Doug Noland

Weekly Commentary: 2016 Year in Review

When looking back on a year, it’s only natural that events later in the year receive added emphasis. The DJIA made it within 23 points of the 20,000 benchmark as the year wound down. All major U.S. equities indices posted all-time highs in December – the Dow, S&P500 and Nasdaq, as well as small and mid-cap indices. After trading as low as 667 back in March 2009, the S&P500 closed out 2016 at 2,239. Over this period the small cap Russell 2000 inflated about four-fold to end the year at 1,357.

The broader market shined in 2016, with the small cap Russell 2000 and S&P400 Mid-Cap indices gaining 18.7% and 19.5%, respectively. Also outshining the S&P500, junk bonds enjoyed their best performance since 2009, with the HYG (high-yield ETF) returning 13.4%. The TLT (long-term Treasury ETF) eked out a 1.0% gain for the year, while the LQD (investment-grade corporate ETF) returned 6.1%.

The S&P500 rallied almost 10% post-election, with the small caps doubling that percentage gain. Trump trepidation may have temporarily pushed the DJIA down almost 1,000 points election night, but post-election optimism rallied right along with market prices. Reagan-style deregulation, along with tax reform, fiscal stimulus, infrastructure spending and trade reform are viewed as ushering in a fundamentally improved environment for corporate America and the U.S. economy overall.

Importantly, the economic backdrop was supportive of market optimism. At 3.5%, Q3 GDP was the strongest in two years. GDP has shown strong momentum, rising from Q1’s 0.8% and Q2’s 1.4%. At 4.6%, November’s unemployment rate was the lowest going back to boom-time August 2007. On the back of surging stock prices, consumer confidence jumped to the highest level since August 2001. Auto sales were on track to reach an annual record 17.5 million units. Home prices have returned to record levels, with existing home sales the strongest since 2007.

It’s reasonable to posit that U.S. lending conditions have become the loosest since (at least) 2007, helping to explain the strength in auto and home sales along with the general economy. It’s worth noting that the 2016 U.S. fiscal deficit rose a third to $587 billion, or 3.2% of GDP. Revenues increased 1%, while spending jumped 5%.

As of the end of Q3, the U.S. economy was on track for the strongest Credit growth since 2008. Q3 seasonally-adjusted and annualized (SAAR) Non-financial Credit growth reached $2.679 TN (about $2.375 TN SAAR over three quarters) the strongest expansion since 2007’s record $2.503 TN. Household mortgage Credit has been expanding the most rapidly since 2007. M2 “money” supply increased over $900bn in 2016, expanding about 8.0%. Clearly, U.S. rates have been held way to too low for way too long.

Ultra-loose finance was a global phenomenon. According to the Financial Times, global debt issuance reached an all-time high $6.60 TN, surpassing 2006’s record. Global corporate issuance was up 8% from 2015 to $3.60 TN. The year supported the view that things tend to get crazy near the end of epic Bubbles.

A summarizing December 30th Bloomberg headline: “A Year in China Markets: Yuan Down, Stocks Down, Bonds Faltering.” For the year, China’s currency declined 6.6%, “the most in two decades.” The yuan began the year weak and end the year weaker. “Money” flooded out of China at the beginning of 2016, then somewhat stabilized before the floodwaters began to rise again during the fourth quarter.

Chinese stocks also had a rough year. The Shanghai Composite dropped 11.3%, with the CSI Smallcap 500 Index down 17.8%. China’s growth-oriented ChiNext index was hit even harder, sinking 27.7%. Chinese international reserves dropped another $280 billion during the year to $3.330 TN. Reserves have declined a stunning $940 billion since the June, 2014 peak.

With year-end optimism dominating, it’s easy to forget that China was in the process of bringing global markets to their knees early in the year. According to the Financial Times, global markets lost $4.0 TN in the first ten trading sessions of 2016 – the “worst-ever” start to a trading year. The Shanghai Composite sank a quick 25% in January, with fears of a bursting Chinese Bubble hammering global markets. The S&P500 dropped 11%, the worst start to a year in decades. The Nasdaq Composite fell 16%. By early February, crude was already down almost 30%. The GSCI commodities index lost 14%, trading to a low going all the way back to 2004.

As fears rose of a bursting global Bubble, bank stocks fell under heavy selling pressure. U.S. banks (BKX) and broker/dealers (XBD) were each down over 20% in the year’s initial weeks. The Hang Seng China Financials index sank almost 25%. Japanese banks were under even more intense selling pressure, with the TOPIX-Banks Index falling 35%. European stocks (STOXX 600) dropped almost 30%. By mid-February, Germany’s behemoth Deutsche Bank was sporting a y-t-d loss of almost 40% – and it was making folks nervous.

Again, year-end optimism clouds our memories and interpretations of early-year market behavior. But my view at the time was that the global Bubble was faltering. The great Chinese Bubble was at serious risk of implosion, with stocks crashing, the economic boom faltering, bond defaults multiplying and “money” trying to exit as fast as possible. In short, China’s debt Bubble was at acute risk of crashing, imperiling some of that nation’s largest banks – huge institutions that now populate the top of the list of the world’s largest banks.

While they surely received zero consideration, I’d award global central bankers “2016 Person of the Year.” Understandably, most see “The Year of Donald Trump” or “The Year of Global Populism.” Yet from my analytical perspective it was “Yet Another Year of Desperate Central Bankers.” Recall that market sentiment early in the year held that central banks had largely expended their ammo. There was even talk of “quantitative tightening.” The Fed had commenced a tightening cycle and EM central banks were under pressure to sell Treasuries and other reserve assets to help stabilize their currencies. Meanwhile, the BOJ and ECB had already pushed rate cuts and QE to their limits – or so it seemed. Ominously, markets were faltering in the face of, seemingly, peak “whatever it takes.”

With Japanese unemployment at 3.3%, the Bank of Japan on January 29th did the previously thought impossible (and something Kuroda had said the prior week was not even being considered) – rates were pushed into negative territory with a warning that they could go even lower. Reuters: “BOJ stuns markets with surprise move to negative interest rates.” BOJ Governor Haruhiko Kuroda, responding to unstable global markets: “What’s important is to show people that the BOJ is strongly committed to achieving 2% inflation and that it will do whatever it takes to achieve it.”

Reuters: “Kuroda said the world’s third-biggest economy was recovering moderately and the underlying price trend was rising steadily. ‘But there’s a risk recent further falls in oil prices, uncertainty over emerging economies, including China, and global market instability could hurt business confidence and delay the eradication of people’s deflationary mindset,’ he said.”

Draghi’s ECB entered the fray on March 9th. Determined to “beat market expectation,” ECB doves pushed the hawks completely out of the way to boost monthly QE by 20bn euros (second increase in three months), slash rates, introduce a new LTRO lending program, and add corporate debt to its buy list. Mario Draghi rather proudly stated: “We have shown that we are not short of ammunition.”

The FOMC refrained from rate normalization during January and March meetings, as the tone was set for “whatever it takes” central banking worldwide. The subsequent global market rally was interrupted by the previously thought impossible, a majority in the UK voting on Thursday, June 23rd to exit the EU.

A shocked market pounded the pound down more than 10%, before the British currency ended that Friday’s session down 8.3%. The euro fell 3%, while EM currencies were under heavy selling pressure. Safe haven assets surged. Treasury yields sank to 1.41%, the yen jumped 3.8% and gold rose 4%. Meanwhile, global equities erased $2.0 TN of value. Italian and Spanish stocks were down about 12%, with losses of about 6% for German and French equities. European bank stocks were crushed. The DJIA dropped 611 points on June 24th trading. The Nasdaq Composite was down 202 points, or 4.1%, its worst showing since 2011. Crude sank 5%. It would prove a great buying opportunity for almost all global risk assets.

On August 4th, the Bank of England (with unemployment at 4.9% and market yields collapsing) moved forward with “whatever it takes,” cutting rates and reviving QE. From the UK Guardian: “Carney rebuffed suggestions the Bank was over-reacting to the Brexit vote and implied the UK would fall into recession without the new measures. ‘There is a clear case for stimulus, and stimulus now, in order to have an effect when the economy really needs it,’ he said.” The FTSE 100 ended the year up 14.4% at an all-time high. Not faring as well, the British pound dropped 16.3% versus the dollar.

By August markets took serious comfort from “whatever it takes.” And when it came to global reflation and reversing faltering market Bubbles, global central bankers had received extraordinary assistance from Beijing. Panicked Chinese officials had imposed a series of extreme measures to bolster liquidity and market prices, while adopting various control measures that restricted “money” leaving the country. The so-called “national team” had become an aggressive buyer of Chinese equities. Most importantly, a surge in state-directed lending saw Total Social Financing jump an incredible $525bn in January, spurring what would be a record $1.5 TN of first-half Credit growth – and full-year 2016 Credit expansion approaching an unmatched $3.0 TN.

