Bill Gross penned another interesting commentary, “A Sense of an Ending.” The title comes from a Julian Barnes novel, of which Gross pulls the following quote: “There is accumulation; there is responsibility, there is unrest – great unrest.”
Mr. Gross and I share similar analytical frameworks. He focuses on debt, while discussing a market cycle that commenced back in 1981 with Treasury bonds yielding 14.5%. Gross believes that the great Credit Cycle has about run its course.
It’s worth pulling some data from 1981. Emblematic of this historic boom, I’m fond of tallying Treasuries, Agency Securities, Corporate Bonds and Muni debt (from the Fed’s Z.1) as a proxy for “Total Debt Securities (TDS).” Total Equities are added to come to a value for “Total Securities.”
Back in 1981 Treasuries totaled $816bn, Agency Securities $324bn, Corporate Bonds $550bn and Muni debt $444bn. TDS ended 1981 at $2.134 TN, or 66% of GDP. At $1.382 TN, Total Equities amounted to 43% of GDP. This put “Total Securities” at $3.516 TN, or 109% of GDP.
Fast-forward to the end of 2014: Treasury Securities had inflated to $12.996 TN; Agency Securities to $7.934 TN; Corporate Bonds to $11.569 TN; and Municipal debt to $3.652 TN. Total Debt Securities grew to $36.152 TN, or 208% of GDP. Total Equities inflated to $36.457 TN, or 209% of GDP. Having inflated almost 2,000% since 1981, Total Securities ended 2014 at $72.608 TN, or an unprecedented 417% of GDP.
I really don’t prefer to come off as some whacko extremist, which perhaps helps explain why I highlight the thoughts of market gurus such as Bill Gross and Stanley Druckenmiller. From my analytical perspective, we’re in the “Terminal Phase” of a historic global experiment in electronic “money” and Credit, in “activist” monetary management and in economic structure. Getting somewhat closer to Bill Gross’s parlance, we’re in the endgame of a historic experiment in market-based finance. And in a 35-year Super-Bubble, it’s only fitting that the endgame has things turning extraordinarily chaotic: Policy measures turn progressively desperate, throwing gas on increasingly manic and unhinged markets.
Back to the data: On the back of 209% growth of GSE Securities (to $3.916 TN) and 176% expansion of Corporate Bonds (to $4.480 TN), Total Debt Securities inflated 116% during the nineties to $13.506 TN. Total Equities inflated an incredible 416% during the decade to $19.401 TN. After beginning at 178%, Total Securities ended the nineties at 341% of GDP.
There were key developments during the nineties that remain fundamental to understanding today’s complex Bubble predicament. So I’ll keep pounding away. The move to “activist” monetary management under the prolonged reign of chairman Greenspan was paramount. The aggressive “asymmetrical” rate slashing provided a powerful backstop for risk-taking, certainly including leveraged securities speculation. Less obvious, the Fed’s early-nineties yield curve manipulation – covert bank recapitalization – provided extraordinary opportunities to profit from securities leveraging.
There’s another momentous development overlooked over the years. After “decade of greed” eighties excess, the post-Bubble backdrop was one of a highly impaired banking system. The savings & loan industry had collapsed. The Texas banks were wiped out. Even some major banking institutions (Citibank!) were in trouble, especially after the collapse of the coastal real estate Bubbles (East and West, commercial and residential). Greenspan took extraordinary measures, adopting “activist” policymaking that the Fed believed was justified because of mounting risks of economic depression and deflation. They’ve been fighting this bogeyman on and off now for 25 years.
There’s great irony in the free-market proponent Alan Greenspan morphing into the father of centrally planned “activist” monetary management. To be sure, this transformation changed history. Central to Greenspan’s thinking was the view that it was imperative to both recapitalize the banking system and spur market-based Credit expansion. It was the Fed’s role to ensure system reflation – a task left primarily to the GSEs, fledgling securities and derivatives markets and rapidly expanding broker/dealer and hedge fund industries (“Wall Street finance”).
It was believed that the upshot of safeguarding the banking system’s capital base would be a sounder financial system and stable economy. This view was closely related to the (Friedman/Bernanke) view that much of the Great Depression could have been avoided had the Fed recapitalized the banking system after the crash. Moreover, Greenspan saw a financial system where various risks (i.e. Credit, duration and liquidity) were dispersed throughout the “marketplace” as more robust than the traditional model of risk accumulating at highly leveraged banks. Central to this doctrine is that markets behave efficiently and rationally – i.e. self-adjustment around an equilibrium level, as opposed to unstable markets prone to self-reinforcing excess and Bubbles. This specious premise had New Age central bankers happy to intervene to backstop tottering markets without having to fret upside dislocations and Bubbles.
