Doug Noland

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.”

Weekly Commentary: Updating Government Finance Quasi-Capitalism

I found my thoughts this week returning to Hyman Minsky, financial evolution and Capitalism. Updating my 2013 Government Finance Quasi-Capitalism thesis seemed overdue.

“Minsky saw the evolution Capitalist finance as having developed in four stages: Commercial Capitalism, Finance Capitalism, Managerial Capitalism and Money Manager Capitalism. ‘These stages are related to what is financed and who does the proximate financing – the structure of relations among businesses, households, the government and finance’…”

Money Manager Capitalism: “The emergence of return and capital-gains-oriented block of managed money resulted in financial markets once again being a major influence in determining the performance of the economy… Unlike the earlier epoch of finance capitalism, the emphasis was not upon the capital development of the economy but rather upon the quick turn of the speculator, upon trading profits… A peculiar regime emerged in which the main business in the financial markets became far removed from the financing of the capital development of the country. Furthermore, the main purpose of those who controlled corporations was no longer making profits from production and trade but rather to assure that the liabilities of the corporations were fully priced in the financial market…”

Late in life (1993) Minsky wrote: “Today’s financial structure is more akin to Keynes’ characterization of the financial arrangements of advanced capitalism as a casino.” More and more concerned by the proclivity of “Money Manager Capitalism” to foment instability and crises prior to his death in 1996, Minsky would have been absolutely appalled by the late-nineties “Asian Tiger” collapse, the Russia implosion, LTCM and the “tech” Bubble fiasco. Minsky was no inflationist. His focus would have been to rectify the institutional and policy deficiencies that were responsible for progressively destructive mayhem.

Policymakers instead responded to instability and crisis with increasingly “activist” (inflationist) measures. In particular, the Fed (and global central bankers) moved aggressively to backstop marketplace liquidity. At the same time, the government-sponsored enterprises (GSEs) began guaranteeing a large percentage of new mortgage Credit, while employing their balance sheets (liabilities enjoying implied federal backing) in similar fashion to central banks, as so-called “buyer of last resort” during periods of market tumult and speculative deleveraging.

These government-related liquidity backstops and guarantees fundamentally altered finance. Back in 2001, I updated Minsky’s stages of Capitalistic Development with a new phase, “Financial Arbitrage Capitalism”. Evolving financial, institutional and policymaker frameworks had seemingly mitigated volatility and crisis. Then the 2008 debacle unmasked what had been an unprecedented buildup of risky Credit, problematic risk intermediation processes and the accumulation of leverage and speculative positions. Policymakers and the markets had been oblivious to catastrophic latent liquidity risk inherent to the new institutional structure.

“The worst crisis since the Great Depression” provoked extraordinary policy measures. In 2013, after witnessing previously unimaginable central bank interest-rate manipulation, monetization and the specific policy objective of inflating securities markets, I was compelled to again update Minsky’s stages: “Government Finance Quasi-Capitalism”.

As finance has a proclivity of doing, “Money Market Capitalism” evolved over time to become increasingly unstable. Policy responses then nurtured a freakish financial backstop that greatly incentivized leveraged speculation throughout the securities and derivatives markets. This process fundamentally loosened financial conditions and spurred risk-taking and spending. After attaining significant momentum in the nineties, the progressively riskier phase of “Financial Arbitrage Capitalism” reached its zenith with the issuance of $1.0 TN of subprime CDOs is 2006/07.

The policy response to the 2008/2009 crisis was nothing short of phenomenal. A Trillion of QE from the Fed, zero rates and massive bailouts. Still, the Fed at the time claimed to be committed to returning to the previous policy regime as soon as practical. The Fed devoted significant resources toward mapping out a return to normalcy, going so far as releasing in 2011 a detailed “exit strategy” for normalizing rates and returning its balance sheet to pre-crisis levels.

But with the European crisis at the brink of turning global back in 2012, it had become clear by that point that thoughts of returning to so-called “normalcy” were illusionary. It may have been the ECB’s Draghi talking “whatever it takes,” but he was speaking for global central bankers everywhere. QE was no longer just a crisis measure. It would effortlessly provide unlimited ammo for which to inflate securities markets and spur risk-taking and economic activity. If zero rates were not providing the expected market response, no reason not to go negative. If buying sovereign bonds wasn’t getting the job done, move on to corporates and equities.

Such a deviant policy backdrop coupled with an already deeply distorted and speculative market environment ensured descent into a truly freakish financial landscape. Most obvious, markets have come to largely disregard risk. Serious cracks in China and Europe have been largely ignored by global markets. The increasingly alarming geopolitical backdrop is completely disregarded. Brexit was regarded – for about a trading session. Global economic vulnerability is on full display, though massive QE and negative-yielding developed country sovereign debt ensures a “money” deluge into the corporate debt marketplace. Concern for risk has hurt performance. Recurring bouts of concern puts one’s career at risk – whether one is a portfolio manager, financial advisor, trader, independent investor, analyst or strategist.

The financial and institutional arrangements that I collectively refer to as “Government Finance Quasi-Capitalism” have over time had profound impacts on the securities markets. Policymakers have largely removed volatility from equities (VIX ends the week at 11.39) and fixed income. U.S. corporate debt issuance remains at near-record pace. Stock prices are at all-time highs in the U.S. and elevated around the world. Bond prices are near records almost everywhere. Risk premiums in general have collapsed. Why then is unease so prevalent throughout the securities markets?