When it comes to major Credit Bubbles, there’s inherently a fine line between a bursting Bubble and a perilous amplification of Terminal Phase Excess. It’s worth recalling that previous Chinese official efforts to rein in overheated real estate (apartment) markets worked to push excess liquidity into increasingly speculative stock markets. Trading around 2,200 in mid-2014, the Shanghai Composite surged to a peak Bubble 5,380 by mid-2015. Ironically, efforts this year to stabilize faltering equities, mounting Credit stress and a rapidly slowing economy incited a precarious liquidity (speculative blow-off) stampede into real estate and bond Bubbles.

Chinese mortgage finance Bubble excess this year pushed China’s housing Bubble to a state of being completely out of control. Year-over-year prices surged 46% in Shanghai, 35% in Beijing, 51% in Shenzhen and 49% in Nanjing. Despite mounting defaults and Credit stress, the over-abundance of cheap liquidity ensured that Chinese companies continued their aggressive leveraging. Growing another 16.5% during 2016, China now takes claim to the third-largest global bond market. Total repo financing is said to now exceed the amount of available outstanding bonds, in the face of an ongoing rapid expansion of “Shadow Finance” and speculative leveraging.

Total Chinese debt now easily exceeds 250% of GDP. It was also a record year for Chinese outbound M&A – $219 billion (Dealogic). As the year progressed, rapid Credit growth fueled rises in consumer and producer inflation: China’s November PPI was up 3.3% y-o-y, the strongest rise since 2011

As 2016 came to an end, Chinese officials appeared to recognize the dilemma they faced. The talk was how surging home prices posed a risk to social stability, and of the need for more aggressive measures to thwart Bubbles. In particular, “shadow banking” and speculation appear to be in official crosshairs.

The Shanghai Composite dropped 6.4% in December. More ominously, China’s bond markets turned increasingly unstable. Ten-year Chinese government yields surged 50 bps in several weeks (to 3.32%), before a year-end rally had yields closing 2016 at 3.04%. Year-end funding pressures were even more intense than usual.  More importantly, increasingly conspicuous cracks are forming in China’s corporate financing markets. Liquidity, default, fraud and counter-party issues are taking a rising toll. Desperate measures in 2016 to mask systemic debt problems with record amounts of new debt and market intervention will have dire consequences.

It’s that ominous dynamic of rapidly rising Credit necessary to stimulate even declining economic growth. But massive Credit did stabilize Chinese economic activity in 2016, playing a major role in the stabilization of global crude and commodity prices – price recoveries that were instrumental in stabilizing global debt concerns that were spreading from commodity-related companies, countries and regions.

It’s worth noting that the popular U.S. high-yield bond ETF (HYG) was down almost 7.0% by mid-February. Emerging market stocks and bonds were trading at multi-year lows. Key EM currencies, including the Mexican peso, South Korean won, South African rand, Indian rupee, Russian ruble, and Turkish lira, were under heavy selling pressure. Remember the fears for Glencore and other companies highly leveraged to commodities?

Well, Glencore’s stock ended 2016 up over 200%. U.S., European and Asian junk debt, for the most part, enjoyed a banner year. The HYG returned 13.4% in 2016, ahead of the 9.3% gain for the EMB (EM bond ETF). EM stocks (EEM) rose 11.7%. The GSCI Commodities Index jumped 27.9%, led by a 45% increase in crude prices. Stocks in Brazil gained 38.9%, Russia 26.8% and Mexico 6.2%. Down a quick 12% to start the year, Canadian stocks ended 2016 with a 17.5% gain, the “Developed World’s Top Market.”

Who back in February would have forecast oil, junk, Brazil and Russia at the top of the 2016 leaderboard? Who would have predicted Friday’s AP headline? “Energy Companies and Banks Led Rally on S&P 500 in 2016.” But it’s always the leveraged and finance-dependent entities “at the margin” that are most sensitive to changing financial conditions. Without extreme “whatever it takes” measures (from global central banks and China) it would be today a very different world. This year’s biggest winners – stocks, bonds, currencies, etc. – could have instead been huge losers, with the Periphery dragging down the Core.

But with global QE in the neighborhood of $2.0 TN annually and hundreds of billions flowing out of China, the vulnerable Periphery enjoyed a liquidity windfall. Global fragilities were in the short-term ameliorated by unprecedented global rate and liquidity dynamics. The year began with the world at the precipice of a bursting Bubble. The bottom line is that the global Bubble persevered and then inflated significantly.

To be sure, Global Monetary Disorder become deeply entrenched. After trading at a 13-year low $26.05, WTI crude more than doubled (“biggest annual gain since 2009”) to trade as high as $54.50 near year-end (OPEC managing the first production cut since 2008). Trading inversely to risk assets, bullion began the year at $1,061, surged to $1,375 (7/11) and then reversed course to end the year at $1,152. After starting 2016 at 111, the HUI gold equities index surged to 286 in July, before reversing course to close the year up 64% at 182. Wild moves were not limited to commodities. The British pound sank 10% versus the dollar on Brexit, to a 31-year low. The Mexican peso collapsed 14% to an all-time low on Trump’s equally stunning win. Draghi’s December move to expand and extend ECB monetary stimulus pushed the euro to a 14-year low against the U.S. currency.

The Japanese yen has for some time been a leading funding currency for global leveraged speculation. The dollar/yen began the year at 120.22 before trading as high as 121.69 on January 29th. Fears of global de-risking/de-leveraging saw the yen rally strongly versus the dollar. This advance was capped by a Brexit induced better than 4% surge that had the dollar/yen trading below 100 on June 24th (first time below 100 since 2013). The dollar/yen began to rally in September, although it traded as low as 101.20 during chaotic U.S. election-night trading. Then an abrupt rally had the dollar/yen trade as high as 118.66 on December 15th, before closing 2016 at 116.96.

Yet nowhere was Monetary Disorder more prominent in 2016 than throughout global bond markets. When it appeared global yields could not possibly decline much more, the impossible: They sank a lot lower, hitting historic extremes in the wake of the Brexit vote. UK debt has traded for a very long time, yet never at yields as low as those of 2016. After beginning the year at 1.96%, 10-year gilt yields dropped to 1.22% in early-July. After starting 2016 at 2.27%, 10-year Treasury yields hit a record low 1.36% on July 8th. Japan’s JGB yields sank to negative 29 bps, after starting the year at positive 27 bps. Swiss 10-year yields were a negative five bps to begin the year, but then sank to an incredible negative 63 bps. Bund yields dropped to negative 19 bps (began 2016 at 63bps), as French yields fell all the way to 10 bps (99 bps). Highly indebted Italy saw its 10-year yields sink to an impossibly low 1.04% (1.60%), and Spanish yields fell to an equally incredible 0.88% (1.77%). By August, an impossible $13.4 TN of global bonds were trading with negative yields (FT).

It evolved into a spectacular market dislocation and melt-up, surely fueled by derivative-related trading and a powerful short-squeeze. Typical of blow-off tops with their abrupt reversals, market euphoria proved short-lived. From 2016 lows, Treasury yields surged 124 bps, with British gilt yields up 109 bps. From lows to highs, bund yields rose 59 bps, French yields 77 bps and Spanish yields 73 bps.

Of special note, Italian yields jumped 109 bps from earlier lows, with a year-end rally reducing the 2016 yield rise to 22 bps at 1.82%. Portuguese bonds ended the year at 3.76%, up 124 bps. Providing a good microcosm of “Periphery” instability, Greek bond yields surged to 11.57% in February only to close 2016 at 7.11%. In a few short weeks, Mexican (peso) yields surged 160 bps, with significant yield rises throughout EM.

For the year, the Argentine peso declined 18.6%, the Turkish lira 17.2%, the Mexican peso 17.0%, the Polish zloty 6.3%, the Philippine peso 5.2% and the Malaysian ringgit 4.3%. Mexico was forced to raise rates to support a rapidly sinking peso and counter prospects for an inflationary surge.

Wild markets for the most part didn’t help the struggling leveraged speculating community. A December 28th Bloomberg headline: “The Golden Era of Hedge Funds Draws to a Close With Clients in Revolt.” While most funds again underperformed expectations, the industry got through 2016 without major redemptions. This they owe to central bankers and Chinese officials. And another Bloomberg headline, this one from December 30th: “Actively Managed Funds Take a Beating.” Throughout 2016, and especially after the election, “money” literally flooded into equity index and other passively managed ETFs. Central bankers ensured that managers attentive to risk and risk management had another crummy year.

