Mnuchin continued. ‘But we will closely monitor, as we do in the Treasury, currency manipulation across lots of different markets. And make sure people don’t use currency for unfair trade advantages.'”
July 21 – Wall Street Journal (Jeffrey T. Lewis): “U.S. Treasury Secretary Steven Mnuchin said he ‘wouldn’t minimize’ the possibility that the U.S. will impose tariffs on all $500 billion worth of goods that the U.S. imports from China, amplifying a threat President Donald Trump made… earlier in the week… Mr. Mnuchin stressed that the administration’s goal is to achieve a ‘more balanced’ trade relationship with China, by getting the Asian country to open its economy and permitting U.S. exports there to increase.”
July 21 – Wall Street Journal (Jamie Tarabay): “The goal of China’s influence operations around the world is to replace the United States as the world’s leading superpower, the CIA’s Michael Collins said Friday. Speaking at the Aspen Security Forum during a session on the rise of China, Collins, the deputy assistant director of the CIA’s East Asia Mission Center, said Chinese President Xi Jinping and his regime are waging a ‘cold war’ against the US. ‘By their own terms and what Xi enunciates I would argue by definition what they’re waging against us is fundamentally a cold war, a cold war not like we saw during the Cold War, but a cold war by definition. A country that exploits all avenues of power licit and illicit, public and private, economic and military, to undermine the standing of your rival relative to your own standing without resorting to conflict. The Chinese do not want conflict,’ Collins said.”
Federal Reserve Watch:
July 25 – Bloomberg (Rich Miller): “When Alan Greenspan ruled the Federal Reserve, investors became convinced the central bank could be counted on to prevent a stock market collapse — the so-called Greenspan put. Now, Chairman Jerome Powell is under pressure to adopt what would amount to a put of his own, except this time it would be tied to the bond market. Some Fed regional bank presidents want the central bank to be cautious in raising interest rates to prevent short-term Treasury yields from rising above long-term ones — providing a kind of comfort that Greenspan gave equity investors… While sounding sympathetic to their worries, Powell doesn’t seem inclined to go along with the idea of running monetary policy to avoid flipping the curve.”
U.S. Bubble Watch:
July 26 – New York Times (Jim Tankersley): “The amount of corporate taxes collected by the federal government has plunged to historically low levels in the first six months of the year, pushing up the federal budget deficit much faster than economists had predicted. The reason is President Trump’s tax cuts. The law introduced a standard corporate rate of 21%, down from a high of 35%, and allowed companies to immediately deduct many new investments…The Office of Management and Budget said this month that it had revised its forecasts from earlier this year to account for nearly $1 trillion of additional debt over the next decade – on average, almost $100 billion more a year in deficits.”
July 26 – Financial Times (John Authers): “When Richard Fuld, the chief executive of Lehman Brothers, received the news in 2008 that no one would ride to the rescue of his failing bank, he is reported to have said: ‘So I’m the schmuck?’ Almost a decade later, Lehman is still the only US investment bank that was allowed to fail. Its peers have been restored to health with risks removed. Mr Fuld appears to be the ultimate ‘schmuck’ of the financial crisis. But that judgment may be premature… While risk no longer sits in the banking system, it has not vanished. It grows ever clearer that risk has been moved, primarily to the pension system. This means that the long-term dangers in the financial system have become more insidious: easier to ignore but ultimately even more dangerous.”
July 24 – Bloomberg (Shobhana Chandra): “Sales of previously owned U.S. homes unexpectedly fell in June, indicating a shortage of affordable listings and rising prices continue to limit demand… Contract closings fell 0.6% m/m to a 5.38m annual rate (est. 5.44m), a third straight decline, after a revised 5.41m (prev. 5.43m). Median sales price increased 5.2% y/y to a record $276,900. Inventory of available properties rose 0.5% y/y to 1.95m for first increase since mid-2015.”
July 24 – Wall Street Journal (Esther Fung): “Chinese real-estate investors, facing pressure from Beijing, are reversing a yearslong buying spree in the U.S. where they often paid record prices for marquee properties like New York’s Waldorf Astoria hotel. Chinese insurers, conglomerates, and other investors have turned net sellers of U.S. commercial real estate for the first time in a decade. They have spent tens of billions of dollars to acquire hotels, office buildings, and vast swaths of empty land to build residential towers. But Chinese investors sold $1.29 billion worth of U.S. commercial real estate in the second quarter, while purchasing only $126.2 million of property, according to… Real Capital Analytics. This marked the first time that these investors were net sellers for a quarter since 2008.”
