Doug Noland

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.”

Weekly Commentary: The "Neutral Rate"

The neutral (or natural) rate of interest is the rate at which real GDP is growing at its trend rate, and inflation is stable. It is attributed to Swedish economist Knut Wicksell, and forms an important part of the Austrian theory of the business cycle. The neutral rate provides an important benchmark for policymakers to compare with the market rate. When interest rates are neutral the economy is on a sustainable path, and it is deviations from neutrality that cause booms and busts.” (Financial Times/lexicon)

Wicksell based his theory on a comparison of the marginal product of capital with the cost of borrowing money. If the money rate of interest was below the natural rate of return on capital, entrepreneurs would borrow at the money rate to purchase capital (equipment and buildings), thereby increasing demand for all types of resources and their prices; the converse would be true if the money rate was greater than the natural rate of return on capital. So long as the money rate of interest persisted below the natural rate of return on capital, upward price pressures would continue… Price stability would result only when the money rate of interest and the natural rate of return on capital—the marginal product of capital—were equal.” “Wicksell’s Natural Rate”, Federal Reserve Bank of St. Louis Monetary Trends, March 2005

Wicksell’s “natural rate” is a powerful analytical concept. In a more traditional backdrop, I would view the so-called “natural rate” as the price of Credit where supply and demand intersect at a point of relative stability for returns on capital. When economic returns are high, heightened demand for Credit (to fund investment) pushes up its cost. Over time, increased investment will result in an expanded supply of output and lower returns. Weak economic returns then engender less demand for borrowings and a resulting lower cost of Credit.

The hypothetical “natural rate” embodies a self-regulating system. During Wicksell’s time, money and Credit entered into the economic system primarily through lending for capital investment. And, importantly, there were constraints on the supply of “money” available to be lent. Banks were the dominant source of lending, and they were subject to specific restraints on Credit expansion (i.e. bank reserve and capital requirements, the gold standard).

Wicksell’s “natural rate” is incompatible with contemporary finance. These days, finance is introduced into systems (economic and financial) with little association to economic returns. Indeed, the primary mechanisms for the creation of new finance are government (fiscal and monetary) spending and asset-based lending. Furthermore, there are no restrains on the available supply of Credit, so its price is outside the purview of supply and demand. For the most part, the government dictates the price of finance. This system is neither self-adjusting nor self-correcting.

Enter the current monetary debate: Things have not progressed as expected. Years of unthinkable monetary stimulus have failed to achieve either general prosperity or consistent inflation in the general price level. Fragilities are as acute as ever. So policymaker reassessment is long overdue. Not surprisingly, however, there’s no second guessing “activist” (inflationist) monetary doctrine. Central bankers are not about to admit that a policy of zero rates and Trillions of monetization is fundamentally flawed. Apparently, we are to believe that forces outside their control have pushed down the “neutral rate.” The solution, predictably, is lower for longer – along with more government spending and programs. So focus on the “neutral rate” becomes the latest elaborate form of policymaking rationalization/justification.

From Ben Bernanke’s August 8, 2016 blog, “The Fed’s Shifting Perspective on the Economy and its Implications for Monetary Policy”: “Projections of r* can be interpreted as estimates of the ‘terminal’ or ‘neutral’ federal funds rate, the level of the funds rate consistent with stable, noninflationary growth in the longer term… As mentioned, a lower value of r* implies that current policy is not as expansionary as thought… In particular, relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited. Moreover, there may be a greater possibility that running the economy a bit ‘hot’ will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.”

Today’s monetary “debate” is reminiscent of Alan Greenspan’s fateful foray into New Paradigm worship. In particular, he viewed (going back to 1996) that technological advancement and attendant productivity gains had fundamentally raised the economy’s “speed limit”. Monetary policy could be run looser than in the past – and run it did. Such fallacious thinking was only temporarily discredited with the the bursting of the “tech” Bubble, as captured in a 2001 WSJ article:

December 28, 2001 – Wall Street Journal (Greg Ip and Jacob M. Schlesinger): “Five years ago, Alan Greenspan began pushing a reluctant Federal Reserve to embrace his New Economy vision of rapid productivity growth and rising living standards. Today, Fed policy makers are debating whether they went too far. The answer could help determine whether the current recession marks a temporary aberration in an era of swift growth, or whether the rapid growth of the late 1990s itself was the aberration. Mr. Greenspan hasn’t lost the faith. ‘New capital investment, especially the high-tech type, will continue where it left off,’ he declared in a speech… He ignored the collapse of so many symbols of the 1990s boom, including Enron Corp., the sponsor of the ‘distinguished public service’ award he received that evening. ‘The long-term outlook for productivity growth, as far as I’m concerned, remains substantially undiminished,’ the Fed chairman asserted.”