For one, it’s impossible these days to gauge risk. How much are QE and rate policies impacting securities prices? Will global policymaker have the capacity to withdraw from unprecedented measures, or have they become trapped in disproportionate stimulus with no way out? How big is the downside? How will the future policy backdrop play out? The truth is that no one – certainly not the policymaker community – has any idea what the future holds for policy or the markets. A turn back in the direction of reasonableness and “normalcy” or a further spiral out of control?

There’s a strong argument that investing has been largely relegated to a thing of the past. If risk is completely unclear, it’s impossible to gauge risk versus reward. Furthermore, how are company fundamentals (i.e. earnings, cash-flow, etc.) impacted by massive monetary and fiscal stimulus? How about the macro economy? And if risk vs. reward is unknowable and valuation metrics so obscured, it’s delusional to refer to “investment”.

A defining feature of Government Finance Quasi-Capitalism is that speculation now completely dominates investment. An unintended consequence of policymakers suppressing volatility and masking risk is that active management has been severely disadvantaged relative to passive management. Traditional investment analysis and risk management have been a significant detriment to performance. Why bother, when fees are lower with passive anyway? So “money” has flooded into ETFs and other index products simply to speculate on “the market.” Passive management really couldn’t care less about China, European banks, Brexit, Japan, Bubbles or policymaking more generally.

The abnormal backdrop does a major disservice to those that appreciate the unstable backdrop and hence seek to proceed cautiously. Indeed, Government Finance Quasi-Capitalism has nurtured one of history’s great speculative Bubbles in perceived low-risk “investments.” Trillions of liquidity injections coupled with volatility suppression has ensured that Trillions have flooded into dividend-paying stocks, “low beta,” “smart beta” and other perceived low-risk equity market strategies.

Government Finance Quasi-Capitalism has transformed Trillions of risk assets into perceived “money-like” instruments, throughout the securities markets and surely in derivatives. These massive flows into perceived safety have been instrumental in fueling the entire market to record highs in the face of persistent and growing risks. Previously, Financial Arbitrage Capitalism fomented “money” risk misperceptions and resulting liquidity crisis vulnerability in the “repo” market. Similar risks continue to mount in the Government Finance Quasi-Capitalism period throughout perceived low-risk equities, fixed income, corporate debt more generally and higher-yielding assets throughout the overall economy (i.e. commercial real estate).

U.S. household Net Worth is at record highs, while the ratio of Net Worth to GDP is near all-time highs. It’s worth noting that U.S. unemployment at 4.9% is outdone by China’s 4.1% and Japan’s 3.1%. Why then is there such social tension and geopolitical unease?

The Financial Arbitrage Capitalism period was notable for a momentous misallocation of real and financial resources. The economic structure suffered mightily, clearly evidenced by deteriorating productivity associated with deep structural deficiencies, along with underlying economic fragility. I would strongly argue that the ongoing Government Finance Quasi-Capitalism phase, with a massive inflation of government debt and only more grotesquely distorted markets, is even more dysfunctional at creating and distributing real economic wealth. Thus far it has succeeded in inflating perceived financial wealth, although this has only exacerbated the social and political problems associated with blatant wealth inequities.

Government Finance Quasi-Capitalism creates essentially unlimited demand for perceived low-risk corporate Credit (think Apple, Microsoft, Verizon, etc.), creating myriad market, financial and economic distortions. For one, it feeds financial engineering, including stock-repurchases and M&A. This dynamic exacerbates the big firm advantage and monopoly power more generally, at the expense of economic efficiency. I would contend it also is an increasingly important aspect of wealth inequality: the few really big get bigger and more powerful at the expense of everyone else. Financial flows are siphoned away from the general economy to be flooded into the hot sectors. A handful of cities – think SF, Seattle, Portland, Austin, L.A., and New York – lavish in prosperity while small town America is left to rot.

I have asserted that Bubbles only redistribute and destroy wealth. I have further posited that geopolitical instability is a dangerous consequence of the global government finance Bubble. Both China and Japan are in the midst of respective precarious Bubble Dynamics. It’s no coincidence that animosities and geopolitical risks between the Chinese and Japanese are rapidly escalating. Tensions between Russia and the West have close ties to the global Bubble. Turkey’s problems are exacerbated by its bursting Bubble. The Middle East, Latin America and Asia are all suffering from Bubble consequences. Brexit was Bubble fallout.

I am most nervous because I see no dialing back Government Finance Quasi-Capitalism. Government intervention – in the U.S., Europe, Japan, China and EM – has been so egregious and overpowering that retreat has become unthinkable. Policymakers would have to admit to historic misjudgment – and then be willing to accept the consequences of reversing course. Global markets and economies are now fully dependent upon aggressive fiscal and monetary stimulus. Bubbles are in the process of “going to unimaginable extremes – and then doubling!” Bursting Bubbles will evoke finger-pointing and villainization. That’s when the geopolitical backdrop turns frightening.

This week, the Bank of England (BOE) surprised the markets with a move to even more aggressive monetary stimulus. Global central bankers these days all play from similar playbooks, although when presented with the opportunity each takes their whirl at experimentation. Bank of England Governor Mark Carney’s announcement that the BOE would commence corporate bond purchases solidified the market view that global central bankers will increasingly look to corporate debt for QE fodder. The BOE also announced a new lending facility, hoping to entice banks into lending more aggressively.