I expect future historians will see 2016 chiefly through the geopolitical perspective. How can market happenings compete against Brexit, the Trump phenomenon and Renzi’s failed political reform referendum (to name only the most obvious)? But clearly unstable markets, unsettled societies and simmering geopolitical turmoil are more than coincidental. At their roots, all can be traced to a prolonged period of unchecked finance, central bank activism and the general effects of inflationism.

Consequences were on increasing display throughout 2016. There was the rising tide of anti-establishment populism that seemingly became a global phenomenon. There was the deep discontent that led to Brexit and President-elect Trump. This was part of general instability and uncertainty that afflicted financial markets – in the process ensuring “whatever it takes” went to even crazier extremes. And, almost ironically, this is the type of mercurial social and monetary backdrop conducive to powerful markets reversals and attendant bouts of hope and optimism.

December 27 – Bloomberg (Vince Golle): “The last time Americans’ optimism about the stock market registered such a dramatic one-month surge was during the dot-com boom. As stocks reached a record, the share of households anticipating higher equity prices a year from now surged to 44.7% in December from 30.9% a month earlier, the biggest monthly advance since November 1998…”

As an extraordinary year came to an end, confidence overtook caution. Just kind of pushed it aside. Markets became willing to dismiss myriad risks – all the uncertainties associated with China, Italy, rising populism, terrorism, geopolitical, etc. It was as if everyone just turned tired of worrying. There was as well a willingness to imagine the best of President-elect Trump’s policies, while disregarding all the uncertainty that comes with such a unique personality. It’s going to be an incredibly fascinating 2017.

For the Week:

The S&P500 declined 1.1% (up 9.5% in 2016), and the Dow dipped 0.9% (up 13.4%). The Utilities were little changed (up 13.2%). The Banks gave back 1.4% (up 25.6%), and the Broker/Dealers sank 2.2% (up 15.3%). The Transports lost 1.6% (up 20.4%). The S&P 400 Midcaps slipped 0.8% (up 18.7%), and the small cap Russell 2000 declined 1.0% (up 19.5%). The Nasdaq100 dropped 1.5% (up 5.9%), and the Morgan Stanley High Tech index fell 1.3% (up 12.3%). The Semiconductors fell 2.3% (up 36.6%). The Biotechs sank 3.3% (down 19.4%). With bullion recovering $18, the HUI gold index rallied 7.9% (up 64%).

Three-month Treasury bill rates ended the week at 50 bps. Two-year government yields slipped a basis point to 1.19% (up 14 bps for 2016). Five-year T-note yields fell 10 bps to 1.93% (up 18bps). Ten-year Treasury yields dropped nine bps to 2.45% (up 20bps). Long bond yields declined five bps to 3.07% (up 5bps).

Greek 10-year yields dropped 22 bps to close the year at 7.02% (down 30bps in 2016). Ten-year Portuguese yields added two bps to 3.75% (up 123bps). Italian 10-year yields slipped a basis point to 1.81% (up 31bps). Spain’s 10-year yields increased one basis point to 1.38% (down 39bps). German bund yields slipped a basis point to 0.20% (down 42bps). French yields declined one basis point to 0.68% (down 31bps). The French to German 10-year bond spread was unchanged at 48 bps. U.K. 10-year gilt yields dropped 11 bps to 1.24% (down 73bps). U.K.’s FTSE equities index jumped 1.1% (up 14.4%).

Japan’s Nikkei 225 equities index dropped 1.6% (up 0.4% for 2016). Japanese 10-year “JGB” yields declined a basis point to 0.04% (down 22bps). The German DAX equities index added 0.3% (up 6.9%). Spain’s IBEX 35 equities index slipped 0.2% (down 2.0%). Italy’s FTSE MIB index declined 0.6% (down 10.2%). EM equities were mixed. Brazil’s Bovespa index surged 4.0% (up 38.9%). Mexico’s Bolsa gained 1.0% (up 6.2%). South Korea’s Kospi declined 0.5% (up 3.3%). India’s Sensex equities index rallied 2.2% (up 1.9%). China’s Shanghai Exchange slipped 0.2% (down 12.3%). Turkey’s Borsa Istanbul National 100 index jumped 1.5% (up 8.9%). Russia’s MICEX equities index rallied 2.7% (up 26.8%).

Junk bond mutual funds saw inflows of $592 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates added two bps to a 27-month high 4.32% (up 31bps y-o-y). Fifteen-year rates rose three bps to 3.55% (up 31bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 4.37% (up 27bps).

Federal Reserve Credit last week expanded $3.7bn to a nine-week high $4.427 TN. Over the past year, Fed Credit contracted $27.4bn (down 0.6%). Fed Credit inflated $1.616 TN, or 58%, over the past 216 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt jumped $8.0bn last week to $3.180 TN. “Custody holdings” were down $144bn y-o-y, or 4.3%.

M2 (narrow) “money” supply last week added $1.3bn to $13.236 TN. “Narrow money” expanded $909bn, or 7.4%, over the past year. For the week, Currency increased $0.3bn. Total Checkable Deposits gained $8.8bn, while Savings Deposits declined $6.3bn. Small Time Deposits slipped $1.3bn. Retail Money Funds gained $1.2bn.

Total money market fund assets jumped $15.9bn to $2.728 TN. Money Funds declined $31bn y-o-y (1.1%).

Total Commercial Paper surged $20.5bn to $987bn. CP declined $70bn y-o-y, or 6.7%.

Currency Watch:

December 29 – Wall Street Journal (Lingling Wei): “China’s central bank is adjusting the mix of foreign currencies used in setting the yuan’s official daily value… Starting Jan. 1, the central bank will expand the number of currencies in the basket uses to calibrate the yuan’s value to 24 from 13 and reduce the weighting given to the U.S. dollar to 22.4%, from 26.4%… China wants a slightly weaker currency to help exporters and maintain competitiveness with other economies as the dollar rises, but it doesn’t want to lose control. By diluting the dollar’s share and bringing in currencies from the Korean won to the Saudi riyal and Swedish krona, the People’s Bank of China is giving itself more room to maneuver to keep the yuan from falling too fast, analysts said.”

The U.S. dollar index slipped 0.6% to 102.4 (up 3.8% y-t-d). For the week on the upside, the South African rand increased 1.9%, the Swedish krona 1.1%, the New Zealand dollar 0.9%, the Swiss franc 0.7%, the Norwegian krone 0.7%, the Canadian dollar 0.7%, the Brazilian real 0.6%, the euro 0.6%, the British pound 0.5% and the Australian dollar 0.5%. For the week on the downside, the Mexican peso declined 0.6%, the South Korean won 0.4% and the Taiwanese dollar 0.3%. The Chinese yuan was little changed versus the dollar (down 6.6%).

Commodities Watch:

The Goldman Sachs Commodities Index jumped 1.7% (up 27.9% in 2016). Spot Gold rallied 1.6% to $1,152 (up 8.6%). Silver gained 1.4% to $15.98 (up 15.8%). Crude rose 81 cents to $53.83 (up 45%). Gasoline added 1.9% (up 32%), and Natural Gas gained 1.7% (up 60%). Copper rose 1.1% (up 17%). Wheat jumped 3.7% (down 13%). Corn recovered 1.8% (down 2%).

Italy Watch:

December 26 – Reuters (Silvia Aloisi and Stephen Jewkes): “The European Central Bank has told Monte dei Paschi it needs to plug a capital shortfall of 8.8 billion euros ($9.2bn), higher than a previous 5 billion euro gap estimated by the bank… Last Friday the Italian government approved a decree to bail out Monte dei Paschi after Italy’s No. 3 lender failed to win investor backing for a desperately needed 5 billion euro capital increase. The bank said on Monday it had officially asked the ECB last Friday for go ahead for a ‘precautionary recapitalization’.”

December 26 – Reuters (Maria Sheahan): “European Central Bank policymaker Jens Weidmann said plans for a state bailout of Italian bank Monte dei Paschi di Siena should be weighed carefully as many questions remain to be answered… ‘For the measures planned by the Italian government the bank has to be financially healthy at its core. The money cannot be used to cover losses that are already expected,’ Bild quoted Weidmann as saying…”

Europe Watch:

December 27 – Reuters (Maria Sheahan): “Germany’s Bundesbank has this year taken back more of its gold than planned as it moves towards hoarding half of the world’s second-largest reserve at home, Bundesbank President Jens Weidmann told German daily Bild. ‘We brought back significantly more gold to Germany in 2016 again than initially planned. By now, almost half of the gold reserves are in Germany,’ the paper quoted Weidmann… In the wake of the euro zone crisis, many ordinary Germans want to see more of the 3,381 tonnes of gold in vaults at home.”

