In a tiny subsection of the analytical world, analysis is becoming more pointed and poignant. I appreciate Bill Gross’s August commentary, where he concluded: “Say a little prayer that the BIS, yours truly, and a growing cast of contrarians, such as Jim Bianco and CNBC’s Rick Santelli, can convince the establishment that their world has changed.”
I’ll include the names Russell Napier, Albert Edwards and David Stockman as serious analysts whose views are especially pertinent. I presume each will exert minimal effect on “the establishment.”
Back to Bill Gross: “The BIS emphatically avers that there are substantial medium term costs of ‘persistent ultra-low interest rates’. Such rates they claim, ‘sap banks’ interest margins…cause pervasive mispricing in financial markets…threaten the solvency of insurance companies and pension funds…and as a result test technical, economic, legal and even political boundaries.’ ‘…The reason [the Fed will commence rate increases] will be that the central bankers that are charged with leading the global financial markets – the Fed and the BOE for now – are wising up; that the Taylor rule and any other standard signal of monetary policy must now be discarded into the trash bin of history.”
Count me skeptical that central bankers are on the brink of “wising up.” I have less confidence these days in the Fed than ever. For one, they are hopelessly trapped in Bubbles of their own making. Sure, crashing commodities and bubbling stock markets incite a little belated rethink. Yet I’ve seen not a hint of indication that policymakers are about to discard flawed doctrine. Devising inflationary measures – clever and otherwise – will remain their fixation. For a long time now, I’ve identified inflationism as the root cause of precarious financial and economic dynamics that will end in disaster. It’s been painful to witness the worst-case scenario unfold before our eyes.
Ben Bernanke (and his cohorts and most of the economic community) believes much of the hardship from the Depression would have been averted had only the Fed aggressively printed money after the 1929 stock market crash. Modern-day inflationism rests on the premise that central banks (in a fiat world) can control a general price level. This view ensures that Credit and speculative Bubbles, while potentially problematic, are not to be overly feared. Discussion of mal-investment and economic imbalances is archaic and irrelevant. And somehow the view holds that Bubble risk pales in comparison to “The Scourge of Deflation.”
After all, central bankers can always reflate system Credit and spur a generalized inflation. Stated differently, it is believed that central bankers and their electronic printing presses have the power to inflate out of deflationary Credit and economic busts. And repeated bouts of reflationary policies over recent decades have seemingly confirmed the merit of conventional doctrine. It has evolved to the point where the primary issue is whether policymakers have the determination to reflate sufficiently.
The onus, I suppose, is on my analysis (and other “contrarians”) to convince readers that This Time Is Different. Especially over the past three years, unprecedented central bank “money” printing has corresponded with heightened disinflationary forces globally. As I note repeatedly, the upshot has been unprecedented divergence between inflating securities/asset market Bubbles and deflating fundamental economic prospects. This divergence has widened notably over recent weeks. The fact that egregious monetary inflation has been pulled to the heart of contemporary “money” and Credit – central bank Credit and sovereign debt – is as well fundamental to the “End is Nigh” Thesis.
The work of the great Hyman Minsky plays prominently throughout my analytical framework. In particular, I appreciate his keen focus on “financial evolution.” Over time, it is inherent in finance (i.e. Credit and markets) to gravitate from the cautious and stable to the aggressive and increasingly unstable. It’s human, Credit and market nature. Minsky’s “Financial Instability Hypothesis” and the late-stage “Ponzi Finance” dynamic are more pertinent today than ever.
Finance has evolved profoundly over the past thirty years. Evolution in central bank monetary management has been equally momentous. Over time, the increasingly unhinged global fiat financial “system” turned acutely unstable. The Fed, in particular, resorted to market intervention and nurturing non-bank Credit expansion in order to sustain booms, inflated asset markets and an economy afflicted with deep structural maladjustment. This required the Federal Reserve’s adoption of doctrine ensuring liquid and stable securities markets – a historic boon to leveraged speculation, the evolving (and highly leveraged) derivatives marketplace and securities prices generally.
Fed and global central bank backstops buttressed the historic expansion in market-based finance. The proliferation of interlinked global market Bubbles then drove outrageous policy experimentation. In time, the resulting globalized Bubble in market-based finance and speculation ensured that bolstering securities markets developed into the chief priority for the Fed and fellow global central bankers and officials. Just look at the Chinese over recent weeks.
Long-time readers know I am particularly fond of the “Financial Sphere vs. Real Economic Sphere” framework. It is valuable to view these as two separate but interrelated “Spheres,” with contrasting supply/demand, price and behavioral dynamics. In simplest terms, throwing excess “money”/liquidity at these respective “Spheres” over an extended period will foster disparate dynamics and consequences. And, importantly, over recent decades the Fed and global central bank policies have gravitated toward increasingly desperate “Financial Sphere” intervention and manipulation. The crisis response to the 2008/2009 crisis and then again in 2012 were decisive.