From a policy standpoint, market-based Credit proved phenomenally seductive. For one, the Fed then controlled history’s most powerful monetary transfer mechanism: system Credit, risk-taking and wealth could all be spurred along simply by contemplating a 25 bps reduction in the funds rate. At the same time, one could rest on a New Paradigm notion that markets were uniquely capable of properly pricing and allocating finance (along with real resources). Moreover, it was easy during the nineties to overlook the booming market in GSE securities, corporate bonds, ABS and an array of derivative products when traditional measures of boom-time banking excess were largely absent. Market-based Credit turned out to be unbelievably enticing – for market participants, bankers and central bankers.
History is unambiguous: Credit is inherently unstable. And for years I have argued that market-based Credit is highly unstable. And especially after recent years, I will add more generally that a market-based financial system is dangerously unstable. There is, however, a powerful counter-argument that is essentially the bedrock of today’s bullish view on securities markets: Astute policymakers have come to garner the insight and employ the necessary tools to bolster and stabilize markets and, accordingly, economies. For better or worse, market-based finance and the attendant “activist” monetary management regime overpowered the world.
The evolution of policy saw aggressive rate cuts in response to systemic risk, active communication of policy intensions to the markets and even the orchestration of bailouts – later morphing into something more dangerous. “Activist” policymaking transformed into massive monetization and explicit market manipulation – whatever it takes to sustain the great securities bull market. Amazingly, the centrally planned inflation of risk markets became the prevailing monetary policy tool. After all, with securities markets having inflated to multiples of underlying real economies, ensuring strong (“bull”) markets became the central banks’ chief “monetary transmission mechanism.” Moreover, with vulnerable economic structures, nothing would be tolerated that might risk pushing economies back into recession. The mighty bull market had to continue – for the good of all humanity.
Importantly, systemic risk rises exponentially during the “Terminal Phase.” The clearest example was the explosion of mispriced mortgage Credit during 2006/07 – surging quantities of high-risk loans/securities that depended on ever increasing quantities of high-risk lending, higher home prices and a thriving securities marketplace.
Today’s (not as discernable) “Terminal Phase” is dependent upon an unending stream of willing buyers of inflated securities in the face of mounting market and economic risks. It depends on corporate America’s insatiable appetite for its own stock. It depends on the leveraged speculating community staying in the game and remaining bullish. It absolutely relies on the system continuing to expand Credit – at home and abroad. And all of this is dependent upon “activist” policy measures that have pretty much run their course (over almost 30 years).
As an analyst of Bubbles, there’s always a fundamental question: What is the source of the Credit fueling the boom and how stable is it? If the boom is fueled by market-based finance, then there is an inherent stability issue. Years of policy measures to intervene and manipulate markets essentially foster a massive financial scheme – a confidence game. The question then becomes the relative stability or fragility of this scheme. At this point, what are the prospects for an expansion of Credit sufficient to sustain a historic Bubble in market-based finance?
And this gets right to the heart of the matter: Asset-based Credit rests on the ongoing inflation of asset prices. It is, after all, a real challenge to leverage an asset declining in value. As was experienced in 2009, faltering asset markets incite a self-reinforcing contraction of Credit and asset values. More generally, a system comprised largely of market-based finance rests upon ever-rising security market prices.
“Moneyness of Credit” was fundamental to the mortgage finance Bubble. I have argued that the “Moneyness of Risk Assets” has been integral to something much bigger – the global government finance Bubble. So all Bubble analysis now has an international component. Globally, there’s a prevailing market view that policymakers will backstop markets and economies. Stocks and bonds (and derivatives!) around the world are viewed as being superior liquid stores of value (money-like). This epic misperception comes compliments of the Fed, BOJ, ECB, SNB, BOE (global central banks generally) and Chinese officials.
When focusing on unfolding global fragilities, China will play a prominent role. Some twenty years after Greenspan, the Chinese fell into a similar trap: a push to “de-regulate” and safeguard their banking system led to a runaway expansion of risky non-bank and market-based finance. In the process they lost control of their financial and economic Bubbles. This week saw additional weak data out of China – and, of course, louder chatter of imminent major Chinese stimulus. In perhaps a sign of friction to come, China’s trade minister this week called out other countries’ currency devaluations as responsible for the waning competitiveness of Chinese manufacturers.
That China, a country of almost 1.4 billion, jumped aboard the global Credit Bubble is a key reason why I’m convinced in “Terminal Phase” analysis. That two of the world’s most powerful central banks – the Bank of Japan and European Central Bank – desperately resorted to rank currency devaluation is also central to my “End is Near!” thesis.
On the one hand, the unprecedented expansion of Chinese manufacturing capacity ensures an enduring supply overhang (and downside cost pressures) for scores of goods and commodities. As such, the irrepressible Chinese Bubble put the final dagger in the notion that respective central banks around the world control their domestic price levels. Meanwhile, BOJ and ECB devaluations incited massive speculative leveraging (“carry trades”), while providing a temporary new lease on life for leveraged macro “investing.” Market-based finance depends on rising securities prices. Denominated in yen and euros, global securities markets inflated tremendously over the past year.