Minsky’s phases of capitalistic evolution were U.S.-focused. It’s disturbing that Government Finance Quasi-Capitalism has evolved into such powerful global phenomenon. This ensures market fragilities and economic maladjustment on a globalized and highly correlated basis. Thus far, global central bankers have maintained a rather consistent and concerted approach. Central banks seem to collectively recognize that they are together trapped in the same dynamic. This has encouraged cooperation and coordination. At some point, however, zero-sum game dynamics will prevail.

I’ve briefly touched upon the misallocation of real and financial resources, along with attendant social, political and geopolitical risks associated with economic stagnation and gross wealth inequalities. One can these days see the “third world” as increasingly chaotic. One can as well see EM regressing toward more “third world” tendencies. And in the developed U.S. and Europe, in particular, one can witness more EM-like tendencies of wealth inequality, polarized societies, corruption and political instability.

There’s another key facet of Government Finance Quasi-Capitalism: A troubled global banking sector. Sinking stock prices seem to confirm that banks are a big loser, as governments impose command over financial relationships and economic structure. This is a complex subject. I would argue that governments have placed banking institutions in a difficult – perhaps dire – predicament. In general, banks have become increasingly vulnerable to mounting financial and economic vulnerability. Highly leveraged banking systems from the UK to China will have no alternative than to lend, no matter the degree of policy-induced financial and economic instability. And the more government policies inflate asset prices (including U.S. housing), the more these assets Bubbles will depend on ongoing bank lending support.

Moreover, keep in mind that banking systems have been delegated the task of intermediating central bank Credit (largely) into bank deposits. Central bank issued Credit (IOUs) ends up chiefly on commercial bank balance sheets, banks having accepted central bank funds in exchange for new bank deposit “money”. So in this high-risk backdrop of government-induced market distortions, banks are building increasingly risky loan books (and “investment” portfolios) while sitting on specious (and inflating) holdings of central bank and government obligations. And this high-risk structure works only so long as Credit – central bank, government and financial sector – continues to expand.

Government Finance Quasi-Capitalism really amounts to a Hyman Minsky “Ponzi Finance” dynamic on an unprecedented global scale. Worse yet, the greatest impairment unfolds right in the heart of contemporary “money” and Credit.

It’s worth noting that despite Friday’s 4.9% surge Italian Bank Stocks sank 6.2% this week (down 51% y-t-d). Japan’s TOPIX Bank Index dropped 3.1% (down 32% y-t-d). Japanese 10-year JGB yields jumped 10 bps to a three-month high negative 10 bps. Ten-year Treasury yields rose 14 bps this week. There’s an increasingly unpredictable element to the U.S. Bubble Economy that should keep the Federal Reserve and the bond market uneasy. Currency market instability persists. The pound remains vulnerable, while the yen is curiously resilient. EM is a mystery wrapped inside an enigma. And if bond yields begin to surprise on the upside, a whole lot of “money” is going to be positioned on the wrong side of an extremely Crowded Trade.

For the Week:

The S&P500 added 0.4% to a new record high (up 6.8% y-t-d), and the Dow gained 0.6% (up 6.4%). The Utilities sank 2.6% (up 17.7%). The Banks jumped 2.0% (down 4.2%), and the Broker/Dealers rose 2.0% (down 6.5%). The Transports increased 0.3% (up 4.8%). The S&P 400 Midcaps added 0.2% (up 11.7%), and the small cap Russell 2000 gained 0.9% (up 8.4%). The Nasdaq100 advanced 1.3% (up 4.3%), and the Morgan Stanley High Tech index rose 1.4% (up 7.0%). The Semiconductors gained 0.9% (up 16.6%). The Biotechs jumped 2.0% (down 9.4%). Though bullion was down $15, the HUI gold index was little changed (up 147%).

Three-month Treasury bill rates ended the week at 26 bps. Two-year government yields rose six bps to 0.72% (down 33bps y-t-d). Five-year T-note yields jumped 12 bps to 1.14% (down 61bps). Ten-year Treasury yields surged 14 bps to a seven-week high 1.59% (down 66bps). Long bond yields jumped 14 bps to 2.32% (down 70bps).

Greek 10-year yields jumped 14 bps to 8.12% (up 80bps y-t-d). Ten-year Portuguese yields declined six bps to 2.84% (up 32bps). Italian 10-year yields slipped three bps to 1.13% (down 43bps). Spain’s 10-year yield were unchanged at 1.01% (down 76bps). German bund yields rose five bps to negative 0.07% (down 69bps). French yields gained five bps to 0.15% (down 84bps). The French to German 10-year bond spread was unchanged at 22 bps. U.K. 10-year gilt yields dipped one basis point to 0.67% (down 129bps). U.K.’s FTSE equities index advanced 1.0% (up 8.8%).

Japan’s Nikkei equities index dropped 1.9% (down 14.6% y-t-d). Japanese 10-year “JGB” yields surged 10 bps to negative 0.10% (down 36bps y-t-d). The German DAX equities index increased 0.3% (down 3.5%). Spain’s IBEX 35 equities index declined 0.6% (down 10.5%). Italy’s FTSE MIB index fell 1.3% (down 22.4%). EM equities were mixed. Brazil’s Bovespa index added 0.6% (up 33%). Mexico’s Bolsa dropped 1.1% (up 9.8%). South Korea’s Kospi index was little changed (up 2.9%). India’s Sensex equities was about unchanged (up 7.5%). China’s Shanghai Exchange slipped 0.1 (down 15.9%). Turkey’s Borsa Istanbul National 100 index gained 0.9% (up 6.0%). Russia’s MICEX equities index was unchanged (up 10.4%).