New technologies are seductive. Rapid technological advancement coupled with momentous financial innovation proved absolutely engrossing. It was easy to ignore Enron, WorldCom and the like, just as it was to disregard 1994’s bond market tumult, the Mexican meltdown, the SE Asia debacle, the Russian collapse and LTCM. By 2001 it was rather obvious that New Age finance was highly unstable. Yet the 2002 corporate debt crisis along with the arrival of Dr. Bernanke to the the Marriner S. Eccles Building ensured that the FOMC pursued even more egregious policy blunders.

The Federal Reserve has been rationalizing loose monetary policies for 20 years now. Instead of Alan Greenspan’s electrifying productivity miracle, it’s a future of dreadful “secular stagnation.” Enron was little small potatoes compared to the frauds that followed. And the key issue from two decades ago somehow remains unaddressed: over-liquefied and speculative securities markets are incapable of effectively allocating financial and real resources. Moreover, central bank command over both the cost of finance and the performance of securities markets ensures dysfunction both financially and economically.

Contemporary notions of a “neutral rate” are deeply flawed – to the point of being ludicrous. From Bloomberg: “The Fed aims to set short-term interest rates in relation to the ‘natural rate’—the one that would produce full employment without excess inflation.” Yet it’s not the Fed funds rate spawning “full employment,” and central bankers certainly do not control a general price level. It is instead the ongoing historic Bubble in market-based finance that dictates the flow of “money” and Credit throughout the economy. One would have to be a diehard optimist to believe either markets or global economies are on a “sustainable path”. Market participants have been incentivized to take excessive risks and to speculate, with central bankers clearly responsible for inflationary Bubbles that have engulfed global securities and asset markets.

There’s no mystery surrounding the sinking employment rate. Ultra-loose monetary policies (rates and QE) have stoked excess securities market inflation, boosting perceived wealth while fostering extremely loose corporate Credit conditions. Such a backdrop spurs business borrowing, spending and hiring. Still, ongoing pathetic growth and productivity dynamics, along with weakening profits, corroborate the view that resources continue to be poorly allocated.

A low unemployment rate concurrent with mild CPI inflation is no conundrum either. On a global basis, unfettered finance has spurred unprecedented over- and malinvestment, ensuring downward price pressures. To be sure, the proliferation of new technologies and digitized output has fundamentally broadened the available supply of goods. Moreover, at home and abroad, unsound global finance has fomented wealth inequality that plays prominently in the disinflationary backdrop more generally.

A low “neutral rate” might be consistent with an economic boom, or it could just as well be compatible with financial and economic collapse. Causation – the driving force behind either boom or bust – is found with intertwined and closely correlated global securities markets. Two decades of persistently loose monetary policies have created deep economic maladjustment and historic asset price Bubbles. And these days central bankers see resulting stagnation (growth, productivity, pricing power, profits, etc.) as evidence of a historically low “neutral rate” – that is then used to justify their runaway experiment in ultra-loose monetary management.

Back in 2013, in the midst of a bout of market tumult, chairman Bernanke reassured the markets that the Fed was prepared to “push back against a tightening of financial conditions.” In the eyes of the market, this significantly augmented/clarified “whatever it takes.” The Federal Reserve – and global central bankers more generally – could simply not tolerate fledgling risk aversion (“risk off”) in the securities markets that would impinge financial conditions more generally. The Fed would use its rate and QE policy specifically to backstop the securities markets, in the process sustaining Bubble Dynamics.

“Whatever it takes” and “pushing back” unleashed a precarious Terminal Bubble Phase. With economic and market risks now so elevated, even the thought of recession or bear market has become unacceptable to central bankers.

There was a research piece this week from Federal Reserve Bank of San Francisco President John Williams, “Monetary Policy in a Low R-star World:” “The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest. While price level or nominal GDP targeting by monetary authorities are options, fiscal and other policies must also take on some of the burden to help sustain economic growth and stability.” And there was Thursday’s Washington Post op-ed from Larry Summers: “What We Need to do to Get Out of This Economic Malaise.” “I cannot see how policy could go wrong by setting a level target of 4 to 5% growth in nominal gross domestic product and think that there could be substantial benefits.”

Let me suggest what is going wrong.  Even after several years of typical recovery, there would be the issue of mounting imbalances and excesses. With almost eight years of history’s most extreme monetary stimulus – including zero rates, massive monetization and the direct targeting of securities and asset inflation – there is surely an extraordinary degree of underlying economic maladjustment. One should expect an inordinate number of uneconomic enterprises, along with the now typical amounts of fraud and nonsense (that prosper on loose finance).

Historic excess and distortions have for years accumulated throughout the securities markets. The underlying amount of speculative leverage likely exceeds 2008. Eight years of Federal Reserve zero rates and liquidity backstops have severely perverted market risk perceptions. Literally Trillions have flowed into perceived liquid and low-risk securities – fixed-income and equities. Trillions have chased yields and returns, assuming liquidity while being indifferent to risk. The unwieldy global pool of speculative finance has inflated by Trillions. Meanwhile, the Fed’s serial interventions to smother “Risk Off” has undoubtedly cultivated major latent fragilities within the derivatives trading complex.