As I focused on last week, the end result has been unprecedented market distortions and “Crowded Trade” problems. At this point, normalization is impossible. The Bubble must inflate or it falters. And last week I posed the question: “What more can policy measures do to promote additional speculative leveraging?” While these big “macro” speculative bets may continue to play out for now, the risk vs. reward calculus for being short the euro and yen is much less compelling today than six months ago.
European bond markets continued to unravel this week, with securities market pressures building globally. Friday’s payroll data (on the heels of the UK election) provided a decent risk-market jolt. At 5.3%, the April unemployment rate would seem to support the bullish view. Curiously, “king dollar” was unable to muster much of a Friday rally. Tuesday’s $51.4bn March trade deficit (“worst in six years”) followed by Wednesday’s dismal 1.9% decline in Q1 productivity supported the emerging view of unsound U.S. economic fundamentals.
From my analytical perspective, the dynamic underpinning U.S. Credit is unsound. First of all, traditional sources of Credit growth have been insufficient to sustain inflated securities markets and an unbalanced economic boom. It is my strongly held view that an array of speculative leverage is underpinning the U.S. Bubble. I suspect there is enormous leverage throughout the U.S. debt market – from T-bills, longer-term Treasuries to MBS to corporates. I would be surprised if there was not enormous leverage embedded in myriad derivative trading strategies. There is likely as well leveraging involved in about every source of yield – from dividend stocks, to perceived low-risk corporate bonds, to REITs, to commercial real estate and residential rentals.
There is also anecdotal support for my view that enormous amounts of global “hot money” have been flooding into U.S. asset markets – notably from China, Japan, Europe and Latin America. This helps to explain booming U.S. real estate markets in the face of paltry mortgage Credit growth. And how much leveraged speculative finance has been arriving via borrowing/shorting in (devaluing) yen and euros for easy profits in the bubbling market for king dollar securities?
In total, I believe domestic and foreign-sourced “hot money” would be measured in the Trillions. And I believe this Bubble Finance likely amounts to a substantial proportion of overall system finance, the “money” that feeds its way into spending, incomes, corporate cash-flows and government receipts. This is the finance that fuels the markets, makes the fiscal situation appear manageable and, importantly, spurs record stock buybacks. And it is this “money” the fuels asset markets higher, in the process ensuring loose corporate Credit conditions that drive an ongoing M&A boom. While most see a great bull market, I see a deeply systemic Bubble with dire consequences.
A period of wild volatility would be perfectly reasonable if indeed “The End is Near!” It appears global markets have entered just such a period.
For the Week:
The S&P500 increased 0.4% (up 2.8% y-t-d), and the Dow gained 0.9% (up 2.1%). The Utilities declined 1.0% (down 7.2%). The Banks jumped 1.5% (down 1.1%), and the Broker/Dealers added 0.4% (up 4.3%). The Transports increased 0.3% (down 4.1%). The S&P 400 Midcaps added 0.3% (up 4.6%), and the small cap Russell 2000 gained 0.6% (up 2.5%). The Nasdaq100 declined 0.5% (up 5.2%), while the Morgan Stanley High Tech index was little changed (up 2.7%). The Semiconductors fell 0.5% (up 2.2%). The Biotechs jumped 2.7% (up 16.0%). Although bullion rose $10, the HUI gold index fell 2.2% (up 7.3%).
Three-month Treasury bill rates ended the week at a basis point. Two-year government yields declined three bps to 0.57% (down 10bps y-t-d). Five-year T-note yields dipped one basis point to 1.49% (down 16bps). Ten-year Treasury yields rose three bps to a nine-week high 2.15% (down 2bps). Long bond yields gained seven bps to 2.90% (up 15bps).
Greek 10-year yields were little changed at 10.36% (up 62bps y-t-d). Ten-year Portuguese rose 17 bps 2.24% (down 38bps). Italian 10-yr yields surged 21 bps to 1.67% (down 22bps). Spain’s 10-year yields rose 20 bps to 1.66% (up 5bps). German bund yields jumped 17 bps to 0.54% (unchanged). French yields gained 18 bps to 0.83% (unchanged). The French to German 10-year bond spread widened one to 29 bps. U.K. 10-year gilt yields increased four bps to 1.88% (up 13bps).
Junk funds saw outflows surge to $2.745bn (from Lipper).
Freddie Mac 30-year fixed mortgage rates jumped 12 bps to an eight-week high 3.80% (down 7bps y-t-d). Fifteen-year rates rose eight bps to 3.02% (down 13bps). One-year ARM rates were down three bps to 2.46% (up 6bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 13 bps to 3.99% (down 29bps).
Federal Reserve Credit last week declined $11.3bn to $4.433 TN. Over the past year, Fed Credit inflated $177bn, or 4.2%. Fed Credit inflated $1.622 TN, or 58%, over the past 130 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt surged $24.5bn last week to $3.313 TN. “Custody holdings” were up $28.4bn y-t-d.