Junk bond mutual funds saw outflows jump to $2.464 billion (from Lipper).

Freddie Mac 30-year fixed mortgage rates fell five bps to a near-record low 3.43% (down 48bps y-o-y). Fifteen-year rates declined four bps to 2.74% (down 39bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates down seven bps to 3.62% (down 48bps).

Federal Reserve Credit last week fell $8.9bn to $4.426 TN. Over the past year, Fed Credit declined $21.5bn. Fed Credit inflated $1.615 TN, or 58%, over the past 195 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $1.3bn last week to $3.219 TN. “Custody holdings” were down $136bn y-o-y, or 4.1%.

M2 (narrow) “money” supply last week surged $49.7bn to a record $12.933 TN. “Narrow money” expanded $879bn, or 7.3%, over the past year. For the week, Currency increased $2.2bn. Total Checkable Deposits gained $3.5bn, and Savings Deposits surged $41.2bn. Small Time Deposits were unchanged, while Retail Money Funds rose $2.8bn.

Total money market fund assets jumped $24bn to $2.739 TN. Money Funds rose $69bn y-o-y (2.6%).

Total Commercial Paper declined $3.9bn to a 2016 low $1.022 TN. CP declined $45bn y-o-y, or 4.2%.

Currency Watch:

August 4 – Wall Street Journal (Saumya Vaishampayan and Takashi Nakamichi): “Investors largely ignored jawboning by Japanese currency officials aimed at stemming the yen’s rise, suggesting that Tokyo is losing its influence on the market. ‘My understanding is that there have been movements that are quite biased, one-sided and speculator-driven,’ Masatsugu Asakawa, vice finance minister for international affairs, told reporters following a meeting… with senior Bank of Japan officials. ‘We will pay the closest possible attention [to the yen] and watch it intensely to ensure that speculator-driven movements won’t accelerate, and if necessary, we will take firm action,’ Mr. Asakawa said.”

The U.S. dollar index gained 0.7% to 96.24 (down 2.5% y-t-d). For the week on the upside, the Brazilian real increased 1.2%, the Australian dollar 0.3% and the Japanese yen 0.2%. For the week on the downside, the British pound declined 1.2%, the Swiss franc 1.2%, the South African rand 1.1%, the Canadian dollar 1.1%, the euro 0.8%, the New Zealand dollar 0.8%, the Norwegian krone 0.7%, and the Swedish krona 0.1%. The Chinese yuan declined 0.4% versus the dollar (down 2.6% y-d-t).

Commodities Watch:

August 5 – Financial Times (Neil Hume and Henry Sanderson): “Investors have pumped more than $50bn into commodities this year, chasing a recovery in oil prices while falling interest rates have increased the attraction of haven assets like gold. The inflows mark the best start to a year since 2009… The new money, combined with rising prices, have pushed total commodity assets under management to $235bn, up from a low of $161bn reached at the end of 2015.”

The Goldman Sachs Commodities Index rallied 0.8% (up 9.7% y-t-d). Spot Gold declined 1.1% to $1,336 (up 26%). Silver fell 3.2% to $19.73 (up 43%). WTI Crude recovered 53 cents to $41.98 (up 13%). Gasoline rallied 4.1% (up 8%), while Natural Gas fell 3.5% (up 18%). Copper sank 3.2% (up 1%). Wheat gained 2.0% (down 12%). Corn fell 2.5% (down 7%).

Turkey Watch:

August 5 – Bloomberg (Constantine Courcoulas): “The fate of billions of dollars in investments in Turkish bonds hangs in the balance as Moody’s… prepares to reveal whether it’s handing the country a second junk rating on its debt. Moody’s, which put Turkey on review for a downgrade immediately after a failed military plot to oust the government last month, currently ranks the nation’s debt at Baa3, its lowest rung within investment grade. A rating review is scheduled for Friday and derivatives traders are already treating it as speculative, with the score implied by credit default swaps at Ba3, three steps into high-yield territory…”

Brexit Watch:

August 4 – Wall Street Journal (Jason Douglas and Paul Hannon): “The Bank of England cut its benchmark interest rate to the lowest in its 322-year history and revived a financial crisis-era bond-buying program to cushion the U.K. economy from the aftershocks of the vote to leave the European Union. Thursday’s unexpectedly large and diverse stimulus package—which included a torrent of cheap cash for banks—underscores the concern at the central bank following the June 23 referendum… The stimulus package contained four elements. The BOE cut its benchmark interest rate to 0.25% from 0.5% and said it expects to cut it further toward zero in the months ahead. It revived a program to buy U.K. government bonds that has been on pause since 2012, and announced it would begin buying corporate bonds, too. The final part was a new term-funding program for banks, offering lenders ultracheap four-year loans to finance lending to households and businesses.”

August 3 – Reuters (Costas Pitas): “House prices in London’s most expensive areas recorded their biggest fall in nearly seven years in July after the Brexit vote reinforced a downward trend caused by a rise in property taxes, a consultancy said… Knight Frank’s prime central London index fell 1.5% last month from a year earlier… ‘Since the vote, a number of buyers have requested discounts due to the climate of political and economic uncertainty,’ Head of London Residential Research Tom Bill said.”