China Bubble Watch:

December 22 – Bloomberg: “President Xi Jinping said China should deflate property bubbles and regulate the market for rental housing to better meet people’s residential needs, reinforcing the objectives outlined last week at an annual gathering of the country’s top economic leaders. ‘The country should accurately understand the residential feature of housing’ and create a better system for purchases and rentals to better serve new urban populations, Xi said… ‘The market will play the leading role in catering to multi-layered demand, while the government will take care of basic housing demand.’”

December 25 – Bloomberg: “China Guangfa Bank Co. said Monday that documents and seals for a letter claiming to guarantee bond payments by the lender were forged, in the second such incident in the nation this month, raising concern about transparency in the world’s third-biggest bond market… ‘Over the past few years, business growth of financial institutions has outpaced their capability to boost internal controls and also gone beyond the radar of regulators,’ said He Xuanlai… analyst at Commerzbank AG… A lack of transparency and protection in bond documentation are adding to angst among investors after Sealand Securities Co. said earlier this month a former employee was found to have forged a seal to conduct bond trading. Concern about China’s bond market has been climbing after at least 28 onshore notes defaulted this year amid an economic slowdown, jumping from seven in 2015.”

December 28 – Bloomberg (Justina Lee): “China bulls could be facing a grim New Year’s eve. The first day of 2017 is when an annual $50,000 quota to convert the yuan into foreign exchange resets, stoking concern there will be a rush to sell the local currency. With tax payments and a regulatory assessment also tightening liquidity in the money market toward year-end, January may bring scant relief as lenders prepare for stronger cash demand before Lunar New Year holidays, which are only a month away. China’s markets are seeing renewed pressure this month as the Federal Reserve projects a faster pace of rate increases for 2017 and its Chinese counterpart tightens monetary conditions to spur deleveraging and defend the exchange rate. The declines are capping off a tough year for investors during which bonds, shares and currency all slumped.”

December 27 – Bloomberg: “The onshore yuan’s surging trading volume is another piece of evidence that capital is fleeing China at a faster pace. The daily average value of transactions in Shanghai climbed to $34 billion in December as of Monday, the highest since at least April 2014… That’s up 51% from the first 11 months of the year. The increase suggests quickening outflows, given that data in recent months showed banks were net sellers of the yuan, according to Harrison Hu, …chief greater China economist at Royal Bank of Scotland… This month’s jump in trading volume signals sentiment has kept deteriorating since November, when the nation’s foreign-exchange reserves shrank by the most since January.”

December 29 – Bloomberg: “China pledged more proactive fiscal policy in 2017 while vowing to enhance control over local government debt, as policy makers in the world’s second-largest economy seek to sustain steady growth while defusing risks. Fiscal policy will be more proactive and effective next year, and more tax cuts will be rolled out… China will ‘reasonably’ expand expenditures and improve efficacy, while strengthening management of local government debt, it said.”

December 28 – Bloomberg: “China’s requirement for how much cash banks must hold as reserves is ‘very high’ and should be reduced at an ‘appropriate time,’ a senior banking regulator said… Other financing tools can be used to manage the money supply after easing the required reserve ratio, China Banking Regulatory Commission official Yu Xuejun said… New monetary tools such as the medium-term lending facility are best used after a cut… The People’s Bank of China has held the RRR at 17% since February after four cuts last year.”

Global Bubble Watch:

December 27 – Financial Times (Eric Platt): “Global debt sales reached a record in 2016, led by companies gorging on cheap borrowing costs that are now threatened by Donald Trump’s pledge to fire up the US economy. The bond rally that dominated the first half of the year helped entice borrowers that issued debt via banks to take on just over $6.6tn, according to… Dealogic, breaking the previous annual record set in 2006. Companies accounted for more than half of the $6.62tn of debt issued, underlining the extent to which negative interest-rate policies adopted by the European Central Bank and the Bank of Japan, as well as a cautious Federal Reserve, encouraged the corporate world to increase its leverage. Corporate bond sales climbed 8% year on year to $3.6tn… The year’s debt sales were buoyed by China and Japan-based issuers, up 23 and 30% respectively, from a year earlier.”

December 19 –Reuters (Marc Jones): “The number of firms worldwide that have defaulted this year has reached 150, up more than 40% year-on-year, making 2016 the worst year for corporate stress since the height of the global financial crisis, ratings firm Standard and Poor’s said. S&P data showed that two defaults last week by U.S.-based firms had brought up the milestone and taken the U.S.-only count to 99, or two-thirds of the overall total. Just over 40%, or 63, had been by oil and gas firms, with 50 of those also in the United States. Emerging markets had accounted for 28 defaults overall, followed by Europe on 12.”

December 29 – Financial Times (Arash Massoudi, James Fontanella-Khan and Don Weinland): “A final flurry of large takeovers during the last months of 2016 lifted global dealmaking to its second-best annual level since the financial crisis as appetite for corporate acquisitions continued in spite of political turmoil and heightened regulatory scrutiny. Merger and acquisition activity in the fourth quarter reached $1.2tn, the busiest period for dealmaking in 2016… In total, the volume of global M&A was $3.6tn in 2016, a 17% drop from last year’s record $4.37tn but enough to make the year the second highest for dealmaking since 2007… Chinese companies became a major force in cross-border M&A in 2016, accounting for $220bn of transactions — almost double the amount of 2015.”

December 28 – Bloomberg (Tom Metcalf and Jack Witzig): “In a year when populist voters reshaped power and politics across Europe and the U.S., the world’s wealthiest people are ending 2016 with $237 billion more than they had at the start. Triggered by disappointing economic data from China at the beginning, the U.K.’s vote to leave the European Union in the middle and the election of billionaire Donald Trump at the end, the biggest fortunes on the planet whipsawed through $4.8 trillion of daily net worth gains and losses during the year, rising 5.7% to $4.4 trillion by the close of trading Dec. 27, according to the Bloomberg Billionaires Index.”

U.S. Bubble Watch:

December 27 – Bloomberg (Michelle Jamrisko): “Consumer confidence climbed in December to the highest level since August 2001 as Americans were more upbeat about the outlook than at any time in the last 13 years, according to the… Conference Board. Measure of consumer expectations for the next six months rose to 105.5, the highest since December 2003, from 94.4…”

December 26 – Wall Street Journal (Corrie Driebusch and Aaron Kuriloff): “Corporate stock repurchases are on the upswing once again, wrong-footing skeptics who predicted 2016 would mark the beginning of the end of a postcrisis spending spree. Through Dec. 16, companies this month have stepped up their buybacks by nearly two-thirds over the same period last year, according to Goldman Sachs… Repurchases have been a major contributor to the nearly eight-year stock rally. From the start of 2009 to the end of September 2016, companies in the S&P 500 spent more than $3.24 trillion repurchasing shares… In the first three quarters of the year, companies in the S&P 500 spent just over $400 billion on stock buybacks, down from the $426 billion in the same period last year…”

December 27 – Bloomberg (Vince Golle): “The last time Americans’ optimism about the stock market registered such a dramatic one-month surge was during the dot-com boom. As stocks reached a record, the share of households anticipating higher equity prices a year from now surged to 44.7% in December from 30.9% a month earlier, the biggest monthly advance since November 1998, the Conference Board’s report… showed…”

December 29 – Reuters (Swetha Gopinath): “U.S. shale drillers are set to ramp up spending on exploration and production next year as recovering oil prices prompt banks to extend credit lines for the first time in two years. The credit increase is small, but with major oil producers worldwide aiming to hold down production in 2017, U.S.-based shale drillers are looking to boost market share to take advantage of higher prices, and greater availability of capital will make that easier.”

December 28 – Wall Street Journal (Kirsten Grind and Peter Rudegeair): “This is a great time to be in the house-flipping business. The number of investors who flipped a house in the first nine months of 2016 reached the highest level since 2007. About one-third of the deals were financed with debt, a percentage not seen in eight years. Now Wall Street, which was nearly felled by real-estate forays almost a decade ago, is getting back into the action. A number of banks are arranging financing vehicles for house-flippers, who buy and sell homes in a matter of months.”

EM Watch:

December 27 – Dow Jones: “Brazil’s government deficit widened to 9.28% of gross domestic product in the 12 months through the end of November, compared with 8.83% through the end of October… The primary budget balance, which excludes interest payments and is a measure of the government’s ability to reduce its debt, increased to 2.50% of GDP…”

Leveraged Speculator Watch:

December 28 – CNBC (Jeff Cox): “Hedge funds have jacked up their bets on the stock market to their highest levels of 2016 and cut back on short positions to a three-year low amid a blistering post-election rally. For the fourth quarter, the $3 trillion industry increased its net exposure — the difference between short and long positions — to 63%, a level that equates to a net $656 billion, according to Bank of America Merrill Lynch data. Hedge funds were last this optimistic in the fourth quarter of 2015.”