M2 (narrow) “money” supply declined $27.4bn to $11.863 TN. “Narrow money” expanded $607bn, or 5.4%, over the past year. For the week, Currency increased $0.3bn. Total Checkable Deposits declined $5.0bn, and Savings Deposits fell $16.0bn. Small Time Deposits slipped $1.2bn. Retail Money Funds declined $5.6bn.
Money market fund assets gained $8.5bn to $2.590 TN. Money Funds were down $124bn year-to-date, while being about unchanged from a year ago.
Total Commercial Paper declined $6.5bn to $1.017 TN. CP declined $25.6bn over the past year, or 2.5%.
May 6 – Bloomberg (Cynthia Kim and Whanwoong Choi): “South Korea’s top currency official fired a warning to Japan: his nation has stepped up scrutiny of the yen’s tumble against the won after damage to exporter earnings. ‘Korean companies face bigger difficulties this year than last,’ said Song In Chang, the ministry’s director general in charge of foreign exchange market policies. ‘What’s different is that we have been paying attention to the won-yen rate since last year, whereas the won-dollar was our main focus before that.’”
The U.S. dollar index declined 0.4% to 94.82 (up 5.0% y-t-d). For the week on the upside, British pound increased 2.0%, the Mexican peso 2.7%, the Brazilian real 1.3%, the Australian dollar 1.0%, and the Canadian dollar 0.7%. For the week on the downside, the Swedish krona declined 1.7%, the Norwegian krone 1.6%, the New Zealand dollar 0.6%, the Japanese yen 0.3%, the Swiss franc 0.2% and the euro 0.2%.
The Goldman Sachs Commodities Index was little changed (up 6.3% y-t-d). Spot Gold gained 0.8% to $1,188 (up 0.3%). July Silver jumped 2.1% to $16.47 (up 5.6%). June Crude increased 24 cents to $59.39 (up 12%). June Gasoline fell 2.6% (up 35%), while June Natural Gas rallied 3.7% (unchanged). July Copper slipped 0.3% (up 3%). May Wheat was hit for 3.3% (down 20%). May Corn declined 1.3% (down 9%).
May 6 – Financial Times (Joel Lewin and Joe Rennison): “Sharply rising long-dated government bond yields are weighing on credit markets, testing the resolve of investors who piled into riskier debt this year as the European Central Bank flooded the financial system with money. Investors have pulled money out of exchange traded funds that track global corporate bonds at a record pace, with $1.8bn leaving the sector in the past five days, according to data provider Markit. The rush for the exit comes as eurozone and US government bond yields rose further on Wednesday. German 10-year Bund yields have climbed 47 bps since mid-April, and US 10-year Treasuries 29 bps over the past week.”
May 6 – Bloomberg (Simon Kennedy and Alessandro Speciale): “Based on UBS Group AG’s analysis of the junk-bond market, Janet Yellen’s warning of danger in U.S. stocks has some merit. The speculative-grade debt market is starting to show some cracks. Investors are less willing to finance the lowest-rated companies, with borrowers such as Cliffs Natural Resources Inc. and Capital Product Partners LP struggling to attract lenders. Relative yields for the riskiest portion of the market have been increasing, and it’s getting harder to trade the notes, according to UBS’s analysis. Historically, this sort of backdrop has signaled trouble ahead for stocks. During downturns, junk-bond prices tend to start falling three months ahead of equities…‘There are clear signs that we may be approaching a turning-point in the credit cycle,’ UBS analysts Ramin Nakisa, Stephen Caprio and Matthew Mish wrote… Given corporate-debt markets have swelled way beyond their size before the 2008 financial crisis, stock pickers need to pay even more attention to what’s happening in bonds this time around, they said.”
May 6 – Bloomberg (Kasia Klimasinska): “Investors wondering about the U.S. government’s role in the Puerto Rican debt crisis are hearing echoes of Detroit. In 2013, lawmakers opposed a federal bailout of the auto-producing hub, and the Obama administration didn’t step in to prevent the largest municipal bankruptcy in U.S. history, in July of that year. The Treasury has a similar no-rescue approach with the Caribbean island beset by unsustainable debt. What Treasury officials are offering Puerto Rico is advice on how to help ease its fiscal burdens and ensure the U.S. territory receives all federal funding it’s eligible for — about $6 billion a year.”
May 6 – Financial Times (Robin Wigglesworth and Henny Sender): “Puerto Rico faces a hot, sticky and tense summer, as the Caribbean island battles to salvage a deal with hedge funds that would keep it financed for another year and avoid a messy default and restructuring. Whether it can dodge that fate has never been more uncertain. The US territory was forced to turn to hedge funds to fund itself a year ago, after a fiscal crisis and a barrage of credit rating agency downgrades caused its traditional investor base — staid US municipal bond funds unused to the whiff of danger — to flee in droves in 2013-14. The hedge funds… bought a big chunk of a $3.5bn bond issue last year, and had struck a tentative agreement to back another debt sale as long as Puerto Rico overhauled and increased its sales tax regime. Yet last week the island’s House of Representatives voted down the sales tax bill, despite the Government Development Bank… warning that doing so would scupper its chances of returning to bond markets and lead to a government shutdown within three months. The aborted vote triggered a rout in Puerto Rico’s bonds, and many analysts and investors now fear that a default and restructuring is now inevitable. ‘It’s an overlevered economy with too much debt. There are two ways to get out of that: economic growth or restructuring,’ says Peter Hayes, head of BlackRock’s municipal bond team. ‘I think there is a growing realisation in Puerto Rico that they have to restructure.’”