From Russell Napier “Most investors still believe that we live in a fiat currency world. They believe central bankers can create as much money as they believe to be necessary. Such truths are on the front page of every newspaper, but they may contain just as much truth as the headlines of their tabloid cousins. A belief in this ability to create money is the biggest mistake in analysis ever identified by this analyst. The first reality it ignores is that money, the stuff that buys things and assets, is created by an expansion of commercial bank, and not central bank, balance sheets. The massively expanded central bank balance sheets have not lifted the growth in broad money in the developed world above tepid levels. Until that happens, developed world monetary policy must be regarded as tight and not easy.”
This is thoughtful and important analysis. I’ll approach it from my somewhat contrasting analytical framework. From CBB day one, I’ve tried to significantly broaden how we define and analyze “money” and so-called “money supply.” I draw from Mises’ “fiduciary media” and inclusion of financial instruments with the “functionality” of traditional narrow definitions of money supply (i.e. currency, central bank Credit and bank deposits). For me, the perception of a safe and liquid store of (nominal) value is critical.
Moneyness is a market perception. The epicenter of danger lies in the virtual insatiable demand for “money.” This leaves it prone to over-issuance. There is a powerful proclivity for government intervention, manipulation and inflation. The perception of moneyness is, in the end in a world of fiat, self-destructive.
After the past almost seven years, I don’t question central banks’ capacity to create “money.” And my framework doesn’t ascribe special status and power to commercial bank “money” or balance sheets. Besides, U.S. M2 “money supply” has inflated about $2.5 TN in three years, or 20%. Over three years U.S. Commercial Bank Liabilities have inflated the same $2.5 TN, or almost 20%.
The past three years have witnessed historic “money” and Credit expansion on a global basis. The fundamental problem is that global central bank (and governmental) policies over 30 years have profoundly distorted and undermined market incentive structures. The issue is not insufficient “money” – central bank, bank or otherwise. Finance has, however, been incentivized to flow in excess chiefly into the Financial Sphere, where it enjoys comforting policymaker control and support. As global maladjustment and imbalances (which engender disinflationary pressures) mount, why invest in the Real Economy Sphere when it appears so much safer and easier to chase returns in inflating central bank-supported securities market booms?
Why would company managements not use abundant corporate cash flow to repurchase shares when waning returns make it increasingly difficult to justify Real Economy investment? Why proceed with major new investment plans when ultra-easy M&A finance favors acquisitions? Why not just join The Crowd throwing “money” at tech startups and biotech where real economic returns are irrelevant anyways? Why not just “invest” in ETFs shares that buy shares in companies that repurchase their shares? Better yet, why not invest in “safe” bond funds that invest in safe companies that safely borrow “money” to buy back their shares and make acquisitions? Above all, don’t just sit there in “money” that returns near zero when there’s been such a proliferation of “money-like” financial instruments and products with the promise of decent yields and returns? You see, it’s just not a quantity of “money” issue.
This vein of analysis offers layers of progressive complexity. Financial Sphere Bubbles over time engender major structural maladjustment. Throughout equities and debt markets, Bubble Dynamics ensure liquidity flows in progressive excess to the hot asset classes, sectors and products. If the Fed, central banks or the Chinese government seek to underpin such dynamics, momentum will eventually climax with precarious Terminal Phase “blow off” excess. This played prominently in techland in the late-nineties, housing/consumption during the mortgage finance Bubble period, in commodities and EM in the post-2008/09 crisis “global reflation trade,” and more recently (most conspicuously) in technology and biotech.
I have argued that it is a perilous myth that central bankers these days control a general price level. They instead incentivize massive financial flows into securities markets and fashionable sectors. Over time, ramifications and consequences reach the profound. For one, excess liquidity promotes over/mal-investment. It’s only the scope, nature and aftermath that remain in question.
If major Bubble flows inundate new technology investment, the resulting surge in the supply of high-margin products engenders disinflationary pressures elsewhere. Policy responses to perceived heightened “deflation” risks then only work to exacerbate Bubbles, mounting imbalances and structural fragilities. This was a critical facet of “Roaring Twenties” analysis that was lost in time.
Bubbles categorically redistribute and destroy wealth, and I will turn more optimistic when policymakers finally “wise up” to this harsh reality. On the one hand, progressively destabilizing Financial Sphere monetary disorder ensures deep economic maladjustment (i.e. excessive Bubble-related spending in tech, housing related, EM, commodities and China). On the other, serial securities and asset market booms and busts spur destabilizing wealth redistributions – a boon to some and economic hardship (boom and bust collateral damage) to many. Both work to foster economic stagnation – deep structural impairment impervious to central bank reflationary measures.