Geopolitical Watch:

December 27 – Reuters (J.R. Wu and Ben Blanchard): “China’s sole aircraft carrier has arrived at a naval base on the southern Chinese province of Hainan, a senior Taiwanese military officer said…, after drills that took it around self-ruled Taiwan, an island China claims as its own. Taiwan warned on Tuesday that ‘the threat of our enemies is growing day by day’, as Chinese warships led by the carrier sailed towards Hainan through the disputed South China Sea.”

December 28 – Reuters (Ben Blanchard): “Quoting a poem by the founder of Communist China Mao Zedong, China’s government said… that the efforts by Hong Kong and Taiwan independence supporters to link up were doomed to fail, as they would be dashed to the ground like flies. Chinese leaders are increasingly concerned about a fledgling independence movement in the former British colony of Hong Kong, which returned to mainland rule in 1997 with a promise of autonomy, and recent protests in the city. China is also deeply suspicious of Taiwan President Tsai Ing-wen, elected earlier this year, who Beijing suspects is pushing for the self-ruled island’s independence.”

December 22 – Financial Times (Tom Mitchell and Demetri Sevastopulo): “China has warned Donald Trump that ‘co-operation is the only correct choice’ after the US president-elect tapped a China hawk to run a new White House trade policy office. The appointment of Peter Navarro, a campaign adviser, to a formal White House post shocked Chinese officials and scholars who had hoped that Mr Trump would tone down his anti-Beijing rhetoric after assuming office.  Mr Navarro… is the author of Death by China and other books that paint the country as America’s most dangerous adversary.”

December 29 – Reuters (Jeff Mason): “President Barack Obama… authorized a series of sanctions against Russia for intervening in the 2016 U.S. presidential election and warned of more action to come. ‘These actions follow repeated private and public warnings that we have issued to the Russian government, and are a necessary and appropriate response to efforts to harm U.S. interests in violation of established international norms of behavior,’ Obama said…’These actions are not the sum total of our response to Russia’s aggressive activities. We will continue to take a variety of actions at a time and place of our choosing, some of which will not be publicized,’ he said.”

December 19 –Reuters: “The Russian ambassador to Turkey was shot in the back and killed as he gave a speech at an Ankara art gallery on Monday by an off-duty police officer who shouted ‘Don’t forget Aleppo’ and ‘Allahu Akbar’ as he opened fire. President Tayyip Erdogan… cast the attack as an attempt to undermine NATO-member Turkey’s relations with Russia – ties long tested by the war in Syria. He said he had agreed in a telephone call with Russia’s Vladimir Putin to step up cooperation in fighting terrorism.”

Doug Noland: Renzi Falls, Markets Rise

Italian bank stocks (FTSE Italia bank index) declined a modest 2.3% Monday on the back of Sunday’s resounding defeat of Italian Prime Minister Renzi’s political reform referendum. The bank index then proceeded to surge 9.0% Tuesday, 4.5% Wednesday and another 3.6% Thursday, for a stunning 27% rally off November 28th trading lows. “Par for the course,” as they say.

Weekly Commentary: Peak Monetary Stimulus

October 28 – Bloomberg (Eliza Ronalds-Hannon and Claire Boston): “After all central bankers have done since the financial crisis to prop up bond prices, it didn’t take much for them to send the global debt market reeling. Bonds worldwide have lost 2.9% in October, according to the Bloomberg Barclays Global Aggregate Index, which tracks everything from sovereign obligations to mortgage-backed debt to corporate borrowings. The last time the bond world was dealt such a blow was May 2013, when then-Federal Reserve Chairman Ben S. Bernanke signaled the central bank might slow its unprecedented bond buying.”

German bund yields surged 16 bps this week to 0.16% (high since May), with Bloomberg calling performance the “worst month since 2013.” French yields jumped 18 bps this week (to 0.46%), and UK gilt yields rose 17 bps (to 1.26%). Italian yields surged a notable 21 bps to a multi-month high 1.58%.

A cruel October has seen German 10-year yields surging 31bps, with yields up 58 bps in the UK, 31 bps in France, 40 bps in Italy, 33 bps in Spain and 30 bps in the Netherlands. Ten-year yields have surged 43 bps in Australia, 40 bps in New Zealand and 25 bps in South Korea.

Countering global bond markets, Chinese 10-year yields traded Monday at a record low 2.60%. There seems to be a robust safe haven dynamic at work. It’s worth noting that China’s one-year swap rate ended the week at an 18-month high 2.73%, with China’s version of the “TED” spread (interest-rate swaps versus government yields) also widening to 18-month highs.

Here at home, 10-year Treasury yields this week jumped 12 bps to 1.85%, the high since May. Long-bond yields rose 15 bps to 2.62%, with yields up 30 bps in four weeks.

And while sovereign bond investors are seeing a chunk of their great year disappear into thin air, the jump in yields at this point hasn’t caused significant general angst. During the October sell-off, corporate debt has outperformed sovereign, and there are even U.S. high yield indices that have generated small positive returns for the month. Corporate spreads generally remain narrow – not indicating worries of recession or market illiquidity.

October 27 – Wall Street Journal (Ben Eisen): “By some measures, October is already a record month for mergers and acquisitions. Qualcomm $39 billion deal to buy NXP Semiconductors helped push U.S. announced deal volume this month to $248.9 billion, according to… Dealogic. That tops the previous record of $240.2 billion from last July… It was assisted by last week’s record weekly U.S. volume of $177.4 billion.”

And while bond sales have slowed somewhat in October, global corporate bond issuance has already surpassed $2.0 TN. The Financial Times is calling it “the best year in a decade,” with issuance running 9% ahead of a very strong 2015. According to Bloomberg, this was the third-strongest week of corporate debt issuance this year.

At this point, there’s not a strong consensus view as to the factors behind the global backup in yields. Some see rising sovereign yields as an indication of central bank success: with inflation finally having turned the corner, there will be less pressure on central bankers to push aggressive stimulus. Others argue that central bankers are coming to accept that the rising risks of QE infinity and negative rates have overtaken diminishing stimulus benefits.

Importantly, there’s no imminent reduction in the approximately $2.0 TN annual QE that has been underpinning global securities and asset prices. It’s hard to believe it’s been almost three and one-half years since the Bernanke “taper tantrum.” With only one little baby-step rate increase to its Credit, rate normalization couldn’t possibly move at a more glacial pace.

There’s deep complacency in the U.S. regarding vulnerability to reduced monetary stimulus. The Fed wound down QE and implemented a rate increase without major market instability. I believe this was only possible because of the extraordinary monetary stimulus measures in play globally. “Whatever it takes” central banking, in particular from the ECB and BOJ, unleashed Trillions of liquidity (and currency devaluation) that certainly underpinned U.S. securities and asset markets. Prices of sovereign debt, including Treasuries, have traded at levels that assume global central banker support will last indefinitely. Markets have begun reassessing this assumption.

October 28 – Reuters (Leika Kihara): “As his term winds down, Bank of Japan Governor Haruhiko Kuroda has retreated from both the radical policies and rhetoric of his early tenure, suggesting there will be no further monetary easing except in response to a big external shock. In a clear departure from his initial ‘shock and awe’ tactics to jolt the nation from its deflationary mindset, he has even taken to flagging what little change lies ahead, trying predictability where surprise has failed. This new approach will be on show next week, when the BOJ is set to keep policy unchanged despite an expected downgrade in forecasts that could show Kuroda won’t hit his perpetually postponed 2% inflation target before his five-year term ends in April 2018. ‘The days of trying to radically heighten inflation expectations with shock action are over,’ said a source familiar with the BOJ’s thinking. ‘No more regime change.’”

My view that “QE has failed” has seemed extreme – even outrageous to conventional analysts. Yet Japan is the epicenter of the Bernanke doctrine of radical experimental inflationism. Unshakable central banker “shock and awe” and “whatever it takes” were supposed to alter inflationary expectations throughout the economy, in the process boosting asset prices, investment, incomes, spending and – importantly – the general price level. Deflation, it was argued, was self-imposed.

It may have worked brilliantly in theory – it’s just not looking so bright in practice. An impervious Japanese CPI has continued to decline, while the central bank has pushed bond prices to ridiculous extremes by purchasing a third of outstanding government debt. Major risks associated with an out-of-control central bank balance sheet and asset Bubbles are not inconspicuous in Japan. There is today heightened pressure in Japanese policy circles to wind down this experiment before it’s too late. It will not go smoothly.

In the category “truth is stranger than fiction”, November 8th can’t arrive soon enough. Suddenly, it appears the markets may have some election risk to contemplate. And there will be no rest for the weary. The ECB meets one month later, on December 8th.