May 6 – Bloomberg (Joseph Ciolli): “Mergers put a floor under energy stocks in 2015, they pushed biotech to records and breathed life into food makers. And yet their influence on U.S. equities is, by one measure, only beginning to be felt. At $1.1 trillion, the value of completed takeovers in the last 12 months represents just over 4% of U.S. market capitalization… That’s more than half the level in five previous bull markets — even though the Standard & Poor’s 500 Index’s six-year advance just became the second-longest of the last half century. As a source of demand for U.S. stocks, companies already dwarf mutual funds, thanks to $2 trillion of buybacks announced since 2009. Their role would expand should the old rate of takeovers be restored. The pace of deals is showing signs of growing: volume for March and April was the highest since any two-month period since at least 2003. ‘There’s more and more money coming into the market from these types of deals, and you could make the argument that the demand side for stocks is building,’ Bruce Bittles, chief investment strategist at… Robert W. Baird & Co…. ‘It’s definitely a bullish element.’ …M&A is gathering steam, with the $558 billion in announced deals in March and April rising above $400 billion for the first time since June 2007…”
U.S. Bubble Watch:
May 8 – Wall Street Journal (Dan Strumpf): “Stock buybacks are notching new records on several fronts. U.S. companies announced $141 billion of new stock buyback programs last month, the highest level ever for new buyback programs during a single month and an increase of 121% from April 2014, according to… Birinyi Associates Inc. The rise now puts 2015 on pace to reach $1.2 trillion worth of announced buyback programs, shattering the 2007 record of $863 billion in authorized buybacks, Birinyi said Thursday…”
May 5 – Reuters (Lucia Mutikani): “A surge in imports lifted the U.S. trade deficit in March to its highest level in nearly 6-1/2 years, suggesting the economy contracted in the first quarter… ‘It looks like we are going to have negative GDP for the first quarter, just based on trade, but we expect a robust rebound in the second quarter. A lot of the headwinds we saw in the first quarter have unwound,’ said Jacob Oubina, senior U.S. economist at RBC Capital Markets… The Commerce Department said the trade deficit jumped 43.1% to $51.4 billion in March, the largest since October 2008. The percent rise was the biggest since December 1996. The surge came as imports snapped back after being held down by a now-settled labor dispute at key West Coast ports.”
May 6 – Bloomberg: “Productivity over the past six months fell by the most in more than two decades, leading to increases in U.S. labor costs that threaten corporate profits. The measure of employee output per hour decreased at a 1.9% annualized rate after a revised 2.1% drop in the prior three months… The decline on average over the past two quarters was the biggest since the first six months of 1993. Expenses per worker increased more than projected at the start of the year.”
May 4 – Wall Street Journal (Mike Cherney and Dan Strumpf): “Companies and consumers are on a borrowing spree and, for now, are in a strong position to pay the money back. U.S. corporate-debt issuance is running at its fastest clip ever in 2015 after three consecutive record years. Borrowing by investors against their stockbrokerage accounts has risen to fresh records. And household borrowing has picked up after plunging during the ‘Great Recession.’ But while many leverage indicators are rising, bullish stock and bond investors stress that many measures of broad economic health and income are rising as well… Net leverage for highly rated U.S. nonfinancial companies, a measure that tracks debt less cash as a multiple of annual earnings, was 1.88 times at the end of 2014, according to Morgan Stanley data. That is up from 1.63 times at the end of 2007, on the eve of the financial crisis. But the ratio of companies’ earnings to their annual interest expense was 11.02 times, up from 9.43 times at the end of 2007, according to Morgan Stanley, indicating greater capacity to service obligations.”
May 6 – Reuters (Robert Frank): “The luxury-home market saw a burst of sales activity in the first quarter, though prices are starting to fall. According to the CNBC Luxury Real Estate Report…, sales of homes priced at $1 million or more were up 13% year over year—the strongest year-on-year increase in several quarters… Demand remains especially high in Silicon Valley, as the tech money continues to pour into real estate. A home in Los Altos, California, sold in the first quarter for $8.5 million—more than $1.5 million above the asking price. A home in nearby Palo Alto sold for $6.5 million on an asking price of $5.5 million.”