Reflationary policies and attendant inflated market Bubbles can hold the consequences at bay for a while. Importantly, resulting monetary disorder works to exacerbate both Financial Sphere and Real Economy Sphere maladjustment with potentially catastrophic consequences. Economists have traditionally debated “money illusion” (notably Irvine Fisher and JM Keynes). “Wealth illusion” is today more appropriate. The U.S. economic structure remains viable – these days the “envy of the world” – only so long as perceived wealth from securities markets remains grossly inflated. The consumption-based U.S. economy now requires record household sector perceived wealth (inflated Household Net Worth). And this requires ongoing loose financial conditions, strong Credit growth and buoyant financial flows.
Because of the importance of the data, I wanted to circle back briefly to document key data released in last month’s Q1 2015 Z.1 “flow of funds” Credit report.
As a proxy for the “U.S. debt securities market,” I combine Fed data for outstanding Treasury, Agency, Corporate and muni debt securities. I then combine this with Total Equities to come to my proxy of the “Total Securities” markets. During Q1, Total Securities jumped $759bn to a record $73.195 TN. Total Securities as a percentage of GDP jumped five percentage points to a record 414%. For perspective, this ratio began the nineties at 183%, concluded 1999 at 356% and then rose to 371% to end 2007.
The value of U.S. Household (and non-profits) assets jumped $1.611 TN during Q1. By largest categories, Financial Assets jumped another $1.07 TN and Real Estate assets increased $500bn. And with Household Liabilities little changed for the quarter, Household Net Worth (assets minus liabilities) rose $1.6 TN to a record $84.925 TN. Over the past year, Household Net Worth inflated about $4.6 TN, with a two-year gain of $12.6 TN. Since the end of 2008, Household Net Worth has ballooned a stunning $28.4 TN, or 50%.
One cannot overstate the integral role the inflation in Household Net Worth has played in the Fed’s reflationary policymaking. Household Net Worth ended Q1 at a record 481% of GDP. This compares to 447% to end Bubble Year 1999 and 476% in Bubble Year 2007.
As was the case again during Q1, during the inflationary boom period strong inflationary biases ensure that “wealth” increases a multiple of underlying Credit growth. This dynamic was on full display during both the tech and mortgage finance Bubble episodes. I recall being amazed at how $1 TN of mortgage Credit growth would fuel a $4.0 TN inflation in Household Net Worth. This “virtuous” dynamic turned vicious during the subsequent bust. The amount of new Credit required just to stabilize an inflated and maladjusted system becomes enormous.
There is now chatter of the Chinese government intervening in the stock market to the tune of $100bn in a single session. We’ve seen how, despite repeated bailouts and debt reductions, the Greek black hole grows only bigger. Meanwhile, with commodities in freefall, it was another ominous week for EM. And these examples provide apt reminders of inflationism’s biggest flaw: once commenced, it’s about impossible to rein in. I would add that “money” printing will never resolve the issue of structural maladjustment. Monetary inflation will, however, ensure only greater quantities of “money” will be required come the inevitable bust. And those quantities will eventually bring to question the confidence in “money.” Read monetary history.
The S&P500 gained 1.5% (up 2.2% y-t-d), and the Dow increased 0.7% (down 0.7%). The Utilities jumped 3.8% (down 3.7%). The Banks were little changed (up 5.5%), while the Broker/Dealers fell 0.9% (up 5.3%). The Transports surged 4.0% (down 8.2%). The S&P 400 Midcaps rallied 1.8% (up 3.5%), and the small cap Russell 2000 advanced 1.0% (up 2.8%). The Nasdaq100 added 0.7% (up 8.3%), and the Morgan Stanley High Tech index rose 1.1% (up 5.1%). The Semiconductors increased 0.6% (down 5.9%). The Biotechs rose 1.0% (up 23.9%). With bullion down $4, the HUI gold index dropped another 2.8% (down 31.9%).
Three-month Treasury bill rates ended the week at six bps. Two-year government yields dipped one basis point to 0.66% (down one basis point y-t-d). Five-year T-note yields fell eight bps to 1.53% (down 12bps). Ten-year Treasury yields dropped eight bps to 2.18% (up one basis point). Long bond yields declined five bps to 2.91% (up 16bps).
Japan’s Nikkei equities index added 0.2% (up 18.0% y-t-d). Japanese 10-year “JGB” yields slipped a basis point to 0.39% (up 7bps y-t-d). The German DAX equities index dipped 0.3% (up 15.3%). Spain’s IBEX 35 equities index fell 1.1% (up 8.8%). Italy’s FTSE MIB index was little changed (up 23.8%). Emerging equities markets were unimpressively mixed. Brazil’s Bovespa index rallied 3.3% (up 1.7%). Mexico’s Bolsa gained 1.1% (up 3.7%). South Korea’s Kospi index declined 0.8% (up 6.0%). India’s Sensex equities index was unchanged (up 2.2%). China’s Shanghai Exchange sank 10.0% (up 13.3%). Turkey’s Borsa Istanbul National 100 index rallied 1.5% (down 6.8%). Russia’s MICEX equities index surged 4.6% (up 19.5%).