The current policy objective should be for Fed to begin extricating itself from market dominance. It’s absolutely crucial for the economy and markets to commence the process of learning to stand on their own. At this point, such a transition would not go smoothly. The alternative is only deeper structural impairment and more extreme financial and economic fragility.

The system has been put in a quite precarious position, but it’s time to let Capitalism sorts its way through. The very opposite seems ensured. We’re in the early stage of even more egregious government (fiscal and monetary) intervention in the economy and markets. The election will usher in a surge of deficit spending. Meanwhile, the Federal Reserve appears poised to use a low “neutral rate” as an excuse to cling to ultra-loose monetary policies.

I am often reminded of misguided late-nineties dollar optimism. New Paradigm thinking had the markets content to overlook underlying U.S. financial and economic fragilities, not to mention massive intractable Current Account Deficits. King dollar had become a Crowded Trade, although nothing in comparison to this cycle’s dollar exuberance. Curiously, the dollar index declined 1.2% this week. In the face of Japan’s deep problems and policy shortcomings, the $/yen traded below 100 this week (yen up 16.9% y-t-d). Despite the eurozone’s serious deficiencies, the euro ended the week above 113 (up 4.3% y-t-d). In general, emerging markets are a mess, yet many EM currencies have rallied strongly against the dollar.

Integral to the dollar bull case have been expectations that an outperforming U.S. economy would ensure rising U.S. rates and attractive interest-rate differentials. Yet king dollar excesses (foreign and speculative flows) exacerbated Bubble Dynamics, with market and economic vulnerabilities now having trapped the Yellen Fed in ultra-loose monetary measures. Global markets appear to have begun anticipating a weaker dollar. This would certainly help to explain the big turnarounds in commodities and EM.

If the Fed is hellbent on spurring inflation (at home and abroad), a weaker dollar could go a long way. But policy savants be careful what you wish for. After all, global markets are awash in Crowded Trades betting on dollar strength, disinflationary forces, low bond yields and market stability – as far as the eye can see. There is today no “neutral rate” that could possibly neutralize such a perilous global Bubble.

For the Week:

The S&P500 was unchanged (up 6.8% y-t-d), while the Dow slipped 0.1% (up 6.5%). The Utilities dropped 1.3% (up 16.2%). The Banks jumped 1.7% (down 3.9%), and the Broker/Dealers rose 1.1% (down 6.3%). The Transports advanced 1.6% (up 5.6%). The S&P 400 Midcaps added 0.3% (up 11.7%), and the small cap Russell 2000 increased 0.6% (up 8.9%). The Nasdaq100 was unchanged (up 4.6%), and the Morgan Stanley High Tech index gained 1.2% (up 9.1%). The Semiconductors jumped 2.2% (up 20.1%). The Biotechs declined 0.7% (down 13.0%). Though bullion added $6, the HUI gold index fell 3.6% (up 142%).

Three-month Treasury bill rates ended the week at 30 bps. Two-year government yields rose five bps to 0.75% (down 30bps y-t-d). Five-year T-note yields rose seven bps to 1.16% (down 59bps). Ten-year Treasury yields gained seven bps to 1.58% (down 67bps). Long bond yields increased six bps to 2.29% (down 73bps).

Greek 10-year yields fell 13 bps to 7.86% (up 54bps y-t-d). Ten-year Portuguese yields surged 31 bps to 2.98% (up 46bps). Italian 10-year yields jumped nine bps to 1.13% (down 46bps). Spain’s 10-year yield increased three bps to 0.95% (down 82bps). German bund yields rose seven bps to negative 0.04% (down 66bps). French yields gained seven bps to 0.18% (down 81bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields rose 10 bps to 0.62% (down 134bps). U.K.’s FTSE equities index declined 0.8% (up 9.9%).

Japan’s Nikkei 225 equities index dropped 2.2% (down 13.1% y-t-d). Japanese 10-year “JGB” yields increased three bps to negative 0.09% (down 26bps y-t-d). The German DAX equities index fell 1.6% (down 1.8%). Spain’s IBEX 35 equities index sank 3.0% (down 11.5%). Italy’s FTSE MIB index was hit 4.0% (down 23.9%). EM equities were mixed. Brazil’s Bovespa index gained another 1.5% (up 36.5%). Mexico’s Bolsa was little changed (up 12.4%). South Korea’s Kospi index added 0.3% (up 4.8%). India’s Sensex equities slipped 0.3% (up 7.5%). China’s Shanghai Exchange jumped 1.9% (down 12.2%). Turkey’s Borsa Istanbul National 100 index was about unchanged (up 8.9%). Russia’s MICEX equities index slipped 0.4% (up 11.3%).

Junk bond mutual funds saw inflows of $889 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates declined two bps to 3.43% (down 54bps y-o-y). Fifteen-year rates slipped two bps to 2.74% (down 52bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up three bps to 3.61% (down 47bps).