October 27 – Bloomberg (Jeff Black and Jill Ward): “European Central Bank officials signaled that they support extending asset buying beyond the earliest end-date of March, arguing that returning to a healthy level of inflation demands maintaining the pace as the economy heals. Speaking in London…, Irish central bank Governor Philip Lane said that the ‘broad narrative’ in the market about the ECB’s strategy on bond purchases is that it will continue until inflation is heading reliably toward the target of just under 2%. His comments echoed remarks by Executive Board member Benoit Coeure… and Spain’s Governor Luis Maria Linde… ‘March was always an intermediate staging post,’ said Lane. ‘The narrative of the euro area is that there’s been this moderate but sustained recovery, by and large driven by domestic factors, especially consumption. But inflation remains low compared to target and essentially that’s the assessment.’”

I’m not so sure Germany and fellow ECB hawks saw March as “always an intermediate staging post.” Draghi purposely avoided commencing the discussion of extending QE past March. What will likely be a heated debate will take place in December.

October 25 – Reuters (Gernot Heller): “There is a growing international consensus that monetary policy has reached the limits of its possibilities, German Finance Wolfgang Schaeuble told a group of government officials in Berlin… Schaeuble also said that he believed that there was an excess of liquidity and excess of indebtedness internationally.”

Over recent months, German public opinion has turned even more against QE. Bundesbank President Jens Weidmann has been opposed to QE from day one, and his skepticism has been shared by fellow German (ECB executive board member) Sabine Lautenschläger. A majority of Germans believe QE is hurting Deutsche Bank and the German banking system more generally. And there is growing frustration that the ECB is a mechanism for redistributing German wealth. The stakes for dismissing German concerns are growing.

Draghi has grown accustomed to playing dangerously. Front-running committee deliberations, he has signaled to the markets that QE will run past March. Comments and leaks from within the ECB have encouraged the markets to assume that aggressive stimulus will run uninterrupted for months to come. All this places great pressure on ECB hawks. And this is a group that has seen its concerns repeatedly rejected; a group that has surely become only more troubled by the course of Eurozone and global monetary policymaking. If they have much say in policy come December, markets will tantrum. I can imagine that Draghi’s pressure tactics must by this point be wearing really thin.

Fledgling “risk off” turned more apparent this week. Notably, the broader U.S. equities market came under pressure. Having outperformed over recent months, the now Crowded Trades in the mid- and small-caps saw price drops of 1.8% and 2.5%. In general, the beloved high dividend and low volatility stocks – colossal Crowded Trades – also badly lagged the market. The REITS (VNQ) dropped another 3.6% this week, having declined 13% from August highs to trade to the lowest level since April. The homebuilders (XHB) declined to the low since March. It’s worth noting that Ford this week also traded to lows going back to March.

Abnormal has been around so long now we’ve grown accustomed. Fifteen-year mortgage rates at 2.78%. ARMs available at 2.75%. And I’m hearing automobile advertisements even more outrageous than 2007. “Lease Kia two for $222 a month.” How much future demand has been pulled forward by history’s lowest interest rates – and accompanying loose Credit.

QE is not disappearing any day soon. Yet there’s a decent argument that we’re at Peak Monetary Stimulus. The Fed is preparing for a hike in December. The Kuroda BOJ has lost its appetite for surprising markets with added stimulus. And I suspect the ECB is just over a month away from a contentious discussion of how to taper QE starting after March 2017. Market liquidity may not be a pressing concern today, but it will be in the not too distant future.

For the Week:

The S&P500 declined 0.7% (up 4.0% y-t-d), while the Dow was little changed (up 4.2%). The Utilities gained 1.0% (up 12.7%). The Banks rose 1.2% (up 2.0%), while the Broker/Dealers declined 1.6% (down 4.0%). The Transports were about unchanged (up 6.8%). The broader market was under pressure. The S&P 400 Midcaps fell 1.8% (up 7.2%), and the small cap Russell 2000 sank 2.5% (up 4.6%). The Nasdaq100 declined 1.0% (up 4.6%), while the Morgan Stanley High Tech index gained 0.8% (up 10.9%). The Semiconductors increased 0.5% (up 23.4%). The Biotechs sank 3.1% (down 22.3%). Though bullion gained $9, the HUI gold index dropped 4.1% (up 86%).

Three-month Treasury bill rates ended the week at 28 bps. Two-year government yields added three bps to 0.85% (down 20bps y-t-d). Five-year T-note yields rose eight bps to 1.32% (down 43bps). Ten-year Treasury yields jumped 12 bps to 1.85% (down 40bps). Long bond yields surged 14 bps to 2.62% (down 40bps).

Greek 10-year yields declined seven bps to 8.21% (up 89bps y-t-d). Ten-year Portuguese yields jumped 15 bps to 3.31% (up 79bps). Italian 10-year yields surged 21 bps to 1.58% (down one bp). Spain’s 10-year yields rose 12 bps to 1.23% (down 54bps). German bund yields jumped 16 bps to 0.16% (down 46bps). French yields gained 18 bps to 0.46% (down 53bps). The French to German 10-year bond spread widened two to 30 bps. U.K. 10-year gilt yields rose 17bps to 1.26% (down 70bps). U.K.’s FTSE equities index slipped 0.3% (up 12.1%).

Japan’s Nikkei 225 equities index rallied 1.6% (down 8.2% y-t-d). Japanese 10-year “JGB” yields inched up a basis point to negative 0.06% (down 32bps y-t-d). The German DAX equities index was little changed (down 0.4%). Spain’s IBEX 35 equities index rose 1.1% (down 3.6%). Italy’s FTSE MIB index gained 0.9% (down 19.1%). EM equities were mixed. Brazil’s Bovespa index added 0.3% (up 48%). Mexico’s Bolsa fell 0.8% (up 11.7%). South Korea’s Kospi declined 0.7% (up 3.0%). India’s Sensex equities slipped 0.5% (up 7.0%). China’s Shanghai Exchange added 0.4% (down 12.3%). Turkey’s Borsa Istanbul National 100 index dipped 0.6% (up 9.2%). Russia’s MICEX equities index gained 1.2% (up 12.5%).

Junk bond mutual funds saw outflows of $48 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell five bps last week to 3.47% (down 29bps y-o-y). Fifteen-year rates slipped a basis point to 2.78% (down 20bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up four bps to 3.67% (down 17bps).

Federal Reserve Credit last week declined $4.6bn to $4.430 TN. Over the past year, Fed Credit contracted $28.3bn (0.6%). Fed Credit inflated $1.619 TN, or 58%, over the past 207 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.8bn last week to $3.125 TN. “Custody holdings” were down $167bn y-o-y, or 5.1%.

M2 (narrow) “money” supply last week fell $9.3bn to $13.115 TN. “Narrow money” expanded $956bn, or 7.9%, over the past year. For the week, Currency increased $2.7bn. Total Checkable Deposits dropped $76.2bn, while Savings Deposits jumped $68.5bn. Small Time Deposits were little changed. Retail Money Funds declined $3.9bn.

Total money market fund assets expanded $16.1bn to $2.651 TN. Money Funds declined $66bn y-o-y (2.4%).

Total Commercial Paper declined $2.2bn to $903bn. CP declined $153bn y-o-y, or 14.5%.

Currency Watch:

The U.S. dollar index slipped 0.3% to 98.34 (down 0.4% y-t-d). For the week on the upside, the South African rand increased 1.1%, the euro 0.9% and the Swiss franc 0.6%. For the week on the downside, the Mexican peso declined 2.1%, the Brazilian real 1.4%, the Swedish krona 1.1%, the Japanese yen 0.9%, the British pound 0.4%, the Canadian dollar 0.5%, the Norwegian krone 0.2% and the Australian dollar 0.1%. The Chinese yuan declined 0.2% versus the dollar (down 4.4% y-t-d).

Commodities Watch:

October 24 – Bloomberg (Ranjeetha Pakiam): “Further weakness in China’s currency and investors’ concerns over the outlook for the nation’s property market may spur gold demand in Asia’s top economy, according to Goldman Sachs… ‘The potential drivers of increased Chinese physical buying include purchasing gold as a way to hedge for potential currency depreciation in the face of capital controls,’ analysts including Jeffrey Currie and Max Layton, wrote… Bullion consumption in China may also rise ‘as a way of diversifying away from the property market,’ they said.”

The Goldman Sachs Commodities Index declined 1.5% (up 18.7% y-t-d). Spot Gold added 0.7% to $1,275 (up 20%). Silver gained 1.3% to $17.76 (up 29%). Crude dropped $2.19 to $48.66 (up 31%). Gasoline fell 4.1% (up 16%), and Natural Gas sank 7.0% (up 19%). Copper surged 5.2% (up 3%). Wheat declined 1.4% (down 13%). Corn gained 0.7% (down 1%).