May 4 – Wall Street Journal (Aaron Kuriloff): “California’s drought is starting to spread to the market for bonds issued by water utilities, long considered one of the safest types of debt sold by state and local governments. Some investors are steering clear of the bonds from hard-hit areas of the U.S. west, amid concerns that restrictions on water use will drive down water-authority revenue. Some authorities may have a tough time raising rates to offset that lost income. If shortages persist, credit ratings may weaken and prices for outstanding bonds fall, according to analysts and rating firms… All California municipal bonds posted a 0.55% decline for the month, counting price moves and interest payments, according to Barclays PLC. California is in its fourth year of drought, one of the worst on record for the nation’s most populous state. It is costing billions of dollars in losses in its agricultural sector and prompting the first-ever mandatory statewide cutbacks in water use.”
Federal Reserve Watch:
May 7 – Reuters (Jonathan Spicer and Ann Saphir): “The Federal Reserve is sketching out plans to prevent an abrupt contraction in its massive balance sheet next year, when some $500 billion in bonds expire and risk disrupting markets and the U.S. economic recovery. Though it ended a stimulative asset-purchase program last October, the Fed is still buying mortgage and Treasury bonds to replenish its $4.5-trillion portfolio as holdings mature… Asked publicly and privately about the longer-term strategy, Fed policymakers say they are in no rush to shrink the portfolio, suggesting they will seek to avoid a ‘cliff’ – a disruptive end to reinvestments that might come if bonds are simply allowed to run off through maturity or prepayment.”
May 6 – Bloomberg (Katherine Burton and Christopher Condon): “Between Boyz II Men at The Mirage and Celine Dion at Caesars Palace, a hot new act is playing Vegas: Ben Bernanke. One day only, live from Sin City… Fifteen months after leaving the Fed and its trappings of mystery and power, Bernanke, 61, is settling into the peripatetic and highly lucrative life of a Washington former. Beyond the dancing fountains of the Bellagio… Bernanke will play to a full house at the SkyBridge Alternatives Conference on Wednesday: 1,800 hedge fund types who used to hang on his every word. Bernanke is, in a sense, one of them now — a well-paid investment consultant who can fete clients, open doors and add a gloss of Fed luster to conferences and meetings. Call it Bernanke Inc., a post-Fed one-man-show that’s worth millions annually on the open market… First there are speaking fees, which bring in at least $200,000 per engagement… Then there are new advisory roles at Pacific Investment Management Co., the big bond house; and Citadel, one of the world’s largest hedge funds. Executive recruiters say each is probably worth more than $1 million a year. Finally, there’s a book deal, details of which haven’t been made public. Bernanke’s predecessor, Alan Greenspan, reportedly landed an $8.5 million contract for his memoir in 2006.”
Global Bubble Watch:
May 6 – Bloomberg (Tracy Alloway): “Duration: d(y)o͝orˈāSH(ə)n/ Noun — The time in which an event takes place. Also, the sensitivity of a bond’s price to changes in its yield. Over the past couple of weeks, investors in German government bonds have received a crash course in ‘duration,’ a geeky concept that is nevertheless a driving force in fixed income. Buying longer-dated bonds with longer duration has been a popular strategy for investors seeking higher returns in an era of low interest rates. It can be risky, given that such debt is extremely sensitive to changes in interest rates and yields. When they go up, the price of bonds with a greater duration will fall a lot more than that of shorter-dated debt. The painful interplay of duration, bond prices, and yield has become startlingly apparent in recent days, as investors have rushed to sell longer-dated German government bonds Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, crunches the numbers on the outsize moves in bunds and comes up with some ugly math for investors:… 30-year bund yields have now increased 53bps over the past two weeks. For the typical high yield bond with a duration of 4.4, a 53bps increase in yield would imply roughly a 2.3% decline in bond price – or the equivalent of about a third of a year’s worth of yield. However, at their peak two weeks ago 30-year bunds had duration of 23.7. Hence 30-year bund prices have declined approximately 12% over the last two weeks, or roughly 25 years worth of yield!”
May 6 – Bloomberg (Cynthia Kim and Whanwoong Choi): “The new fixed-income haven is, of all things, the market for junk bonds. With government securities in Germany to Japan and Ireland yielding less than nothing, money is pouring into exchange-traded funds that buy speculative-grade debt… The pace is staggering. So far this year, about $9 billion has flowed into the funds globally, a significant chunk for the $44.4 billion market in junk-debt ETFs. In the land of negative yields, even the most conservative firms such as Zurich Insurance Group AG… are planning to invest in sub-investment grade debt for the first time… While last week’s sudden selloff in euro sovereign debt gives investors all the more reason to crowd into high-yield assets, the lingering concern is that buyers are exposing themselves to even greater losses. And with the European Central Bank’s bond purchases still keeping government yields close to historic lows, many bond investors have few other options. ‘Investors are being forced by the central bank to assume more risk,’ Jens Vanbrabant, a money manager at ECM Asset Management… ‘They’re trying to adapt their investment parameters to the new situation of zero or negative yields.’”