Federal Reserve Credit last week expanded $10.4bn to $4.438 TN. Over the past year, Fed Credit declined $22.3bn. Fed Credit inflated $1.627 TN, or 58%, over the past 197 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.9bn last week to $3.203 TN. “Custody holdings” were down $153bn y-o-y, or 4.6%.

M2 (narrow) “money” supply last week increased $5.6bn to a record $12.971 TN. “Narrow money” expanded $884bn, or 7.3%, over the past year. For the week, Currency increased $0.8bn. Total Checkable Deposits surged $69.8bn, while Savings Deposits dropped $65.3bn. Small Time Deposits added $1.0bn. Retail Money Funds slipped $0.7bn.

Total money market fund assets dropped $34.9bn to a six-week low $2.710 TN. Money Funds rose $24bn y-o-y (0.9%).

Total Commercial Paper dropped $11.0bn to $1.012 TN. CP declined $45bn y-o-y, or 4.2%.

Currency Watch:

The U.S. dollar index dropped 1.2% to 94.5 (down 4.2% y-t-d). For the week on the upside, the euro increased 1.5%, the Swiss franc 1.4%, the British pound 1.2%, the Japanese yen 1.1%, the New Zealand dollar 1.0%, the Swedish krona 0.8%, the Canadian dollar 0.6%, and the Mexican peso 0.2%. For the week on the downside, the Brazilian real declined 0.4%, the Australian dollar 0.3%, the South African rand 0.3%, and the Norwegian krone 0.1%. The Chinese yuan declined 0.3% versus the dollar (down 2.5% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index surged 4.9% (up 18.9% y-t-d). Spot Gold added 0.4% to $1,341 (up 26%). Silver declined 2.1% to $19.31 (up 40%). WTI Crude surged $4.08 to $48.57 (up 31%). Gasoline jumped 10.8% (up 20%), while Natural Gas slipped 0.4% (up 10%). Copper gained 1.8% (up 2%). Wheat surged 5.3% (down 5%). Corn advanced 3.2% (down 4%).

Turkey Watch:

August 14 – Reuters (Humeyra Pamuk): “Turkey will not compromise with Washington over the extradition of the Islamic cleric it accuses of orchestrating a failed coup, Prime Minister Binali Yildirim said…, warning of rising anti-Americanism if the United States fails to extradite.”

August 18 – Reuters (Ayla Jean Yackley): “Turkish authorities ordered the detention of nearly 200 people, including leading businessmen, and seized their assets as an investigation into suspects in last month’s failed military rebellion shifted to the private sector. President Tayyip Erdogan has vowed to choke off businesses linked to U.S.-based Muslim cleric Fethullah Gulen, whom he blames for the July 15 coup attempt, describing his schools, firms and charities as ‘nests of terrorism.’ Tens of thousands of troops, civil servants, judges and officials have been detained or dismissed in a massive purge…”

August 14 – Reuters (Michelle Martin and Humeyra Pamuk): “Turkey could walk away from its promise to stem the flow of illegal migrants to Europe if the European Union fails to grant Turks visa-free travel to the bloc in October, Foreign Minister Mevlut Cavusoglu told a German newspaper. His comments… coincide with rising tensions between Ankara and the West that have been exacerbated by the failed coup attempt… Turkey is incensed by what it sees as an insensitive response from Western allies to the failed putsch, in which 240 people were killed.”

Brexit Watch:

August 13 – Bloomberg (Scott Hamilton and Colin Keatinge): “Monetary policy is only a ‘short-term balm’ that can’t fully insulate the U.K. from the long-term impacts of the vote to leave the European Union, Bank of England Chief Economist Andrew Haldane wrote… The bank’s package of monetary policy measures unleashed earlier this month, including the first interest-rate cut in seven years, are designed to be a shot in the arm for business and consumer confidence after the vote to leave the European Union ‘has thrown up a dust cloud of economic uncertainty, making it harder for companies to plan, with potentially adverse implications for future investment and jobs,’ Haldane said…”

August 15 – Reuters (Ana Nicolaci da Costa): “The price of homes for sale in England and Wales fell in August, posting the biggest drop since November… Asking prices fell by a monthly 1.2%…, after shedding 0.9% in July. The biggest drop was in London and the South East, with asking prices falling by 2.6% and 2.0% respectively.”

August 16 – Bloomberg (Janet Lorin): “Larger investment banks with their European headquarters in London are already making plans for their own withdrawal. Many plan to start the process of moving jobs from the U.K. within weeks of the government triggering Brexit, people briefed on the plans of four of the biggest firms told Bloomberg’s Gavin Finch. That suggests the banks may move faster than their public messages of patience would imply, and reflects dismay with the U.K.’s lack of a clear plan to protect its status as a global financial hub. There are concerns British-based banks will lose the right to sell services freely around the European Union.”