July 24 – CNBC (Diana Olick): “Southern California home sales hit the brakes in June, falling to the lowest reading for the month in four years. Sales of both new and existing houses and condominiums dropped 11.8% year over year, as prices shot up to a record high, according to CoreLogic. The report covers Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties. Sales fell 1.1% compared with May… The weakness was especially apparent in sales of newly built homes, which were 47% below the June average. Part of that is that builders are putting up fewer homes, so there is simply less to sell.”
July 22 – Reuters (Jonathan Spicer): “By almost every measure, the U.S. economy is booming. But a look behind the headlines of roaring job growth and consumer spending reveals how the boom continues in large part by the poorer half of Americans fleecing their savings and piling up debt. A Reuters analysis of U.S. household data shows that the bottom 60% of income-earners have accounted for most of the rise in spending over the past two years even as the their finances worsened – a break with a decades-old trend where the top 40% had primarily fueled consumption growth.”
July 22 – Wall Street Journal (Jacob Bunge): “Meat is piling up in U.S. cold-storage warehouses, fueled by a surge in supplies and trade disputes that are eroding demand. Federal data… are expected to show a record level of beef, pork, poultry and turkey being stockpiled in U.S. facilities, rising above 2.5 billion pounds… U.S. consumers’ appetite for meat is growing, but not fast enough to keep up with record production of hogs and chickens. That leaves the U.S. meat industry increasingly reliant on exports, but Mexico and China-among the largest foreign buyers of U.S. meat-have both set tariffs on U.S. pork products…”
July 24 – Financial Times (Gabriel Wildau): “China has announced a mix of tax cuts and infrastructure spending citing ‘uncertainty’, as it ramps up efforts to stimulate demand and counteract a weakening economy. The move… came the same day as an injection of $74bn into the banking system by the People’s Bank of China through its Medium-term Lending Facility – the central bank’s largest ever, single-day cash injection using that tool. The fiscal measures provide growing evidence that policymakers are concerned about how the trade war with the US will exacerbate a domestic slowdown… The PBoC has already cut the required reserve ratio (RRR) for some banks three times this year in a bid to boost the money supply. Unveiling the measures, the State Council cited external ‘uncertainty’…”
July 26 – Bloomberg (Siddharth Verma and Luke Kawa): “The Beijing ‘put’ is back. China’s bid to boost policy stimulus to barricade its domestic economy from the brewing trade war is breathing life into risk assets battered by liquidity and geopolitical angst. Among the winners: Asian junk bonds, the besieged industrial-metals complex and emerging-market stocks. The MSCI Emerging Market Index is heading toward its first monthly gain since the melt-up euphoria of January… ‘The largest surprise is that the meeting did not mention deleveraging and financial risk control, a centerpiece in China’s economy policy since late 2017,’ Credit Suisse Group AG strategists led by Vincent Chan wrote… ‘They will be favorable to sectors sensitive to investment demand, like industrials and materials.'”
July 22 – Financial Times (Gabriel Wildau and Yizhen Jia): “A wave of defaults is sweeping across China’s Rmb1.3tn ($190bn) peer-to-peer lending industry, causing investors to withdraw funds and platforms to collapse, the latest casualties of Beijing’s broader crackdown on debt and financial risk. About 150 online lending platforms have suffered ‘problems’ since the beginning of June this year, compared with 217 such cases in all of 2017, according to Online Lending House, a research group… The group defines ‘problems’ as investors being unable to withdraw money, police investigating a platform, or owners running away. In the wealthy city of Hangzhou, local officials converted two sporting stadiums into makeshift welcome centres where various district-level petition bureaus – the traditional channel for Chinese citizens to file miscellaneous grievances – could receive complaints from P2P investors.”