May 6 – Wall Street Journal (Juliet Chung): “A broad market reversal is battering hedge funds, spoiling the industry’s strongest annual start since the financial crisis. Many funds that bet on global financial and economic trends… suffered losses in April as they tried to benefit from a constellation of market moves that gained momentum in mid-2014 and were widely expected to continue throughout 2015. They included rising European bond prices, spurred by the European Central Bank’s bond-buying program, and falling commodity prices as global growth stalled. But several factors upended those bets, beginning in late March and intensifying recently. Several rounds of unexpectedly weak U.S. economic data forced many investors to push back their forecast for when the Federal Reserve may raise interest rates. The dollar plunged 6% against the euro since mid-March after gaining 29% over a period of nearly nine months. Growing worries about Greece defaulting on its debts caused German bonds to drop, sending the yields up sharply. Oil prices, which were down more than 50% at one point, suddenly found a bottom… The losses in April erased some funds’ gains for the year and whittled the returns of others…”
May 5 – New York Times (Alexandra Stevenson): “For investors in hedge funds, like big pension funds, 2014 was not a lucrative year. But for those who managed their money, the pay was spectacular. The top 25 hedge fund managers reaped $11.62 billion in compensation in 2014, according to an annual ranking to be published… by Institutional Investor’s Alpha magazine. That collective payday came even as hedge funds, once high-octane money makers, returned on average low-single digits. In comparison, the benchmark Standard & Poor’s 500-stock index posted a gain of 13.68% last year when reinvested dividends were included.”
May 5 – Washington Post (Emily Badger): “‘Billionaires’ Row’ is rising over midtown, a collection of glassy new pinnacles that promise the kind of condo views you can only get in Manhattan by building taller than everything else around. With its $95 million penthouse, 432 Park Avenue tops out just shy of 1,400 feet. It will remain the tallest residential building in the Western Hemisphere until the Nordstrom Tower — high-end shopping below, lavish apartments above — goes up four blocks away. Between them are a few more audacious developments, all part of a race for ever-taller towers to distinguish luxury living in an increasingly crowded city. These new buildings — a product of developer ingenuity, architectural advance and international wealth — are changing more than the city’s famous skyline, though. They will also transform New York far below, further darkening city streets and casting long shadows that will sweep across Central Park.”
May 6 – Bloomberg (Emily Badger): “Asian collectors snapped up paintings by Vincent Van Gogh, Pablo Picasso and Claude Monet at a Sotheby’s auction in New York that totaled $368.3 million. The tally on Tuesday was the second highest for an Impressionist and modern art auction at Sotheby’s and a 67% increase from a similar sale last May… The auction was the first test of the art market during two weeks of bellwether sales of Impressionist, modern, postwar and contemporary art in New York that are expected to total as much as $2.3 billion. For the moment, the market is showing no sign of slowing down, dealers said. ‘The fundamentals haven’t changed,’ said Guy Jennings, managing director of the Fine Art Fund Group… ‘Interest rates are incredibly low. The stock market is incredibly high. Everyone is making money.’”
May 5 – Wall Street Journal (Kwanwoo Jun, Tom Wright and Nopparat Chaichalearmmongkol): “As debt has grown across Asia, an increasing portion of the lending has come from nonbank lenders—raising regulators’ concerns about the stability of their financial systems. ‘Shadow banking’ has been a well-documented driver of China’s debt boom, accounting for about a fifth of total lending since 2008. But shadow banks also have boosted their lending in South Korea, Thailand and Malaysia, all places where consumers have grown increasingly indebted. Government officials worry because these lenders, which include credit cooperatives, consumer lenders, credit-card issuers and trust companies, are often less regulated than banks, serve poorer, riskier borrowers and pose different risks to economies.”
May 6 – Bloomberg (Simon Kennedy and Alessandro Speciale): “Central bankers are proving to be the gang that can’t shoot straight. A quarter of a century since New Zealand opened the era of inflation targeting, policy makers from the U.S., euro area, U.K. and Japan are all undershooting their consumer-price goals. Of the Group of Seven, only Canada is currently meeting its mandate. Rather than lowering their sights to make things easier, the misses are fanning calls for targets to be increased from the 2% most aim for to perhaps as high as 4%. While a similar idea was pitched five years ago by International Monetary Fund economists led by Olivier Blanchard, and endorsed by Nobel laureate Paul Krugman, this time around it may be the central-banking community itself proposing a rethink. Former Federal Reserve Chair Ben S. Bernanke last month suggested he would be open to an increase in the U.S. Federal Reserve’s 2% goal, saying there is nothing ‘magical’ about that number. Fed Bank of Boston President Eric Rosengren said the same month it could be the case ‘inflation targets have been set too low.’ His colleague from San Francisco, John Williams, told the New York Times that if the future is one of weaker growth because of demographics and productivity then it’s worth asking ‘is the 2% inflation goal sufficiently high in that kind of world?’”