Europe Watch:

August 4 – Bloomberg (Sofia Horta E Costa and Justin Villamil): “Europe’s banking shares are back in the limelight for all the wrong reasons. On Tuesday, the second day of trading since stress tests showed almost all euro-area lenders would have sufficient capital to cope with a crisis, Germany’s Commerzbank AG and Deutsche Bank AG tumbled to fresh record lows, dragging a Stoxx Europe 600 Index gauge of their peers towards its biggest two-day loss in almost four weeks. ‘I don’t want to say it, but it’s Armageddon for the banks,’ if the index drops any further, said Joe Tracy, head of continental European equities at Svenska Handelsbanken… As recently as July last year, shares of European banks were worth the most since 2008. They’ve lost about 40% of their value since then, or more than half a trillion euros ($560bn)…”

August 5 – Bloomberg (Stephen Morris): “European banks have pushed back profitability targets so many times, the dates are now more placeholders than deadlines. Eight years after the financial crisis hit its peak, several of the region’s lenders said they’ll probably need more time to reach the return on equity goals they set for the next few years… The commentary has been almost uniform across the industry and is bad news for a sector that’s already seen dramatic share-price declines. The European Stoxx 600 Banks Index has fallen 32% this year and the 30 firms it tracks trade on average at half their book value…”

August 1 – Bloomberg (Camila Russo): “While the stress tests showed most of the region’s banks would keep an adequate level of capital in a crisis, investors remained skeptical about the results. Lenders in the benchmark Stoxx Europe 600 Index slipped 1.8%, reversing a gain of as much as 1.3%. UniCredit SpA sank 9.4%, while Britain’s Barclays Plc dropped 2% as it fared worse than Deutsche Bank AG, down 1.8%… The stress-test results come at a time of growing pessimism about the industry, whose shares have already slumped the most among sectors this year.”

August 1 – Reuters (Robert Muller and Marcin Goclowski): “Factory activity in the Czech Republic unexpectedly shrank in July for the first time since April 2013 and barely grew in Poland, surveys showed on Monday, suggesting a decline in output ahead. Central Europe’s growth has outpaced most of the European Union’s, but it now faces a slowdown in EU development funds as a new funding period gets under way.”

Fixed-Income Bubble Watch:

August 1 – Bloomberg (Sally Bakewell): “Foreign buyers are poised to push their record 40% share of the U.S. corporate-bond market even higher as they seek to escape negative yields that have swept the globe. While Europe is the biggest overseas owner of the debt with 80% of the foreign holdings, investors from Asia were the fastest-growing buyers, according to Nathaniel Rosenbaum at Wells Fargo… Bond buyers are pouring into U.S. corporate securities as European Central Bank policies aimed at stimulating growth push yields on more and more sovereign and company debt below zero. The declines were extended in June after the ECB expanded asset purchasing to include corporate bonds, a move that helped drive yields on a record 496 billion euros ($554bn) of highly rated corporate bonds into negative territory…”

Global Bubble Watch:

August 5 – Wall Street Journal (Sam Goldfarb and Christopher Whittall): “Central banks have a new favorite tool for boosting lackluster growth: corporate-debt purchases. Two months after the European Central Bank started buying corporate bonds, the Bank of England said Thursday that it would adopt a similar strategy. It will buy as much as £10 billion ($13.33bn) of U.K. corporate debt starting in September as part of a larger package of stimulus measures, including £60 billion of additional government-bond purchases… But the decision again raises concerns about possible side effects of unconventional monetary policies, including excessive risk taking by investors… In the U.S., the average yield of investment-grade corporate bonds was 2.85% Wednesday, compared with 3.67% at the end of 2015… The average spread to Treasury yields also has shrunk, to 1.48 percentage points from 1.72. Companies have issued $519.2 billion of investment-grade corporate bonds this year, just below their pace at this time last year when issuance ultimately reached a record $794.6 billion…”

July 31 – Bloomberg (Thomas Black): “Corporate earnings are heading for a fifth straight quarter of declines, dragged down mostly by energy companies’ struggles with low oil prices and a tepid global economy that threatens to throttle sales growth in many industries… The global economy is forecast to expand 2.9% this year… That’s the lowest rate since 2009… With about two-thirds of Standard & Poor’s 500 Index members having reported, earnings have declined 3.3% from a year earlier and sales have slumped 0.5%… Asia and Europe have fared worse. With 294 companies on the MSCI AC Asia Pacific Index having announced results, earnings have plummeted 19%. In Europe, profits have dropped 14% with results in from almost two-thirds of companies on the Stoxx Europe 600 Index.”

August 4 – Bloomberg (Sid Verma): “A global fight for yield has boosted the appeal of dividend-juicy stocks around the world. What’s surprising is where developed-market investors are now staging this battle — in emerging market stocks — and the justification that’s involved: low bond yields in their usual domain. ‘Investors are switching into EM stocks for yield ‘income’ given a lack of bond income in developed markets,’ UBS AG analysts led by Geoff Dennis write… That turns on its head the traditional way that investors have viewed EM equities. The stocks are typically seen as a bet on rising global growth prospects and as such, are bought for capital gain rather than income.”