Junk funds this week saw outflows surge to $1.7 billion (from Lipper).
Freddie Mac 30-year fixed mortgage rates fell six bps to a two-month low 3.98% (up 11bps y-t-d). Fifteen-year rates declined four bps to 3.17% (up 2bps). One-year ARM rates slipped two bps to 2.52% (up 12bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 4.09% (down 19bps).
Federal Reserve Credit last week declined $4.5bn to $4.457 TN. Over the past year, Fed Credit inflated $92.8bn, or 2.1%. Fed Credit inflated $1.646 TN, or 59%, over the past 141 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt dropped $12.4bn last week to a two-month low $3.328 TN. “Custody holdings” were up $35bn y-t-d.
M2 (narrow) “money” supply jumped $18.3bn to a record $12.062 TN. “Narrow money” expanded $630bn, or 5.5%, over the past year. For the week, Currency increased $2.8bn. Total Checkable Deposits added $2.4bn, and Savings Deposits gained $14.6bn. Small Time Deposits slipped $1.7bn. Retail Money Funds were little changed.
Money market fund assets were about unchanged at $2.648 TN. Money Funds were down $85bn year-to-date, while gaining $94bn y-o-y (3.7%).
Total Commercial Paper jumped another $10.8bn to a seven-month high $1.048 TN. CP increased $22BN over the past year.
The U.S. dollar index was about unchanged at 97.19 (up 7.7% y-t-d). For the week on the upside, the Mexican peso increased 1.0%, the British pound 0.7%, the Australian dollar 0.4%, the Norwegian krone 0.3%, and the New Zealand dollar 0.2%. For the week on the downside, the Brazilian real declined 2.0%, the Swedish krona 0.5%, the Swiss franc 0.4%, the Canadian dollar 0.3%, the Japanese yen 0.1% and the South African rand 0.1%. The euro was unchanged.
July 31 – Wall Street Journal (Christian Berthelsen and Rob Copeland): “Three years after private-equity giant Carlyle Group LP touted its purchase of a hedge-fund firm, a rout in raw materials has helped drive down holdings in its flagship fund from about $2 billion to less than $50 million… The firm, Vermillion Asset Management LLC, suffered steep losses and a wave of client redemptions in its commodity fund after a string of bad bets… A collapsing market for raw materials is spreading pain well beyond commodities specialists to some of the heaviest hitters on Wall Street. This week alone, commodity-trading firms Armajaro Asset Management LLP and Black River Asset Management LLC, a unit of agricultural conglomerate Cargill Inc., said they are closing funds. Several other firms that managed billions of dollars already have closed their doors, including London-based Clive Capital LLP and BlueGold Capital Management LLP. Large money managers including Brevan Howard Asset Management LLP and Fortress Investment Group LLC have wound down commodity strategies.”
The Goldman Sachs Commodities Index sank 2.1% (down 9.5% y-t-d). Spot Gold slipped 0.4% to $1,095 (down 7.6%). September Silver rallied 1.8% to $14.75 (down 5%). September Crude fell $1.02 to $47.12 (down 12%). August Gasoline sank 3.1% (up 20%), and August Natural Gas fell 2.2% (down 6%). September Copper declined 0.8% (down 16%). September Wheat dropped 2.4% (down 15%). September Corn sank 5.3% (down 4%).
Greece Crisis Watch:
July 27 – Financial Times (Peter Spiegel and Claire Jones): “The eurozone’s central bankers should be prepared to use their firepower more aggressively to prevent any economic uncertainty in Greece spreading across the currency union, the International Monetary Fund has warned. The IMF guidance, contained in its annual report on the eurozone’s economy published on Monday, comes despite the European Central Bank’s unprecedented quantitative easing programme, in which it is purchasing €60bn in mostly government-backed bonds every month in an effort to stimulate investment and growth. The IMF praised the QE programme, saying it ‘strongly supports’ the ECB’s current plans to keep the bond purchases running through September 2016, and credited the policy with preventing the six-month Greek crisis from causing more damage to the wider eurozone.”