July 22 – Bloomberg: “China’s regulators took a softer stance than expected as they tightened rules around the $15 trillion asset management industry, underscoring the balancing act between deleveraging the financial system and slowing an economy already facing challenges. The People’s Bank of China released guidelines… aimed at asset management products, soon after the banking and securities regulators published their own rules on specific wealth products. The regulations, aimed at shrinking China’s sprawling shadow-banking system, were less severe than industry participants and observers had feared, a recognition by policy makers of economic strains that have emerged in recent months.”
July 26 – Bloomberg: “China said the changes U.S. airlines have agreed to make on how they refer to Taiwan is incomplete with the carriers seeking two more weeks to fully implement the requirement. American Airlines Group Inc., Delta Air Lines Inc., United Continental Holdings Inc. and Hawaiian Holdings Inc. are the last four foreign airlines out of 44 that didn’t fully comply with an order to reflect the island as part of China… The deadline was yesterday. The regulator didn’t say what changes the airlines promised were incomplete.”
July 26 – Bloomberg (Amogelang Mbatha and Pauline Bax): “BRICS nations must reject protectionism ‘outright’ and promote trade and investment liberalization, Chinese President Xi Jinping said. ‘We must work together at the UN, G20 and World Trade Organization to safeguard a rule-based multilateral trading regime,’ Xi said at the BRICS summit… The session was also attended by the leaders of Brazil, Russia, India and South Africa.”
July 24 – Bloomberg: “China’s record-pacing defaults this year have exposed more than just which borrowers took on too much debt. It’s also putting a spotlight on the nation’s sluggish credit raters. Any investor relying on domestic Chinese rating firms would have been ill served with Wintime Energy Co., which had not a single rating downgrade before it this month descended into China’s biggest default of 2018. It’s one of several examples where debt raters have failed to telegraph deteriorating credit quality this year. The problem: until the past few years, China didn’t let any company default… Now, without clear guidelines on which firms still have implicit guarantees, ratings companies are operating in a tricky new environment.”
July 24 – Bloomberg (Onur Ant): “Turkey’s central bank stunned investors by keeping interest rates unchanged, defying market expectations and heeding President Recep Tayyip Erdogan’s demands to refrain from raising borrowing costs. Stocks, bonds and the lira plunged.In its first policy decision since Erdogan won re-election with sweeping new powers, the bank held its one-week repo rate at 17.75%, a full percentage point less than the median estimate… ‘This decision essentially confirms the markets’ worst fears about the central bank’s independence and the future course of economic policies in Turkey,’ said Inan Demir, an economist at Nomura International…”
July 24 – Reuters (Iuri Dantas and Christian Plumb): “Brazil’s leftist Workers Party would use part of the country’s $380 billion in currency reserves to finance an infrastructure development fund if victorious in October presidential elections, a party official said… Marcio Pochmann, an adviser to former President Luiz Inacio Lula da Silva and a coordinator of his planned run for a third term, said roughly 10% of the reserves would be destined for the fund and supplemented by other sources such as loans from state banks Banco do Brasil and Caixa Economica Federal as well as borrowing in the form of debentures.”
July 24 – Bloomberg (Andrew Rosati): “Venezuela’s inflation will skyrocket to 1 million percent by the end of the year as the government continues to print money to cover a growing budget hole, the International Monetary Fund predicted… The crisis is comparable to that of Germany in 1923 or Zimbabwe in the late 2000s, said Alejandro Werner, head of the IMF’s Western Hemisphere department… ‘The collapse in economic activity, hyperinflation, and increasing deterioration in the provision of public goods as well as shortages of food at subsidized prices have resulted in large migration flows, which will lead to intensifying spillover effects on neighboring countries,’ Werner wrote…”
July 25 – Reuters (Brian Ellsworth): “Venezuela will remove five zeroes from the bolivar currency rather than the three zeroes originally planned, President Nicolas Maduro said…, in an effort to keep up with inflation projected to reach 1 million percent this year. The OPEC nation’s economy has been steadily collapsing since the 2014 crash of oil prices left it unable to maintain its socialist economic system…”
Central Bank Watch:
July 22 – Nikkei Asian Review (Moyura Baba): “The Bank of Japan is in a bind created by its prolonged ultra-easy monetary policy and will try to find a solution to the problem during a policy board meeting at the end of July. Prices in Japan have yet to reach the 2% inflation rate targeted by the central bank’s easing of credit. While the adverse effects of the policy on financial institutions cannot be ignored, the yen could appreciate if the BOJ adjusts interest rates… Many are worried about the seemingly endless monetary easing. Financial markets pay keen attention these days when BOJ policymakers use the word ‘cumulative.’ Yukitoshi Funo, a member of the BOJ’s policy board, mentioned it at a news conference in June to describe the ramifications of the policy on the earnings of financial institutions. Another member, Takako Masai, also used the word when she referred to the government bond market at a July news conference.”