August 2 – Bloomberg (Katia Dmitrieva and Natalie Obiko Pearson): “The walls of Clarence Debelle’s Vancouver office on Canada’s west coast are lined with gifts from his real estate clients: jade and turtle dragon figurines; bottles of baijiu, a traditional Chinese alcohol; and enough special-edition Veuve Clicquot to fuel several high-end cocktail parties. They are the product of Vancouver’s decade-long real estate frenzy. The city… has long been one of the world’s most expensive places to live but price gains have reached a whole new level of intensity this year. Low interest rates, rising immigration, and a surge of foreign money—particularly from China—have all driven the increases. Consider the latest milestones: • The cost of a single-family home surged a record 39% to C$1.6 million ($1.2 million) in June from a year earlier. • More than 90% of those homes are now worth more than C$1 million, up from 65% a year earlier…”

August 4 – Bloomberg (Yuji Nakamura and Lulu Yilun Chen): “Bitcoin plunged, then erased losses Wednesday as one of the largest exchanges halted trading because hackers stole about $65 million of the digital currency…. Prices dropped 7.8% on Tuesday after declining 6.2% Monday.”

August 1 – Bloomberg (Marton Eder and Krystof Chamonikolas): “Some nations don’t even need a government for investors to snap up bonds and send their borrowing costs to record lows in the post-Brexit hunt for yield. That’s what’s happening in Croatia, whose Eurobonds are heading for their fifth straight quarterly gain even after the country’s government imploded in June, triggering early elections.”

U.S. Bubble Watch:

August 5 – Bloomberg (Michelle Jamrisko): “Employment jumped in July for a second month and wages climbed, pointing to renewed vigor in the U.S. labor market that will sustain consumer spending into the second half of the year. Payrolls climbed by 255,000 last month, exceeding all forecasts…, following a 292,000 gain in June… The jobless rate held at 4.9% as many of the people streaming into the labor force found jobs.”

August 5 – Reuters: “The U.S. trade deficit rose to a 10-month high in June as rising domestic demand and higher oil prices boosted the import bill while the lagging effects of a strong dollar continued to hamper export growth. The… trade gap increased 8.7% to $44.5 billion in June, the biggest deficit since August 2015.”

July 31 – Financial Times (Allistair Gray): “US banks have ramped up lending to consumers through credit cards and overdrafts at the fastest pace since 2007, triggering concerns that they are taking on too much risk in a slowing economy. The industry has piled on about $18bn of card loans and other types of revolving credit within just three months, as consumers borrow more and banks battle for customers with air miles, cashback deals and other offers.”

August 1 – Wall Street Journal (Josh Mitchell): “The U.S. government desperately wants Mr. Osborne and his wife to start repaying their combined $46,500 in federal student debt. But they are among the more than seven million Americans in default on their loans, many of them effectively in a standoff with the government. These borrowers have gone at least a year without making a payment—ignoring hundreds of phone calls, emails, text messages and letters from federally hired debt collectors. Borrowers in long-term default represent about 16% of the roughly 43 million Americans with student debt, now totaling $1.3 trillion across the U.S., and their numbers have continued to climb despite the expanding labor market. Their failure to repay… threatens to leave taxpayers on the hook for $125 billion, the total amount they owe.”

August 2 – Financial Times (James de Bunsen): “Investor positioning is as extreme as it has been since the dotcom bubble. In a neat bit of symmetry, it is some of the assets that were so detested at that time that now look most overinflated. Low volatility, high quality and defensive, with a yield, please — nothing else will do. Investors are continually having to convince themselves that these lofty valuations and record-low yields are merited because growth is anaemic, deflationary forces abound and rate rises are years away. Nevertheless, we believe that changing perceptions over monetary and fiscal policy could overwhelm these factors and cause a meaningful and painful rotation within markets.”

July 29 – CNBC (Jon Marino): “The market is showing signs that companies can’t keep issuing dividends to investors at the record pace they have developed, and the hunt for yield just got a little harder. Vanguard is shutting new investors out of its $30 billion Dividend Growth mutual fund, which has seen $3 billion in cash inflows over the last 6 months and nearly doubled in size in the last three years… ‘Vanguard is proactively taking steps to slow strong cash flows to help ensure that the advisor’s ability to produce competitive long-term results for investors is not compromised,’ Vanguard CEO Bill McNabb said…”

August 4 – Wall Street Journal (Austen Hufford): “Fannie Mae said it would send a $2.9 billion dividend payment to the U.S. Treasury in September as revenue and profit declined sharply in its latest quarter amid low interest rates. The… company posted net income of $2.95 billion for the second quarter, down from $4.64 billion a year prior and $1.14 billion in the first quarter. Revenue dropped 12% to $5.46 billion. The drop in profit was driven primarily by falling long-term interest rates, which hurt the value of derivatives Fannie uses to manage risk.”

China Bubble Watch:

August 3 – Reuters: “China will use multiple monetary policy tools and maintain ample liquidity and reasonable growth in lending and overall credit in the second half of the year, the central bank said… The People’s Bank of China (PBOC) will maintain a prudent monetary policy and fine-tune it as necessary, according to a summary of an internal meeting posted on the bank’s website.”

August 4 – Financial Times (Don Weinland): “China’s banking regulator has warned companies not to use the word ‘bank’ in their names following a series of scandals and multibillion-dollar investment scams. Several outfits posing as accredited financial institutions have been exposed by the regulator in the past year… An international trade union spotted a company whose name included the words ‘Goldman Sachs’ operating in Shenzhen… Misappropriation of the title touches a nerve with China’s financial regulators, which worry about social unrest stemming from plundered investments. Roger Ying, founder of Pandai, a peer-to-peer lending platform in Beijing, said: ‘Bank is a very sensitive word as it implies government ownership. Banks are there to instil confidence in the people. Thus authorities don’t want other financial services companies to be using the word ‘bank’ to raise funds illegitimately if they don’t have a banking licence.’”