Europe Watch:

August 18 – New York Times (Landon Thomas Jr.): “In Italy, where two decades of economic stagnation have created a long line of barely breathing companies, Feltrinelli, one of the country’s largest booksellers, stands out. Since 2012, the company has chalked up three consecutive years of losses totaling nearly 11 million euros ($12.4 million). Even so, late last year, Feltrinelli was able to secure a fresh €50 million line of credit from a syndicate that included two of Italy’s largest banks, UniCredit and Intesa Sanpaolo, at an interest rate below what top-rated companies in Europe were paying. As Italy and Europe more broadly struggle to come to grips with an escalating problem with bad loans, a new paper by economists connected to the Center for Economic Policy Research… highlights the extent to which Italy’s main banks — known to be the weakest in the eurozone in terms of cash reserves — have stepped up their lending to the country’s most troubled companies.”

Fixed-Income Bubble Watch:

August 14 – Wall Street Journal (Carolyn Cui and Mike Bird): “Bond investment funds that usually have little appetite for riskier debt are boosting their exposure to the developing world, a move that is helping drive this year’s emerging-markets rally. International bond funds run by BlackRock Inc., Legg Mason Inc. and OppenheimerFunds are among the big money managers that have been increasing their positions in emerging-market debt in recent months. That shift reflects how global bond funds are feeling the pinch from low U.S. interest rates and negative rates in Japan and much of Europe.”

Global Bubble Watch:

August 18 – New York Times (Robin Wigglesworth): “Paul Singer, head of $28bn hedge fund Elliott Management, has warned that the global bond market is ‘broken’, and predicted that the end of the current environment is ‘likely to be surprising, sudden, intense, and large’… In his second quarter letter to investors… Mr Singer sounded an ominous warning on the state of the global debt market, with more than $13tn of bonds trading with negative yields. The hedge fund manager said it was ‘the biggest bond bubble in world history,’ and cautioned that investors should shy away from sub-zero yielding debt. ‘Hold such instruments at your own risk; danger of serious injury or death to your capital!’, he wrote… He added that ‘the ultimate breakdown (or series of breakdowns) from this environment is likely to be surprising, sudden, intense, and large’.”

August 16 – Reuters (Claire Milhench): “Global investors have cut their cash holdings sharply and added to emerging market and U.S. stocks in August as global growth expectations have rebounded, a Bank of America Merrill Lynch (BAML) survey indicated… Cash levels dropped to 5.4% from a 15-year high of 5.8% in July… A net 23% of investors now expect the global economy to improve over the next 12 months, an optimism reflected in the overall equity allocation recovering to a net overweight of 9%. This was up from a net 1% underweight last month – the first underweight in four years. Among the biggest beneficiaries of this switch were emerging market stocks, where the allocation rose to a net 13% overweight – the highest level since September 2014. This was up from 10% last month.”

August 16 – Bloomberg (Vincent Cignarella): “This wasn’t supposed to happen. The central banks of Australia and New Zealand lowered benchmark interest rates and their respective currencies promptly strengthened. Traders puzzled by the way foreign-exchange markets are behaving should consider that potential for capital appreciation, in addition to yield, may be a significant driver of recent moves. Investors are engaging in a type of ‘reverse carry trade,’ buying low-yield currencies for high-yield pairs and accepting small interest rate differential losses for potential large capital gains where central banks are cutting rates or buying more domestic bonds. Those moves should push up the price of underlying assets and, in theory, outweigh small losses on interest rate carry.”

U.S. Bubble Watch:

August 18 – The Economist: “WHAT are the most dysfunctional parts of the global financial system? China’s banking industry, you might say, with its great wall of bad debts and state-sponsored cronyism. Or the euro zone’s taped-together single currency, which stretches across 19 different countries, each with its own debts and frail financial firms. Both are worrying. But if sheer size is your yardstick, nothing beats America’s housing market. It is the world’s largest asset class, worth $26 trillion, more than America’s stockmarket. The slab of mortgage debt lurking beneath it is the planet’s biggest concentration of financial risk. When house prices started tumbling in the summer of 2006, a chain reaction led to a global crisis in 2008-09. A decade on, the presumption is that the mortgage-debt monster has been tamed. In fact, vast, nationalised, unprofitable and undercapitalised, it remains a menace to the world’s biggest economy.”

August 18 – Bloomberg (Joe Light): “The hole at the corner of 15th and L streets, in downtown Washington, is deep — and getting deeper. Earth-movers there are laying the foundations of a shiny new headquarters for Fannie Mae, the bailed-out giant of American mortgages. But the sleek design, replete with glass sky bridges, belies a sober reality: Fannie Mae and its cousin, Freddie Mac, are once again headed for trouble. In fact, there’s almost no way around it. On Jan. 1, 2018, the two government-sponsored enterprises will officially run out of capital under the current terms of their bailout. After that, any losses would be shouldered by taxpayers. Granted, few people are predicting a disaster like the one in 2008, when the GSEs had to be thrown a $187.5 billion federal lifeline. But eight years later, people still don’t agree on what to do with these wards of the state… ‘Everyone agreed that this was a broken business model that made no sense,’’ said Douglas Holtz-Eakin, president of the American Action Forum… ‘Now, inertia is driving the way.’”