July 25 – Reuters (Leika Kihara): “The Bank of Japan will next week consider changes to its massive stimulus program to make it more sustainable, such as allowing greater swings in interest rates and widening its stock-buying selection, people familiar with its thinking said. The changes, although small, would be the first since 2016 and the latest sign Governor Haruhiko Kuroda is gradually walking away from his radical stimulus program deployed five years ago to shock the public out of a sticky deflationary mindset.”
Global Bubble Watch:
July 22 – Reuters (David Lawder and Daniel Flynn): “Global finance leaders called on Sunday for stepped-up dialogue to prevent trade and geopolitical tensions from hurting growth, but ended a two-day G20 meeting with little consensus on how to resolve multiple disputes over U.S. tariff actions. The finance ministers and central bank governors from the world’s 20 largest economies warned that growth, while still strong, was becoming less synchronized and downside risks over the short- and medium-term had increased.”
July 23 – Financial Times (Roger Blitz): “China’s weakening renminbi represents a new risk for a number of Asian currencies that had managed to escape much of the recent rout in emerging markets until now. The Korean won, the Taiwanese dollar and the Singapore dollar are among the vulnerable parts of EM in recent weeks, representing a new chapter in this year’s currency weakness versus the US dollar. The dollar’s strength has been the main driver of the 2018 EM weakness with the likes of Argentina, Turkey and South Africa particularly vulnerable given their current account deficits. In contrast, those EM countries with surpluses were sheltered.”
July 26 – Bloomberg (Alex Barinka): “Don’t expect a technology M&A resurgence until Donald Trump’s escalating trade war with China cools off. Qualcomm Inc.’s $44 billion takeover of NXP Semiconductors NV — a two-year-old deal that got trapped in the escalating tariff spat — is dead. The transaction had been anointed by regulators globally, except in China. The Chinese agencies responsible for vetting mergers had even signed off on it… but final authorization was never given by the government. Technology companies, especially semiconductor makers and other hardware businesses, had been waiting for the Qualcomm-NXP deal to close before deciding whether to embark on their own acquisitions, according to industry advisers.”
July 22 – New York Times (Emily Flitter): “In the maze of subsidiaries that make up Goldman Sachs Group, two in London have nearly identical names: Goldman Sachs International and Goldman Sachs International Bank. Both trade financial instruments known as derivatives with hedge funds, insurers, governments and other clients. United States regulators, however, get detailed information only about the derivatives traded by Goldman Sachs International. Thanks to a loophole in laws enacted in response to the financial crisis, trades by Goldman Sachs International Bank don’t have to be reported. A decade after a financial crisis fueled in part by a tangled web of derivatives, regulators still have an incomplete picture of who holds what in this $600 trillion market. ‘It’s a global market, so you really have to have a global set of data,’ said Werner Bijkerk, the former head of research at the International Organization of Securities Commissions, an umbrella group for regulators around the world overseeing derivatives markets. ‘You can start running ‘stress tests’ and see where the weaknesses are. With this kind of patchwork, you will never be able to see that.'”
July 21 – Reuters (Scott Squires): “Japanese Finance Minister Taro Aso said on Saturday he expressed concerns at the G20 finance leaders’ meeting that monetary policy normalization at advanced economies could accelerate capital outflows from China and emerging market economies.”
July 22 – Financial Times (Jennifer Thompson): “Global assets under management are on track to hit the $80tn mark this year, with China and Latin America the fastest-growing regions for investment managers. Assets were $48.2tn on the eve of the financial crisis having grown at a compound annual rate of 12% in the preceding years, according to Boston Consulting Group. The rate fell to 4% between 2007 and 2016 but is now back at the pre-crisis pace. The main drivers are record net inflows to asset managers amid a bull market for both bonds and equities… The market growing at the fastest rate is China, with assets increasing 22% between 2016 and 2017 to $4.2tn.”