China Bubble Watch:

October 24 – Bloomberg (David Biller): “Earlier this year, Mr. and Mrs. Cai, a couple from Shanghai, decided to end their marriage. The rationale wasn’t irreconcilable differences; rather, it was a property market bubble. The pair, who operate a clothing shop, wanted to buy an apartment for 3.6 million yuan ($532,583), adding to three places they already own. But the local government had begun, among other bubble-fighting measures, to limit purchases by existing property holders. So in February, the couple divorced. ‘Why would we worry about divorce? We’ve been married for so long,’ said Cai, the husband… ‘If we don’t buy this apartment, we’ll miss the chance to get rich.’ China’s rising property prices this year have been inspiring such desperate measures, as frenzied buyers are seeking to act before further regulatory curbs are imposed.”

October 25 – Financial Times (Yuan Yang): “China is introducing a slew of new restrictions on property-related lending, as the central government takes the lead in efforts to head off a housing bubble. Property developers are facing curbs on their ability to raise financing by issuing debt or equity, after two government regulators were instructed to step in, it has emerged. The China Securities Regulatory Commission and the National Development and Reform Commission — China’s economic planner — have been instructed by high-level officials to restrict developers’ issuances in the Hong Kong stock market, in the Hong Kong bond market and in the Chinese interbank bond market… The news comes less than a week after the Shanghai Stock Exchange froze all bond issuances by property developers.”

October 26 – Wall Street Journal (Anjani Trivedi): “Attempts to cut down China’s debt problems aren’t working, so Beijing is casting a wider net. Whether it works or not, the move adds to the sense that monetary tightening is in the air. In a document sent out this month and widely published Wednesday, China’s central bank tightened the noose once again on banks use of wealth-management products—investment vehicles sold to customers that are typically stashed off-balance sheet to avoid banks’ breaching regulatory capital limits. The latest rules appear to be a more all-encompassing attempt to follow up on previous, ineffectual directives to curb such shadow lending. The latest iteration forces banks to include these WMPs in calculations of banks ‘broad credit,’ which will force them to set aside more capital against these assets.”

October 26 – Reuters (Chen Yang): “China’s central bank will take into account off-balance sheet financing at commercial banks to assess their overall financial health, three sources with direct knowledge of the matter said… The People’s Bank of China will make the change to its so-called Macro Prudential Assessment (MPA) risk-tool to broaden its regulatory oversight to include wealth management products often sold by banks and not counted on their balance sheets… The move marks another step in the PBOC’s efforts to control rising leverage in the nation’s financial system and underscored worries among analysts that unsustainable credit could hit an already slowing economy hard.”

October 25 – Bloomberg (Jeff Black and Carolynn Look): “China’s overnight money rate climbed to the highest level in 18 months, fueled by capital outflows as the yuan weakened to a six-year low. The one-day repurchase rate, a gauge of interbank funding availability, jumped 17 bps, the most since February, to 2.41%… ‘Yuan depreciation-fueled outflows are causing a shortfall in base money supply and tightening liquidity,’ said Liu Dongliang, a senior analyst at China Merchants Bank… ‘This will add pressure to institutions which are highly leveraged in bond investments, if the tightness continues.’ …Liquidity in China’s interbank market has been hard hit by the currency’s accelerated decline. A net $44.7 billion worth of yuan payments left the nation last month… That’s the most since the government started publishing the figures in 2010, and compares with August’s outflow of $27.7 billion. Goldman Sachs… warned Friday that China’s currency outflows have risen to $500 billion this year.”

Europe Watch:

October 26 – Reuters (Francesco Canepa and Frank Siebelt): “The European Central Bank is nearly certain to continue buying bonds beyond its March target and to relax its constraints on the purchases to ensure it finds enough paper to buy, central bank sources have told Reuters. The moves will come in an attempt to bolster what is being heralded as the start of an economic recovery in the euro zone. ECB policymakers are due to decide in December on the future shape and duration of their 80 billion euros (£71.58 billion) monthly quantitative easing (QE) scheme, based on new growth and inflation forecasts.”

October 27 – Reuters (Balazs Koranyi): “The effectiveness of the European Central Bank’s ultra-loose monetary policy may decline over time while side effects could increase, a key policymaker argued… ‘The longer the measures are in place, the less effective they may become,’ ECB board member Yves Mersch said… ‘The fact that additional lending in the euro area is losing momentum and that German banks are saying that the negative deposit facility rate is constraining lending volumes warrants attention… We must be vigilant that this development does not spread to other euro area countries.’”

October 27 – Bloomberg (George Georgiopoulos): “The ECB will decide in December on the mechanism of prolonging its quantitative easing asset purchase program, European Central Bank policymaker Ewald Nowotny said… ‘There will be two decisions. It’s not as dramatic as they sound. One of course is to prolong, to what extent, for what duration,’ Nowotny, a member of the Governing Council of the European Central Bank, said… The second, he said, was what assets to purchase. ‘… Do we have enough assets to buy, and this is a point of discussion that we are just now underway,’ Nowotny said.”

October 24 – Reuters (Jonathan Cable): “Business activity in the euro zone has expanded at the fastest pace this year so far in October, as a buoyant Germany offset the impact from firms raising prices at the sharpest rate in more than five years, a survey showed… IHS Markit’s euro zone flash composite Purchasing Managers’ Index… jumped to 53.7 from September’s 52.6.”

October 26 – Bloomberg (Jeff Black and Carolynn Look): “Mario Draghi used his second appearance in Berlin in a month to drive home his message that a three-decade slide in long-term interest rates can only be properly arrested with the help of governments. The ‘type of actions we need, if we want interest rates at higher levels, are those that can raise the natural rate,’ the European Central Bank president said… ‘And this requires a focus on policies that can address the root causes of excess saving over investment — in other words, fiscal and structural policies.”

October 24 – Bloomberg (Alessandro Speciale and Carolynn Look): “Anti-establishment parties are gaining ground in the heart of the European Union, and they may pose a bigger challenge to the region’s economy than any of those that have drawn support in the periphery over the past years. While populists in Spain or Italy are revolting against restrictive fiscal policies and a weakening of social safety nets, the backlash in France and Germany focuses on monetary union itself. Parties openly advocating a break from the euro are building momentum ahead of a year of election across the region and politicians skeptical about EU integration are already twisting policy decisions.”

Fixed-Income Bubble Watch:

October 24 – Bloomberg (Brian Chappatta and Anchalee Worrachate): “The hottest craze in fixed income is at risk of overheating. A headlong rush into higher-yielding, long-term bonds in recent years has created one of the most crowded trades in financial markets. Investors seeking relief from central banks’ zero-interest-rate policies have poured into government debt due in a decade or more, swelling the amount worldwide by a record $733 billion this year. It’s more than doubled since 2009 to about $6 trillion… Now money managers overseeing more than $1 trillion say the case for owning longer maturities — stellar performers for most of 2016 — is crumbling. There’s mounting evidence that inflation is starting to stir, just as some central banks hint that higher long-term interest rates may be the key to boosting growth. That’s troubling because a key bond-market metric known as duration has reached historic levels, and the higher that gauge goes, the steeper the losses will be when rates rise.”

October 26 – Bloomberg (John Gittelsohn): “Bad times lie ahead for bondholders as rising inflation and resurging deficits conspire to drive up interest rates, according to Jeffrey Gundlach. ‘We’re in the eye of a hurricane for the next three to four years,’ Gundlach, chief executive officer of DoubleLine Capital, said… ‘Come 2018, 2019 and 2020, look out!’”

Global Bubble Watch:

October 24 – Wall Street Journal (Julie Steinberg and Kane Wu): “As the West sank into recession in 2008, Chinese tycoon Chen Feng decided it was time to stretch his wings. Mr. Chen’s conglomerate, HNA Group, already had a collection of domestic assets that spanned hotel chains, supermarkets, shipping firms and Hainan Airlines, the country’s biggest privately held airline. The next place to go, Mr. Chen told a local business magazine… Mr. Chen is part of an aggressive new generation of Chinese deal makers. Not only are they buying up foreign assets at the fastest pace in history—Chinese companies’ announced overseas acquisitions have hit a record $199 billion so far this year—they are also snagging bigger deals in increasingly high-profile areas like movies, airplanes and hotels.”

October 26 – Bloomberg (Matt Scully): “Deutsche Bank AG is reviewing whether it misstated the value of derivatives in its interest-rate trading business, and is sharing its findings with U.S. authorities, according to people with knowledge of the situation. The bank is looking at valuations on a type of derivative known as zero-coupon inflation swaps… After finding valuations that diverged from internal models, it began questioning traders, the people said.”