August 16 – Bloomberg (Sid Verma and Luke Kawa): “Stock buybacks appear to be slowing down, suggesting either corporate America’s outlook has dimmed, stock valuations have become prohibitively high or, most optimistically, that companies are starting to listen to investors and put funds toward other uses. Buybacks announced for the second quarter’s earnings season between July 8 and August 15 totaled an average of $1.8 billion a day, the lowest volume in an earnings season since the summer of 2012, according to TrimTabs Investment Research… In the first seven months of 2016, buybacks totaled $376.5 billion, according to TrimTabs. That’s down 21% from $478.4 billion in the first seven months of last year.”

August 19 – Wall Street Journal (Mike Bird, Vipal Monga and Aaron Kuriloff): “Big companies are handing more of their profits to shareholders than at any time since the financial crisis, as record-low bond yields put a premium on dividends. Payouts at S&P 500 companies for the past 12 months amounted to almost 38% of net income over the period, according to FactSet, the most since February 2009. In the second quarter, 44 S&P 500 companies paid an annual dividend that exceeded their latest 12 months of net income… That is the most in a decade and a practice some analysts deem unsustainable.”

August 12 – Wall Street Journal (Maria Armental): “As U.S. stocks rally, private-equity firms are taking the other side of the trade. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Index all notched record highs Thursday, a triple-threat that hadn’t occurred since the dot-com boom. Meanwhile, 15 block trades, bulk sales of big chunks of stock, raised a total of $5 billion in the biggest week for such deals since March 2015. Private-equity firms, which use block trades to sell out of companies they previously took public, accounted for nine of the 15 deals.”

August 17 – Bloomberg (Rachel Evans): “Store closures by Macy’s Inc. could hurt more than the mall rats, according to Morningstar Credit Ratings. Almost $30 billion of bonds backed by commercial mortgages are exposed to the retailer, which last week announced plans to shutter 100 outlets, the rating company wrote… More than $3.6 billion in loans would be affected by the closing of 28 stores that Morningstar identifies as most at risk, several of which support multiple asset-backed securities…”

Federal Reserve Watch:

August 17 – Financial Times (Sam Fleming): “A divided Federal Reserve left open the prospect of a further interest rate rise this year even as policymakers insisted they needed more evidence on the durability of the rebound before feeling confident enough to pull the trigger. Minutes to their latest July meeting revealed a hard-fought debate over when to move rates, with a couple of participants urging an immediate move, while others were urging caution amid questions over how rapidly inflation will return to target.”

August 16 – Bloomberg (Matthew Boesler): “The Federal Reserve could potentially raise interest rates as soon as next month, New York Fed President William Dudley said, warning investors that they are underestimating the likelihood of increases in borrowing costs. ‘We’re edging closer towards the point in time where it will be appropriate, I think, to raise interest rates further,’ Dudley… said… Asked whether the FOMC could vote to raise the benchmark rate at its next meeting Sept. 20-21, Dudley said, ‘I think it’s possible.’”

Central Bank Watch:

August 16 – Bloomberg (Jeanna Smialek): “The world made it through the Great Recession. Now it’s entered what you might call the Great Reassessment. High-profile researchers are publicly questioning the most basic tenets of monetary policy in the run-up to the Federal Reserve Bank of Kansas City’s economic symposium in Jackson Hole, Wyoming, which starts Aug. 25. San Francisco Fed President John Williams has issued a call for a major rethink among central bankers and fiscal policy makers, with an eye on scrapping low-inflation targeting. Former Fed Chairman Ben Bernanke analyzes why the Fed has been revising its economic projections. Meanwhile, a new IMF paper assesses both the effectiveness of, and the outlook for, Europe’s negative interest-rate policies.”

August 18 – Bloomberg (Jana Randow and Carolynn Look): “European Central Bank officials ‘widely’ agreed that their immediate reaction to the outcome of the U.K.’s referendum shouldn’t fuel excessive speculation about more stimulus. ‘The view was widely shared that the Governing Council needed to reiterate its capacity and readiness to act, if warranted, to achieve its objective, using all the instruments available within its mandate, while not fostering undue expectations about the future course of monetary policy,’…”

China Bubble Watch:

August 12 – Bloomberg (Paul Panckhurst): “International Monetary Fund staff said that 19 trillion yuan ($2.9 trillion) of Chinese ‘shadow’ credit products are high-risk compared with corporate loans and highlighted the danger that defaults could lead to liquidity shocks. The investment products are structured by the likes of trust and securities companies and based on equities or on debt — typically loans — that isn’t traded… The commentary highlighted the potential for risks bigger to the nation’s financial stability than from companies’ loan defaults. While loan losses can be realized gradually, defaults on the shadow products could trigger risk aversion that’s harder to manage… The ‘high-risk’ products offer yields of 11% to 14%, compared with 6 percent on loans and 3% to 4% on bonds, the commentary said. The lowest-quality of these products are based on ‘nonstandard credit assets,’ typically loans, it said.”