July 22 – Bloomberg (Kevin Costelloe): “Italy’s coalition government is heading for an internal struggle over spending, with outspoken Deputy Premier Matteo Salvini ready to flout European Union budget rules while the finance minister urges caution. ‘Italians voted for us to be better off, to go into retirement at the right age, to pay lower taxes compared with today’s craziness,’ Salvini told reporters… He said he’d prefer to keep within EU deficit restrictions, but ‘if we have to go above those limits for the good of the Italians, that won’t be a problem for us.'”
July 24 – Financial Times (Kate Allen): “Foreign investors shed record volumes of Italian debt in May as a sharp sell-off hit the country’s bond market… Italy’s governing coalition is set to bring forward a contentious budget this autumn, which some investors fear could threaten the country’s fiscal outlook. Earlier this month the new government said it would not take any further measures to cut its deficit this year and warned of a possible downgrade to growth forecasts. The country’s bond yields have settled back from the highs they hit at the peak of the sell-off in late May… Two-year Italian debt is yielding about 0.7%, having been in negative territory until mid-May, while 10-year paper is yielding around 2.7%, up from 1.9% before the sell-off.”
July 22 – Bloomberg (Masaki Kondo and Chikafumi Hodo): “A dramatic day for Japan’s debt market saw yields surge on media reports of possible changes to the nation’s ultra-loose monetary policy, spurring the central bank to offer to buy an unlimited amount of bonds. The yield on 10-year government securities soared as much as six basis points to 0.09%, its biggest increase in almost two years, pulling the yen higher and weighing on stocks. While the yield came down after the purchase offer by the Bank of Japan, it then bounced back to just one basis point below the day’s high.”
Fixed Income Bubble Watch:
July 23 – Wall Street journal (Daniel Kruger and Megumi Fujikawa): “Government bond prices world-wide tumbled Monday, roiled by reports that central banks could be on the verge of taking another step back from the easy-money policies that have characterized the postcrisis period. News reports that the Bank of Japan might consider changing its interest-rate targets helped push the yield on the 10-year Japanese government bond as high as 0.09%… from 0.03% late Friday. While that rate and other government bond yields are still generally low, it was the largest one-day move higher for the Japanese bonds in nearly two years. Many investors worry that the end of ultra-low interest rates and other monetary stimulus will remove a critical support that’s lifted markets since the financial crisis.”
July 22 – Wall Street Journal (Riva Gold and Christopher Whittall): “Many bonds around the globe are becoming harder to trade, prompting some investors to shift to other markets and raising concerns about a broad decline in liquidity. The median gap between the price at which traders offer to buy and sell, a proxy for the ability to move in and out of markets quickly, has widened this year across European corporate debt and emerging-market government and corporate bonds, according to… MarketAxess. Trading in some derivatives has picked up as traders pull back from bond markets they view as increasingly unruly and expensive.”
July 26 – Wall Street Journal (Michael Wursthorn and Daniel Kruger): “Investors are fleeing U.S. stocks at a rapid clip as ongoing market volatility and trade tensions push them to seek safety among less risky assets such as U.S. Treasurys. More than $20 billion was pulled from long-term mutual funds and exchange-traded funds focused on U.S. stocks in June, capping the third-worst first half for equity flows over the past 10 years… The trend doesn’t appear to be slowing: Investors redeemed more than $11.6 billion from domestic stock funds in the three weeks ended July 18, according to the Investment Company Institute.”
July 24 – CNBC (Jeff Cox): “Investors hunting for yield no longer have to look very far. After a decade in which short-term cash and equivalents earned next to nothing, that part of the market has now begun to pick up and offer legitimate returns for those looking for safety in an uncertain environment. In particular, the three-month Treasury bill’s yield crossed 2% recently, the first time that has happened in more than a decade. The move has come as the Federal Reserve has continued to boost short-term rates and as the economy continues to show signs of picking up, inflation takes root and investors look for safety amid stock market volatility.”