October 26 – Financial Times (Caroline Binham and Martin Arnold): “The Bank of England has asked large British lenders to detail their current exposure to Deutsche Bank and some of the biggest Italian banks, including Monte dei Paschi, amid mounting market jitters over the health of Europe’s financial sector. The request was made in recent weeks by the BoE’s Prudential Regulation Authority as investors sold off Deutsche and Monte dei Paschi…”

October 23 – CNBC (Javier E. David): “Despite the chill winds of a softening luxury real estate market and political uncertainty across the globe, it’s still a buyer’s market for the ultra-wealthy, a recent survey suggests. In partnership with the YouGov Affluent Perspective, Luxury Portfolio International surveyed the top echelon of consumers across 12 countries, finding that the majority of those consumers were ‘cautious but optimistic’ in the face of an uncertain and often turbulent world economy… Research from Credit Suisse showed that there are more than 123,000 individuals in this category, a whopping 53% jump in just five years.”

U.S. Bubble Watch:

October 24 – Reuters (Caroline Humer and Toni Clarke): “The average premium for benchmark 2017 Obamacare insurance plans sold on Healthcare.gov rose 25% compared with 2016…, the biggest increase since the insurance first went on sale in 2013 for the following year. The average monthly premium for the benchmark plan is rising to $302 from $242 in 2016…”

October 24 – New York Times (Landon Thomas Jr.): “European and Asian investors have been rushing into the United States bond market, spurred by a global glut of savings that has reached record levels. Running from near-zero interest rates at home, foreign buyers are piling into the booming market for corporate bonds, including high-grade debt securities… and riskier fare churned out by energy and telecommunications companies. A growing number of economists are concerned that this flood of money may inflate the value of these securities well beyond what they are worth, potentially leading to a market bubble that eventually bursts.”

October 26 – Wall Street Journal (Annamaria Andriotis): “For auto lenders, there is trouble on the used-car lot. Several large companies have warned that prices of used vehicles are likely to weaken, potentially leading to higher losses on loans on which cars are the collateral. That, combined with looser terms for loans and the growth of loans going to subprime borrowers, is sounding a warning for the long credit boom that has spurred auto sales. Auto-loan balances topped $1 trillion for the first time ever this year.”

October 27 – Bloomberg (Oshrat Carmiel): “Home prices in New York’s Hamptons fell the most in almost three years as buyers in the beachfront towns sought out less-expensive properties and shunned the middle of the market, priced from $1 million to $5 million. Homes in the area, a second-home mecca favored by Wall Street executives, sold for a median of $825,000 in the third quarter, down 13% from a year earlier…”

Federal Reserve Watch:

October 24 – Wall Street Journal (Kate Davidson and Jon Hilsenrath): “Federal Reserve officials, wary of raising short-term interest rates amid the uncertainty surrounding the U.S. presidential election, are likely to stand pat at their November policy meeting and remain focused on lifting them in December. Their challenge will be deciding how strongly to signal their expectation of a move at their last scheduled meeting of the year, Dec. 13-14. Market expectations suggest officials may not need to fire strong new warning shots: Traders in futures markets already place a 74% probability on a Fed rate increase by then.”

Japan Watch:

October 24 – Bloomberg (Keiko Ujikane): “Japan’s consumer prices fell for a seventh straight month and household spending slumped again in September, underscoring the challenges Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda face in trying to revive the world’s third-largest economy… Consumer prices excluding fresh food, the BOJ’s primary gauge of inflation, dropped 0.5% in September from a year earlier. Household spending fell 2.1% from a year earlier…”

October 26 – Reuters (Leika Kihara and Yoshifumi Takemoto): “Years of heavy money printing by the Bank of Japan has made the bond market dysfunctional and fiscal policy heavily dependent on cheap money offered by the bank, a former BOJ deputy governor said, warning against expanding monetary stimulus further. Toshiro Mutoh, who retains strong influence among policymakers, also said it would be hard for Japan to intervene in the currency market to stem yen gains… Having gobbled up a third of the Japanese government bond (JGB) market, the BOJ is also nearing the limit of its massive asset-buying program.”

October 27 – Reuters (Leika Kihara): “Bank of Japan Governor Haruhiko Kuroda said… the central bank would not try to push down super-long government bond yields – even if they rise further – because it is focused on controlling the yield curve for out to 10 years. Kuroda told parliament he saw no immediate need to change the minus 0.1% short-term interest rate target and the 10-year government bond yield target of around zero percent, suggesting that the BOJ will hold off on easing policy at next week’s rate review. Kuroda also rejected the idea of buying foreign-currency denominated bonds…”

October 23 – Bloomberg (Connor Cislo): “Japanese exports fell for a 12th consecutive month in September, rounding out a rough year for manufacturers struggling with a stronger yen and soft global demand… Overseas shipments dropped 6.9% in September from a year earlier…”

EM Watch:

October 26 – Bloomberg (Matthew Hill, Elena Popina and Natasha Doff): “Mozambique’s Eurobonds slumped to a record for a second day after the government hired advisers to negotiate a restructuring that at least one adviser said could involve write downs for investors… The $727 million security has fallen 22 cents on the dollar to 59 cents…”

October 24 – Bloomberg (David Biller): “Economists reduced their growth forecast for Brazil next year to its lowest level in two months, underscoring how Latin America’s largest nation is struggling to emerge from recession. Gross domestic product will expand 1.23% in 2017, according to a central bank survey of economists…”

Leveraged Speculator Watch:

October 27 – Bloomberg (Dakin Campbell): “A team of Citigroup Inc. derivatives traders generated about $300 million of revenue this year, thriving from serving companies and investors trying to anticipate central bank decisions, according to people with direct knowledge of the matter. The windfall was produced by the bank’s U.S. dollar interest-rate swaps desk…”

Geopolitical Watch:

October 21 – New York Times (Nicole Perlroth): “Major websites were inaccessible to people across wide swaths of the United States on Friday after a company that manages crucial parts of the internet’s infrastructure said it was under attack. Users reported sporadic problems reaching several websites, including Twitter, Netflix, Spotify, Airbnb, Reddit, Etsy, SoundCloud and The New York Times. The company, Dyn, whose servers monitor and reroute internet traffic, said it began experiencing what security experts called a distributed denial-of-service attack just after 7 a.m… And in a troubling development, the attack appears to have relied on hundreds of thousands of internet-connected devices like cameras, baby monitors and home routers that have been infected… with software that allows hackers to command them to flood a target with overwhelming traffic.”

October 26 – Reuters (Robin Emmott and Phil Stewart): “Britain said… it will send fighter jets to Romania next year and the United States promised troops, tanks and artillery to Poland in NATO’s biggest military build-up on Russia’s borders since the Cold War. Germany, Canada and other NATO allies also pledged forces at a defense ministers meeting in Brussels on the same day two Russian warships armed with cruise missiles entered the Baltic Sea between Sweden and Denmark, underscoring East-West tensions… NATO Secretary-General Jens Stoltenberg said the troop contributions to a new 4,000-strong force in the Baltics and eastern Europe were a measured response to what the alliance believes are some 330,000 Russian troops stationed on Russia’s western flank near Moscow.”

October 25 – Wall Street Journal (Thomas Grove): “Russian authorities have stepped up nuclear-war survival measures amid a showdown with Washington, dusting off Soviet-era civil-defense plans and upgrading bomb shelters in the biggest cities. At the Kremlin’s Ministry of Emergency Situations, the Cold War is back. The country recently held its biggest civil defense drills since the collapse of the U.S.S.R., with what officials said were 40 million people rehearsing a response to chemical and nuclear threats. Videos of emergency workers deployed in hazmat suits or checking the ventilation in bomb shelters were prominently aired on television when the four days of drills were held across the country. Students tried on gas masks and placed dummies on stretchers in school auditoriums.”

October 27 – Reuters (Michael Martina and Benjamin Kang Lim): “China’s Communist Party gave President Xi Jinping the title of ‘core’ leader on Thursday, putting him on par with past strongmen like Mao Zedong and Deng Xiaoping, but it signaled his power would not be absolute. A lengthy communique released by the party following a four-day, closed-door meeting of senior officials in Beijing stressed maintaining the importance of collective leadership. The collective leadership system ‘must always be followed and should not be violated by any organization or individual under any circumstance or for any reason’, it said.”

October 26 – Reuters (Ben Blanchard): “China will carry out military drills in the South China Sea all day on Thursday, the country’s maritime safety administration said…, ordering all other shipping to stay away. China routinely holds drills in the disputed waterway, and the latest exercises come less than a week after a U.S. navy destroyer sailed near the Paracel Islands, prompting a warning from Chinese warships to leave the area.”