China Bubble Watch:
July 28 – Wall Street Journal (Shen Hong and Wei Gu): “When investors in China’s main stock market saw shares in the country’s biggest oil company slide on Monday, they sensed Beijing had—at least temporarily—given up. In their scramble to prop up the market in recent weeks, government-owned funds have focused their buying on major state-owned companies such as PetroChina Co. With a market value of 1.92 trillion yuan ($309bn), PetroChina alone accounts for 5.3% of the weighting of the Shanghai Composite Index, which tracks the exchange’s 1,114 companies. The 20 largest, all state-owned, account for a combined 32% of the index’s weighting. Yunfeng Wu, a Shanghai-based retail investor, said that when he saw the oil giant’s shares in free fall, he took it as a sign the Chinese government wouldn’t intervene to prevent the broader market from tanking. His hunch looks right: Petrochina’s shares ended the day down 9.6%, while the Shanghai market slid 8.5%, its biggest one-day fall in eight years…. The main vehicle, China Securities Finance Corp., has been spending up to 180 billion yuan ($29bn) a day since July 8 to try to stabilize the market, according to a person familiar with the matter. But there was little buying on Monday, the person said. ‘Without the government defending the market, there was a stampede to get out,’ said Larry Wan, chief investment officer at Shanghai Life Insurance…”
July 31 – Reuters (Koh Gui Qing): “China needs to ensure that risks presented by a slowing economy do not morph into social risks, the state planner said on Friday, acknowledging the problems the country faces should unemployment rise. Keeping unemployment low is a top policy priority for China’s stability-obsessed government, a task that it has admitted will become more difficult as growth grinds toward a 25-year low this year. The government should ‘further improve the social security system … to ensure economic risks do not morph into social risks’, the National Development and Reform Commission said… ‘When issuing major policies and reform measures, (the government) should insist on carrying out social stability assessments,’ it said.”
July 30 – Financial Times (Tom Mitchell): “China’s stock market regulator began its most recent press briefing with a telling instruction for the mostly local journalists in attendance. ‘We have a requirement concerning speculative reports,’ said the China Securities Regulatory Commission. ‘They must first be confirmed by the CSRC in order to prevent the spread of false information and market disturbance.’ The warning was a reminder that as a ‘national team’ comprised of largely state-owned entities struggles to shore up China’s stock market, the government is orchestrating an equally important cheerleading campaign involving a broad array of state media outlets… Reflecting government concern that the SCI is more likely to fall through the 3,500-point floor than soar past the securities association’s 4,500 target, this week the CSRC has adopted language reminiscent of Maoist campaigns against ‘capitalist roaders’ and other ‘bad elements.’ In terse late night statements, posted in question and answer format, the CSRC has pledged to pursue all ‘relevant clues’ as it pursues stock ‘dumping’ in contravention of its July 8 decree banning listed companies’ large shareholders and directors from selling their shares.”
July 31 – Reuters (Michelle Price and Pete Sweeney): “China is pressing foreign and Chinese-owned brokerages in Hong Kong and Singapore to hand over stock trading records, sources said, extending its pursuit of ‘malicious’ short sellers of Chinese stocks to overseas jurisdictions. China’s main share markets, both among the world’s five biggest, have slumped around 30% since mid-June and authorities have been flailing in efforts to prevent a further sell-off that could spill over into the wider economy. The markets regulator, the China Securities Regulatory Commission (CSRC), wants the trading records to try to identify those with net short positions who would profit in case of further falls in China-listed shares, three sources at Chinese brokerages and two at foreign financial institutions said.”
July 31 – Reuters: “China’s sole financial futures exchange will tighten rules governing trading that it regards as ‘irregular’ to tackle what it sees as excessive speculation in the markets, it said on Friday. The China Financial Futures Exchange will classify some arbitrage and speculative activity in stock index futures as ‘irregular’ it said… The new rules will become effective on Monday. More than 400 withdrawn orders for a single contract or more than five self-trades per day will be considered ‘irregular trading’, the statement said. On Friday, Chinese stocks posted their biggest monthly loss in nearly six years, even as Beijing rolled out a series of support measures and promised to step up efforts to bolster the flagging economy.”
July 29 – Financial Times (Lucy Hornby): “Chinese banks risk becoming entangled in the fallout from a liquidity freeze at an exchange for rare metals that has also been providing high interest rate investment products through bank branches across the country. Against a backdrop of renewed turmoil in the Chinese equity markets, there have been protests in the past two weeks in both Kunming and Shanghai as investors in the financial products sold by the Fanya Metal Exchange demand their money back. It emerges that some have already started taking their protests to the banks that distributed the products. Fanya is a forum for trading minor and rare metals that has also functioned as a shadow banking conduit — not only leveraging metal deposited with the exchange as collateral for loans, but offering high interest investment products to retail investors. The exchange, which is based in Kunming, stopped disbursing funds this month to depositors. About $6.4bn in investments is frozen, according to estimates by Chinese media.”