August 15 – Bloomberg: “China’s central bank urged investors not to focus too much on short-term concerns and said the diverging pace of credit expansion doesn’t mean monetary policy is losing steam. July credit growth slowing to a two-year low was a distortion and the reports for August and September will show it rebounding… Markets should avoid over-interpretation of short-term data for a specific month, the PBOC said. The commentary also said the growing gap between two money-supply gauges, M1 and M2, isn’t an indicator of a ‘liquidity trap,’ an economics term for when central bank cash injections into the economy fail to spur growth as monetary policy loses potency.”

August 17 – Reuters (Yawen Chen and Sue-Lin Wong): “China home prices rose 0.8% in July nationwide, but stalled or fell in more cities than in June, adding to concerns that one of the economy’s key growth drivers is losing steam but offering some relief for policymakers worried about property bubbles. A robust recovery in home prices and sales gave a stronger-than-expected boost to the world’s second-largest economy in the first half of the year, helping to offset stubbornly weak exports.”

Japan Watch:

August 14 – Bloomberg (Anna Kitanaka, Yuji Nakamura and Toshiro Hasegawa): “The Bank of Japan’s controversial march to the top of shareholder rankings in the world’s third-largest equity market is picking up pace. Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year… BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy.”

August 15 – Reuters (Leika Kihara): “The Bank of Japan’s policy review could put up for debate its target for expanding base money through massive asset purchases, sources say, but the challenge would be to avoid spooking bond markets… The BOJ’s announcement last month of a thorough review of its policy and its effects triggered a sharp bond sell-off as investors feared the central bank, wary of its dwindling policy tools, might lean toward reducing its government bond purchases. It is currently buying roughly 110-120 trillion yen in bonds each year to meet its pledge to expand base money… by an annual 80 trillion yen ($790bn). But after initial successes in the asset-buying program, which is aimed at ending two decades of deflationary pressure, prices are falling again.”

August 16 – Nikkei AR: “Tuesday marked six months since the Bank of Japan introduced negative interest rates, and the effects and drawbacks of the unusual step have come to the fore. The policy has yet to produce falls in the yen’s value, arousing concern about adverse effects on earnings at financial institutions… It thus remains halfway to its target of stimulating the real economy to push up prices. Negative interest rates ‘will help the [Japanese] economy expand by stimulating investment and consumption,’ BOJ Gov. Haruhiko Kuroda said… ‘Together with an increase in inflation expectations, the rate of price growth will move toward 2%,’ he said.”

August 15 – Reuters (Leika Kihara and Tetsushi Kajimoto): “Japan’s economic growth ground to a halt in April-June as weak exports and shaky domestic demand prompted companies to cut spending… The weak reading underscores the challenges policymakers face in ending two decades of crippling deflation, as an initial boost from Abe’s stimulus programs, dubbed ‘Abenomics’, appears to be quickly fading. The world’s third-largest economy expanded by an annualized 0.2% in the second quarter, less than the 0.7% increase markets had expected and a sharp slowdown from a revised 2.0% increase in January-March…”

August 17 – Bloomberg (Connor Cislo): “Japan’s exports declined the most since 2009, with shipments down for a 10th consecutive month. The continued drop highlights the difficulty of kick-starting growth and pulling Japan’s economy out of the doldrums. Overseas shipments fell 14% in July from a year earlier… Imports dropped 24.7%, leaving a trade surplus of 513.5 billion yen ($5.2bn).”

EM Watch:

August 18 – Bloomberg (Marton Eder): “The rout in Ukrainian assets worsened, with the nation’s restructured bonds heading for their worst week since May, on concern a flare-up in fighting between government troops and separatists in the country’s east may be a precursor to a full-blown conflict. The yield on the government’s $1.7 billion Eurobond due 2019 rose 15 bps to 8.51%…, bringing the increase this week to 44 bps. The hryvnia currency slumped toward to the weakest level in three months…”

August 18 – Bloomberg (Ye Xie): “A 40% increase in the amount of corporate debt coming due in developing nations over the next three years is creating a potential default risk if investors start pulling money out of emerging markets, according to the Bank for International Settlements. About $340 billion of debt is maturing between this year and 2018… The total payments due each year during the period is equivalent to the net bond sales by non-financial companies in developing nations in 2015, it said. ‘Given the steep repayment schedule that lies ahead, the refinancing capacity of highly leveraged EME companies is likely to be tested soon, especially if the rise of the U.S. dollar continues,’ economists led by Nikola Tarashev wrote… Debt sold by non-financial companies in developing nations increased to 110% of their gross domestic product by 2015, up from less than 60% in 2006, BIS said…”