August 1 – Bloomberg: “A Chinese shipbuilder said it may not be able to repay bonds due this week, highlighting rising default risks in the nation as the economy slumps. Wuhan Guoyu Logistics Industry Group Co. said there is uncertainty if it can repay the 400 million yuan ($60.2 million) of notes due Aug. 6 because of a capital shortage… Chinese companies are struggling with record debt payment in the second half as Premier Li Keqiang seeks to cut overcapacity even after the economy grew at the slowest pace in a quarter century. At least 17 bonds have defaulted this year, already exceeding the seven for all of 2015.”

Japan Watch:

August 3 – Reuters (Stanley White): “At least two members of the Bank of Japan’s board questioned its actions at their June meeting, minutes show, highlighting doubts about the sustainability of its policies. At the June meeting one board member called for the BOJ to reduce its bond buying while another said the BOJ had switched its focus to interest rates away from buying assets. At a subsequent meeting on July 29 the BOJ surprised investors by saying it would release a comprehensive review of its quantitative easing in September, further reinforcing the view that the BOJ’s current policy may be reaching its limit… The BOJ currently buys 80 trillion yen a year of Japanese government bonds to reach its 2% inflation target.”

July 31 – Reuters (Stanley White): “The Bank of Japan’s review of its monetary stimulus program promised for September has revived expectations it could adopt some form of ‘helicopter money’, printing money for government spending to spur inflation. The BOJ disappointed market hopes… that it might increase its heavy buying of government debt or lower already negative interest rates, cementing the view that it is running out of options within its existing policy framework to lift prices and end two decades of deflationary pressure. With little to show for three years of massive monetary easing, economists say BOJ governor Haruhiko Kuroda’s ‘comprehensive assessment’ of policy could push it into closer cooperation with Prime Minister Shinzo Abe, who announced a fiscal spending package worth more than 28 trillion yen ($275bn)…”

August 2 – Reuters (Tetsushi Kajimoto): “Japanese Prime Minister Shinzo Abe’s cabinet approved 13.5 trillion yen ($132bn) in fiscal measures… even as the central bank fought market speculation that it is preparing to put the brakes on monetary stimulus for the world’s third-biggest economy. The government’s package includes 7.5 trillion yen in spending by the national and local governments, and earmarks 6 trillion yen from the Fiscal Investment and Loan Program… But even before the announcement, Japanese government bonds saw their worst sell-off in more than three years as investors feared the Bank of Japan may ratchet back the pace of its aggressive government bond buying.”

Central Bank Watch:

August 4 – Reuters (Caroline Copley): “There are possibilities to adjust the European Central Bank’s quantitative easing (QE) programme, but it is important not to alter the design, Bundesbank President Jens Weidmann said… ‘With a view to the programme, there are adjustment possibilities. But from my point of view we must be very careful with the configuration,’ Weidmann told weekly Die Zeit. The ECB currently buys bonds weighted to each country’s contribution to the central bank’s capital… Weidmann said an increase in buying bonds from countries with particularly high indebtedness or bad credit ratings would distance the ECB further from its core mandate. ‘If we grant individual countries special conditions or concentrate increasingly on highly-indebted countries than we will blur the lines between monetary policy and fiscal policy somewhat further,’ he told the paper.”

EM Watch:

August 5 – CNBC (Fred Imbert): “Thousands of people from around the world will be flocking the streets of Rio de Janeiro during the 2016 Olympic Games, but the country’s political and economic state of affairs is anything but festive. ‘What was supposed to be an event to [showcase] Brazil to the rest of the world has now become a nightmare,’ Carlos Caicedo, senior principal analyst for Latin America at IHS Markit… told CNBC… ‘The Olympics no longer matter to anyone in Brazil now.’ What people care about is how the country’s huge political and economic crises will be solved, Caicedo said.”

August 4 – Bloomberg (Archana Narayanan): “Saudi Arabian interest-rate swaps climbed this week to levels last seen during the financial crisis, stoking speculation that the central bank needs to step up efforts to ease the country’s liquidity crisis. The five-year swap rate jumped as much as 30 bps this week to 3.70% on Wednesday, the highest close since January 2009, following a 22 bps increase in July. The central bank offered domestic lenders about 15 billion riyals ($4bn) in short-term loans at a discounted rate at the end of June, people familiar with the matter said last month.”

July 31 – Bloomberg (Archana Narayanan, Matthew Martin and Glen Carey): “Saudi Arabia’s central bank offered lenders short-term loans in late June to help ease liquidity constraints, according to five people familiar with the matter. The Saudi Arabian Monetary Agency, or SAMA, as the central bank is known, offered about 15 billion riyals ($4bn)…”

August 4 – Bloomberg (Y-Sing Liau): “The bad news just doesn’t stop for Asia’s worst-performing currency. Already reeling from a renewed slump in oil prices and a political scandal that just won’t go away, the Malaysian ringgit is now facing the prospect of another cut in interest rates. It’s the region’s biggest loser in the past month… The currency’s slide highlights all is not well as the nation’s economy heads for its worst performance this decade. Crude oil’s plunge to a four-month low this week undermines the finances of net oil exporter Malaysia, while the appeal of its relatively high bond yields is being tempered by the scandals surrounding a troubled state investment fund.”