July 31 – Reuters: “China plans to set up a state-backed credit guarantee firm to offset some of the risks faced by banks and spur lending where it is needed in a cooling economy, the cabinet said… In its second meeting in the week, the State Council said it wants to quicken growth of the credit guarantee sector to ease funding for small companies and agricultural firms. Credit guarantee firms help borrowers obtain bank loans by guaranteeing a part. As in other countries, small businesses in China have a hard time getting loans from banks as they are deemed to be riskier borrowers than their bigger peers. The difficulties faced by small companies, which account for three quarters of the jobs in China, have become more pressing as a stuttering Chinese economy subjects the labor market to increased stress.”
July 28 – Bloomberg: “China halted power flows from solar panels for the first time as congestion on its electricity grid prevented renewable energy from reaching customers. About 9% of the nation’s solar capacity sat idle in the first six months of the year, according to data from the National Energy Administration… Dormant generators were mainly in the northwestern region of Gansu and Xinjiang. China’s electricity grid is struggling to absorb quickly increasing flows from both renewables and coal-fired power plants. Authorities either delay hooking new plants to the grid or idle facilities whose output can’t be managed.”
Fixed Income Bubble Watch:
July 31 – Bloomberg (Michelle Kaske): “Puerto Rico said it won’t make a bond payment due Saturday, putting the commonwealth on a path to default and promising to initiate a clash with creditors as it seeks to renegotiate its $72 billion of debt. The government doesn’t have the money for the $58 million of principal and interest due on Public Finance Corp. bonds, Victor Suarez, the chief of staff for Governor Alejandro Garcia Padilla said during a press conference Friday in San Juan. ‘We cannot make the payment tomorrow because we do not have the funds available,’ Suarez told reporters. ‘This payment will be made as we address how to restructure the government’s debt prospectively.’ The default marks an escalation in the debt crisis that’s been racking the island, where officials are pushing for what may be the biggest restructuring ever in the municipal market.”
July 31 – Reuters (Megan Davies and Jessica Dinapoli): “Puerto Rico’s expected default on debt due Saturday would be the start to what could end up becoming one of the largest municipal restructurings, with the potential to open the door to a fight with investors and spark volatility in bond prices. Puerto Rico Governor Alejandro Garcia Padilla shocked investors in June when he said the island’s debt – totaling $72 billion – was unpayable and required restructuring. Puerto Rico has flagged that it will likely skip a $58 million payment due Aug. 1 on its Public Finance Corporation (PFC) debt… ‘What could surprise investors is when they actually hear the word default, and that a default occurred,’ said Lyle Fitterer, head of tax-exempt fixed income at Wells Capital Management… ‘The immediate reaction might be a slight sell-off in the marketplace because I think people will start to anticipate, OK, what’s the next series of debt they’re going to default on?’ It would mark the first missed debt payment. According to a 2014 bond offering statement, Puerto Rico has never defaulted on the payment of principal or interest of debt.”
July 31 – Bloomberg (Lisa Abramowicz): “When you use borrowed money to make a bet, you can win big and you can lose big, as some investors in closed-end debt funds are finding out right now. Shares of such funds are plunging way below the value of their underlying assets, with the biggest discounts since the U.S. financial crisis. Traders seem to just want to get this stuff off their books, even at a painful price. At best, these funds are just a small corner of the $39 trillion U.S. debt market and their suffering is perhaps a temporary phenomenon that doesn’t reflect broader problems. At worst, it’s a harbinger of a more significant selloff ahead in debt markets that have swelled to unprecedented sizes on the heels of the Federal Reserve’s stimulus. ‘The bigger fish to fry is now in U.S. credit markets,’ wrote Credit Suisse Group AG analyst Sean Shepley… The steep decline in credit closed-end fund shares is ‘a signal both of underlying credit market illiquidity and also of end investor risk aversion.’”
U.S. Bubble Watch:
July 28 – New York Times (Steve Lohr): “After Paul Minton graduated from college, he worked as a waiter, but always felt he should do more. So Mr. Minton, a 26-year-old math major, took a three-month course in computer programming and data analysis. As a waiter, he made $20,000 a year. His starting salary last year as a data scientist at a web start-up here was more than $100,000. ‘Six figures, right off the bat,’ Mr. Minton said. ‘To me, it was astonishing.’ Stories like his are increasingly familiar these days as people across a spectrum of jobs — poker players, bookkeepers, baristas — are shedding their past for a future in the booming tech industry. The money sloshing around in technology is cascading beyond investors and entrepreneurs into the broader digital work force, especially to those who can write modern code, the language of the digital world.”