May 7 – Bloomberg (Scott Hamilton and Nikos Chrysoloras): “Greek Finance Minister Yanis Varoufakis said his government is prepared to go ‘down to the wire’ in talks with its creditors as policy makers signal they’re losing patience with the country after months of brinkmanship. Varoufakis, who denies he’s been sidelined by Greek Prime Minister Alexis Tsipras in the negotiations, said he expects an agreement in the next two weeks, though one is unlikely to be announced when euro-area finance chiefs meet on Monday. Greece has less than a week to prove to the European Central Bank that it’s serious about reaching an agreement with international lenders. Failure to make progress in bailout talks or repay about 745 million euros ($839 million) owed to the International Monetary Fund on May 12 may prompt the imposition of tighter liquidity rules on its banks.”
May 8 – Bloomberg (Alessandro Speciale): “German industrial production unexpectedly declined in March in a sign that Europe’s largest economy remains vulnerable to global economic weakness. Output, adjusted for seasonal swings and inflation, fell 0.5% after stagnating in February… The typically volatile number compares with a median estimate of a 0.4% gain in a Bloomberg survey. Production rose 0.1% from a year earlier.”
China Bubble Watch:
May 8 – Reuters (Kevin Yao): “China’s exports unexpectedly fell 6.4% in April from a year earlier, while imports tumbled by a deeper-than-forecast 16.2%, fuelling expectations that Beijing will quickly roll out more stimulus to avert a sharper economic slowdown. The dismal trade performance raises the risk that second-quarter economic growth may dip below 7% for the first time since the depths of the global financial crisis, adding to official fears of job losses and growing levels of bad debt. ‘This is bad. I expect an interest rate cut this weekend,’ said economist Tim Condon at ING in Singapore… Earlier this week, China’s trade minister said the devaluation of currencies by some countries has led to sharp gains in the yuan, hurting the competitiveness of Chinese exports.”
May 5 – Caixin: “China’s central bank is considering lending to policy banks through a new tool so they can buy bonds issued by local governments, a person close to the regulator says. The loans would have a maturity of at least 10 years, the source said. Other details of how this would work remain unclear, but the tool will be unlike anything the bank has used before, he said. ‘It will be a new monetary tool the world has never seen,’ the person said. ‘The format does not matter, and all possible means could be taken.’ He said the regulator will use the new instrument to provide China Development Bank (CDB) and perhaps other policy banks with capital so they can buy bonds that local governments have issued. The Ministry of Finance has said local governments can issue 1 trillion yuan ($160bn) worth of bonds this year to repay their old debts — in other words allowing them to swap existing debts, which are mostly bank loans, for bonds that have longer maturities and cost less. The problem is that commercial banks are not interested in the bonds.”
May 7 – Reuters: “China’s leaders, caught off guard by a sharp economic slowdown and worried about the risk of job losses, are likely to resort to fiscal stimulus to revive growth after a run of monetary policy easings proved less effective, policy insiders said… ‘They are very worried. If they don’t take bolder measures, it will be very hard to achieve the full-year growth target, and there is risk the slowdown may get out of control,’ an economist at a well-connected think-tank said of top policymakers. ‘Fiscal policy will become more forceful, and infrastructure investment will accelerate, while monetary policy will be more flexible,’ said the economist.”
May 8 – Bloomberg (Christopher Langner): “Fitch Ratings has called real estate the ‘biggest threat’ to Chinese banks as surging loans tied to properties coincide with defaults and falling sales. Corporate loans backed by buildings have grown almost fivefold since 2008 and residential mortgages have more than tripled in the period among lenders rated by Fitch… That’s seen property loans held by China’s four biggest lenders soar to a total 2.26 trillion yuan ($364bn)… Collateral is supposed to reduce bank risk — but the rise of property collateral in corporate loans may actually increase the chance of bank failure,’ Fitch analysts Jack Yuan and Grace Wu said… ‘This is because the widespread use of such collateral has lowered the perceived risks of lending, fueling China’s credit build-up and spreading real-estate risk to other sectors of the economy.’”
May 8 – Bloomberg: “Chinese banks’ bad loans surged by the most in more than a decade in the first quarter as defaults spread from small private firms to state-owned entities amid a property-market slump and an economic slowdown. Nonperforming loans climbed 140 billion yuan ($23bn) from the beginning of the year to 982.5 billion as of March 31… The increase is the biggest since quarterly data became available in 2004 and equivalent to about 56% of new bad loans in the whole of 2014.”
May 6 – Reuters (Michelle Nichols): “Yemen urged the international community ‘to quickly intervene by land forces to save’ the country, specifically in the cities of Aden and Taiz, according to a letter sent to the United Nations Security Council on Wednesday. The letter from Yemen’s U.N. Ambassador Khaled Alyemany… could provide legal cover for such a move. A Saudi Arabia-led coalition launched air strikes against Houthi rebels a day after Yemen notified the 15-member Security Council in a March 24 letter that it had requested military help from Gulf Arab states. The Houthi militia battled its way into Aden’s Tawahi district on Wednesday despite Saudi-led air strikes, strengthening its hold on the city whose fate is seen as crucial to determining the country’s civil war.”