July 24 – Financial Times (Alexandra Scaggs): “Protections for lenders to junk-rated companies have been the weakest on record this year, according to… Moody’s, which could hamper recovery rates if a downturn prompts a string of bankruptcies or defaults. The erosion of strength in leveraged-loan covenants, meant to protect lenders’ collateral, has been fuelled by rising demand for floating-rate securities such as loans… The vast majority of leveraged loans – roughly 80%, said Moody’s – issued in the first quarter were considered to be ‘covenant-lite’. These are loans that do not have maintenance covenants requiring borrowers to uphold certain financial standards, such as maximum levels of indebtedness.”
Leveraged Speculator Watch:
July 25 – Financial Times (Robin Wigglesworth and Lindsay Fortado): “Investor inflows to computer-powered ‘quantitative’ hedge funds have halved this year to the most sluggish pace since 2009, after a spate of poor performance from many of the industry’s biggest players. So-called ‘quants’ use a wide array of approaches, from taking advantage of tiny arbitrage opportunities in stock markets to surfing trends in commodity prices. But they all use powerful computers and complex algorithms to implement automated trading strategies. The success of many big quant funds, coupled with a rising belief that the future of investing will be far more machine-driven, has led to billions gushing into the industry in recent years, and many traditional asset managers to adopt some of its techniques. However, many prominent quants have suffered torrid performance this year… Overall, quant equity hedge funds have dropped 1% this year, and quant ‘macro’ funds have lost more than 4%, according to HFR.”
July 25 – Wall Street Journal (Mengqi Sun): “Wall Street money managers are having problems hanging onto insurance companies as customers. American International Group Inc. and MetLife Inc. pulled more than $700 million from hedge funds in the first quarter of 2018… That followed billions of dollars in withdrawals over the previous two years. Net hedge-fund outflows from all U.S insurers amounted to $8.7 billion in 2016 and 2017, according to… A.M. Best Co. Total insurance-industry assets held by hedge funds were $16.4 billion at the”
July 22 – CNBC (Everett Rosenfeld and Kevin Breuninger): “President Donald Trump threatened his Iranian counterpart in a Sunday night Twitter post: To Iranian President Rouhani: ‘NEVER, EVER THREATEN THE UNITED STATES AGAIN OR YOU WILL SUFFER CONSEQUENCES THE LIKES OF WHICH FEW THROUGHOUT HISTORY HAVE EVER SUFFERED BEFORE. WE ARE NO LONGER A COUNTRY THAT WILL STAND FOR YOUR DEMENTED WORDS OF VIOLENCE & DEATH. BE CAUTIOUS!’ Trump’s tweet followed Iranian President Hassan Rouhani cautioning the American leader on Sunday about pursuing hostile policies against Tehran, saying: ‘War with Iran is the mother of all wars.’ ‘You are not in a position to incite the Iranian nation against Iran’s security and interests,’ the Iranian leader said, in an apparent reference to reports of efforts by Washington to destabilize Iran’s Islamic government.”
July 25 – Financial Times (Najmeh Bozorgmehr): “A top Iranian commander has warned Donald Trump that the Islamic republic’s forces ‘are close to you in places you cannot think of’ as Tehran ramps up its war of words with the US. The comments by Major General Qassem Soleimani, who commands the Quds, the overseas wing of the elite Revolutionary Guards, imply that Iran is prepared to use its troops and proxies outside the Islamic republic to fight the US. ‘Mr Trump, the gambler! I tell you that we are close to you in places you cannot think of. We are a nation of martyrdom . . . We have gone through difficult times,’ Gen Soleimani said in a speech… ‘Come on! We are waiting for you. We are the men of this field . . . You may start this war but it will be us who decide how to end it.'”
July 24 – Bloomberg (Anthony DiPaola): “The war of words between U.S. President Donald Trump and his counterpart in Iran over oil exports and sanctions is shining a spotlight on the narrow, twisting conduit for about 30% of the world’s seaborne-traded crude. The Middle East’s biggest oil exporters rely on the Strait of Hormuz, the passage linking the Persian Gulf with global waterways, for the vast majority of their crude shipments — some 17.5 million barrels a day. Should a regional conflict block that bottleneck, three of the largest Gulf Arab crude producers have pipeline networks that would potentially enable them to export as much as 4.1 million barrels via alternative outlets… Even so, this amount of oil, if sent by pipeline, would be less than a quarter of the total that typically sails on tankers through Hormuz.”