July 29 – Wall Street Journal (Jeffrey Sparshott): “The cost of renting a home is rising faster than wages across wide swaths of the country, a problem that has become especially acute in the past year, putting a big squeeze on many household budgets. The situation is particularly noticeable in long-pricey areas across the West and in big cities like New York, where the average household pays more than 40% of its gross income for rent, according to online real-estate database Zillow. But rising prices also have spilled over into cities like Denver, Atlanta and Nashville… ‘Rents have skyrocketed so much and incomes haven’t kept pace, so we have an affordability crisis in some of our major metropolitan areas for the middle housing market,’ said Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California…”
Central Bank Watch:
July 31 – Wall Street Journal (Neil MacLucas): “Switzerland’s central bank posted a loss in the first half of the year after its decision to scrap a long-standing cap on the strength of the Swiss franc caused the currency to soar, eroding the value of its euro reserves. The Swiss National Bank… reported a loss of 50.1 billion Swiss francs ($51.8bn) in the six months through June 30… The deficit was almost entirely caused by declines in the value of its huge foreign-currency positions, which are dominated by the euro, and which amounted to 47.2 billion francs. The bank also recorded a 3.2 billion franc loss on its gold holdings, which are denominated in dollars.”
Global Bubble Watch:
July 29 – Wall Street Journal (Juliet Chung and Katy Burne): “Banks are nudging certain hedge-fund clients to use derivatives instead of actual stocks when placing some bets, an effort aimed at lessening the impact of new capital rules on the banks’ businesses. The shift generally involves derivatives called total-return swaps that mimic the effects of owning a stock or other asset. In some instances, banks take less of a balance-sheet hit when they are hedging offsetting client positions targeting the same stock using total-return swaps than they would if the bets were made via securities. Funds using the swaps strike an agreement with a bank to receive any gains or losses in a certain stock or index over a predetermined period. If the stock goes up, the fund gets paid. If it goes down, the fund owes money to the bank. The fund doesn’t take possession of the shares.”
July 31 – Financial Times (Tom Mitchell): “Some of the world’s largest companies have sounded the alarm about the slowdown in the Chinese economy, warning that weaker growth would hit profits in the second half of the year. Car companies such as PSA Peugeot Citroën, Audi and Ford have slashed growth forecasts while industrial goods groups such as Caterpillar and Siemens have all spoken out on the negative impact of China. The warnings are a sign that China’s weaker growth and its stock market rout this month are creating a headache for global corporates that have long relied heavily on the world’s second-largest economy to drive revenues.”
July 28 – Bloomberg: “Automakers may sell fewer vehicles in China this year for the first time since at least 1998 as demand slows in the world’s largest market, according to the low end of Ford Motor Co.’s revised projection. Ford is estimating industrywide sales to be between 23 million and 24 million units this year …, compared with the 23.5 million sold last year. The low end of that forecast would represent the first decline in at least 17 years… Before 1998, only production figures were available. ‘It’s clear we’ve seen a market slowdown in the market there in the industry,’ said Mark Fields, Ford chief executive officer…”
July 28 – Bloomberg (Katie Linsell): “Bank of America Corp. will decide this week whether to remove emerging-market companies from its $2.2 trillion global high-yield index. The lender asked junk-bond investors to vote on the matter as part of an annual review of its benchmarks after a slew of downgrades to Brazilian and Russian companies boosted their share of the index. Bank of America said it will implement any changes at the end of September. The decision pits investors who want the measure to better reflect the corporate high-yield market against those seeking higher yields associated with extra political risk. A removal of emerging-market companies, which accounted for 18% of the index at the end of March, may trigger price swings if bondholders are forced to sell those securities and raise funding costs for excluded companies.”
July 27 – Reuters (Caroline Copley): “The German government’s panel of independent economic advisers favours the creation of a sovereign insolvency mechanism for euro zone states to prevent future crises and says countries should be able to leave the currency bloc as a last resort. In a special report published on Tuesday, the council of five experts known as the ‘wisemen’, said the Greek debt crisis had underscored the urgent need for further reforms to make the euro zone more stable. Alongside measures such as deepening the European banking union, the council said the euro area’s crisis toolkit should be complemented by a mechanism for orderly sovereign insolvencies, which would make the currency area’s no bail-out clause credible. ‘To ensure the cohesion of monetary union, we have to recognise that voters in creditor countries are not prepared to finance debtor countries permanently,’ said Christoph M. Schmidt, Chairman of the German Council of Economic Experts. The Greek crisis has called into question the future of the currency bloc with popular misgivings in Germany over a third bailout for the heavily indebted country running deep.”
EM Bubble Watch:
July 28 – Bloomberg (Benjamin Harvey): “Just weeks after his grip on power looked to be slipping, Turkish President Recep Tayyip Erdogan is widening the net in an offensive against militants to root out political opponents and shore up his power base. Erdogan called… for parliament to lift the immunity from prosecution of lawmakers from the Kurdish party linked to the militant group PKK. That would pave the way for prosecutors to investigate alleged terrorist offenses. Turkey is striking PKK insurgents at home and in northern Iraq while bombing Islamic State in Syria, sending financial markets plunging. Erdogan, 61, is positioning himself to benefit from the crisis. The escalation comes seven weeks after the pro-Kurdish HDP won unprecedented support in Turkish elections, stripping the party founded by Erdogan of its parliamentary majority for the first time in 13 years.”