Leveraged Speculator Watch:

August 3 – Financial Times (Mary Childs and Robin Wigglesworth): “Big hedge funds including Balyasny Asset Management and Tudor Investment Corporation are beefing up their computer-driven approach following seven straight years of investor inflows into the ‘quant’ sector. Some of the industry’s most successful so-called quantitative hedge funds… rely on fast computers, algorithms and data-crunching. They have stood out as the wider industry has struggled to make money and dissatisfied clients have withdrawn funds. The computer-powered hedge fund industry now has almost $880bn of assets under management — up from $408bn in 2009, according to Hedge Fund Research data — and is expected to continue growing.”

Geopolitical Watch:

July 31 – Reuters (Ben Blanchard and Benjamin Kang LIm): “China’s leadership is resisting pressure from elements within the military for a more forceful response to an international court ruling against Beijing’s claims in the South China Sea, sources said… The ruling has been followed in China by a wave of nationalist sentiment, scattered protests and strongly worded editorials in state media. So far, Beijing has not shown any sign of wanting to take stronger action… But some elements within China’s increasingly confident military are pushing for a stronger – potentially armed – response aimed at the United States and its regional allies, according to interviews with four sources with close military and leadership ties. ‘The People’s Liberation Army is ready,’ one source with ties to the military told Reuters. ‘We should go in and give them a bloody nose like Deng Xiaoping did to Vietnam in 1979,’ the source said…”

August 2 – Reuters (Tim Kelly): “Japan’s annual defense review on Tuesday expressed ‘deep concern’ over what it sees as China’s coercion, as a more assertive Beijing flouts international rules when dealing with other nations. Japan’s Defence White Paper comes amid heightened tension in Asia less than a month after an arbitration court in the Hague invalidated China’s sweeping claims in the disputed South China Sea… Japan called on China to adhere to the verdict, which it said was binding. Beijing retorted by warning Tokyo not to interfere. In the defense review approved by Prime Minister Shinzo Abe’s government, Japan warned that ‘unintended consequences’ could result from Beijing’s assertive disregard of international rules. China is poised to fulfill its unilateral demands without compromise…’”

August 2 – CNN (James Griffiths): “China has sent a clear warning to foreigners who enter contested areas of the South China Sea — stay away or you’ll be prosecuted. The warning came in a detailed explanation of last month’s Hague ruling, which found that China’s territorial claims in region have ‘no legal basis’ under the U.N. Convention on the Law of the Sea. China claims almost all of the South China Sea, including islands more than 800 miles (1,200 kilometers) from the Chinese mainland… On Tuesday, the Chinese Supreme People’s Court issued a regulation on judicial interpretation saying there was a ‘clear legal basis for China to safeguard maritime order, marine safety and interests, and to exercise integrated management over the country’s jurisdictional seas.’”

August 5 – Reuters (Michael Martina): “China… accused Japan’s new defense minister of recklessly misrepresenting history after she declined to say whether Japanese troops massacred civilians in China during World War Two. Tomomi Inada, a… lawmaker known for her revisionist views of Japan’s wartime actions, took up her post on Thursday and repeatedly sidestepped questions at a briefing on whether she condemned atrocities committed by Japan. China consistently reminds its people of the 1937 massacre in which it says Japanese troops killed 300,000 people in its then capital.”

August 3 – Reuters (Tim Kelly and Kiyoshi Takenaka): “Tomomi Inada will have precious little time to settle into her new job as Japan’s defense minister, as events on her first day in the office underlined. Hours before the hawkish lawyer was appointed to Prime Minister Shinzo Abe’s cabinet in a limited reshuffle, a North Korean missile landed in or near Japanese-controlled waters for the first time. The show of force, part of Pyongyang’s increasingly provocative arms testing, is a reminder of how strained relations between countries in northeast Asia have become, from North Korea’s nuclear program to China’s assertiveness in the disputed waters of the South and East China Seas. Into the mix steps Inada, a conservative ally of Abe whose support for his goal of revising Japan’s post-war, pacifist constitution risks exacerbating tensions.”

August 3 – Reuters (Ece Toksabay and Nick Tattersall): “President Tayyip Erdogan accused the West of supporting terrorism and standing by coups on Tuesday, questioning Turkey’s relationship with the United States and saying the ‘script’ for an abortive putsch last month was ‘written abroad’. In a combative speech at his palace in Ankara, Erdogan said charter schools in the United States were the main source of income for the network of U.S.-based cleric Fethullah Gulen, who he says masterminded the bloody July 15 putsch. ‘I’m calling on the United States: what kind of strategic partners are we, that you can still host someone whose extradition I have asked for?’ Erdogan said… ‘This coup attempt has actors inside Turkey, but its script was written outside. Unfortunately the West is supporting terrorism and stands by coup plotters,’ he said in comments which were met with applause, and broadcast live.”

August 1 – Financial Times (Guy Chazan): “Germany has said it will not be ‘blackmailed’ by Turkey after Ankara threatened to renounce its March migrant treaty with the EU unless the bloc granted visa-free travel to Turkish citizens. The row over the deal came as Berlin and Ankara clashed over a decision by the German authorities not to let Turkey’s president address a pro-democracy rally in Cologne at the weekend by video link… The two disputes highlight the strains that have emerged in the German-Turkish relationship since July 15, when Turkey was rocked by an attempted military coup.”