August 16 – Bloomberg (Ye Xie and Natasha Doff): “Central banks in developing economies are taking advantage of the biggest rally in their currencies since 2010. Led by Turkey and Thailand, they’re using stronger exchange rates to build up foreign reserves for the first time in two years, replenishing shortfalls created as they attempted to prop up their currencies during recent routs… International reserves have grown by $154 billion, or 1.4%, since the end of March to $11 trillion… Turkey’s cash coffer expanded the most during the period, increasing more than 6%. Thailand’s currency pile rose 5.5%, while Indonesia’s climbed 3.6%”

Leveraged Speculator Watch:

August 16 – Wall Street Journal (Laurence Fletcher and Gregory Zuckerman): “A growing exodus from hedge funds extended to two of the biggest names in the industry Tuesday, Tudor Investment Corp. and Brevan Howard, as disenchanted investors increasingly shun what was once the hottest place to put money. The funds’ problem is clear: They just aren’t performing. Hedge funds and actively managed mutual funds have been underperforming since financial markets began their rebound in early 2009. The average hedge fund is up 3% this year through the end of July, according to… HFR Inc., less than half the S&P 500’s rise… Funds in the $2.9 trillion hedge-fund sector have now experienced three consecutive quarters of withdrawals for the first time since 2009, according to HFR.”

August 16 – Bloomberg (Lu Wang): “The steady drumbeat of gains that has lifted the S&P 500 Index in six of the last seven weeks is making life difficult for bears. Hedge funds that aim to profit from long and short bets have raised net equity holdings in the past three months, with bullish positions now exceeding bearish ones by 22.7 percentage points. That’s higher than 97% of the time since Credit Suisse Group AG began tracking the data in 2009. Perhaps not coincidentally, marketwide readings of short interest just posted the biggest decline in four years, while shares of the most-hated companies led in the rally that just lifted the S&P 500 to another record Monday, its 10th since early July.”

August 15 – Wall Street Journal (Maria Armental): “Billionaire investor George Soros, who rose to fame and fortune by betting against the sterling in 1992, on Monday showed his latest hand: nearly doubling down on his bearish bet against the market. The 86-year-old’s fund disclosed in a regulatory filing it had increased its bet against the S&P 500…, reporting ‘put’ options on roughly 4 million shares as of June 30 in an exchange-traded fund that tracks the index. That’s up from ‘puts’ on 2.1 million shares as of March 31.”

August 16 – Bloomberg (Janet Lorin): “Following the lead of pensions, some U.S. endowments and foundations are souring on hedge funds. Hedge fund fees and lagging performance are cause for concern for nonprofit investors, who are reducing their allocation, according to a survey published Monday by NEPC, a Boston-based consulting firm with 118 endowment and foundation clients with assets of $57 billion… ‘The last several years have been difficult for the industry and investors are starting to look very closely at how hedge funds can work for them,’ Cathy Konicki, who oversees the company’s endowment and foundation business, said…”

Geopolitical Watch:

August 18 – Bloomberg (Daryna Krasnolutska Aliaksandr Kudrytski): “Ukraine isn’t ruling out a full-scale Russian invasion and may institute a military draft if the situation with its neighbor worsens, President Petro Poroshenko said… The confrontation between Ukrainian forces and the rebels in Ukraine’s eastern Donbas region has worsened, Poroshenko said… Putin vowed to respond with ‘serious measures.’ ‘The probability of escalation and conflict remains very significant,’ Poroshenko said… ‘We don’t rule out full-scale Russian invasion.’”

August 19 – Wall Street Journal (James Marson and Thomas Grove): “Russia is bolstering its military presence on its western border, sending tens of thousands of soldiers to newly built installations within easy striking distance of Ukraine. The moves, which come as Moscow ratchets up confrontation over the Black Sea peninsula of Crimea, are a centerpiece of a new military strategy the Kremlin says is meant to counter perceived threats from the North Atlantic Treaty Organization.”

August 13 – Bloomberg (Monami Yui): “The Japanese government has decided on a plan to develop land-to-sea missiles with a range of 300 kilometers (186 miles) to protect the nation’s isolated islands, including the Senkaku, the Yomiuri newspaper reported… China has been stepping up pressure on Japan over the disputed Senkaku Islands, which are called Diaoyu in Chinese. Hundreds of fishing boats and more than a dozen coastguard vessels have been spotted recently in the area, encroaching at times on what Japan sees as its territorial waters.”

August 17 – Bloomberg (Iain Marlow): “From the sandstone walls of the 17th-century Red Fort in India’s capital, Prime Minister Narendra Modi sent a warning shot this week to his counterparts in Islamabad and Beijing. Modi’s reference to disputed territories on Monday during his annual Independence Day speech — his most high-profile appearance of the year — signaled that India would become more aggressive in asserting its claims to Pakistan-controlled areas of Kashmir. The region is a key transit point in the $45 billion China-Pakistan Economic Corridor known as CPEC that will give Beijing access to the Arabian Sea through the port of Gwadar.”