July 28 – Reuters (Tulay Karadeniz): “Turkish President Tayyip Erdogan said… it was impossible to continue a peace process with Kurdish militants and urged parliament to strip politicians with links to ‘terrorist groups’ of immunity from prosecution. His comments come days after the Turkish air force bombed camps in northern Iraq belonging to the Kurdistan Workers Party (PKK), following a series of attacks on police officers and soldiers blamed on the Kurdish militant group. The PKK said the air strikes, launched virtually in parallel with strikes against Islamic State fighters in Syria, rendered the peace process meaningless but stopped short of formally pulling out. ‘It is not possible for us to continue the peace process with those who threaten our national unity and brotherhood,’ Erdogan told a news conference… before departing on an official visit to China.”
July 28 – Financial Times (Joe Leahy): “Standard & Poor’s warned Brazil… that its investment grade rating was at risk as falling growth and political infighting hurt efforts to restore order to public finances. The agency placed Brazil’s foreign currency rating, which is one notch above junk, on negative outlook for possible downgrade, initially weakening Brazil’s currency, the real, up to 2% against the dollar. ‘The execution risks have risen,’ said Lisa Schineller, sovereign analyst with Standard & Poor’s. ‘These execution risks stem from both the political and economic front, causing what we believe is a greater than one in three likelihood that the policy correction could see further slippage.’ The S&P announcement came just four months after the agency last affirmed Brazil’s investment grade rating and one week after the government of President Dilma Rousseff revised budget targets.”
July 29 – Financial Times (Charles Clover and Victor Mallet): “More than 100 Chinese naval ships and dozens of aircraft fired live ammunition over the contested South China Sea this week in military manoeuvres that are likely to raise the political temperature in the region. The demonstration of firepower, broadcast on national television, appeared calculated to reassert Beijing’s claim to hegemony in the area, where a number of neighbouring countries have also staked claims. It also raised criticism from observers in the region who equated it with sabre-rattling. ‘An exercise on this scale in the South China Sea seems a needlessly excessive show of force,’ said Rory Medcalf, head of the National Security College at the Australian National University.”
Russia and Ukraine Watch:
July 28 – Bloomberg (Kateryna Choursina and Aliaksandr Kudrytski): “The battle readiness of Ukraine’s military and the rebels it’s fighting in the country’s east is at its highest level since a February truce, monitors warned, a situation that risks tipping the conflict back into war. After more than a year of fighting, sides are fortifying positions and amassing weapons, said Alexander Hug, deputy chief of the Organization for Security and Cooperation’s mission in Ukraine. His comments follow a report Monday that cease-fire violations had reached a daily record… There’s ‘a preparedness of both sides to a degree we haven’t seen before,’ Hug told reporters… Tensions are building amid a crucial phase for the peace plan, signed in Minsk, Belarus more than five months ago. At stake is the constitutional status of the rebel-held territory in Ukraine’s industrial heartland, near the Russian border, and the election of officials in those regions.”
July 31 – Reuters (Alexander Winning, Jason Bush and Gabriela Baczynska): “Russia’s central bank cut its key interest rate by 50 bps to 11% on Friday as expected, saying risks of the economy cooling now outweighed inflation risks. ‘The balance of risks shifts towards the considerable economic cooling despite a slight increase in inflation risks,’ the bank said… The bank also said that an unexpectedly severe contraction in domestic demand in the first half of 2015 meant that it may revise down its output forecast. The bank had previously forecast a 3.2% GDP contraction in 2015. The 50 bps cut means the central bank has now cut its one-week minimum auction repo rate by a cumulative 6 percentage points in 2015…”
July 30 – Bloomberg (Kevin Buckland and Shigeki Nozawa): “Japan’s default risk has fallen the most among Group of Seven nations this year, so why are some of its leading economists more worried than ever? The Bank of Japan’s unprecedented stimulus, which has scope to buy every new bond the government issues, is keeping yields artificially low even as sovereign notes head for their first annual loss since 2003… The Cabinet Office acknowledged last week it can’t see the government achieving its target of a primary budget surplus in five years, and the central bank has yet to outline how it plans to taper its asset-purchase program. No sovereign debt has performed as poorly as Japan’s this month, and only Greece has done worse over the past five years. On a relative basis, at 232% of gross domestic product, Japan’s more than a quadrillion yen ($8.1 trillion) in debt makes Greece’s look enviably manageable.”